Overview
This lecture introduces core concepts of managerial accounting and cost classification, focusing on how understanding costs drives strategic business decisions and professional success.
Types of Accounting
- Financial accounting reports past performance for external users under strict rules (GAAP).
- Managerial accounting informs internal decision-making, focuses on the future, and has no standardized rules.
Cost Classification Purposes (AFPDB)
- Assign costs to cost objects (e.g., product, department).
- Prepare financial statements (e.g., inventory, COGS).
- Predict cost behavior (how costs change with activity).
- Support decision-making (e.g., add a product, drop a line).
- Budgeting and planning (forecast and control future costs).
Direct vs. Indirect Costs
- Direct costs can be easily traced to a specific cost object (e.g., materials in a product).
- Indirect costs cannot be traced easily and must be allocated (e.g., manager salary, utilities).
- Common costs support multiple objects and cannot be traced to just one.
Manufacturing Cost Categories
- Direct materials: raw materials traced to products (e.g., iPhone screen).
- Direct labor: wages for employees directly making products (declining in modern factories).
- Manufacturing overhead (MO): all manufacturing costs not direct (e.g., indirect materials, indirect labor, factory costs).
Prime and Conversion Costs
- Prime costs = direct materials + direct labor.
- Conversion costs = direct labor + manufacturing overhead.
Non-Manufacturing Costs (Period Costs)
- Selling costs: getting/filling orders (advertising, sales commissions, shipping).
- Administrative costs: general management, HQ expenses, HR, legal.
Product vs. Period Costs
- Product costs are accumulated in inventory, become COGS when sold.
- Period costs are expensed immediately on the income statement.
Cost Behavior
- Variable costs change in total with activity, per unit cost stays constant.
- Fixed costs stay constant in total within relevant range, per unit cost decreases as volume increases.
- Mixed costs have both variable and fixed components (e.g., base salary plus commission).
Special Decision-Making Costs
- Differential (incremental) costs: differences between alternatives; only these matter for choices.
- Opportunity cost: value of the next best alternative forgone.
- Sunk costs: already incurred, irrelevant for future decisions.
Income Statement Formats
- Traditional format groups costs by function (COGS, selling, admin) for external reporting.
- Contribution format separates variable from fixed costs for internal analysis, revealing contribution margin.
Key Terms & Definitions
- Cost Object — anything for which a cost is measured (product, department).
- Direct Cost — cost traced directly to a cost object.
- Indirect Cost — cost not easily traced, allocated to objects.
- Common Cost — supports multiple cost objects; cannot be traced to one.
- Product Cost — costs included in inventory (DM, DL, MO).
- Period Cost — costs expensed as incurred, not included in inventory.
- Prime Cost — direct materials + direct labor.
- Conversion Cost — direct labor + manufacturing overhead.
- Variable Cost — changes in total, constant per unit with activity.
- Fixed Cost — constant in total within the relevant range.
- Mixed Cost — contains both fixed and variable components.
- Differential Cost — difference in cost between two alternatives.
- Opportunity Cost — benefit lost when one option is chosen over another.
- Sunk Cost — past cost; cannot be changed and should be ignored for decisions.
- Relevant Range — activity levels where fixed cost remains unchanged.
Action Items / Next Steps
- Complete Problem 1-23 (Tesla cost classification).
- Complete Problem 1-35 (special order/differential analysis).
- Build both income statement formats in Excel for the same company.
- Form study groups to teach and quiz key concepts.
- Prepare for next class on job order costing; bring calculator.