Accounting Principles, 5e Weygandt, Kieso, & Kimmel Prepared by Marianne Bradford, Ph.D. Bryant College John Wiley & Sons, Inc. CHAPTER 20 MANAGERIAL ACCOUNTING After studying this chapter, you should be able to: 1 Explain the distinguishing features of managerial accounting. 2 Identify the 3 broad functions of management. 3 Define the 3 classes of manufacturing costs. 4 Distinguish between product and period costs. 5 Explain the difference between a merchandising and a manufacturing income statement. CHAPTER 20 MANAGERIAL ACCOUNTING After studying this chapter, you should be able to: 6 Indicate how cost of goods manufactured is determined. 7 Explain the difference between a merchandising and a manufacturing balance sheet. PREVIEW OF CHAPTER 20 MANAGERIAL ACCOUNTING Managerial Accounting Basics Comparing managerial and financial accounting Ethical standards Management functions Managerial Cost Concepts Manufacturing Product costs versus period costs PREVIEW OF CHAPTER 20 MANAGERIAL ACCOUNTING Manufacturing Costs in Financial Statements Income statement Balance sheet Cost Concepts: a review Contemporary Developments in Managerial Accounting Service industry trends Value chain management STUDY OBJECTIVE 1 Explain the distinguishing features of managerial accounting. MANAGERIAL ACCOUNTING BASICS Managerial accounting (management accounting) is a field of accounting that provides economic and financial information for managers and other internal users. MANAGERIAL ACCOUNTING BASICS The activities that are part of managerial accounting are as follows: 1 Explaining manufacturing and nonmanufacturing costs and how they are reported in the financial statements. 2 Computing the cost of providing a service or manufacturing a product. 3 Determining the behavior of costs and expenses as activity levels change and analyzing cost-volume-profit relationships within a company. MANAGERIAL ACCOUNTING BASICS 4 Assisting management in profit planning and formalizing these plans in the form of budgets. 5 Providing a basis for controlling costs and expenses by comparing actual results with planned objectives and standard costs. 6 Accumulating and presenting relevant data for management decision making. ILLUSTRATION 20-1 DIFFERENCES BETWEEN FINANCIAL AND MANAGERIAL ACCOUNTING FINANCIAL ACCOUNTING Primary Users of Reports External users: stockholders, creditors, and regulatory. Types and Frequency of Reports Classified financial statements. Issued quarterly and annually. Purpose of Reports General-purpose information for all users. ILLUSTRATION 20-1 DIFFERENCES BETWEEN FINANCIAL AND MANAGERIAL ACCOUNTING FINANCIAL ACCOUNTING Content of Reports Pertains to business as a whole and is highly aggregated (condensed). Limited to double-entry accounting system and cost data. Reporting standard is generally accepted accounting principles. Verification Process Annual independent audit by certified public accountant. ILLUSTRATION 20-1 DIFFERENCES BETWEEN FINANCIAL AND MANAGERIAL ACCOUNTING MANAGERIAL ACCOUNTING Primary Users of Reports Internal users: officers, department heads, managers, and supervisors. Types and Frequency of Reports Internal reports. Issued as frequently as needed. Purpose of Reports Special-purpose information for a particular user for a specific decision. ILLUSTRATION 20-1 DIFFERENCES BETWEEN FINANCIAL AND MANAGERIAL ACCOUNTING MANAGERIAL ACCOUNTING Content of Reports Pertains to subunits of the entity and may be very detailed. May extend beyond double-entry accounting system to any type of relevant data. Reporting standard is relevance to the decision to be made. Verification Process No independent audits. ETHICAL STANDARDS FOR MANAGERIAL ACCOUNTANTS Managerial accountants recognize that they have an ethical obligation to their companies and the public. The Institute of Management Accountants (IMA) has developed a code of ethical standards, entitled Standards of Ethical Conduct for Management Accountants. This code divides the managerial accountant’s responsibilities into 4 areas: 1 competence, 2 confidentiality, 3 integrity, and 4 objectivity. STUDY