Building Blocks of Management Accounting

1. Building Blocks of Management Accounting Chapter 2

2. Objective 1 Distinguish among service, merchandising, and manufacturing companies

3. Service Companies • Sell services • No inventory or cost of goods sold accounts • Labor costs – incurred to develop new services, advertise, provide customer service

4. Merchandising 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

5. 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

6. Objective 2 Describe the value chain and its elements

7. Value Chain • Activities that add value to products and services R&D Design Production/ Purchases Customer Service Distribution Marketing

8. E2-16

9. Objective 3 Distinguish between direct and indirect costs and identify the inventoriable product costs and period costs of merchandising and manufacturing firms

10. Cost 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

11. Determining Total Costs

12. Product 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

13. Inventoriable Product Costs R&D Design Production/ Purchases Inventoriable Product Costs Customer Service Distribution Marketing Period Costs

14. 2007 Income Statement 2007 Product costs Operating expenses

15. 2007 Income Statement Cost of goods sold Inventory sold in 2007 2007 Balance Sheet 2007 Product costs Inventory Inventory sold in 2008 2008 Income Statement Cost of goods sold

16. Merchandising Company Product Costs • Purchase price plus cost of getting merchandise ready for sale

17. Manufacturing CompanyProduct Costs • Direct materials • Direct labor • Manufacturing overhead Direct Costs Indirect Costs

18. Manufacturing Overhead • Indirect costs related to manufacturing operations • Generally all manufacturing costs that are not direct costs • Indirect materials • Indirect labor

19. Prime and Conversion Costs Direct Materials Direct Labor Manufacturing Overhead Prime Costs Conversion Costs

20. Direct & Indirect Labor Compensation • Salaries & wages • Fringe benefits • Payroll taxes

21. E2-19

22. E2-19

23. E2-19 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

24. E2-19 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

25. Objective 4 Prepare the financial statements for service, merchandising, and manufacturing companies

26. Service Company • All costs are period costs • Operating income = Service revenue – operating expenses

27. Merchandising Company – Income Statement Sales - Cost of goods sold Gross profit - Operating expenses Operating income

28. 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

29. Manufacturing Companies – Income Statement Sales - Cost of goods sold Gross profit - Operating expenses Operating income

30. 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

31. Manufacturing Company – Income Statement Cost of goods manufactured: Beginning work in process inventory + Direct materials used + Direct labor + Manufacturing overhead Total manufacturing costs to account for - Ending work in process inventory Cost of goods manufactured

32. Manufacturing Company – Income Statement Direct materials used: Beginning materials inventory + Purchases of direct materials + Freight in Materials available for use - Ending materials inventory Direct materials used

33. Manufacturing CompaniesProduct & Period Costs INCOME STATEMENT BALANCE SHEET Inventoriable Product Costs Sales when sales occur Materials Inventory Finished Goods Inventory - Cost of Goods Sold - Work in Process Inventory Operating Expenses Period Costs = Operating Income

34. Manufacturing CompaniesInventory Accounts Materials Inventory Beginning inventory Materials used Purchases & freight Ending inventory

35. Manufacturing CompaniesInventory Accounts Work in Process Inventory Beginning inventory Cost of goods manufactured Materials used Direct labor Manufacturing overhead Ending inventory

36. Manufacturing CompaniesInventory Accounts Finished Goods Inventory Income Statement Beginning inventory Cost of goods sold Cost of goods manufactured Ending inventory

37. E2-21 Strike Company Statement of Cost of Goods Manufactured For 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

38. E2-21 Cost 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

39. E2-22 Strike Marine Company Income Statement For Year Ended December 31, 2007 Sales $384,000 Cost of goods sold 206,000 Gross profit $178,000 Operating expenses: Marketing expenses $77,000 General and administrative expenses 29,000 106,000 Income before income tax $72,000 Income tax expense 23,000 Net income $49,000

40. E2-19 • __________ can be traced to cost objects. • ____________ are expensed when incurred. • _____ are the combination of direct materials and direct labor. • Compensation includes wages, salaries, and _________________. Direct costs Period costs Prime fringe benefits

41. E2-18 • ________________________ are treated as _______until sold. • ________________________ include costs from only the production or purchases element of the value chain. • _____________are allocated to cost objects. • Both direct and indirect costs are ______ to ________________. Inventoriable product costs assets Inventoriable product costs Indirect costs assigned cost objects

42. E2-18 • __________________ include costs from every element of the value chain. • __________________ are the combination of direct labor and manufacturing overhead. • _________________________ are expensed as __________________when sold. Full product costs Conversion costs Inventoriable product costs cost of goods sold

43. E2-18 l. Manufacturing overhead includes all ______________ of production. indirect costs

44. Objective 5 Describe costs that are relevant and irrelevant for decision making

45. Controllable vs Uncontrollable Costs • Controllable – management can influence or change cost • Uncontrollable – management cannot change or influence cost in the short-run

46. Relevant and Irrelevant Costs • Relevant – costs that differ between alternatives – differential costs • Irrelevant – costs that do not differ • Sunk costs

47. Objective 6 Classify costs as fixed or variable and calculate total and average costs at different volumes

48. Cost Behavior • Variable costs • Fixed costs

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

50. Total Fixed Costs