- One important function of managerial accounting
is computing the internal cost
of providing our products or our services.
Let's do an illustration.
We're in hypothetical company, Ryan Furniture Company.
Ryan Company manufactures custom-made wood furniture.
A customer comes in and orders one custom-made dining table,
a beautiful piece of work made out of oak.
The customer says, "I'm going around to various
"furniture makers, describing to them the table that I want.
"I need a bid.
"How much will you charge me to make this table for me?"
Well, if I want to make an intelligent bid,
I had better first figure out how much
it will cost me to make the table.
First, making the wood table will require some wood.
In managerial accounting, we call
this cost direct materials.
This is the actual stuff that the item is made out of.
In this case, it's wood.
If we're making automobiles, the direct materials cost
would be the metal and the rubber
and the other things that go into making automobiles.
The direct materials cost is pretty easy to estimate.
You describe the size of the table
and the design and the type of wood, oak in this case,
and our experienced people can
figure out how much wood will be required.
Let's say that the wood will cost me
about $1,000 in this case.
By the way, I'm not telling any of this to the customer.
I'm doing this privately in the back room.
Direct materials cost, about $1,000.
But the wood doesn't form itself into a table.
In this case, let's say that the number of worker hours
to make the table is about 30 hours.
In managerial accounting, we call these
people the direct labor people.
They're the skilled craftspeople who actually do the work.
This project will take my skilled craftspeople 30 hours.
And I pay them a wage rate of $30 per hour.
So, the estimate of the direct labor cost is $900.
Direct materials cost is $1,000,
the direct labor cost is $900.
These two numbers are easy.
Anybody who makes furniture can easily estimate
the amount of direct materials,
the amount of oak in this case,
that's required to make the table.
The number of hours required for the direct labor hour
people to complete the table is also easily estimated.
I need some infrastructure, I need a building
and some machines and electricity
and some supervisors and some maintenance people.
These costs are called overhead costs.
And it's a bit more difficult to figure out
how much of, say, the supervisor cost
should be assigned to this table
and that bookcase in the corner
and that desk on the far side of the room.
Overhead cost is difficult to track to individual
products or processes or customers.
So, the three categories of product cost
are direct materials, direct labor, and overhead.
The cost of direct materials and direct labor
is easily traceable to individual products.
Overhead is more difficult
and, so, merits a separate discussion.