CHAPTER

1. CHAPTER 20 MANAGEMENT ACCOUNTING:The Manufacturing Business

2. MANAGEMENT ACCOUNTING The Basics Financial Accounting (CAs) Management Accounting (CMAs) External users (Public) Internal users (officers, management, Dept. Heads, etc.) Classified Financial Statements Internal reports Issued Annually Issued as frequently as needed To provide general all-purpose info for all users To provide specific information for internal management/decision makers Pertains to entity as a whole and is very condensed Pertains to departments and divisions and may be very detailed Past orientation: historical cost data Future orientation: budgets & projections as well as historical cost Reporting standards are GAAPs Reporting standard is relevance to the decision to be made Annual independent audit required No independent audits

3. MANAGEMENT ACCOUNTING The Functions of Management Accountants • The notes for this chapter are broken down into the four functions that Management Accountants perform. They: • Determine which costs are involved in manufacturing, and report them in the financial statements. • Establish the cost of manufactured items (for controlling, reporting, and for setting selling price-levels) • Provide information on where and why costs are changing (for decision making purposes). • Evaluate cost behaviour in a company as production levels change (i.e. Economies of Scale).

4. MANAGEMENT ACCOUNTING • Determine which costs are involved in manufacturing, and report them in the Financial Statements.

5. MANAGEMENT ACCOUNTING • Determine which costs are involved in manufacturing The Product’s Cost (Steel) Direct Materials Direct Labour Overhead

6. MANAGEMENT ACCOUNTING • Determine which costs are involved in manufacturing

7. MANAGEMENT ACCOUNTING • Determine which costs are involved in manufacturing • Direct Materials: Raw materials that can be physically and conveniently associated with the finished product during the manufacturing process. • Those that cannot be easily associated become part of overhead. • Direct Labour: The work of factory employees that can be physically and conveniently associated with converting raw materials into finished goods. • Labour that cannot be easily associated with the production process becomes part of overhead

8. MANAGEMENT ACCOUNTING • Determine which costs are involved in manufacturing • Overhead: Consists of costs that are indirectly associated with the manufacture of the finished product. • Manufacturing overhead includes • Indirect materials; • Indirect labour; • Amortization on factory buildings and machinery; and • Insurance, taxes, and maintenance on factory facilities.

9. MANAGEMENT ACCOUNTING • Determine which costs are involved in manufacturing Direct Materials Manufacturing Costs Direct Labour Product Costs Overhead Administrative Expenses Operating Costs Selling Expenses Period Costs

10. MANAGEMENT ACCOUNTING • Determine which costs are involved in manufacturing Cost Flow in a Manufacturing Business • So now we know what is involved in the cost of manufactured products. (DM, DL, OH) • The next thing we have to look at is how these Manufacturing Costs flow from the Balance Sheet (as inventory items) to the Income Statement (as Cost of Goods Sold). • We’ll then look at how this “Flow” is shown on the financial statements.

11. MANAGEMENT ACCOUNTING • Determine which costs are involved in manufacturing What is the Cost of Goods Sold? Recall the COGS for a Merchandise Business: • The cost of buying (and having shipped in) the items that were sold to customers. Beginning Inventory Ending Inventory COST OF GOODS SOLD Net Purchases Cost of Goods Available for Sale

12. MANAGEMENT ACCOUNTING • Determine which costs are involved in manufacturing What is the Cost of Goods Sold? The COGS for a Manufacturing Business: • COGS is still the cost of the items sold to customers. However, since WE make the products, COGS must include all Manufacturing Costs. • The first thing you must realise, is that manufacturing businesses have three inventories • Goods (and costs) move from one inventory to the other during the manufacturing process. • (Incidentally, each of the three is valued according to FIFO, LIFO, or Average Cost too)! Direct Labour (DL) and Overhead (OH) are added here. (Also known as conversion costs) Raw Materials Inventory (DM) Work in Process Inventory Finished Goods Inventory

13. MANAGEMENT ACCOUNTING • Determine which costs are involved in manufacturing What is Cost of Goods Sold? Raw Materials Inventory Finished Goods Inventory Beginning Raw Materials Inventory Ending Raw Materials Inventory Raw Materials Purchased Direct Materials Used Beginning Finished Goods Inventory Direct Labour Overhead Work in Process Inventory Beginning Work in Process Inventory Manufacturing Costs Ending Work in Process Inventory Cost of Goods Manufactured Ending Finished Goods Inventory Manufacturing Costs Are Added to the Value of Inventory COST OF GOODS SOLD

