Chapter 2
Basic Managerial Accounting
Concepts
COPYRIGHT © 2012 Nelson Education Ltd.
Learning Objectives
1. Explain the meaning of cost and how costs are
assigned to products and services
2. Define the various costs of manufacturing products
and providing services as well as the costs of selling
and administration
3. Prepare income statements for manufacturing and
service organizations
2-2
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OBJECTIVE 1
Explain the meaning of
cost and how costs are
assigned to products
and services
COPYRIGHT © 2012 Nelson Education Ltd.
Cost
• Amount of cash or cash equivalent
sacrificed for goods and/or services
• Expected to bring a current or future
benefit to organization
Let’s look at an example
A furniture manufacturer buys lumber for $10,000
Cost of the lumber is the amount given
up…$10,000
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Expenses
As costs are used up in production of
revenues, they expire
Expired costs are called expenses
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Cost vs. Price
Be careful!
Cost and Price are not the same thing
Price
Cost
What we pay
for something
Amount we charge
our customers for
our products or
services
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Accumulating Costs
Received
telephone bill
Telephone Expense
Phone
Bill
$150
Recorded in
Telephone
Expense
account
Bal. $800
+ $150
$950
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Accumulating Costs
This is helpful but
managers also need to
know which departments
used the $950 in
Telephone Expense
Telephone Expense
Bal. $800
+ $150
$950
In other words, managers
want to know how costs are
assigned to cost objects
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Cost Objects
• Any item for which costs are measured
and assigned
• Examples:
– Products
– Customers
– Departments
– Regions
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Assigning Costs
Sales Dept.
Manufacturing
Dept.
Let’s say the Telephone
Expense was incurred by the
Sales and the Manufacturing
Departments
The Sales and
Manufacturing departments
are cost objects
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Assigning Costs
Sales Dept.
Telephone Expense
$350
Bal. $800
+ $150
$950
Manufacturing
Dept.
$600
The accountant assigns the Telephone
Expense to the two cost objects
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Assigning Costs
• Costs can be assigned in a number of ways
• Some methods are more accurate, but time
consuming
• Others are simple, but not as precise
These methods will be discussed further
in upcoming chapters
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Cost Classification
• Different costs are used for different
purposes
• Classification helps make sense of great
variety of costs
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Tracing Direct Costs
Direct Costs:
• Easily and accurately
traced to a cost object
• Relationship between
the cost and the object
can be physically
observed
Indirect Costs:
• Cannot be easily
traced to a cost object
• Relationship between
the cost and the object
not easily observed
• Assigned through
allocation
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Other Categories of Cost
• Variable Cost
– increases in total as output increases and
decreases in total as output decreases
• Fixed Cost
– total does not increase as output increases and
does not decrease as output decreases
• Opportunity Cost
– benefit given up or sacrificed when one alternative
is chosen over another
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OBJECTIVE 2
Define the various costs of
producing products and
services, as well as the costs
of selling and administration
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Output
One of the most important cost objects of
a company is its output
Two types of output:
Products
Services
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Output Continued
Products:
• Goods produced by converting raw materials
through use of labour and capital inputs
• Produced by manufacturing organizations
Services:
• Tasks or activities performed for a customer or an
activity performed by a customer using an
organization’s products or facilities
• Produced by services organizations
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Cost Types
• Product (manufacturing) costs
– Associated with the manufacture of goods or
the provision of services
• Nonproduction costs
– All other costs
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Nonproduction Costs
Examples:
•
Designing
•
Distribution
•
Developing
•
Customer Service
•
General
Administration
•
Marketing
These are Administrative costs
COPYRIGHT © 2012 Nelson Education Ltd.
These are Selling
costs
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Product Cost Classifications
Only three cost elements can be assigned to
products for financial reporting:
Direct
Materials
Overhead
Direct
Labour
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Direct Materials & Labour
Direct Materials:
• Part of final product
• Directly traced to goods and services being
produced
Direct Labour:
• Directly traced to goods or services being produced
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Manufacturing Overhead
All product costs other than direct
materials or direct labour:
Indirect
Materials
Supplies
Utilities
Indirect
Labour
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Total Product Cost
Total Product
= Direct + Direct + Manufacturing
Cost
Materials
Labour
Overhead
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Product Cost Per Unit
Unit Cost
=
Total Product Cost
Number of Units
Produced
Let’s work through an
example
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Cornerstone 2-1
How to Calculate Product Cost in Total and Per Unit
Information:
• BlueDenim Company makes blue jeans. Last week:
– Direct materials (denim, thread, zippers, and rivets)
costing $48,000 were put into production
– Direct labour of $30,000 (50 workers × 40 hours × $15
per hour) was incurred
• Overhead equals $72,000
• By the end of the week, the company had manufactured
30,000 pairs of jeans
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COPYRIGHT © 2012 Nelson Education Ltd.
