Needles Powers Crosson Principles of Accounting 12e Managerial Accounting and Cost Concepts 17 C H A P T E R © human/iStockphoto.

NeedlesPowersCrosson

Principles of Accounting

12e

Managerial Accounting and Cost Concepts17

C H A P T E R

© human/iStockphoto

LEARNING OBJECTIVES

©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

LO1: Distinguish managerial accounting from financial accounting.

LO2: Explain how managers recognize cost and how they define product or service unit cost.

LO3: Describe the flow of costs through a manufacturer’s inventory accounts.

LO4: Compare how service, retail, and manufacturing organizations report costs on their financial statements and how they account for inventories.

LO5: Compute the unit cost of a product or service. LO6: Explain how managerial accounting supports the

management process to produce business results. LO7: Identify the standards of ethical conduct for

management accountants.

SECTION 1: CONCEPTS


Measurement: measuring business activities by recording data about them for future use

Recognition: the determination of when a business transaction should be recorded

Classification: the process of assigning transactions to the appropriate accounts

The Role of Managerial Accounting

The role of managerial accounting is to enable managers and people throughout an organization to:– make informed decisions– be more effective at their jobs– improve the organization’s performance

The Institute of Management Accountants (IMA) defines managerial accounting (or management accounting) as a profession that involves partnering in management decision making, devising planning and performance management systems, and providing expertise in financial reporting and control to assist management in the formulation and implementation of an organization’s strategy.


Managerial Accounting and Financial Accounting: A Comparison

Both managerial accounting and financial accounting assist decision makers by identifying, measuring, processing, and communicating relevant information.

However, managerial accounting and financial accounting differ in a number of ways, as summarized in the table on the next slide.

Note that managerial accounting is not a subordinate activity to financial accounting, but is a process that includes financial accounting, tax accounting, information analysis, and other accounting activities.


Comparison of Managerial Accounting and Financial Accounting



Cost Recognition

A single cost can be classified and used in several ways, depending on the purpose of the analysis.

The next slide provides an overview of commonly used cost recognition classifications. These classifications enable managers to:– Control costs by determining which are traceable to a

particular cost object, such as a service or product.– Calculate the number of units that must be sold to

achieve a certain level of profit (cost behavior).– Identify the costs of activities that do and do not add

value to a product or service.– Recognize and measure costs for the preparation of

financial statements.


Overview of Cost Recognition Classification


Cost Measurement

Managers measure costs by tracing them to cost objects, such as products or services, sales territories, departments, or operating activities.

– In service organizations, costs can be traced to a specific service, such as preparation of tax returns in an accounting firm.

– In retail organizations, costs can be traced to a department, such as the produce department in a grocery store.

– In manufacturing organizations, costs can be traced to a product, such as the candy produced by a candy company.

– Direct costs are costs that can be measured conveniently and economically by tracing them to a cost object.

– Indirect costs are costs that cannot be measured conveniently and economically by tracing them to a cost object. They are included in the cost of a product or service by using formulas.


Financial Reporting

Period costs (or noninventoriable costs) are costs of resources that are not assigned to products. They are recognized as operating expenses on the income statement.

Product costs (or inventoriable costs) include direct materials, direct labor, and overhead (indirect costs). They are recognized on the income statement as cost of goods sold and on the balance sheet as inventory.

Product unit cost is the cost of manufacturing a single unit of a product.

Service unit cost is the cost to perform one service.


Financial Reporting

The three elements of product or service cost are:

- Direct materials costs: the costs of materials that can be conveniently and economically measured when making specific units of the product

- Direct labor costs: the costs of the hands-on labor needed to make a product or service that can be measured when making specific units

- Overhead costs (or service overhead, factory overhead, factory burden, manufacturing overhead, or indirect production costs): the costs that cannot be practically or conveniently measured directly to an end product or service. These include:

Indirect materials costs, such as the costs of nails, rivets, lubricants, and small tools

Indirect labor costs, such as the costs of labor for maintenance, inspection, engineering design, supervision, and materials handling


Financial Reporting

The three elements of product cost can also be grouped into prime costs and conversion costs.– Prime costs: the primary costs of production. They

are the sum of the direct materials costs and direct labor costs.