OBJECTIVE 2 Identify the three broad functions of management. MANAGEMENT FUNCTIONS The management of an organization performs (3) broad functions: 1 Planning 2 Motivating and Directing 3 Controlling MANAGEMENT FUNCTIONS PLANNING Planning requires management to 1 look ahead and 2 establish objectives. A key modern management objective is to add value to the business under its control. Value is usually measured by 1 the trading price of the company’s stock and 2 the potential selling price of the company. MANAGEMENT FUNCTIONS ORGANIZING AND DIRECTING Motivating and directing involves coordinating diverse activities and human resources to produce a smooth-running operation. This function relates to implementing of planned objectives. Most companies prepare organization charts to show 1 the interrelationship of activities and 2 the delegation of authority and responsibility within the company. MANAGEMENT FUNCTIONS CONTROLLING Controlling is the process of keeping the firm’s activities on track. In controlling operations, managers determine 1 whether planned goals are being met and 2 when there are deviations from targeted objectives. MANAGERIAL COST CONCEPTS To perform the three management functions effectively, management needs information. One very important type of information is related to costs. The following questions need answering: 1 What costs are involved in making the product or providing a service? 2 If production volume is decreased, will costs decrease? 3 What impact will automation have on total costs? 4 How can costs best be controlled? STUDY OBJECTIVE 3 Define the three classes of manufacturing costs. MANAGERIAL COST CONCEPTS Manufacturing consists of activities and processes that convert raw materials into finished goods. Manufacturing costs are usually classified as follows: 1 direct materials, 2 direct labor, and 3 manufacturing overhead. ILLUSTRATION 20-2 CLASSIFICATIONS OF MANUFACTURING COSTS DIRECT MATERIALS DIRECT LABOR MANUFACTURING OVERHEAD MANUFACTURING COSTS DIRECT MATERIALS Raw materials are the basic materials and parts that are to be used in the manufacturing process. Raw materials that can be physically and directly associated with the finished product during the manufacturing process are called direct materials. Materials MANUFACTURING COSTS INDIRECT MATERIALS Some raw materials cannot be easily associated with the finished product. These are considered indirect materials – which areaccounted for as part of manufacturing overhead and 1 do not physically become part of the finished product or 2 cannot be traced because their physical association with the finished product is too small in terms of cost. MANUFACTURING COSTS DIRECT LABOR Direct labor is the work of factory employees that can be physically and directly associated with converting raw materials into finished goods. The wages of maintenance people, timekeepers, and supervisors are usually identified as indirect labor. Their efforts have no physical association with the finished product. Like indirect materials, indirect labor is Factory part of manufacturing overhead. Labor MANUFACTURING COSTS MANUFACTURING OVERHEAD Manufacturing overhead consists of costs that are indirectly associated with the manufacture of the finished product. These costs may also be manufacturing costs that cannot be classified as direct materials or direct labor. Manufacturing overhead includes Manufacturing Overhead 1 indirect materials; 2 indirect labor; 3 depreciation on factory buildings and machines 4 insurance, taxes, and maintenance on factory facilities. STUDY OBJECTIVE 4 Distinguish between product and period costs. PRODUCT COSTS VERSUS PERIOD COSTS Product costs include each of the manufacturing cost elements (direct materials, direct labor, and manufacturing overhead); they are costs that are a necessary and integral part of producing the finished product. These costs are not expensed to cost of goods sold under the matching principle until the finished goods inventory is sold. PRODUCT COSTS VERSUS PERIOD COSTS Direct materials and direct labor are often