Building Blocks of Management Accounting

Copyright © 2007 Prentice-Hall. All rights reserved

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Building Blocks of Management Accounting

Building Blocks of Management Accounting

Chapter 2


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Objective 1Objective 1

Distinguish among service, merchandising, and

manufacturing companies


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Service CompaniesService Companies

• Sell services

• No inventory or cost of goods sold accounts

• Labor costs – incurred to develop new services, advertise, provide customer service


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Merchandising CompaniesMerchandising Companies

• Purchase inventory from suppliers; resell to customers

• Retailers and wholesalers

• One inventory account – includes all costs to acquire and get inventory ready for sale

• Labor costs – identify new products and locations for stores, advertising, selling, customer service


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Manufacturing Companies Manufacturing Companies

• Use labor, plant, and equipment to convert raw materials into finished products

• Three inventory accounts– Raw Materials inventory– Work in process inventory– Finished goods inventory


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Describe the value chain and its elements


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Value ChainValue Chain

• Activities that add value to products and services

R&D DesignProduction/Purchases

MarketingDistributionCustomer

Service


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E2-16E2-16Samsung Electronics

Cost Classification

Production

R & D DesignDirectMat.

DirectLabor MOH Market. Distrib.

Cust. Service

Salaries of telephone salespeople $ 5

Depreciation on P&E $65

Exterior case $ 6

Scientists’ salaries $12

Delivery expense $ 7

Transmitters 61

Rearrange process $ 2

Assembly-line workers’ wages $10

Tech support hotline $ 3

Toll free line for customer orders 1

Total costs $12 $ 2 $67 $10 $65 $ 6 $ 7 $ 3


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Distinguish between direct and indirect costs and identify the inventoriable product costs and period costs of

merchandising and manufacturing firms


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Cost ObjectCost Object

• Anything for which managers want a separate measurement of cost– Direct cost – can be traced directly to cost

object– Indirect cost – can not be traced directly to

cost object


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Determining Total CostsDetermining Total Costs

Assign direct and indirect costs to

cost object

Trace direct costsAllocate

indirect costs


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Product CostsProduct Costs

Two definitions

1. Full product costs (internal decision making) - all resources used throughout value chain

2. Inventoriable product costs (external reporting) – costs incurred during production or purchases stage of value chain


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Inventoriable Product CostsInventoriable Product Costs

R&D Design

MarketingDistributionCustomer

Service

Production/Purchases

Inventoriable Product Costs

Period Costs


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2007 Product

costs

2007 Income

Statement

Operating expenses


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2007 Product

costs

2007 Income

Statement

Inventory sold in 2007

Cost of goods sold

Cost of goods sold

Inventory

2007 Balance

Sheet

2008 Income

Statement

Inventory sold in 2008


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Merchandising Company Product Costs

Merchandising Company Product Costs

• Purchase price plus cost of getting merchandise ready for sale


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Manufacturing CompanyProduct Costs

Manufacturing CompanyProduct Costs

• Direct materials

• Direct labor

• Manufacturing overhead

Direct Costs

Indirect Costs


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Manufacturing OverheadManufacturing Overhead

• Indirect costs related to manufacturing operations– Generally all manufacturing costs that are not

direct costs– Indirect materials– Indirect labor


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Prime and Conversion CostsPrime and Conversion Costs

Direct Materials

Direct Labor

Manufacturing Overhead

Prime CostsConversion

Costs


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Direct & Indirect Labor Compensation

