Managerial Accounting

By Mohammad Jafaur Ahamed

Many peoples are mistakenly use costs and expenses are same things, but cost and expenses are not the same things. Cost means the sacrifice for acquiring something, for example, purchase a car for taka 5,00,000. On the other hand, expense means the sacrifice for consuming something, for example, you give taka five for riding a car. Here, taka 5,00,000 is treated as cost and taka 5 is treated as expense.

Manufacturing costs: Manufacturing costs are those costs that are used to manufacture goods directly. There are three types of manufacturing costs, which are as follows:

Direct Material: Direct materials are whose materials that become an integral part of the finished product and that can be physically and conveniently traced to the final product. It can be included directly in calculating the cost of the product, such as the steel to make automobile bodies. Generally raw materials are known as direct materials that go into the final product.

Direct Labor: Direct labor costs are those costs that can be easily i. e., physically and conveniently traced to individual units of product. Direct labor is sometimes called touch labor, since direct labor workers typically touch the product while it is being made, e.g., labor costs of machine operators.

Manufacturing Overhead: Manufacturing overhead is the third element of manufacturing cost that includes all costs of manufacturing except direct materials and direct labor. Manufacturing overhead includes items such as indirect materials, indirect labor. The terms indirect manufacturing costs, factory overhead and factory burden, are synonymous with manufacturing overhead. Such as Electricity cost, gas bill, water bill.


 * Direct Material + Direct Labor = Prime Cost


 * Prime Cost + Manufacturing Overhead = Manufacturing Cost


 * Direct Labor + Manufacturing Overhead = Conversion Cost

Non-manufacturing Costs: Generally, non-manufacturing costs are sub-classified into two categories:
 * 1) Marketing Costs / Selling & Distribution Costs: Marketing expenses cover the expenses of making sales and delivering products. These costs are necessary to secure customer orders and get the finished product into the hands of the customer. These costs are called order getting and order filling costs. Examples of marketing cost include advertising, shipping, sales travel, sales commission etc.


 * 1) Administrative Expenses : Administrative expenses include expenses incurred in the direction, control, and administration of the organization. These include all executive, organizational and clerical costs associated with the general management of an organization rather than with manufacturing, marketing, or selling. For example, executive compensation, general accounting expenses.


 * Marketing Costs + Administrative Expenses = Commercial Expenses


 * Manufacturing Cost + Non-manufacturing Cost = Total Operating Cost

Cost behavior refers to how a cost will react or respond to changes in the level of business activity. As the activity level rises and falls, a particular cost may rise and fall as well—or it may remain constant. From the view point of cost behavior, costs are three types:

Fixed Costs : A fixed cost is a cost that remains constant, in total, regardless of changes in the level of activity. Fixed costs are not affected by changes in activity. Consequently, as the activity level rises and falls, the fixed costs remain constant in total amount unless influenced by some outside force, such as a price change. Fixed costs are total fixed for a relevant range of activity level but per unit variable. For planning purposes fixed costs can be viewed as being either committed or discretionary;
 * Committed Fixed Cost: Committed fixed costs relate to the investment in facilities, equipment, and the basic organizational structure of a firm. Examples of such costs include depreciation of buildings and equipment, taxes on real estate, insurance, and salaries of top management and operating personnel. They are long term in nature and can not be significantly changed for short period.
 * Discretionary Fixed Cost: Discretionary fixed costs usually arise from annual decisions by management to spend in certain fixed cost areas. Examples of discretionary fixed costs include advertising, research, public relations, management development programs etc. Discretionary fixed cost is fairly short term, usually a single year and can be cut for short periods of time with minimal damage to the long-run goals of the organization.

Variable Costs: Variable cost is a cost that varies, in total, in direct proportion to changes in the level of activity. The activity can be expressed in many ways, such as units produced, units sold, miles driven, lines of print, hours worked and so forth. A good example of a variable cost is direct materials. The cost of direct materials used during a period will vary, in total, in direct proportion to the number of units that are produced. Variable cost is variable in total but per unit fixed. Variable costs are two types;


 * True Variable Costs: Direct material is a true or proportionately variable cost because the amount used during a period will vary in direct proportion to the level of production activity. Moreover, any amounts purchased but not used can be stored and carried forward to the next period as inventory.
 * Step-Variable Costs: Those costs that increase or decrease only in response to fairly wide changes in activity is known as a step-variable cost. The behavior of a step-variable cost is that it will vary with step by step of activity level. Best example of step-variable cost is labor cost.

Mixed Costs: A mixed cost is one that contains both variable and fixed cost elements. Mixed costs are also known as semi-variable or semi-fixed cost. For example, in case of telephone bill, line rent is fixed cost and call charge is variable cost.

For purposes of assigning costs to cost objects, costs are classified into two categories;

Direct Cost : A direct cost is a cost that can be easily and easily and conveniently traced to the particular cost object under consideration. Examples of direct costs are direct materials, direct labor etc.

Indirect Cost: An indirect cost is a cost that cannot be easily and conveniently traced to the particular cost object under consideration, for examples, indirect materials, indirect labor etc.

Differential Cost and Revenue: Decisions involve choosing between alternatives, in business decisions, each alternative will have certain costs and benefits that must be compared to the costs and benefits of the other available alternatives. A difference in costs between any two alternatives is known as a differential cost. A difference in revenues between any two alternatives is known as differential revenue. A differential cost is also known as an incremental cost, although technically and incremental cost should refer only to an increase in cost from one alternative to another; decreases in cost should be referred to as decremented costs. Differential costs refer both cost increases and cost decreases between alternatives.

Opportunity Cost : Opportunity cost is the potential benefit that is given up when one alternative is selected over another. Opportunity cost is not usually entered in the accounting records of an organization, but it is a cost that must be considered in making decision by management. For example, Tk. 100000 can be invested @ 10% interest in bond or deposited into bank @ 7% interest, if the amount is invested in bond then the bank interest (100000 X 7%) Tk. 7000 will be the opportunity cost of bond interest.

Sunk Cost: A sunk cost is a cost that has already been incurred and that cannot be changed by any decision made now or in the future. Since sunk costs cannot be changed by any decision, they are not differential costs. Therefore, they can and should be ignored when making a decision. For example, a company paid Tk. 50000 before 5 years for purchase a machine.

Product Costs: Product costs include all the costs that are involved in acquiring or making a product. In case of manufactured goods, these costs consist of direct materials, direct labor, and manufacturing overhead. Product costs are viewed as attaching to units of product as the goods are purchased or manufactured and they remain attached as the goods go into inventory awaiting sale. So initially, product costs are assigned to an inventory account on the balance sheet. When the goods are sold, the costs are released from inventory as expenses (known as Cost of Goods Sold) and matched against the revenue. Product cost is also known as inventoriable cost. Product costs are not treated as expense in the period in which these are incurred. They are treated as expense in the period in which the related products are sold.

Period costs: Period costs are all the costs that are not included in product costs. These costs are expensed on the income statement in the period in which they are incurred using the usual rules of accrual accounting. Period costs are incurred for a specific period rather than to a specific product. They are not included as part of the cost of either purchased or manufactured goods. All selling and administrative expenses are considered to be period costs. Sales commission, office rent, executive salaries etc. are the examples of period costs.