1. Managerial Accounting and Cost Concepts
Chapter 2: Managerial Accounting and Cost Concepts.
This chapter explains the differences and similarities between financial and managerial accounting. It also explains how managers need to rely upon different classifications of costs for different purposes. The four main purposes emphasized in this chapter include preparing external financial reports, predicting cost behavior, assigning costs to cost objects, and making business decisions.
Chapter 2
McGraw-Hill/Irwin
Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved.

2. Planning Identify alternatives.
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Planning
Identify alternatives.
Select alternative that does the best job of furthering organization’s objectives.
Develop budgets to guide progress toward the selected alternative.
An important part of planning is to identify alternatives and then to select from among the alternatives the one that does the best job of furthering the organization’s objectives. Once alternatives have been identified, the plans of management are often expressed formally in budgets. Budgets are usually prepared under the direction of the controller, who is the manager in charge of the accounting department. Typically, budgets are prepared annually.
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3. Directing and Motivating
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Directing and Motivating
Directing and motivating involves managing day-to-day activities to keep the organization running smoothly.
Employee work assignments.
Routine problem solving.
Conflict resolution.
Effective communications.
In addition to planning for the future, managers must oversee day-to-day activities to keep the organization functioning smoothly. Managerial accounting data, such as daily sales reports, are often used in this type of day-to-day decision making.
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4. The control function ensures that plans are being followed.
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Controlling
The control function ensures that plans are being followed.
Feedback in the form of performance reports that compare actual results with the budget are an essential part of the control function.
In carrying out the control function, managers seek to ensure that the plan is being followed. Feedback, which signals whether operations are on track, is the key to effective control. A performance report compares budgeted to actual results. It suggests where operations are not proceeding as planned and where some parts of the organization may require additional attention.
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5. Planning and Control Cycle
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Planning and Control Cycle
Formulating long-and short-term plans (Planning)
Begin
Comparing actual to planned performance (Controlling)
Implementing plans (Directing and Motivating)
Decision Making
The work of management, which is known as the planning and control cycle, can be depicted as shown. The process is a continuous loop in many organizations. Once plans are made, they are implemented. The controlling process starts with measuring actual performance and then comparing those results with planned performance. Corrective action may be necessary if actual results differ significantly from the plan. In some cases, new information may result in altering the plan before the cycle is repeated. Note that decision making is involved in all management activities.
Measuring performance (Controlling)
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6. Comparison of Financial and Managerial Accounting
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Comparison of Financial and Managerial Accounting
There are seven key differences between managerial accounting and financial accounting:
 Users: Financial accounting reports are prepared for external parties, whereas managerial accounting reports are prepared for internal users.
 Emphasis on the future: Financial accounting summarizes past transactions. Managerial accounting has a strong future orientation.
 Relevance of data: Financial accounting data should be objective and verifiable. Managerial accountants focus on providing relevant data even if these data are not completely objective and verifiable.
 Less emphasis on precision: Financial accounting focuses on precision when reporting to external parties. Managerial accounting aids decision makers by providing good estimates as soon as possible rather than waiting for precise data later.
 Segments of an organization: Financial accounting is concerned with reporting for the company as a whole. Managerial accounting focuses more on the segments of the company. Examples of segments include: product lines, sales territories, divisions, departments, etc..
 Generally Accepted Accounting Principles (GAAP): Financial accounting conforms to GAAP. Managerial accounting is not bound by GAAP.
 Managerial accounting – not mandatory: Financial accounting is mandatory because various outside parties require periodic financial statements. Managerial accounting is not mandatory.
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7. Example: A radio installed in an automobile
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Direct Materials
Raw materials that become an integral part of the product and that can be conveniently traced directly to it.
Direct materials are raw materials that become an integral part of the finished product and whose costs can be conveniently traced to it. Examples include the aircraft engines on a Boeing 777, the Intel processing chip in a personal computer, the blank video cassette in a pre-recorded video, and a radio in an automobile.
Example: A radio installed in an automobile
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8. Example: Wages paid to automobile assembly workers
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Direct Labor
Those labor costs that can be easily traced to individual units of product.
Direct labor consists of that portion of labor cost that can be easily traced to a product. Direct labor is sometimes referred to as “touch labor,” since it consists of the costs of workers who “touch” the product as it is being made.
Example: Wages paid to automobile assembly workers
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9. Manufacturing Overhead
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Manufacturing Overhead
Manufacturing costs that cannot be traced directly to specific units produced.
Examples: Indirect materials and indirect labor
Materials used to support the production process. Examples: lubricants and cleaning supplies used in the automobile assembly plant.
