Chapter 26 Managerial Accounting Concepts and Principles

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Learning Objective 1 Explain the purpose and nature of managerial accounting.

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Managerial accounting provides financial and non-financial information to managers of an organization and other decision makers. Financial accounting provides general purpose financial information to those who are outside the organization. Purpose of Managerial Accounting Managerial Accounting vs. Financial Accounting

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Planning and Control

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Comparing Financial and Managerial Accounting

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Learning Objective 2 Describe the lean business model.

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Customer Orientation Global Economy Lean Business Model Elimination of Waste Satisfy the Customer Positive Return Managerial Accounting in Business

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Customer Orientation in a Global Economy Lean Practices

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin New ways to improve operations Continuous Improvement

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin on Quality improvement applied to all aspects of business activities. Seek and uncover waste. Employees encouraged to try new methods to improve quality. Company emphasizes value of quality through quality awards. Total Quality Management

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Complete products just in time to ship to customers. Complete parts just in time for assembly into products. Receive materials just in time for production. Schedule production. Receive customer orders. Just-In-Time (JIT) Manufacturing

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin To accomplish just-in-time manufacturing: Processes must be aligned to eliminate delays and inefficiencies. Companies must establish good relations with suppliers. Just-In-Time (JIT) Manufacturing

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Understand the nature and sources of cost Measure value provided to customers Determine price customers pay Implications of Lean Manufacturing

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Learning Objective 3 Describe the accounting concepts useful in classifying costs.

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Behavior Traceability Controllability Relevance Function Managerial Cost Concepts

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin A fixed cost does not change with changes in the volume of activity. A variable cost changes in proportion to changes in the volume of activity. A mixed cost refers to a combination of fixed and variable costs. Classification by Behavior Cost behavior means how a cost will react to changes in the level of business activity.

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Rent Cost Tires Cost Cost behavior means how a cost will react to changes in the level of business activity. Total fixed costs do not change when activity changes. Total variable costs change in proportion to activity changes. Cost behavior means how a cost will react to changes in the level of business activity. Total fixed costs do not change when activity changes. Total variable costs change in proportion to activity changes. Classification by Behavior

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Direct costs Costs traceable to a single cost object. Examples: material and labor cost for a product. Indirect costs Costs that cannot be traced to a single cost object. Example: maintenance expenditures benefiting two or more departments. Classification by Traceability

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin The degree of control depends on the level of management in the organization. More Control Very little control Classification by Controllability

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Classification by Relevance: Sunk Costs Sunk costs are all costs incurred in the past that cannot be avoided or changed. Sunk costs should not be considered in decisions. Example You bought an automobile that cost $15,000 two years ago. The $15,000 cost is sunk because whether you drive it, park it, trade it or sell it, you cannot change the $15,000 cost. Example You bought an automobile that cost $15,000 two years ago. The $15,000 cost is sunk because whether you drive it, park it, trade it or sell it, you cannot change the $15,000 cost.

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Classification by Relevance: Out-of-Pocket Costs An out-of-pocket cost that requires a future outlay of cash. Out-of-pocket costs should be considered in decisions. An out-of-pocket cost that requires a future outlay of cash. Out-of-pocket costs should be considered in decisions. Example You plan on buying a new car for $25,000 next month. The cost of the new car is an out-of- pocket cost because you can choose to spend the $25,000 or not in the future.

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Classification by Relevance: Opportunity Costs The potential benefit lost by choosing a specific action from two or more alternatives. Example: If you were not attending college, you could be earning $20,000 per year. Your opportunity cost of attending college for one year is $20,000.

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Learning Objective 4 Define product and period costs and explain how they impact financial statements.

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin The Product Classification by Function: Product Costs Direct Labor Direct Material Manufacturing Overhead

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Period costs are expenses not attached to the product. Classification by Function: Period Costs Administrative Costs Non-manufacturing costs of staff support and administrative functions – accounting, data processing, personnel, research and development. Selling Costs Costs incurred to obtain customer orders and to deliver finished goods to customers – advertising and shipping.

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Period Costs (Expenses) Product Costs (Inventory) Inventory Not Sold in 2008 Operating Expenses Cost of Goods Sold Raw Materials Goods in Process Finished Goods Cost of Goods Sold 2008 Costs Incurred 2008 Income Statement 2009 Income Statement 2008 Balance Sheet Inventory Inventory Sold in 2008 Period and Product Costs in Financial Statements

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Question The primary distinction between product and period costs is... a. Product costs are expensed in the period incurred. b. Period costs are expensed in the period incurred. c. Product costs are inventoriable. d. Period costs are inventoriable. The primary distinction between product and period costs is... a. Product costs are expensed in the period incurred. b. Period costs are expensed in the period incurred. c. Product costs are inventoriable. d. Period costs are inventoriable.

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin The primary distinction between product and period costs is... a. Product costs are expensed in the period incurred. b. Period costs are expensed in the period incurred. c. Product costs are inventoriable. d. Period costs are inventoriable. The primary distinction between product and period costs is... a. Product costs are expensed in the period incurred. b. Period costs are expensed in the period incurred. c. Product costs are inventoriable. d. Period costs are inventoriable. Question

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Identification of Cost Classifications Potential Multiple Cost Classifications

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin I suppose these same cost concepts apply to service companies. Cost Concepts for Service Companies

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Learning Objective 5 Explain how balance sheets and income statements for manufacturing and merchandising companies differ.

