Chapter
16
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Management Accounting:
A Business Partner
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Management Accounting:
Basic Framework
Management accounting and
assigning decision-making authority.
Accounting systems help to identify
who has authority over assets.
Accounting information supports
planning and decision-making.
Accounting reports provide a means of
monitoring, evaluating, and rewarding performance.
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Comparing Financial Accounting
and Management Accounting
Financial Accounting
Management Accounting
Provide information about the
Provide information for
Purpose
financial position and
planning, evaluating, and
performance of the company.
rewarding performance.
Balance sheet, income
Types of
statement, and statement of Various, non-standard reports.
Reports
cash flows.
Standards
GAAP
None
Reporting Usually, the company taken
A component of the
Entity
as a whole.
company's value chain.
Time
Usually a year, quarter, or a
Any period.
Periods
month.
Investors, creditors, and other Management, customers, and
Users
external parties.
others in the value chain.
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Accounting for Manufacturing
Operations
Steps in the Manufacturing Process:
Buy raw
materials.
Convert raw
materials into
finished goods.
Sell
finished
goods.
Direct
materials
costs.
Direct labor and
manufacturing
overhead costs.
Cost of
goods
sold.
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Direct Materials
Raw materials
& component
parts that
become an
integral part
of finished
products.
Can be traced
directly and
conveniently
to products.
If materials cannot be traced directly to products,
the materials are considered indirect and are part
of manufacturing overhead.
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Direct Labor
Includes the payroll cost of direct workers.
Direct labor
×
hours
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Wage
rate
Those employees
who work directly
on the goods
being
manufactured.
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Direct Labor
Includes the payroll cost of direct workers.
The cost of
employees who do
not work directly on
the goods is
considered indirect
labor and is part of
manufacturing
overhead.
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Those employees
who work directly
on the goods
being
manufactured.
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Manufacturing Overhead
All manufacturing costs other than direct
materials and direct labor.
Includes:
Indirect materials.
 Indirect labor.
 Machinery and
equipment costs.
 Cost of regulatory
compliance.

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Manufacturing Overhead
All manufacturing costs other than direct
materials and direct labor.
Includes:
Indirect materials.
 Indirect labor.
 Machinery and
equipment costs.
 Cost of regulatory
compliance.

McGraw-Hill/Irwin
Does not include
selling or general
and administrative
expenses.
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Manufacturing Overhead
The cost to
produce a unit of
product includes:
Direct material
Direct labor
Manufacturing
overhead
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Manufacturing Overhead
The cost to
produce a unit of
product includes:
Direct material
Direct labor
Manufacturing
overhead
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Manufacturing overhead
must be mathematically
allocated to each unit of
product using a
predetermined overhead
application rate.
(This will be discussed
later in this chapter.)
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Product Costs Versus Period Costs
Product Costs
(manufacturing
costs)
Period Costs
(operating
expenses and
income taxes.)
McGraw-Hill/Irwin
Balance Sheet
as
incurred
as
incurred
Current assets
and inventory
Income
Statement
Revenue
COGS
Gross profit
Expenses
Net income.
When goods
are sold.
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Inventories of a Manufacturing
Business
Raw materials - inventory on
hand and available for use.
Finished
goodscompleted
goods awaiting
sale.
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Work in
process partially
completed
goods.
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The Flow of Physical Goods
Direct
materials
purchased
Materials
Warehouse
Direct
materials
used
Factory
Direct labor &
Manufacturing overhead
Goods
sold
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Finished goods
Warehouse
Finished
goods
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The Flow of Manufacturing Costs
Direct
materials
purchased
Direct
materials
used
Materials
Inventory
$$$
$$$
Work in Process
Inventory
$$$
$$$
Direct labor &
Manufacturing overhead
Cost of
Goods Sold
$$$
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Finished Goods
Inventory
$$$
Cost of goods
manufactured
$$$
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The Flow of Manufacturing Costs
Example
Pure-Ice Inc. had $52,000 of inventory in
direct materials inventory on January 1,
2002. During the year, Pure-Ice
purchased $586,000 of additional direct
materials. At December 31, 2002, $78,000
of the direct materials were still on hand.
How much direct material was
placed into production during 2002?
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The Flow of Manufacturing Costs
Example
+
=
–
=
Beginning materials
inventory
Materials purchased
Materials available to be
placed into production
Materials placed into
production
Ending materials
inventory
McGraw-Hill/Irwin
$
52,000
586,000
638,000
??
$
78,000
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The Flow of Manufacturing Costs
Example
+
=
–
=
Beginning materials
inventory
Materials purchased
Materials available to be
placed into production
Materials placed into
production
Ending materials
inventory
McGraw-Hill/Irwin
$
52,000
586,000
638,000
!
560,000
$
78,000
© The McGraw-Hill Companies, Inc., 2002
The Flow of Manufacturing Costs
Example
In addition to the direct materials, PureIce incurred $306,000 of direct labor cost
during 2002. Manufacturing overhead for
2002 was $724,000.
Pure-Ice started 2002 with $132,000 in
work in process. During 2002, units
costing $1,480,000 were transfered to
finished goods inventory.
What is the ending balance in work
in process at December 31, 2002?