Direct & Indirect Labor Compensation

• Salaries & wages

• Fringe benefits

• Payroll taxes


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E2-19E2-19DM DL IM IL

Other MOH

Period

a. Airplane seats 250

b. Depr. on admin offices

60

c. Assembly workers’ wages

600

d. Plant utilities 120

e. Prod. supervisors’ salaries

100

f. Jet engines 1,000

g. Machine lubricants 15

h. Depreciation on forklifts

50


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E2-19E2-19

DM DL IM ILOther MOH

Period

i. Prop tax on corp marketing offices

25

j. Cost of warranty repairs

225

k. Factory janitors’ wages

30

l. Designing new plant layout

175

m. Machine operators health insurance

40

TOTAL 1,250 640 15 130 170 485


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E2-19E2-19

2) Total manufacturing overhead costs = IM +IL + Other MOH=

$15 + 130 + 170 = $315

3) Total inventoriable product costs =

DM + DL +MOH =

$1,250 + 640 +315 = $2,205


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E2-19E2-19

4) Total prime costs = DM + DL =

$1,250 + 640 = $1,890

5) Total conversion costs = DL + MOH = $640 + 315 = $955

6) Total period costs = $485


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Prepare the financial statements for service,

merchandising, and manufacturing companies


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Service CompanyService Company

• All costs are period costs

• Operating income = Service revenue – operating expenses


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Merchandising Company – Income Statement

Merchandising Company – Income Statement

Sales

- Cost of goods sold

Gross profit

- Operating expenses

Operating income


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Merchandising Company – .Income Statement

Merchandising Company – .Income Statement

Cost of goods sold:

Beginning inventory

+ Purchases

+ Freight-in

Cost of goods available for sale

- Ending inventory

Cost of goods sold


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Manufacturing Companies – Income Statement

Manufacturing Companies – Income Statement

Sales

- Cost of goods sold

Gross profit

- Operating expenses

Operating income


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Manufacturing Company – Income Statement


Cost of goods sold:

Beginning finished goods inventory

+ Cost of goods manufactured

Cost of goods available for sale

- Ending finished goods inventory

Cost of goods sold


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Cost of goods manufactured: Beginning work in process inventory

+ Direct materials used+ Direct labor+ Manufacturing overheadTotal manufacturing costs to account for- Ending work in process inventory

Cost of goods manufactured


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Direct materials used:

Beginning materials inventory

+ Purchases of direct materials

+ Freight in

Materials available for use

- Ending materials inventory

Direct materials used


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Manufacturing CompaniesProduct & Period Costs

Manufacturing CompaniesProduct & Period Costs

MaterialsInventory

FinishedGoods

Inventory

Sales

Cost ofGoods Sold

INCOME STATEMENT

Operating Expenses

Inventoriable Product Costs

BALANCE SHEET

=Operating Income

whensalesoccur -

-Work inProcessInventory

PeriodCosts


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Manufacturing CompaniesInventory Accounts


Materials InventoryBeginning inventory

Purchases & freight

Ending inventory

Materials used


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Work in Process Inventory

Materials used

Direct labor

Manufacturing overhead

Beginning inventory

Ending inventory

Cost of goodsmanufactured


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Finished Goods Inventory

Beginning inventory

Ending inventory

Cost of goodssoldCost of goods

manufactured

Income Statement


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E2-21E2-21Strike Company

Statement of Cost of Goods ManufacturedFor Year Ended December 31, 2007

Beginning work in process inventory $50,000

Direct materials used:

Beginning materials inventory $25,000

Purchases of direct materials 78,000

Materials available for use $103,000

Ending materials inventory (28,000) 75,000

Direct labor 82,000

Manufacturing overhead (see schedule) 41,000

Total manufacturing costs to account for $248,000

Ending work in process inventory (35,000)

Cost of goods manufactured $213,000


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E2-21E2-21Cost of goods sold: Finished goods inventory, January 1

$18,000 Cost of goods manufactured

213,000

Goods available for sale$231,000

Finished goods inventory, December 31(25,000)

Cost of goods sold$206,000


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E2-22E2-22Strike Marine Company

Income StatementFor Year Ended December 31, 2007

Sales $384,000Cost of goods sold 206,000Gross profit $178,000Operating expenses:Marketing expenses $77,000General and administrative expenses 29,000 106,000Income before income tax $72,000Income tax expense 23,000 Net income $49,000


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E2-19E2-19

a. __________ can be traced to cost objects.

b. ____________ are expensed when incurred.

c. _____ are the combination of direct materials and direct labor.

d. Compensation includes wages, salaries, and _________________.

