© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Management Accounting: A Business Partner Chapter 16

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Management Accounting: Basic Framework

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Comparing Financial Accounting and Management Accounting

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Cost of goods sold. Direct labor and manufacturing overhead costs. Direct materials costs. Steps in the Manufacturing Process: Convert raw materials into finished goods. Sell finished goods. Accounting for Manufacturing Operations Buy raw materials.

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Raw materials & component parts that become an integral part of finished products. Can be traced directly and conveniently to products. Direct Materials If materials cannot be traced directly to products, the materials are considered indirect and are part of manufacturing overhead.

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Includes the payroll cost of direct workers. Direct Labor Those employees who work directly on the goods being manufactured.

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin 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. Direct Labor Those employees who work directly on the goods being manufactured.

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin All manufacturing costs other than direct materials and direct labor. Includes: Indirect materials. Indirect labor. Machinery and equipment costs. Cost of regulatory compliance. Includes: Indirect materials. Indirect labor. Machinery and equipment costs. Cost of regulatory compliance. Manufacturing Overhead

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin All manufacturing costs other than direct materials and direct labor. Does not include selling or general and administrative expenses. Manufacturing Overhead Includes: Indirect materials. Indirect labor. Machinery and equipment costs. Cost of regulatory compliance. Includes: Indirect materials. Indirect labor. Machinery and equipment costs. Cost of regulatory compliance.

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin The cost to produce a unit of product includes: Direct material Direct labor Manufacturing overhead The cost to produce a unit of product includes: Direct material Direct labor Manufacturing overhead Manufacturing Overhead

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin The cost to produce a unit of product includes: Direct material Direct labor Manufacturing overhead The cost to produce a unit of product includes: Direct material Direct labor Manufacturing overhead Manufacturing Overhead 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.) 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.)

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Balance Sheet Current assets and inventory Product Costs (manufacturing costs) Income Statement Revenue COGS Gross profit Expenses Net income. Revenue COGS Gross profit Expenses Net income. When goods are sold. as incurred Period Costs (operating expenses and income taxes.) as incurred Product Costs Versus Period Costs

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Raw materials - inventory on hand and available for use. Work in process - partially completed goods. Finished goods- completed goods awaiting sale. Inventories of a Manufacturing Business

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Direct materials purchased Materials Warehouse Finished goods Finished goods Warehouse Goods sold Direct materials used Factory Direct labor & Manufacturing overhead The Flow of Physical Goods

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Direct materials purchased Direct materials used Cost of goods manufactured Cost of Goods Sold $$$ Materials Inventory $$$ Finished Goods Inventory $$$ Work in Process Inventory $$$ The Flow of Manufacturing Costs Direct labor & Manufacturing overhead

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Pure-Ice Inc. had $52,000 of inventory in direct materials inventory on January 1, 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? Pure-Ice Inc. had $52,000 of inventory in direct materials inventory on January 1, 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? The Flow of Manufacturing Costs Example

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin ? The Flow of Manufacturing Costs Example

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin ! The Flow of Manufacturing Costs Example

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin In addition to the direct materials, Pure- Ice incurred $306,000 of direct labor cost during 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? In addition to the direct materials, Pure- Ice incurred $306,000 of direct labor cost during 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? The Flow of Manufacturing Costs Example

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin The Flow of Manufacturing Costs Example

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin ! The Flow of Manufacturing Costs Example

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin The overhead application rate expresses an expected relationship between manufacturing overhead costs and some activity base related to the production process. Overhead Application Rates

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Overhead costs are estimated based on budgets and using mathematical estimation techniques. Overhead Application Rates

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin The base is the activitiy that “drives” the cost, called the cost driver. Direct labor hours and machine hours are commonly used cost drivers. 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 Rates

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin 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 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 Overhead Application Rates Example

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Overhead Application Rates Example

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Overhead Application Rates Example

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Some companies use different cost drivers for different manufacturing activities, a process called ACTIVITY BASED COSTING. Overhead Application Rates

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin A schedule of the cost of finished goods manufactured is prepared to assist managers in understanding and evaluating the overall cost of manufacturing products. Determining the Cost of Finished Goods Manufactured

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin The cost of goods completed during the period is used to compute COGS for the period.

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin The income statement is prepared using established financial accounting procedures.

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin This is a great job, but the overhead is killing my profit margin! End of Chapter 16