Example
Required:
• Calculate the total product cost for last week
• Calculate the cost of one pair of jeans that were
produced last week
Now that we
know what we
have to do, let’s
get started!
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Total Product Cost
Direct Materials + Direct Labour + Overhead
Direct Materials
$48,000
Direct Labour
30,000
Overhead
72,000
Total Product Cost
$150,000
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Per-Unit Product Cost
Total Product Cost
Number of Units
Produced
$150,000
30,000
$5
per
pair
=
of jeans
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Cornerstone 2-2
How to Calculate Prime Cost and
Conversion Cost in Total and Per Unit
Information:
• Again, looking at BlueDenim Company. Last week:
– Direct materials (denim, thread, zippers, and rivets)
costing $48,000 were put into production
– Direct labour of $30,000 (50 workers × 40 hours × $15
per hour) was incurred
• Overhead equals $72,000
• By the end of the week, the company had manufactured
30,000 pairs of jeans
2-30
COPYRIGHT © 2012 Nelson Education Ltd.
Example
Required:
• Calculate the total prime cost for last week
• Calculate the per-unit prime cost
• Calculate the total conversion cost for last week
• Calculate the per-unit conversion cost
Now that we know what
we have to do, let’s get
started!
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Prime Costs
Direct
Materials
+
Direct
Labour
$48,000
+
$30,000
Prime Costs
per unit
=
$78,000
30,000
=
$2.60
Units produced
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Conversion Costs
Conversion Costs = Direct Labour + Overhead
cost of converting raw materials into a final product
Direct Labour
$30,000
Conversion
Costs per unit
=
+
Overhead
$72,000
$102,000
30,000
=
$3.40
Units produced
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Period Costs
Unlike product costs which are carried in
inventory; period costs are expensed in the
period in which they are incurred
Two categories of period
costs: Selling Costs and
Administrative Costs
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Selling Costs
Costs necessary to market, distribute, and
service a product or service
Examples:
Salaries and
commissions
of sales people
Warehousing
Advertising
Shipping
Customer
Service
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Administrative Costs
All costs associated with research,
development, and general administration of
the organization that cannot be assigned to
selling or production
Examples:
General
Accounting
Legal Fees
Top Executive
Salaries
Expenses of
printing the
annual report
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OBJECTIVE 3
Prepare income statements
for manufacturing and
service organizations
COPYRIGHT © 2012 Nelson Education Ltd.
Financial Statements for
Manufacturing Operations
Business operations
can be classified as:
• Service
• Merchandising
• Manufacturing
Text focuses on
manufacturing
businesses
• Most managerial
accounting concepts also
apply to service and
merchandising businesses
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Direct Materials & Labour
Direct Materials Cost:
• Part of final product
• Directly traced to goods and services being
produced
Direct Labour Cost:
• Directly traced to goods or services being produced
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Factory Overhead Cost
(Manufacturing Overhead)
• Costs other than direct materials and
direct labour cost
• Incurred in manufacturing process
• Combined and classified as factory
overhead cost
• All factory overhead costs are indirect
costs of the product
Examples: heat and light for the factory,
power to run the machines
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Balance Sheet for a
Manufacturing Business
• Three types of inventory:
1. Materials
2. Work in Process (WIP)
3. Finished Goods
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Income Statement for a
Manufacturing Business
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Cost of Goods Manufactured
• Step 1
– Determine the cost of direct materials
used
• Step 2
– Determine the total manufacturing costs
incurred.
• Step 3
– Determine the cost of goods
manufactured.
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Direct Materials Used
• Only the amount used on products produced
during the current period
• Consider beginning and ending inventory
levels
• Key point: Purchases do not equal materials
used
Let’s go through an example
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Cornerstone 2-3
How to Calculate the Direct Materials Used in
Production
Information:
• On May 1, BlueDenim had $68,000 of materials in inventory
• During the month of May, the company purchased $210,000
of materials
• On May 31, materials inventory equalled $22,000
Required:
Calculate the direct materials used in production for May
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Direct Materials
Beginning
Ending
Materials
Materials + Purchases - Materials =
Used in
Inventory
Inventory
Production
$68,000
+ $210,000 ‒ $22,000
=
$256,000
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Work in Process
• Second type of inventory
• Cost of partially completed goods that are still on
the factory floor at the end of the period
• Units are started, but not finished
• Included direct materials, direct labour, and
overhead costs
Let’s continue our example
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Cornerstone 2-4
How to Calculate Cost of Goods Manufactured
(COGM)
Information:
• During the month of May, the company purchased
$210,000 of materials
• On May 31, materials inventory equaled $22,000
• During the month of May, BlueDenim Company incurred:
– Direct labour cost of $135,000
– Overhead of $150,000
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Example
Inventory is as follows:
May 1
Materials
$68,000
Work in Process 50,000
May 31
$22,000
16,000
Required:
• Calculate the cost of goods manufactured for May
• Calculate the cost of one pair of jeans assuming that
115,000 pairs of jeans were completed during May
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BlueDenim Company
Cost of Goods Manufactured
For the Month of May
Direct materials
Direct labour
Overhead
$256,000
135,000
150,000
Total Manufacturing Cost
Work in Process, May 1
Work in Process, May 31
Cost of Goods Manufactured
$541,000
50,000
(16,000)
$575,000
Per unit Cost of
Goods Manufactured
$575,000
=
$5
115,000 units
2-50
COPYRIGHT © 2012 Nelson Education Ltd.