referred to as prime costs due to their direct association with the manufacturing of the finished product. Direct labor and manufacturing overhead are often referred to as conversion costs since they are incurred in converting raw materials into finished goods. Period costs: a) are identifiable with a specific time period, b) relate to nonmanufacturing noninventoriable costs, and c) include selling and administrative expenses. ILLUSTRATION 20-4 PRODUCT VERSUS PERIOD COSTS Product Costs Manufacturing Costs Direct Labor Manufacturing Overhead Period Costs Selling Expenses Nonmanufacturing Costs Administrative Expenses { { Direct Materials Prime Costs Conversion Costs STUDY OBJECTIVE 5 Explain the difference between a merchandising and a manufacturing income statement. COST OF GOODS SOLD COMPONENTS Under a periodic inventory system, the income statements of a merchandiser and a manufacturer differ in the cost of goods sold section. For a merchandiser, cost of goods sold is computed by adding the beginning merchandise inventory and the cost of goods purchased and subtracting the ending merchandise inventory. For a manufacturer, cost of goods sold is computed by adding the beginning finished goods inventory and the cost of goods manufactured and subtracting the ending finished goods inventory. ILLUSTRATION 20-5 COST OF GOODS SOLD COMPONENTS Merchandiser Beginning Merchandise Inventory + Cost of Goods Purchased - Ending Merchandise Inventory = Cost of Goods Sold Manufacturer Beginning Finished Goods Inventory + Cost of Goods Manufactured - Ending Finished Goods Inventory = ILLUSTRATION 20-6 COST OF GOODS SOLD SECTIONS OF MERCHANDISING AND MANUFACTURING COMPANIES The cost of goods sold sections for merchandising and manufacturing enterprises that are presented illustrate the different presentations: MERCHANDISE COMPANY Partial Income Statement For the Year Ended December 31, 2002 Cost of goods sold Merchandise inventory, January 1 Cost of goods purchased Cost of goods available for sale Merchandise inventory, December 31 Cost of goods sold $ 70,000 650,000 720,000 400,000 $ 320,000 ILLUSTRATION 20-6 COST OF GOODS SOLD SECTIONS OF MERCHANDISING AND MANUFACTURING COMPANIES MANUFACTURING COMPANY Partial Income Statement For the Year Ended December 31, 2002 Cost of goods sold Finished goods inventory, January 1 Cost of goods manufactured Cost of goods available for sale Finished goods inventory, December 31 Cost of goods sold $ 90,000 370,000 460,000 80,000 $ 380,000 STUDY OBJECTIVE 6 Indicate how cost of goods manufactured is determined. ILLUSTRATION 20-7 COST OF GOODS MANUFACTURED FORMULA The total cost of work in process for the year is equal to the sum of: 1 the cost of the beginning work in process inventory and 2 the total manufacturing costs for the current period. To find the cost of goods manufactured, we subtract the cost of the ending work in process inventory from the total cost of work in process. Beginning Work in Process Inventory Total Cost of Work in Process + - Total Current Manufacturing Costs Ending Work in Process Inventory = Total Cost of Work in Process = Cost of Goods Manufactured ILLUSTRATION 20-8 COST OF GOODS MANUFACTURED SCHEDULE The Cost of Goods Manufactured Schedule – as shown on the right is an internal financial schedule that shows each of the cost elements explained in Illustration 20-7. OLSEN MANUFACTURING COMPANY Cost of Goods Manufactured Schedule For the Year Ended December 31, 2002 Work in process, January 1 Direct materials Raw materials inventory, January 1 Raw materials purchases Total raw materials available for use Less: Raw materials inventory, December 31 Direct materials used Direct labor Manufacuring overhead Indirect labor Factory repairs Factory utilities Factory depreciation Factory insurance Total manufacturing overhead Total manufacuring costs Total cost of work in process Less: Work in process, December 31 Cost of goods manufactured $ 18,400 $ 16,700 152,500 169,200 22,800 $ 146,400 175,600 14,300 12,600 10,100 9,440 8,360 54,800 376,800 395,200 25,200 $ 370,000 STUDY OBJECTIVE 7 Explain