Managerial Accounting

09/14/2016

What are the most common business sectors and their activities?
Service, merchandising, and manufacturing companies
i.
Triple bottom line the companys performance is evaluated
not only in terms of profitability, but also in terms of its impact on people
and the planet. \
ii.
Service companies are in business to sell intangible services.
Health care, insurance, banking, etc.
Generally dont have inventory.
Incur costs to provide services, develop new services, advertise, and
provide customer service. (Salaries and benefits over 70% of costs).
iii.
Merchandising companies sell tangible products they buy
from suppliers.
Toys, clothing, electronics (resold at higher prices)
Retailers sell to customers.
Wholesalers buy products in bulk from manufacturers, mark up the
prices, and sell those products to retailers.
iv.
Manufacturing companies use labor, plant, and equipment to
convert raw materials into new finished products.
Toyota
Raw materials inventory all raw materials used in manufacturing.
Work in process inventory goods that are partway through the
manufacturing process but not yet complete.
Finished goods inventory completed goods that have not yet been
sold.

Services
Companies

Exam
ples

Primar
y Output

Types
of Inventory

Advertising
agenciesBanksLaw
firms
Insurance
companies

Intangible
services

None

Merchandising
Companies

M
Compa

Amazon.comKrogerWalmart
Wholesalers

Pr
Gamble
MillsDel
To

Tangible products purchased

from suppliers

N
product
workers
equipm
materia
finished

Inventory (or Merchandise

Inventory

R
invento
process
invento
goods in

Which business activities make up the value chain?

i.
Value chain the activities that add value to the companys
products and services.
Research and development, design, production or purchase,
marketing, distribution, customer service
ii.
Research and Development (R&D) Researching and
developing new or improved products or services and the process for
producing them.
iii.
Design Detailed engineering of products and services and the
processes for producing them.
iv.
Production or Purchases Resources used to produce a
product or service or to purchase finished merchandise intended for resale.
v.
Marketing Promotion and advertising of products or services.
Create consumer demand for products and services.
vi.
Distribution Delivery of products or services to customers.
vii.
Customer Services support provided for customers after the
sale.
Coordinating activities across the value chain
i.
Cross-functional teams work on R&D, design, production,
marketing, distribution, and customer service simultaneously.
Sustainability and the value chain
i.
Companies can integrate sustainability throughout the value
chain by
Researching and developing environmentally safe packaging.
Designing the product using lifecycle assessments and biomimicry
practices.
Life cycle assessment means the company analyzes the environmental
impact of a product, from cradle to grave, in an attempt to minimize
negative environmental consequences throughout the entire life span of the
product.
Biomimicry means that a company tries to mimic, or copy, the natural
biological process in which dead organisms become the input for another
organisms process.
Adopting sustainable purchasing practices
Marketing with integrity
Greenwashing the unfortunate practice of overstating a companys
commitment to sustainability.
Distributing using fossil fuel alternatives and carbon offsets.
Providing customer service past the warranty date
How do companies define cost?
Cost objects, direct costs, and indirect costs

i.
Cost object is anything for which managers want a separate
measurement of costs.
Individual units, different models, alternative marketing strategies,
geographic segments of the business, departments, a greet initiative, etc.
ii.
Costs are classified as either direct or indirect with respect to the
cost object.
Direct costis a cost that can be traced to the cost object.
Example: the cost object is one car. The cost of tires is a direct cost of
the vehicle.
Indirect costis a cost that relates to the cost object but cannot be
traced to it.
Example: cost incurred to run a manufacturing plant, including
utilities, property taxes, and depreciation.
If a company wants to know the total cost attributable to a cost object,
it mustassignall direct and indirect costs to the cost object.
Assigning a cost simply means that you are attaching a cost to the
cost object.
Tracing is to assign a direct cost to a cost object.
Allocateis to assign an indirect cost to a cost object.
The indirect cost is allocated evenly to all of the units produced in a
plant.
Assign direct and
indirect costs to cost objects
Trace direct costs to
cost objects