14. MANAGEMENT ACCOUNTING • Determine which costs are involved in manufacturing What is Cost of Goods Sold? Raw Materials Inventory Finished Goods Inventory $25,000 $100,000 $30,000 $95,000 $15,000 $20,000 $70,000 Work in Process Inventory $15,000 $180,000 $35,000 $160,000 $10,000 Manufacturing Costs Are Added to the Value of Inventory $170,000

15. Finished Goods Inventory Work in Process Inventory Raw Materials Inventory MANAGEMENT ACCOUNTING • … and Report Them in the Financial Statements Cost of Goods Sold Finished Goods Inventory, Jan. 1st $20,000 Work in Process, Jan. 1st $15,000 Direct Materials Raw Materials Inventory, Jan. 1st $25,000 $100,000 Add: Raw Materials Purchased $125,000 Total Raw Materials Available Less: Raw Materials Inventory, Dec. 31st $(30,000) $95,000 Direct Materials Used $15,000 Direct Labour Overhead Factory Amortization $15,000 Manufacturing Costs $30,000 Factory Utilities Factory Repairs $5,000 Indirect Labour $20,000 Total Overhead $70,000 Total Manufacturing Costs $180,000 Less: Work in Process, Dec. 31st $(35,000) Cost of Goods Manufactured $160,000 $(10,000) Less: Finished Goods Inventory, Dec. 31st Cost of Goods Sold $170,000

16. MANAGEMENT ACCOUNTING • … and Report Them in the Financial Statements

17. Do Problems: BE20-9, 10 E20-2, -4, -6, -8 P20-4

18. MANAGEMENT ACCOUNTING • Establish the Cost of manufactured items (for controlling, reporting, and for setting selling price-levels)

19. Financial Accounting Management Accounting COGS COGM MANAGEMENT ACCOUNTING • Establish the Costs of Manufactured Items Balance Sheet Income Statement Product Costing Budgeting and Forecasting Journalizing Transactions Cash Flow Statement Monitoring Variance from Budgets to Control Costs External Users via Annual Reports Management and Internal Users via Multiple Reports and Data

20. MANAGEMENT ACCOUNTING • Establish the Costs of Manufactured Items • One of the most important jobs of management accounting is determining the cost of a product. • Think about it: if you don’t know how much it costs, you can’t do any of the following: • Determine a selling price that will cover all costs • Decide how low a sales price or volume discount you can offer • Determine how to control costs (ex: finding which materials are driving cost the most, etc.) • The list goes on and on…

21. MANAGEMENT ACCOUNTING • Establish the Costs of Manufactured Items Activity Based Costing • A popular method for determining cost is ABC Costing. • The hardest part of finding the cost of a product is assigning overhead costs in a reliable and meaningful way. • ABC Costing applies overhead based on those things that actually drive costs (called cost drivers) • For example, if a product requires a lot of machining, “machine hours” will drive costs. • So you find $overhead/machine hour, and apply costs based on how many machine hours a product uses.

22. MANAGEMENT ACCOUNTING • Establish the Costs of Manufactured Items Activity Based Costing The steps are as follows: • Find all costs (DM, DL, OH) • Determine the Overhead Cost/Driver • To do this, first find the quantity of each “driver” (i.e. number of machine hours used in the period) • Then find the all the costs of running the factory & machines during the period (including Amortization) • Then divide to find the Overhead Cost/Driver • Apply the Overhead Cost/Driver rate to each product, for each driver.

23. $20 $24 $30 $60 Generic Deluxe Total Overhead Machining $200,000 Finishing $320,000 Shipping $150,000 MANAGEMENT ACCOUNTING • Establish the Costs of Manufactured Items Activity Based Costing An example: Your company manufactures two models of Widgets: Generic, and Deluxe Step 1: Find All Costs Direct Materials ($40/kg) 0.5 kg 0.6 kg Direct Labour ($10/hour) 3.0 hrs 6.0 hrs Overhead (Indirect) $670,000

24. Total Drivers Driver Generic Deluxe Units to be Made Machining Finishing Shipping MANAGEMENT ACCOUNTING • Establish the Costs of Manufactured Items Activity Based Costing Step 2: Determine the Overhead Cost/Driver • Find the costs of running the factory and machines • Divide to find the Overhead Cost/Driver • Find the quantity of each “driver” $150,000 / 250 Shipments = $600 / Shipment Total Overhead Cost per Driver ($600 x 100S)/10,000 Generic = $6/Widget ($600 x 150S)/5,000 Deluxe = $18/Widget 10,000 5,000 Hrs/Widget 20,000 hrs $10/Hr 1 $200,000 2 Hrs/Widget 2 40,000 hrs $320,000 $8/Hr 4 # of Shipments $150,000 $6/$18 per W 100 150 250 Shpmts (10,000W x 1hr) + (5,000W x 2hrs) (10,000W x 2hrs) + (5,000W x 4hrs) ($200,000 / 20,000 Hours) ($320,000 / 40,000 Hours) $670,000