the difference between a merchandising and a manufacturing balance sheet. CURRENT ASSETS SECTIONS OF MERCHANDISING AND MANUFACTURING BALANCE SHEETS The balance sheet for a merchandiser shows just one inventory category. In contrast, the balance sheet of a manufacturer may have 3 inventory accounts: 1 Finished Goods Inventory – shows the cost of completed goods on hand, 2 Work in Process Inventory – shows the cost applicable to units that have been started into production but are only partially completed, and 3 Raw Materials Inventory – shows the cost of raw materials on hand. ILLUSTRATION 20-10 CURRENT ASSETS SECTIONS OF MERCHANDISING AND MANUFACTURING BALANCE SHEETS Merchandising Company Balance Sheet December 31, 2002 Current assets Cash Receivables (net) Merchandise inventory Prepaid expenses Total current assets $ 100,000 210,000 400,000 22,000 $ 732,000 ILLUSTRATION 20-10 CURRENT ASSETS SECTIONS OF MERCHANDISING AND MANUFACTURING BALANCE SHEETS Manufacturing Company Balance Sheet December 31, 2002 Current assets Cash Receivables (net) Inventories: Finished goods Work in process Raw materials Prepaid expenses Total current assets $ 180,000 210,000 $ 80,000 25,200 22,800 128,000 18,000 $ 536,000 ILLUSTRATION 20-11 ASSIGNMENT OF COSTS TO COST CATEGORIES The manufacturing and selling costs can be assigned to the various categories shown below. Cost Item 1. Material cost ($10 per door) 2. Labor costs ($8 per door) 3. Depreciation on new equipment ($25,000 per year) 4. Property taxes ($6,000 per year) 5. Advertising costs ($30,000 per year) 6. Sales commissions ($4 per door) 7. Maintenance salaries ($28,000 per year) 8. Salary of plant manager ($70,000) 9. Cost of shipping pre-hung doors ($12 per door) Product Costs Direct Direct Manufacturing Materials Labor Overhead Period Costs X X X X Prime Costs Conversion Costs X X X X X X X X X X X X ILLUSTRATION 20-12 COMPUTATION OF TOTAL MANUFACTURING COSTS Total manufacturing costs are the sum of the product costs – direct materials, direct labor, and manufacturing overhead costs. Northridge Company produces 10,000 pre-hung wooden doors the first year. The total manufacturing costs are: Cost Number and Item 1. Material cost ($10 X 10,000) 2. Labor cost ($8 X 10,000) 3. Depreciation on new equipment 4. Property taxes 7. Maintenance salaries 8. Salary of plant manager Total manufacturing costs Manufacturing Cost $ 100,000 80,000 25,000 6,000 28,000 70,000 $ 309,000 CONTEMPORARY DEVELOPMENTS IN MANAGERIAL ACCOUNTING Global competition has intensified. Today, contemporary business managers demand from managerial accountants different and better information than they needed just a few years ago. Service Industry Trends – in some respects the challenges for managerial accounting are greater in service companies than in manufacturing companies. ILLUSTRATION 20-13 SERVICE INDUSTRIES AND COMPANIES What are the questions faced by service company managers in these industries? Transportation Package delivery services Telecommunications Professional services Financial institutions Health Care CONTEMPORARY DEVELOPMENTS IN MANAGERIAL ACCOUNTING VALUE CHAIN The value chain is the term that describes all activities associated with providing a product or service. Activities included in the value chain include: Research and development Ordering raw materials Manufacturing Marketing Delivery Customer relations. CONTEMPORARY DEVELOPMENTS IN MANAGERIAL ACCOUNTING VALUE CHAIN A number of factors affect efforts to manage the value chain and supply chain. Technological change Just-in-time inventory methods Quality Focus on activities COPYRIGHT Copyright © 2002 John Wiley & Sons, Inc. All rights reserved. Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United States Copyright Act without the express written consent of the copyright owner is unlawful. Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc. The purchaser may make back-up copies for his/her own use only and not for distribution or resale. The Publisher assumes no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein. CHAPTER 20 MANAGERIAL ACCOUNTING