Allocate indi
cost objects

Amount of cost assigned

to the cost object is very
precise

Amount of co
the cost object is le

Costs for internal decision making and external reporting

i.
Two definitions of costs: total costs for internal decision making
and inventoriable product costs for external reporting.
Total costs for internal decision making
Total costs include the costs of all resources used throughout the
value chain.
Inventoriable product costs for external reporting
GAAP does not allow companies to use total costs to report inventory
balances or Cost of Goods Sold in the financial statements.
Inventoriable product costs include only the costs incurred during
the production or purchases stage of the value chain.
i.
Inventoriable product costs are treated as an asset (inventory)
until the product is sold.
ii.
All costs incurred in the other stages of the value chain must be
expensed in the period in which they are incurred (period costs).
Period costs are costs that are expensed in the period in which they
are incurred; often called Operating Expenses, or Selling, General, and
Administrative Expenses.
Period costs are always expensed in the period in which they are
incurred and never become part of an inventory account.
Merchandising companies inventoriable product costs
i.
Merchandising companies inventoriable product costs include
only the cost of purchasing the inventory from suppliers plus any cost
incurred to get the merchandise to the merchandisers place of business and
ready for sale.
Freight, import duties or tariffs, etc.
Manufacturing Companies inventoriable product costs
i.
Manufacturing companies inventoriable product costs include
only those costs incurred during the production element of the value chain.
ii.
Three types of manufacturing costs: direct materials, direct
labor, manufacturing overhead.
Direct Materials (DM) are the primary raw materials that become a
physical part of the finished product.
Direct Labor (DL) is the cost of compensating employees who
physically convert raw materials into the companys products.
Manufacturing Overhead (MOH)includes all manufacturing costs
other than direct materials and direct labor.
Includes all indirect manufacturing costs (all manufacturing costs other
than direct materials and direct labor).
i.
Indirect materials include materials used in the plant that are
not easily traced to individual unites.

Example: janitorial supplies, lubricants for machines, physical

components of the finished product that are very inexpensive (invoice
sticker).
ii.
Indirect labor includes the cost of all employees in the plant
other than those employees directly converting the raw materials into the
finished product
Salaries, wages and benefits of forklift operators, plant security
officers, janitor, and supervisors.
iii.
Other indirect manufacturing costs include such plantrelated costs as insurance and depreciation on the plant and plant
equipment, plant property taxes, plant repairs and maintenance, and plant
utilities.
Review: inventoriable product costs or period costs?
i.
Costs such as depreciation, insurance, utilities, and property
taxes are inventoriable product costs only when those costs are related to
the manufacturing plant.
When they are they are related to nonmanufacturing activities such as
R&D or marketing, they are treated as period costs.
Service companies and merchandisers do no manufacturing, so they
always treat depreciation, insurance, utilities, and property taxes as period
costs.

Accounting Treatment

Type of CompanyService
company

Merchandising company
Manufacturing company

Inventoriable Product
Costs

Period co

Initially recorded as
inventory
Expensed as Cost of
Goods Sold only when
inventory is sold
Always recorded as an
expense
Never considered part of
inventory

Always rec
expense
Never con
inventory

None
All costs along the value

All costs a

chain

chain

For example: salaries,

depreciation expense, utilities,
insurance, property taxes, and
advertising

For examp
depreciation exp
insurance, prope
advertising

Purchases of
merchandise
Freight-in; customs and
duties
All costs along the value
chain except for the purchases
element
For example: salaries,
depreciation expense, utilities,
insurance, property taxes,
advertising, and freight-out

All costs a
chain except for
purchases eleme
For examp
depreciation exp
insurance, prope
advertising, and

Direct materials
Direct labor
Manufacturing overhead
(including indirect materials,
indirect labor, and other
indirect manufacturing costs)
All costs along the value
chain except for the production
element

All costs a
chain except for
production elem
For examp
fright-out, all ex
executive headq
(separate from p
including deprec
utilities, insuran
property taxes,

For example: R&D, frightout, all expenses for executive

headquarters (separate from
plant), including depreciation,
utilities, insurance, and
property taxes, advertising,
and CEOs salary

and CEOs salary

Prime and conversion costs

i.
Combinations of manufacturing costs: prime and conversion
costs
Prime costs refer to the combination of direct materials and direct
labor
Conversion costs refer to the combination of direct labor and
manufacturing overhead (costs of converting direct materials into finished
goods).
Additional labor compensation costs
i.
The cost of labor, in all areas of the value chain, includes more
than the salaries and wages paid to employees. The cost also includes
company-paid fringe benefits such as health insurance, retirement plan
contributions, payroll taxes, and paid vacations.
How are inventoriable product costs and period costs shown in the
financial statements?
Service companies
i.
No inventory and thus, no inventoriable product costs, no Cost of
Goods sold. All of the companys costs are period costs, so they are
expensed in the current period as operating expenses.
Revenues, less Operating expenses (salaries expense, office rent
expense, depreciation expense, marketing expense): Operating income.
Merchandising companies
i.
Cost of Goods Sold is deducted from Sales Revenue to yield the
companys gross profit. All operating expenses (all period costs) are
deducted to arrive at the companys operating income.
Sales revenues, less cost of goods sold: gross profit. Less operating
expenses (salaries and wages, rent and utilities, marketing): operating
income.
ii.
Perpetual inventory system an inventory system in which
Cost of Goods Sold and Inventory are updated every time a sale is made.
All inventory is labeled with a unique bar code that reflects 1) the sales
price that will be charged to the customers, and 2) the inventoriable cost of
the merchandise to the store. When a barcoded product is scanned at the
checkout counter, the company accounting records are automatically
updated to reflect 1) the sales revenue earned, 2) the cost of the goods sold,
and 3) the removal of the product from merchandise inventory.
iii.
Periodic Inventory method an inventory system in which
Cost of Goods Sold is calculated at the end of the period, rather than every
time a sale is made.
Reflects breakage, theft, input errors, obsolescence that occurred
during the year.
iv.
Calculation of Cost of Goods Sold for a merchandising firm