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Merchandisers...  Buy finished goods.  Sell finished goods. SaleMart Manufacturers...  Buy raw materials.  Produce and sell finished goods. Reporting Manufacturing Activities

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Manufacturing Inventory Classifications Balance Sheet of a Manufacturer Raw Materials Finished Goods Goods in Process

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Completed products for sale. Materials waiting to be processed. Can be direct or indirect. Partially complete products. Material to which some labor and/or overhead have been added. Balance Sheet of a Manufacturer Raw Materials Finished Goods Goods in Process

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin MERCHANDISER Current Assets  Cash  Receivables  Merchandise Inventory MANUFACTURER Current Assets  Cash  Receivables  Inventories Raw Materials Goods in Process Finished Goods The only difference is inventory. Balance Sheet of a Manufacturer

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Question What type of account is the goods in process account? a. Income statement expense account. b. Balance sheet inventory account. c. Temporary clearing account for direct material and direct labor. d. Holding account for manufacturing overhead and direct labor. What type of account is the goods in process account? a. Income statement expense account. b. Balance sheet inventory account. c. Temporary clearing account for direct material and direct labor. d. Holding account for manufacturing overhead and direct labor.

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin What type of account is the goods in process account? a. Income statement expense account. b. Balance sheet inventory account. c. Temporary clearing account for direct material and direct labor. d. Holding account for manufacturing overhead and direct labor. What type of account is the goods in process account? a. Income statement expense account. b. Balance sheet inventory account. c. Temporary clearing account for direct material and direct labor. d. Holding account for manufacturing overhead and direct labor. Question

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Learning Objective 6 Compute cost of goods sold for a manufacturer.

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Beginning Merchandise Inventory Beginning Finished Goods Inventory Cost of Goods Purchased Cost of Goods Manufactured Ending Merchandise Inventory Ending Finished Goods Inventory Cost of Goods Sold MerchandiserManufacturer + _ + == _ The major difference Manufacturer’s Income Statement

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Cost of goods sold for manufacturers differs only slightly from cost of goods sold for merchandisers. Manufacturer’s Income Statement

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Direct Materials Materials that are separately and readily traced to a particular product. Direct Materials Materials that are separately and readily traced to a particular product. Example: Steel used to manufacture the automobile. Example: Steel used to manufacture the automobile. Manufacturer’s Income Statement

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Direct Labor Labor costs that are separately and readily traced to finished product. Direct Labor Labor costs that are separately and readily traced to finished product. Example: Wages paid to an automobile assembly worker. Example: Wages paid to an automobile assembly worker. Manufacturer’s Income Statement

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Factory Overhead All manufacturing costs except direct material and direct labor Factory costs that cannot be separately or readily traced directly to products. Factory Overhead All manufacturing costs except direct material and direct labor Factory costs that cannot be separately or readily traced directly to products. Examples: Indirect labor – maintenance Indirect material – cleaning supplies Factory utility costs Supervisory costs Manufacturer’s Income Statement

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Direct Material Direct Labor Manufacturing Overhead Prime Cost Conversion Cost Manufacturing costs are often combined as follows: Manufacturer’s Income Statement

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Learning Objective 7 Explain manufacturing activities and the flow of manufacturing costs.

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Finished Goods Beginning Inventory Cost of Goods Manufactured Finished Goods Ending Inventory Raw Materials Beginning Inventory Raw Materials Purchases Raw Materials Ending Inventory Cost of Goods Sold Goods in Process Beginning Inventory Direct Labor Factory Overhead Raw Materials Used Sales activityProduction activity Materials activity Flow of Manufacturing Activities Goods in Process Ending Inventory

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Learning Objective 8 Prepare a manufacturing statement and explain its purpose and links to financial statements.

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Summarizes the types and amounts of costs incurred in a company’s manufacturing process. Summarizes the types and amounts of costs incurred in a company’s manufacturing process. Materials Used +Direct Labor +Factory Overhead =Total Manufacturing Costs +Beginning Work in Process – Ending Work in Process =Cost of Goods Manufactured Manufacturing Statement

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Let’s take a look at Rocky Mountain Bikes’ Manufacturing Statement. Manufacturing Statement

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Manufacturing Statement

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Include all direct labor costs incurred during the current period. Manufacturing Statement

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Manufacturing Statement

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Beginning goods in process inventory is carried over from the prior period. Manufacturing Statement

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Ending goods in process inventory contains the cost of unfinished goods, and is reported in the current assets section of the balance sheet. Manufacturing Statement

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Learning Objective 9 Compute cycle time and cycle efficiency and explain their importance to production management.

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Cycle Time and Cycle Efficiency Cycle time Process time Inspection time Move time Wait time = +++ Time spent producing the product. Time spent inspecting raw materials, goods in process, and finished goods. Time spent moving raw materials, goods in process, and finished goods. Time that an order sits with no production applied to it.

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Cycle Time and Cycle Efficiency Cycle time Process time Inspection time Move time Wait time = +++ Process time is the only value-added time.

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Cycle Time and Cycle Efficiency Cycle efficiency Value-added time Cycle time = Given these times, let’s compute cycle time and cycle efficiency: Process time = 1.8 days Inspection time = 0.5 days Move time = 0.7 days Wait time = 3.0 days Cycle time = 1.8 days days days days = 6.0 days Cycle efficiency 1.8 days 6.0 days = = 30 percent

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin End of Chapter 26