C2 accounting

1

CHAPTER 2

Building Blocks of Managerial Accounting

Copyright © 2015 Pearson Canada Inc.

2

OBJECTIVE 1

Distinguish among service, merchandising, and manufacturing companies


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Service Companies

• Provide an intangible service only• Largest sector in Canada• Examples

–Accountants–Banks–Doctors– Insurance companies

• No inventory for sale to clients


4

Merchandising Companies

• Resell products purchased from suppliers • Retailers vs. Wholesalers• Examples

–Rona –Loblaws–Le Château

• One inventory account – merchandise


5

Manufacturing Companies

• Use labour and other inputs to convert raw materials into finished products

• Examples–Bombardier–Clodhoppers–McCain Foods Ltd–Rocky Mountain Bicycles

• 3 inventory accounts


6

Manufacturing Companies (cont’d)

• Three inventory accounts

– Raw materials

– Work in process

– Finished goods


7

OBJECTIVE 2Describe the value chain and its elements


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Value Chain

Activities that add value to products and services and cost money

R&D DesignProduction/Purchases

MarketingDistributionCustomer Service


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OBJECTIVE 3Distinguish between direct and indirect costs


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Cost Object

Anything for which managers want a separate measurement of cost

–Direct cost» Can easily be traced to the cost object

–Indirect cost» Relates to the cost object but can’t be

traced directly


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OBJECTIVE 4

Identify the inventoriable product costs and period costs of merchandising and manufacturing firms


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Two Definitions of Product Cost

• Total costs – used internally only (may include all resources used throughout the value chain)

• Inventoriable product costs – used for external reporting (defined by IFRS and ASPE)


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R&D Design

MarketingDistributionCustomer Service

Production/Purchases

Inventoriable Product Costs

Total Costs, Inventoriable Product Costs, and Period Costs


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Period Costs: All Costs Incurred in the Other Stages of the Value Chain

Period Costs

MarketingDistributionCustomer

Service

R&D Design


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Inventoriable Product Costs: Merchandiser

Purchase price from suppliers + Freight-in+ Import duties or tariffs


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Inventoriable Product Costs: Manufacturer

• Direct materials• Direct labour• Manufacturing overhead

Direct Costs

Indirect Costs


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Manufacturing Overhead

Indirect costs related to manufacturing that are not direct materials or direct labour

• Indirect materials• Indirect labour• Other indirect manufacturing overhead

Depreciation Utilities Repairs and maintenance Etc.


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Prime and Conversion Costs

Direct MaterialsDirect labour

Manufacturing Overhead

Prime Costs Conversion Costs


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OBJECTIVE 5

Prepare financial statements for service, merchandising, and manufacturing companies


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Income Statement for a Service Company

• Simplest income statement• All costs are period costs

Service revenues - Operating expenses Operating income


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Income Statement of aMerchandiser

• Separates product costs from period costs

Sales revenue- Cost of goods sold (product costs)= Gross profit- Operating expenses (period costs)= Operating income


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Cost of Goods Sold Calculation: Merchandiser

Beginning inventory+ Purchases+ Import duties or tariffs+ Freight-in=Cost of goods available for sale- Ending inventory=Cost of goods sold


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Income Statement for a Manufacturer

• Looks the same as a merchandiser• Calculation of cost of goods sold more complicated

Sales Revenue- Cost of goods sold (product costs)= Gross profit- Operating expenses (period costs)= Operating income


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Cost of Goods Sold Calculation:Manufacturer

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 Calculation: Manufacturer

Beginning work in process inventory+ Direct materials used+ Direct labour+ Manufacturing overhead= Total manufacturing costs to account for- Ending work in process inventory= Cost of goods manufactured


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Direct Materials Used Calculation:Manufacturer

Beginning raw materials inventory+ Purchases of direct materials

including freight-in and any import duties

= Materials available for use - Ending raw materials inventory= Direct materials used


Product and Period CostsType of

CompanyInventoriable Product Costs

Period Costs

Service Company NoneAll costs along the

value chain

MerchandiserPurchases plus cost of freight, import duties,

etc.

All costs except total purchases

Manufacturer DM, DL, MOHAll costs except DM,

DL, MOH

Accounting Treatment

Inventory on balance sheet until sold

Immediately expense

Copyright © 2015 Pearson Canada Inc. 27

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Manufacturing Companies’Inventory Accounts

Raw Materials Inventory

Beginning inventory

Purchases & freight

Ending inventory

Materials usedIn work in process


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Work in Process Inventory

Materials used from raw materials

Direct labourManufacturing

overhead

Beginning inventory

Ending inventory

Cost of goodsManufactured

and sent to finished goods


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Finished Goods Inventory

Beginning inventory

Ending inventory

Cost of goodssoldCost of goods

manufactured

Income Statement


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Balance Sheet DifferencesType of Company Inventory Accounts

Service Company None

Merchandiser Merchandise Inventory

Manufacturer Raw materials, work in process, and finished goods inventory


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OBJECTIVE 6

Describe costs that are relevant and irrelevant to decision making


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Controllable and Uncontrollable Costs

• Controllable – management can influence or change cost (e.g. local advertising)

• Uncontrollable – management cannot change or influence cost in the short-run (e.g. property taxes)


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Relevant and Irrelevant Costs

• Relevant: costs that differ between alternatives– Differential costs– Changes in cost between competing alternatives

• Irrelevant: costs that do not differ– Sunk costs – Costs that don’t change between alternatives


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OBJECTIVE 7

Classify costs as fixed or variable, and calculate total and average costs at different volumes


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Cost behaviour

• Fixed costs – stay constant in total over a wide range of activity levels

• Changes per unit as activity levels change

• Variable costs – change in total in direct proportion to changes in volume

• Stays constant per unit as activity levels change


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Fixed Costs: Stay constant in total over a wide range of activity levels

$0

$500

$1,000

$1,500

$2,000

$2,500

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

Total Sales

To

tal S

ales

Sal

arie

s


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Variable Costs: Change in total in direct proportion to changes in volume

$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

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


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Total Cost

Total cost = Fixed costs + (Variable cost per unit x number of units)

Example:Fixed costs = $20,000Variable cost per unit = $50 per unitNumber of units = 100

Total Cost = $20,000 + ($50 x 100) = $25,000


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Average Cost

Total cost ÷ number of units = Average cost

Example:$25,000 = $250 per unit

100 units

The average cost per unit is NOT appropriate for predicting total costs at different levels of output.


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C2 accounting

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