25. Cost per Driver Drivers Generic Deluxe $40/Kg $10/Hr Generic Deluxe Recall from Step 2: Recall from Step 1: Drivers Cost per Driver Generic Deluxe MANAGEMENT ACCOUNTING • Establish the Costs of Manufactured Items Activity Based Costing Step 3: Apply the Overhead Cost/Driver rate Direct Materials $20 $24 0.5kg 0.6kg $30 $60 Direct Labour 3.0hrs 6.0hrs Overhead (Indirect) $10 $20 1hr Machining 2hrs $10/Hr $16 $32 Finishing 2hrs 4hrs $8/Hr $6 $18 Shipping $6 Per Widget $18 Total Product Cost $82 $154

26. Generic Deluxe Direct Materials $20 $24 $30 $60 Direct Labour Overhead (Indirect) $10 $20 Machining $16 $32 Finishing $6 $18 Shipping Total Product Cost $82 $154 MANAGEMENT ACCOUNTING • Establish the Costs of Manufactured Items How do you use this information? • Pricing products • Can’t set appropriate price without knowing product cost • Determining Contribution Margin • Once you know cost, you can determine the Contribution Margin each product will make to gross profit • Break-even Analysis • Knowing the contribution margin per product sold will allow you to calculate how many units you need to sell to cover non-product costs (i.e. operating costs) and break even. • Set Budgets and Monitor for variance • Once you know cost info, you can predict sales, costs and then monitor regularly for variance. This allows you to identify and control problems in a business. BEP is when Operating Costs = (X)[%a(Ma) + %b(Mb) + %c(Mc)] Where %a is total of all units sold that are product A, Ma is the contribution margin per unit of product A, and X is the total number of units sold of ALL types. BEP = Operating Costs / Contribution Margin per Item

27. Do Problems: See the handout

28. MANAGEMENT ACCOUNTING • Provide information on where and why costs are changing (for decision making purposes)

29. Financial Accounting Management Accounting COGS COGM MANAGEMENT ACCOUNTING • Provide Information on Where and Why Costs are Changing Balance Sheet Income Statement Cost per Driver Product Costing Budgeting and Forecasting Journalizing Transactions Cash Flow Statement Monitoring Variance from Budgets to Control Costs External Users via Annual Reports Management and Internal Users via Multiple Reports and Data

30. MANAGEMENT ACCOUNTING • Provide Information on Where and Why Costs are Changing Budget Variance Analysis Once you've determined products costs and set budgets, the management accountant’s role is to analyze why actual costs differ from budgeted costs (and they always do). This is important information for managers to have They need it in order to determine why costs are rising or falling This enables them to isolate any problems, and deal with them if possible. This is the purpose of completing a Budget Variance Analysis: to find problems.

31. Budgeted Actual MANAGEMENT ACCOUNTING • Provide Information on Where and Why Costs are Changing Budget Variance Analysis • Consider the cost data from the previous ABC Costing example (just for Deluxe Widgets). • Our budgets predicted the following: Deluxe Widgets to be made 5,000 3,000 Direct Materials ($24 per Widget) $120,000 $105,000 If actual costs turned out to be $105,000 what would that tell you? How about now?

32. MANAGEMENT ACCOUNTING • Provide Information on Where and Why Costs are Changing Budget Variance Analysis • The fact is you have absolutely no idea what the number “$105,000” tells you. • That isn’t enough to isolate what caused the variance and solve the problem (if there even is one). • To do this, you require the following info: • Production volume • Efficiency – Units of input per unit of output (i.e. how much material per widget made) • Cost of a unit of input

33. This variance is due to the fact that the actual volume of widgets produced was less than what was planed. This variance results from using more material for the actual production volume than what the budget allows for. This variance is due to a change in the budgeted price paid for the actual quantities used. $40/kg Material Cost 0.6kg Material Usage 5,000 Production Volume TOTALS MANAGEMENT ACCOUNTING • Provide Information on Where and Why Costs are Changing Budget Variance Analysis $40/kg $40/kg $50/kg 0.6kg 0.7kg 0.7kg 3,000 3,000 3,000 $72,000 $105,000 $120,000 $84,000 ($48,000) $12,000 $21,000 Cause: Wastage Price Increases Lower Production