– Conversion costs: the costs of converting or processing direct materials into a finished product. They are the sum of direct labor costs and overhead costs.

The next slide summarizes the relationship among the product cost recognition classifications.


Relationships Among Product Cost Recognition Classifications


Cost Behavior

A variable cost is a cost that changes in direct proportion to a change in productive output.

A fixed cost is a cost that remains constant within a defined range of activity or time period.– Examples of variable and fixed costs:

Service organization: For an airline, the cost of peanuts and beverages is a variable cost, while the depreciation on the planes and the salaries and benefits of the crews are fixed costs.

Retail organization: For a grocery store, variable costs include the cost of groceries sold, while fixed costs include the costs of building rental, depreciation on equipment, and the manager’s salary.

Manufacturing organization: Variable costs include direct materials, direct labor, indirect materials, and indirect labor. Fixed costs include the costs of supervisors’ salaries and depreciation on buildings.


Value-Adding versus Non-Value-Adding Costs

Costs can also be classified as value-adding or non-value-adding.– A value-adding cost is the cost of an activity that

increases the market value of a product or service.– A non-value-adding cost is the cost of an activity

that adds cost to a product or service but does not increase its market value.

Managers examine the value-adding attributes of their company’s operating activities and, wherever possible, reduce or eliminate activities that do not directly add value to a company’s products or services.

The next slide shows how some costs of a candy manufacturer can be recognized in terms of traceability, behavior, value attribute, and financial reporting.


Examples of Cost Recognition Classifications for a Candy Manufacturer



SECTION 2: ACCOUNTING APPLICATIONS

Describe the materials inventory Describe the work in process inventory Describe the finished goods inventory Prepare the income statement Determine the cost of goods sold Prepare the statement of cost of goods

manufactured Determine the product unit cost


Document Flows and Cost Flows Through the Inventory Accounts

Managers accumulate manufacturing costs based on documents pertaining to production-related activities.– Purchase of Materials

Step 1: Acquiring the materials—The purchasing process starts with a purchase request for specific quantities of materials needed. Once approved, the Purchasing Department prepares a purchase order and sends it to a supplier.

Step 2: Receiving the materials—When the materials arrive, the receiving dock examines the materials and enters the information into the company database as a receiving report and moves the materials to the storeroom.

Step 3: Paying for the materials—The accounting department receives a vendor’s invoice from the supplier requesting payment for the materials.

– Production of Goods Step 4: Preparing the materials for production—The storeroom

receives a materials request form describing the types and quantities of materials that the storeroom is to send to the production area.


Document Flows and Cost Flows Through the Inventory Accounts

Step 5: Sending the materials into production—If all is in order, the storeroom has the materials handler move the materials to the production floor.

Step 6: Producing goods—Each of the production employees who make the products prepares a time card to record the number of hours he or she has worked on this and other orders each day. A job order cost card can be used to record all direct materials, direct labor, and overhead costs incurred as the products move through production.

– Product Completion and Sale Step 7: Completing goods—Employees place completed products in

cartons and move the cartons to the finished goods storeroom. Step 8: Selling goods—When the products are sold, a clerk prepares

a sales invoice and another employee fills the order by removing the products from the storeroom, packaging them, and shipping them to the customer. A shipping document shows the quantity of the products that are shipped and gives a description of them.

– These steps are summarized on the next slide.


Activities, Documents, and Cost Flows Through the Inventory Accounts of a Manufacturing Organization


The Manufacturing Cost Flow

Manufacturing cost flow is the flow of direct materials, direct labor, and overhead through the Materials Inventory, Work in Process Inventory, and Finished Goods Inventory accounts into the Cost of Goods Sold account.– The Materials Inventory account shows the balance of

the cost of unused materials—in other words, the cost of materials that have been purchased but not used in the production process.