Cornerstone 2-5
How to Calculate Cost of Goods Sold
(COGS)
Information:
• On May 1 BlueDenim Company had 10,000 units in
finished goods inventory costing $50,000
• On May 31 the company had 26,000 units in finished
goods inventory costing $130,000
Required:
• Calculate the cost of goods sold for May
• Calculate the number of jeans that were sold in May
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Cost of Goods Sold
• Represent the total cost of units sold during a
period
• Includes only product cost
• Includes direct materials, direct labour, and
overhead
• Reported as an expense on the income statement
“Sold” is the key word.
Let’s continue with our example
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BlueDenim Company
Cost of Goods Sold
For the Month of May
Cost of goods manufactured
$575,000
Finished goods, May 1
50,000
Finished goods, May 31
(130,000)
Cost of Goods Sold
$495,000
Reported as an
asset on the
Balance Sheet
Reported as an expense on the
Income Statement
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Units Sold
Number of units sold:
Finished goods inventory, May 1
10,000
Units finished during May
115,000
Finished goods inventory, May 31
(26,000)
Units sold during May
99,000
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Cornerstone 2-6
How to Prepare an Income Statement for a
Manufacturing Firm
Information:
• BlueDenim Company sold 99,000 pairs of jeans in May at a
total cost of $495,000
• Each pair sold at a price of $8
• BlueDenim also incurred two types of selling costs:
– Commissions equal to 10% of the sales price
– Other selling expense of $120,000
• Administrative expense totalled $85,000
Required:
Prepare an income statement for BlueDenim for May
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BlueDenim
Income Statement
For the Month of May
99,000 pairs of
Jeans × $8
Sales revenue
Cost of goods sold
Gross margin
$792,000 × 10%
Less:
Selling expense:
Commissions
$ 79,200
120,000
Fixed selling expense
Administrative expense
Operating income
$792,000
495,000
$297,000
199,200
85,000
$ 12,800
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Cornerstone 2-7
How to Calculate the Percentage of
Sales Revenue for Each Line on the
Income Statement
Let’s continue our example
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BlueDenim Company
Income Statement
For the Month of May
Sales revenue
Cost of goods sold
$792,000
495,000
Gross margin
Less:
Selling expense:
Commissions
$ 79,200
Fixed selling expense 120,000
Administrative expense
$297,000
Operating income
199,200
85,000
$ 12,800
%
100.0
Each item is
divided by
Sales revenue
e.g. $792,000/
$792,000 =
100%
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BlueDenim Company
Income Statement
For the Month of May
Sales revenue
Cost of goods sold
$792,000
495,000
Gross margin
Less:
Selling expense:
Commissions
$ 79,200
Fixed selling expense 120,000
Administrative expense
$297,000
Operating income
%
100.0
62.5
$495,000/
$792,000
= 62.5%
199,200
85,000
$ 12,800
2-59
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BlueDenim Company
Income Statement
For the Month of May
Sales revenue
Cost of goods sold
$792,000
495,000
%
100.0
62.5
Gross margin
Less:
Selling expense:
Commissions
$ 79,200
Fixed selling expense 120,000
Administrative expense
$297,000
37.5
199,200
85,000
$ 12,800
25.2
Operating income
10.7
1.6
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Cornerstone 2-8
How to Prepare an Income Statement for a
Service Organization
Information:
• Komala Information Systems designs and installs software
• Last month, Komala had costs of:
– Materials, $5,000
– Direct labour, $35,000
– Overhead, $55,000
– Selling expenses, $5,000
– Administrative expenses, $7,000
• Sales totalled $130,000
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Komala Information Systems
Income Statement
For the Past Month
Sales Revenues:
Less operating expenses
Software licensing
Service technicians
R&D
Selling expenses
Administrative expense
$130,000
$ 5,000
35,000
55,000
5,000
7,000
Operating income
107,000
$23,000
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Income Statement:
Service Firm
• Cost of services sold is typically made up of:
– Materials
– Labour
– Overhead
• No beginning or ending inventories
• cost of services sold will always equal cost of
services manufactured
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