Start with the beginning inventory and add to it all of the companies
inventoriable product costs for the period: the cost of the merchandise
purchased from manufacturers or distributors, freight-in, and any import
duties. The resulting total reflects the cost of all goods that were available
for sale during a period. Then subtract the cost of the products still in ending
inventory to arrive at the Cost of Goods Sold
Manufacturing companies
i.
The income statement for a manufacturer is essentially identical
to that of a merchandising company, the only difference is that the company
is selling product that it has made, rather than merchandise that it has
purchased.
Result: the calculation of Cost of Goods Sold is different.
Calculating cost of goods manufactured and cost of goods sold.
In order to calculate COGS, a manufacturer must first figure out the
amount of direct materials used and the cost of goods manufactured.
Cost of Goods Manufactured represents the cost of those goods that
were completed and moved to Finished Goods Inventory during the period.
Step 1: Calculate the cost of the direct materials used during the year
i.
Start with the beginning balance in the Raw Materials Inventory
and add to it all of the direct materials purchased during the year, including
any freight-in and import duties. This tells us the amount of materials that
were available for use during the year. Finally, subtract out the ending
balance of Raw Materials, to find the cost of the direct materials used.
Step 2: Calculate the cost of goods manufactured
i.
Start with the beginning balance in work in process and then add
to it all three manufacturing costs that were incurred during the year (DM
used, DL, and MOH). Then subtract out the goods still being worked on at
year end, to find the COGM.
Step 3: Calculate the cost of goods sold
i.
Start with the beginning balance of Finished Goods Inventory and
add to it the product that was manufactured during the year (CGM) to arrive
at the total goods available for sale. Then subtract what was left in Finished
Goods Inventory to get the COGS.
By analyzing what occurred in each other the three inventory
accounts, we are able to calculate the COGS shown on the companys
Income Statement.
Step 1 and 2 are sometimes combined into one schedule called the
Schedule of Cost of Goods Manufactured.
Sometimes all three steps are combined into a Schedule of Cost of
Goods Sold.
Comparing balance sheets
i.
The only difference in the three types of companies balance
sheets relates to how inventory is shown in the current asset section

Service companies show no inventory

Merchandising companies show inventory or merchandise inventory
Manufacturing companies show Raw Materials, Work in Process, and
Finished Goods Inventory
What other cost terms are used by managers?
Controllable versus uncontrollable costs
i.
Controllable costs management is able to influence or change
them.
ii.
Uncontrollable costs costs that in the short run, companies
are locking in to certain costs arising from previous decisions.
Relevant and irrelevant costs
i.
Differential costs the difference in cost between two
alternative courses of action.
ii.
Sunk cost costs that have already been incurred.
Fixed and variable costs
i.
Fixed costs stay constant in total over a wide range of activity
levels.
ii.
Variable costs change in total in direct proportion to changes in
volume.
How manufacturing costs behave
i.
Direct materials are variable costs.
ii.
Direct labor is generally treated as a variable cost.
iii.
Manufacturing overhead includes both variable and fixed costs.
The cost of indirect materials is variable
The cost of property tax, insurance, and straight-line depreciation on
the plant and equipment is fixed.
The cost of utilities is partially fixed and partially variable.
Direct materials +

A variable cost

Direct labor +

Generally treated as a variab

Manufacturing overhead =

A mixture of fixed and variab

Inventoriable product cost

A mixture of fixed and variab

Calculating total and average costs

i.
Managers need to understand how costs behave to predict total
costs and calculate average costs
ii.
Total fixed costs +
(variable costs per unit x number of units) = total costs
iii.
Average cost or manufacturing is total cost divided by the
number of units
Total cost/number of units = average cost per unit
iv.
Average cost per unit is NOT appropriate for predicting total
costs at different levels of output.
v.
The average cost per unit is valid only at ONE level of output
the level used to compute the average cost per unit. Thus, NEVER use
average cost to forecast costs at different output levels.
vi.
Marginal cost is the cost of making one more unit.

How do you compute costs of goods sold?

Service companies:
No cost of goods sold because they dont sell tangible goods.
Merchandising companies:
Beginning inventory
+purchases plus freight in and import duties
= Cost of goods available for sale
-Ending Inventory
=Cost of goods sold
Manufacturing companies:
Beginning finished goods inventory
+Cost of goods manufactured
= Cost of goods available for sale
Ending finished goods inventory
= Cost of goods sold
How do you compute the cost of goods manufactured?
Beginning work in process inventory
+Total manufacturing cost incurred during year
(direct materials used + direct labor + manufacturing overhead)
=Total manufacturing cost to account for
-Ending work in process inventory
= Cost of goods manufactured
How should managers forecast total costs for different productions
volumes?
Total cost = total fixed costs + (variable cost per unit x number of
units)