– The Work in Process Inventory account shows the manufacturing costs that have been incurred and assigned to partially completed units of product—in other words, the costs involved with manufacturing the unfinished product.

– The Finished Goods Inventory account shows the costs assigned to all completed products that have not been sold.


Manufacturing Cost Flow: Choice Candy Company


The Materials Inventory Account(slide 1 of 2)


The Materials Inventory Account(slide 2 of 2)


Work in Process Inventory

The Work in Process Inventory account records the balance of partially completed units of the product.– As direct materials and direct labor enter the

production process, their costs are added to the Work in Process Inventory account. The cost of overhead for the current period is also added.

– The total costs of direct materials, direct labor, and overhead incurred and transferred to the Work in Process Inventory account during a period are called total manufacturing costs (or current manufacturing costs).


The Work in Process Inventory Account(slide 1 of 2)


The Work in Process Inventory Account(slide 2 of 2)


The Finished Goods Inventory Account(slide 1 of 2)


The Finished Goods Inventory Account(slide 2 of 2)



Income Statement and Accounting for Inventories

All organizations—service, retail, and manufacturing—use the following income statement format:

How the cost of sales or cost of goods sold is computed, however, varies depending on the organization.– The next slide compares the financial statements of

service, retail, and manufacturing organizations and shows the differences in inventory accounts and cost of goods sold.


Financial Statements of Service, Retail, and Manufacturing Organizations


Statement of Cost of Goods Manufactured

The cost of goods manufactured is calculated in the statement of cost of goods manufactured, which summarizes the flow of all manufacturing costs incurred during the period.

The next slide shows Choice Candy’s statement of cost of goods manufactured for the year.


Statement of Cost of Goods Manufactured and Partial Income Statement for a Manufacturing Organization


Statement of Cost of Goods Manufactured(slide 1 of 2)

The statement of cost of goods manufactured is developed in three steps.– Step 1: Compute the cost of direct

materials used during the accounting period.

– For Choice Candy, this is computed as follows.


Statement of Cost of Goods Manufactured(slide 2 of 2)

– Step 2: Calculate total manufacturing costs for the period.

– For Choice Candy, this would be computed as follows.

– Step 3: Determine total cost of goods manufactured for the period.

– For Choice Candy, this would be computed as follows.


Cost of Goods Sold and a Manufacturer’s Income Statement

The total amount of the cost of goods manufactured is carried over to the income statement, where it is used to compute the cost of goods sold.



Computing Product Unit Cost

Product unit cost is the cost of manufacturing a single unit of a product. – It is made up of the cost of goods manufactured

costs of direct materials, direct labor, and overhead. These three cost elements are accumulated as a batch

of products is being produced. When the batch has been completed, the product unit

cost is computed.


Product Cost Measurement Methods

How products flow physically and how costs are incurred does not always match.

Managers may need to use estimates or predetermined standards to compute product costs during the period. – At the end of the period, these estimates

are reconciled with the actual product costs.

– The three methods managers and accountants can use to calculate product unit cost are summarized below.


Actual Costing Method

The actual costing method uses the actual costs of direct materials, direct labor, and overhead to calculate the product unit cost. (These costs, however, may not be known until the end of the period.)– Suppose Choice Candy produced 3,000 candy bars

for a customer. The company accountant calculated the actual costs for the order as follows: direct materials, $540; direct labor, $420; overhead, $240. The actual product unit cost for the order was $0.40, calculated as follows.


Normal Costing Method

The normal costing method combines the easy-to-track actual direct costs of materials and labor with estimated overhead costs to determine product unit cost.– For Choice Candy, suppose that the company

accountant used normal costing to price the order for 3,000 candy bars and that overhead was applied to the product’s cost using an estimated rate of 50 percent of direct labor costs. The costs for the order would include the actual direct materials cost of $540, the actual direct labor cost of $420, and an estimated overhead cost of $210 ($420 X 50%). The product unit cost would be $0.39:


Standard Costing Method

The standard costing method uses estimated or standard costs of direct materials, direct labor, and overhead to calculate the product unit cost.– This method is useful when product cost information

is needed before the accounting period begins.– Suppose that Choice Candy is placing a bid to

manufacture 2,000 candy bars for a new customer. From standard cost information, the accountant estimates the following costs: $0.20 per unit for direct materials, $0.15 per unit for direct labor, and $0.09 per unit for overhead. The standard cost per unit would be $0.44.