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The Flow of Manufacturing Costs
Example
Beginning work in
process inventory
$ 132,000
+ Manufacturing costs
added
1,590,000
= Total costs in process
during
the year $ 560,000 1,722,000
Direct
Materials
–Direct
CostLabor
of goods
306,000
completed during the
Manufacturing
year
(1,480,000)
Overhead
724,000
= Ending work in
Total costs added
process inventory
?
during the year
McGraw-Hill/Irwin
$ 1,590,000
© The McGraw-Hill Companies, Inc., 2002
The Flow of Manufacturing Costs
Example
+
=
–
=
Beginning work in
process inventory
Manufacturing costs
added
Total costs in process
during the year
Cost of goods
completed during the
year
Ending work in
process inventory
McGraw-Hill/Irwin
$
132,000
1,590,000
1,722,000
!
(1,480,000)
$
242,000
© The McGraw-Hill Companies, Inc., 2002
Overhead Application Rates
The overhead application rate expresses an
expected relationship between
manufacturing overhead costs and some
activity base related to the production
process.
Overhead
Application
Rate
McGraw-Hill/Irwin
Estimated
= Overhead
Costs
÷
Estimated Units
in the Activity
Base
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Overhead Application Rates
Overhead costs are estimated based
on budgets and using mathematical
estimation techniques.
Overhead
Application
Rate
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Estimated
= Overhead
Costs
÷
Estimated Units
in the Activity
Base
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Overhead Application Rates
The base is the activitiy that “drives” the
cost, called the cost driver.
Direct labor hours and machine hours are
commonly used cost drivers.
Overhead
Application
Rate
McGraw-Hill/Irwin
Estimated
= Overhead
Costs
÷
Estimated Units
in the Activity
Base
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Overhead Application Rates
Example
Big “T” Company produces
engines for big trucks. Total
overhead for 2002 is estimated to
be $2,600,000. Big “T” applies
overhead based on machine hours.
Big “T” estimates machine hours
for 2002 to be 162,500 hours.
Compute Big “T’s”
predetermined overhead rate
for 2002.
McGraw-Hill/Irwin
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Overhead Application Rates
Example
Overhead
Application
Rate
=
Estimated
Overhead
Costs
Estimated
÷ Units in the
Activity Base
= $ 2,600,000 ÷
162,500
= $
16.00 per hour
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2002
Overhead Application Rates
Example
Overhead
Application
Rate
=
Estimated
Overhead
Costs
Estimated
÷ Units in the
Activity Base
= $ 2,600,000 ÷
= $
McGraw-Hill/Irwin
162,500
16.00 per hour
© The McGraw-Hill Companies, Inc., 2002
Overhead Application Rates
Some companies use different cost drivers
for different manufacturing activities, a
process called ACTIVITY BASED COSTING.
Overhead
Application
Rate
McGraw-Hill/Irwin
Estimated
= Overhead
Costs
÷
Estimated Units
in the Activity
Base
© The McGraw-Hill Companies, Inc., 2002
Determining the Cost of Finished
Goods Manufactured
A schedule of the cost
of finished goods
manufactured is
prepared to assist
managers in
understanding and
evaluating the overall
cost of manufacturing
products.
McGraw-Hill/Irwin
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CONQUEST, INC.
Schedule of the Cost of Finished Goods Manufactured
For the Year Ended December 31, 2002
Work in process inventory, beg.
$
Manufacturing cost assigned to
production:
Direct Materials
$
150,000
Direct Labor
300,000
Manufacturing overhead
360,000
Total manufacturing costs
Total cost of all work in process
during the year
Less: Work in process
inventory, end of year
Cost of finished goods manufactured
$
McGraw-Hill/Irwin
30,000
810,000
840,000
(40,000)
800,000
© The McGraw-Hill Companies, Inc., 2002
Beginning finished goods
inventory
Add: Cost of finished goods
manufactured during the year
CONQUEST, INC.
CostGoods
of finished
Schedule of the Cost of Finished
Manufacturedgoods
For the Year Ended December 31, 2001
available for sale
Work in process inventory, beg.
$
30,000
Less: Ending
finished
goods
Manufacturing cost assigned to
production:
inventory
Direct Materials
$
150,000
Cost
of
Goods Sold
Direct Labor
300,000
Manufacturing overhead
360,000
Total manufacturing costs
Total cost of all work in process
during the year
$
Less: Work in process
inventory, end of year
Cost of finished goods manufactured
$
McGraw-Hill/Irwin
$ 150,000
800,000
950,000
168,000
$ 782,000
810,000
840,000
(40,000)
800,000
The cost of goods
completed during
the period is used
to compute COGS
for the period.
© The McGraw-Hill Companies, Inc., 2002
The income
statement is
prepared
using
established
financial
accounting
procedures.
McGraw-Hill/Irwin
CONQUEST, INC.
Income Statement
For the Year Ended December 31, 2002
Sales
Cost of Goods Sold
Gross profit on sales
Operating expenses
Income from operations
Less: Interest expense
Income before income
taxes
Income tax expense
Net income
$ 1,300,000
782,000
$ 518,000
400,000
$ 118,000
18,000
$
$
100,000
30,000
70,000
© The McGraw-Hill Companies, Inc., 2002
End of Chapter 16
This is a great job, but
the overhead is killing
my profit margin!
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2002