Building Blocks of Managerial
Accounting
Chapter 2
2-1
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Objective 1
Distinguish among service, merchandising,
and manufacturing companies
2-2
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Service Companies
• Sell services
• No inventory or cost of goods sold
accounts
• Labor costs – incurred to develop new
services, advertise, provide customer
service
2-3
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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
2-4
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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
2-5
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Objective 2
Describe the value chain and its
elements
2-6
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Value Chain
• Activities that add value to products and
services
R&D
Design
Production/
Purchases
Customer
Service
Distribution
Marketing
2-7
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Objective 3
Distinguish between direct and indirect
costs
2-8
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Cost Object
• Anything for which managers want a
separate measurement of cost
 Direct cost – can be traced directly to cost
object
 Indirect cost – cannot be traced directly to
cost object
2-9
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Objective 4
Identify the inventoriable product costs and
period costs of merchandising and
manufacturing firms
2-10
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Inventoriable Product Costs
•
Inventoriable product costs – costs
incurred during production or purchases
stage of value chain
2-11
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Inventoriable Product Costs:
Incurred During Production or
Purchases Stage of Value Chain
R&D
Customer
Service
Inventoriable
Design
Product
Costs
Production/
Purchases
Distribution
Marketing
2-12
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Period Costs: All Costs Incurred in
the Other Stages of the Value Chain
Customer
Service
Distribution
Marketing
Period Costs
2-13
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Merchandising Company
Product Costs
• Purchase price plus cost of getting
merchandise ready for sale
2-14
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Manufacturing Company’s
Inventoriable Product Costs
• Direct materials
Direct Costs
• Direct labor
• Manufacturing overhead
Indirect Costs
2-15
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Manufacturing Overhead
• Indirect costs related to manufacturing
operations
• Generally all manufacturing costs that are
not direct costs
 Indirect materials
 Indirect labor
2-16
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Prime and Conversion Costs
Direct
Materials
Direct
Labor
Prime Costs
Manufacturing
Overhead
Conversion
Costs
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2-17
Direct and Indirect Labor
Compensation
• Salaries & wages
• Fringe benefits
• Payroll taxes
2-18
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Service Company
• All costs are period costs
• Operating income = Service revenue –
operating expenses
2-19
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Objective 5
Prepare the financial statements for service,
merchandising, and manufacturing companies
2-20
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Inventory
sold in
2008
2008
Product
costs
Cost of
goods
sold
2008
Income
Statement
2008
Balance
Sheet
Inventory
Inventory
sold in
2009
Cost of
goods
sold
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2009
Income
2-21
Statement
Merchandising Company:
Income Statement
Sales
- Cost of goods sold
Gross profit
- Operating expenses
Operating income
2-22
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Merchandising Company:
Cost of Goods Sold Calculation
Cost of goods sold:
Beginning inventory
+ Purchases
+ Freight-in
Cost of goods available for sale
- Ending inventory
Cost of goods sold
2-23
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Manufacturing Companies:
Income Statement
Sales
- Cost of goods sold
Gross profit
- Operating expenses
Operating income
2-24
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Manufacturing Company:
Calculating Cost of Goods Sold
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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2-25
Manufacturing Company:
Calculating Cost of Goods
Manufactured
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
2-26
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Manufacturing Company:
Direct Materials Calculation
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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2-27
Product and Period Costs
Type of
Company
Service
Company
Merchandising
Company
Manufacturing
Company
Accounting
Treatment
Inventoriable
Product Costs
None
Period Costs
All costs along
the value chain
Purchases plus All costs except
cost of freight
purchases
Direct
All costs except
Materials, Labor production
and MFG OH
Inventory, then Always
expense
Expense
2-28
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Manufacturing Companies’
Inventory Accounts
Materials Inventory
Beginning inventory
Materials used
Purchases & freight
Ending inventory
2-29
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Manufacturing Companies’
Inventory Accounts
Work in Process
Inventory
Beginning inventory
Materials used
Cost of goods
manufactured
Direct labor
Manufacturing
overhead
Ending inventory
2-30
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Manufacturing Companies’
Inventory Accounts
Finished Goods
Inventory
Beginning inventory
Cost of goods
manufactured
Cost of goods
sold
Income Statement
Ending inventory
2-31
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E2-23
a. Direct
__________
costs can be traced to cost
What is the
objects.
term applied to
the total of
b. Period
____________
direct material
costs are expensed when
and direct
incurred.
labor?
c. _____ are the combination of direct
materials and direct labor.
d. Compensation includes wages, salaries,
fringe benefits
and _________________.
