Key costs related to managerial accounting
In accounting, a cost measures how much you pay/sacrifice for something. Managerial accounting must give managers accurate cost information relevant to their management decisions. Here are several cost-related terms you encounter in managerial accounting:
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Direct cost: Cost that you can trace to a specific product
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Indirect cost: Cost that you can’t easily trace to a specific product
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Materials: Physical things you need to make products
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Labor: Work needed to make products
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Overhead: Indirect materials, indirect labor, and other miscellaneous costs needed to make products
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Variable costs: Costs that change in direct proportion with activity level
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Fixed costs: Costs that don’t change with activity level
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Mixed costs: Combination of fixed and variable costs
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Contribution margin: Sales less variable costs
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Product costs: Costs needed to make goods; considered part of inventory until sold
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Period costs: Costs not needed to make goods; recorded as expenses when incurred
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Work-in-process cost: How much you paid for goods that are started but not yet completed
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Finished goods cost: How much you paid for goods completed but not yet sold
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Cost of goods manufactured: The cost of the goods completed during a period
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Cost of goods sold: The cost of making goods that you sold
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Controllable costs: Costs that you can change
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Noncontrollable costs: Costs that you can’t change
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Conversion costs: Direct labor and overhead
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Incremental costs: Costs that change depending on which alternative you choose; also known as relevant costs and marginal costs
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Irrelevant costs: Costs that don’t change depending on which alternative you choose
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Opportunity costs: Costs of income lost because you chose a different alternative
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Sunk costs: Costs you’ve already paid or committed to paying
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Historical cost: How much you originally paid for something
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Cost per unit: Cost of a single unit of product
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Expense: Costs deducted from revenues on the income statement
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Cost driver: Factor thought to affect costs
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Process cost: Cost of similar goods made in large quantities on an assembly line
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Job order cost: Cost of a batch of specially made goods
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Absorption cost: Cost that includes fixed and variable product costs
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Target cost: Cost goal set for engineers designing a product
Budgets that go into creating a master budget
A master budget is a plan created to manage a company’s manufacturing and sales activity to meet profit and cash flow goals. Creating a master budget requires careful coordination of several smaller budgets covering all parts of the organization; that way, the master budget is realistic but not complacent.
The master budget contains the following elements:
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Sales budget
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Production budget
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Direct materials budget
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Direct labor budget
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Manufacturing overhead budget
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Selling and administrative budget
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Capital acquisitions budget
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Cash budget
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Budgeted financial statements
Cost-Volume-Profit Relationships for Managerial Accounting
Managerial accounting provides useful tools, such as cost-volume-profit relationships, to aid decision-making. Cost-volume-profit analysis helps you understand different ways to meet your company’s net income goals. This image describes the relationship among sales, fixed costs, variable costs, and net income:
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The bottom axis indicates the level of production — the number of units you make.
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The left axis indicates value in dollars.
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Where total sales equals total costs, the company breaks even (which is why that’s called the break-even point).
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The shaded area to the upper right of this break-even point is profit.
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The shaded region to the lower left is net loss.
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Total variable costs are a diagonal line because the higher the production, the greater the variable costs.
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The total fixed costs line is horizontal because regardless of the production level, fixed costs stay the same.
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Total costs equal the sum of total variable costs and total fixed costs.