Managerial/Cost Accounting




Pre Reading Comment – page 387

Read the definition of managerial accounting on page 387 of the text.  Unfortunately, out text has nothing else to say about this topic/


Lecture Notes

Lecture Summary

·        Analysis of costs:

o       Product costing

o       Cost behavior and cost types

o       Decision analysis including CostVolumeProfit(CVP)

o       Cost allocations

o       Activity based costing

·        Budgeting


Major Points

Analysis of costs

It may seem obvious that managers need to know what their costs are for products or services they sell, but in truth it may be fairly complicated to understand costs.  For instance, if you operate a retail store, you may pay 56 cents for a candy bar and sell it for 75 cents, so it would seem like you make a profit of 19 cents on each bar.  But don’t you have other costs?  You have to rent the store, pay employees to work the cash register, pay utilities, shipping, and lots and lots of other things.  So what does it really cost you to sell that candy bar?  A significant aspect of managerial accounting involves answering that question.


Why is the question so important?  It will tell you if you are really losing money on sales, or which products are most profitable.  For most managers, though, the real value is in finding where costs are located, analyzing them, and reducing or eliminating those costs that can be changed.  This is a principle activity for business managers.


Product costing

Costs can be classified in two ways:  direct costs and indirect costs.  Direct costs are resources (parts) or activities (labor) that go into a particular product.  For a restaurant, direct costs would be all the ingredients in the food, plus all the labor to make and serve the food.  Indirect costs are resources used for more than one product.  For instance in a restaurant, a stove is used for more than one menu item, so it would be an indirect cost for each item (and very difficult to allocate to either product).  To determine the total cost of a product, you need to calculate both the direct and indirect costs.  In the restaurant example, the cost of a hamburger includes all the direct costs  -- the ingredients plus the labor of the person who makes and serves it – and all the indirect costs of shared items – the stove, the cooking utensils, reusable plates, etc.


Activity #1:  Make a list of the direct and indirect costs that would be included in the cost of your textbook.


Nonmanufacturing Costs (Period costs – both direct and indirect)

Organizations have additional costs beyond what it takes to actually make a product.  Here is a list of common cost areas:



Each of these areas adds costs to a business.


Activity #2: What non-manufacturing costs do you think are incurred by the textbook publishing company?


Activity #3:  Make a list of the costs you will incur for the manufacturing of any of the products you plan to sell in your business.  Then list the non-manufacturing costs you need to cover.  How would you reduce any of these costs?


Cost-Volume-Profit Analysis

Another aspect of cost to consider is volume.  The actual cost to produce one unit varies with the volume being produced.  This is because some costs are fixed and have to be paid whether you produce one unit or one thousand.  Take the example of the restaurant.  You need to buy a stove whether you cook one burger, or 500.  If the stove cost $1000 and has an expected life of ten years, it costs you $100 per year, or about $8 per month.  If you only cook one burger a month on that stove, the burger will cost you $8 plus the cost of the meat and other ingredients.  You will probably lose money when you sell that burger.  When would you make money?  You do a volume analysis to find out.  Here are the formulas to use:


Profit = Revenue – cost

Profit = Revenue – (variable (“direct or marginal”) costs + capacity-related (“fixed or indirect”) costs)


“Variable” costs change with volume.  The more burgers you sell, the more meat you will need.  But capacity-related costs are fixed in that you will need a stove whether you cook one burger or one thousand.  So costs for the first hamburger we sell look like this:


Profit = $2.89 (what we charge customers for the burger) - $1.15 (costs for the bun and meat and catsup) - $8 (monthly cost for the stove)

In this example, if we just sell one burger a month and only use the stove for that one burger, we lose money on the sale:  $2.89-$1.15 - $8


If we change volume, we start getting closer to making a profit:


Number of Burgers Sold


Variable costs

Capacity-related costs























Activity #4:  So far, the only capacity- related expense we have listed is the cost of the stove.  But we could also put labor costs there since you will need a person working the grill whether you sell one burger a month, or if you sell 1000 burgers.  Assuming you pay a grill worker $1000 per month, what profit do you make if you sell 500, 1000, or 2000 burgers in a month?


Breakeven Analysis

You may be interested to know how many burgers you have to sell to breakeven.  These are the formulas to determine that:


Breakeven ($0) = (units sold * contribution margin per unit)- capacity-related costs

Units sold to breakeven = capacity-related costs / contribution margin per unit


In our example, the contribution margin per unit is $1.74 (2.89-1.15) and the capacity related costs are $1008 (the labor costs for the grill person and the monthly cost for the stove)


Units sold to breakeven = 1008/1.74



So in this example, the restaurant would have to sell 580 burgers before it could start making a profit.


Activity #5:  Because of heavy competition, you decide to cut your hamburger price to $2.39.  Now how many do you need to sell before you break even for the month?


Activity #6:  You agree to raise the wages of your grill person to $1200 per month.  Now what is your breakeven point?


Cost allocations

Some costs are shared by multiple departments, or by multiple products.  In order to fully understand the costs of particular departments or particular products, you need to determine how best to allocate those shared costs.  In our restaurant example, you might have a cleaning service that charges the owners $2000 per month, but works in three restaurants – fifteen hours in the first two and just ten hours per week in the smallest store.  So you would divide the costs out proportionally, with $500 allocated to the smallest restaurant and $750 allocated to the larger restaurants.


The same process could be used to allocate the cost to different products.  For instance, if we used the stove 5 hours per day to make burgers, but used it three hours in the morning to make eggs, we would now allocate the stove cost to the two products -- $5.00 per month to burgers, and $3.00 per month to eggs. [Incidentally this allocation of capacity is exactly what happened about ten years ago when fast-food restaurants started opening for breakfast.  They used the same store and the same cooking facilities to make additional products, thus reducing their costs per unit.]


Activity #7:  You make your grillman an offer – you will raise his pay to $1500 per month, but he now also has to watch the French fry machine.  If you assume half his time will go to the fry machine, what is the new breakeven point for burgers?




There are two primary types of budgets kept by companies:  operating budgets and financial budgets.  Operating budgets provide the level of activity to be expected by various units such as production, sales, and purchasing.  Financial budgets show the expected financial consequences of the budget, for example increased sales leading to expected increasing profits.


The operating budget often has these components:


One of the main purposes of an operating budget is to ensure coordination amongst units.  For instance, if the company plans to create a new product line, that should be reflected in the capital spending plan, and all the other plans.  If the labor plan does not include the budget to hire and train the new workers for the additional product, the product will never be launched.


Activity 10:  Assume you want to expand your restaurant to add a new set of healthy foods such as salads.  What items would you have to add to each of the operating budget areas?



Business Plan Aspects

  1. If your business that sells a product, determine the breakeven sales requirement for one of the products.
  2. If your business provides a service, what is the breakeven sales requirement for services provided over a period of time (such as one month)?
  3. Create an operating budget for the company, including each of the six areas.