2-32
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E2-23
What section of
the Balance
Sheet does the
Inventory
account live in?
e. Inventoriable
________________________
product costs are
treated as _______until sold.
f. Inventoriable
________________________
product costs include
costs from only the production or
purchases element of the value chain.
g. Indirect
_____________are
allocated to cost
costs
objects.
assigned
h. Both direct and indirect costs are ______
to ________________.
cost objects
2-33
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E2-23
What is the
name of the
activity that
involves turning
raw materials
into finished
goods?
product costs
i. Full
__________________
include costs
from every element of the value chain.
j. __________________ are the
combination of direct labor and
manufacturing overhead.
product costs are
k. Inventoriable
_________________________
expensed as
__________________when
sold.
cost
of goods sold
2-34
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E2-23
l. Manufacturing overhead includes all
indirect costs of production.
______________
2-35
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Objective 6
Describe costs that are relevant and
irrelevant for decision making
2-36
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Controllable vs Uncontrollable Costs
• Controllable – management can influence
or change cost
• Uncontrollable – management cannot
change or influence cost in the short-run
2-37
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Relevant and Irrelevant Costs
• Relevant – costs that differ between
alternatives
 Differential costs
• Irrelevant – costs that do not differ
 Sunk costs
2-38
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Objective 7
Classify costs as fixed or variable and
calculate total and average costs at
different volumes
2-39
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Cost Behavior
• Variable costs – change in total in direct
proportion to changes in volume
• Fixed costs – stay constant in total over a
wide range of activity levels
2-40
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Total Variable Costs
Total Sales
Commissions
Assume we pay 5% sales commissions on
all sales. The cost of sales commissions
increases proportionately with increases in
$2,500
sales.
$2,000
$1,500
$1,000
$500
$0
$0
$10,000 $20,000 $30,000 $40,000
Total Sales
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2-41
Total Sales Salaries
Total Fixed Costs: Stay Constant in Total
Over a Wide Range of Activity Levels
$2,500
$2,000
$1,500
$1,000
$500
$0
$0
$10,000 $20,000 $30,000 $40,000
Total Sales
2-42
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Total Cost
Total fixed costs
+ (Variable cost per unit x number of units)
= Total Cost
Example:
If Fixed Costs are $20,000,000 and Variable Costs
are $5,000 per vehicle, and there are 10,000
vehicles, then:
Total Cost= $20,000,000 + ($5,000 x 10,000) or
$70,000,000
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2-43
Average Cost
Total cost ÷ number of units = Average cost
Example:
$70,000,000 (Total Cost)_ = $7,000 per vehicle
10,000 vehicles
2-44
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Marginal Cost
• Cost of making one more unit
 Example – fixed costs will not change when
one more unit is manufactured, so therefore
the marginal cost of a unit is simply its
variable cost
2-45
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E2-32
This type of
cost changes
as another cost
changes.
a. Managers cannot influence uncontrollable
__________
_____
costs in the short-run.
b. Total _____________ decrease when
production volume decreases.
c. For decision-making purposes, costs that
do not differ between alternatives are
irrelevant costs
________________.
d. Costs that have already been incurred are
called ____________.
sunk costs
2-46
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E2-32
This type of
cost does not
change with
changes in
other costs.
e. Total ___________ stay constant over a
wide range of production volume.
differential cost is the difference
f. The _______________
in cost between two alternative courses
of action.
marginal cost is the cost
g. The product’s ____________
of making one more unit.
2-47
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E2-32
h. A product’s ____________
fixed costs and
variable costs not the product’s
____________,
___________,
average cost should used to forecast
total costs at different production volumes.
2-48
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End of Chapter 2
2-49
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