Prime

Direct costs

Period costs

fringe benefits


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E2-18E2-18

e. ________________________ are treated as _______until sold.

f. ________________________ include costs from only the production or purchases element of the value chain.

g. _____________are allocated to cost objects.

h. Both direct and indirect costs are ______ to ________________.

Inventoriable product costsassets

Inventoriable product costs

Indirect costs

assignedcost objects


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E2-18E2-18

i. __________________ include costs from every element of the value chain.

j. __________________ are the combination of direct labor and manufacturing overhead.

k. _________________________ are expensed as __________________when sold.

Full product costs

Conversion costs

Inventoriable product costs

cost of goods sold


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E2-18E2-18

l. Manufacturing overhead includes all ______________ of production.indirect costs


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Describe costs that are relevant and irrelevant for

decision making


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Controllable vs Uncontrollable Costs

Controllable vs Uncontrollable Costs

• Controllable – management can influence or change cost

• Uncontrollable – management cannot change or influence cost in the short-run


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Relevant and Irrelevant CostsRelevant and Irrelevant Costs

• Relevant – costs that differ between alternatives – differential costs

• Irrelevant – costs that do not differ– Sunk costs


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Classify costs as fixed or variable and calculate total and

average costs at different volumes


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Cost BehaviorCost Behavior

• Variable costs

• Fixed costs


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Total Variable CostsTotal Variable Costs

Assume we pay 5% sales commissions on all sales. The cost of sales commissions increase proportionately with increases in sales.

$0

$500

$1,000

$1,500

$2,000

$2,500

$0 $10,000 $20,000 $30,000 $40,000

Total Sales

To

tal

Sa

les

Co

mm

iss

ion

s


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Total Fixed CostsTotal Fixed Costs

$0

$500

$1,000

$1,500

$2,000

$2,500

$0 $10,000 $20,000 $30,000 $40,000

Total Sales

To

tal

Sa

les

Sa

lari

es


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Total CostTotal Cost

Total fixed costs

+ Variable cost per unit x number of units

Total Cost


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Average CostAverage Cost

Total cost ÷ number of units


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Marginal CostMarginal Cost

• Cost of making one more unit


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E2-24E2-24

a.Managers cannot influence __________ _____ in the short-run.

b.Total _____________ decrease when production volume decreases.

c. For decision-making purposes, costs that do not differ between alternatives are ________________.

d.Costs that have already been incurred are called ____________.

uncontrollable costs

variable costs

irrelevant costs

sunk costs


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E2-24E2-24

e. Total ___________ stay constant over a wide range of production volume.

f. The _______________ is the difference in cost between two alternative courses of action.

g. The product’s ____________ is the cost of making one more unit.

fixed costs

differential cost

marginal cost


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E2-24E2-24

h. A product’s ____________ and ____________, not the product’s ___________, should used to forecast total costs at different production volumes.

fixed costsvariable costsaverage cost


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E2-25E2-25

a. Total product cost =

$1 x 20,000,000 $20,000,000

5,000,000

$25,000,000

b. Average cost =

$25,000,000/20,000,000 = $1.25


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E2-25E2-25

c. Fixed cost per unit =

$5,000,000 ÷ 20,000,000 = $.25

d. Forecasted product cost =

$1 x 25,000,000 $25,000,000

5,000,000

$30,000,000


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E2-25E2-25

e. Forecasted average product cost =

$30,000,000 ÷ 25,000,000$1.20

f. Forecasted fixed cost

$5,000,000 ÷ 25,000,000$.20


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E2-25E2-25

g. The average product cost decreases as production volume increases because the company is spreading its fixed costs over 5 million more units. The company will be operating more efficiently, so the average cost of making each unit decreases.


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End of Chapter 2End of Chapter 2

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Building Blocks of Management Accounting

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