Computing Service Unit Cost

Services are labor-intensive processes supported by indirect materials or supplies, indirect labor, and other overhead costs.– The most important cost in a service organization

is the direct cost of labor that can be traceable to the service rendered.

– The indirect costs incurred in performing a service are similar to those incurred in manufacturing a product. They are classified as overhead.

– These service costs appear on service organizations’ income statements as cost of sales.



SECTION 3: BUSINESS APPLICATIONS

Planning Performing Evaluating Communicating Ethics


Managerial Accounting and the Management Process

The fundamentals of managing an organization include planning and forecasting operations, organizing and coordinating resources and data, and commanding and controlling resources.

Although management actions differ from organization to organization, they generally follow a four-stage management process:– Planning– Performing– Evaluating– Communicating


Planning(slide 1 of 2)

The overriding goal/vision of a business is to increase the value of the stakeholders’ interest in the business.

The fundamental way in which the company will achieve this goal/vision is described in its mission statement.

The planning process must consider how to add value through strategic, tactical, and operating objectives.– Strategic objectives—broad, long-term goals that determine

the fundamental nature and direction of a business and that serve as a guide for decision making

– Tactical objectives—mid-term goals that position an organization to achieve its long-term strategies

– Operating objectives—short-term goals that outline expectations for the performance of day-to-day operations


Planning(slide 2 of 2)

A business plan is a comprehensive statement of how a company will achieve its strategic, tactical, and operating objectives.– It provides a full description of the business,

including a complete operating budget for the first two years of operations. The budget must include a forecasted income

statement, a forecasted statement of cash flows, and a forecasted balance sheet.

– The business plan often includes performance goals for individuals, teams, products, or services.


Overview of the Planning Framework


Performing

Critical to managing any retail business is a thorough understanding of the supply chain (or supply network)—the path that leads from the suppliers to the final customers, as illustrated below.

– Knowledge of the supply chain allows managers to coordinate deliveries from growers and suppliers so that they can meet customers’ demands without having too much or too little inventory on hand.


Evaluating

Managers evaluate operating results by comparing the organization’s actual performance with the performance levels established in the planning stage.– They earmark any significant variations for

further analysis so that they can correct the problems.

– If the problems are the result of a change in the organization’s operating environment, the managers may revise their original estimates and/or objectives.


Communicating

Whether accounting reports are prepared for internal or external use, they must provide accurate information and clearly communicate this information.– The key to providing accurate and useful internal and

external reports is to apply the four w’s. Why? Know the purpose of the report, and focus on it as you

write. Who? Identify the audience for your report, and communicate at

a level that matches your readers’ understanding of the issue and their familiarity with accounting information.

What? What information is needed, and what method of presentation is best? The information should be not only relevant but also easy to read and understand. Visual aids, such as charts or graphs, may be needed.

When? Know the due date for the report, and strive to prepare accurate reports on a timely basis.


Producing Results with the Management Process



Standards of Ethical Conduct

Managers consider the interests of external parties (customers, owners, suppliers, governmental agencies, and the local community) when they make decisions. When ethical conflicts arise, management accountants have a responsibility to help managers balance those interests.

To provide guidance, the Institute of Management Accountants has issued standards of ethical conduct for practitioners of managerial accounting and financial management.– Those standards, shown on the next two slides, emphasize

that management accountants have responsibilities in the areas of competence, confidentiality, integrity, and credibility.


Statement of Ethical Professional Practice(slide 1 of 2)


Statement of Ethical Professional Practice(slide 2 of 2)