Wages paid to employees who are not directly involved in production work. Examples: maintenance workers, janitors and security guards.
Manufacturing overhead includes all manufacturing costs except direct materials and direct labor. These costs cannot be easily traced to specific units produced (also called indirect manufacturing cost, factory overhead, and factory burden).
Manufacturing overhead includes indirect materials that are part of the finished product, but that cannot be easily traced to it. It includes indirect labor costs that cannot be conveniently traced to the creation of products.
Other examples of manufacturing overhead include: maintenance and repairs on production equipment, heat and light, property taxes, depreciation and insurance on manufacturing facilities, etc.
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10. Nonmanufacturing Costs
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Nonmanufacturing Costs
Selling Costs
Costs necessary to secure the order and deliver the product.
Administrative Costs
All executive, organizational, and clerical costs.
A manufacturing company incurs many other costs in addition to manufacturing costs. For financial reporting purposes, most of these other costs are typically classified as selling costs and administrative costs. These costs are also called selling, general and administrative costs, or SG&A. Selling and administrative costs are incurred in both manufacturing and merchandising firms.
Selling costs include all costs necessary to secure customer orders and get the finished product into the hands of the customer. These costs are also referred to as order-getting and order-filling costs. Examples of selling costs include advertising, shipping, sales travel, sales commissions, sales salaries, and costs of finished goods warehouses.
Administrative costs include all executive, organizational, and clerical costs associated with the general management of an organization. Examples of administrative costs include executive compensation, general accounting, secretarial, public relations, and similar costs involved in the overall general administration of the organization as a whole.
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11. Product Costs Versus Period Costs
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Product Costs Versus Period Costs
Product costs include direct materials, direct labor, and manufacturing overhead.
Period costs include all selling costs and administrative costs.
Inventory
Cost of Good Sold
Balance Sheet
Income Statement
Sale
Expense
Income Statement
Costs can also be classified as product or period costs.
Product costs include all the costs that are involved in acquiring or making a product. More specifically, it includes direct materials, direct labor, and manufacturing overhead. Consistent with the matching principle, product costs are recognized as expenses when the products are sold. This can result in a delay of one or more periods between the time in which the cost is incurred and when it appears as an expense on the income statement. Product costs are also known as inventoriable costs. The discussion in the chapter follows the usual interpretation of GAAP in which all manufacturing costs are treated as product costs.
Period costs include all selling costs and administrative costs. These costs are expensed on the income statement in the period incurred. All selling and administrative costs are typically considered to be period costs. The usual rules of accrual accounting apply to period costs. For example, administrative salary costs are “incurred” when they are earned by the employees and not necessarily when they are paid to employees.
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12. Balance Sheet Manufacturer Current Assets Merchandiser Current assets
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Balance Sheet
Merchandiser
Current assets
Cash
Receivables
Merchandise Inventory
Manufacturer
Current Assets
Cash
Receivables
Inventories
Raw Materials
Work in Process
Finished Goods
Now, let’s consider similarities and differences on the balance sheet for merchandising and manufacturing companies. Both merchandising and manufacturing companies will likely have Cash and Receivables. However, merchandising companies do not have to distinguish between raw materials, work in process, and finished goods. They report one inventory number on their balance sheets, labeled merchandise inventory. Manufacturing companies report three types of inventory on their balance sheets: raw materials, work in process, and finished goods.
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13. Materials waiting to be processed. Completed products awaiting sale.
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Balance Sheet
Merchandiser
Current assets
Cash
Receivables
Merchandise Inventory
Manufacturer
Current Assets
Cash
Receivables
Inventories
Raw Materials
Work in Process
Finished Goods
Materials waiting to be processed.
Partially complete products – some material, labor, or overhead has been added.
Part I
Raw materials are the materials used to make the product.
Part II
Work in process consists of units of product that are partially complete, but will require further work to be saleable to customers.
Part III
Finished goods consists of units of product that have been completed, but not yet sold to customers.
Completed products awaiting sale.
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14. 3-14
The Income Statement
Cost of goods sold for manufacturers differs only slightly from cost of goods sold for merchandisers.
Merchandising companies calculate cost of goods sold as Beginning Merchandise Inventory plus Purchases minus Ending Merchandise Inventory.
For manufacturing companies, the cost of goods sold for a period is not simply the manufacturing costs incurred during the period. Manufacturing companies calculate cost of goods sold as Beginning Finished Goods Inventory plus Cost of Goods Manufactured minus Ending Finished Goods Inventory. Some of the cost of goods sold may be for units completed in a previous period. And some of the units completed in the current period may not have been sold and will still be on the balance sheet as assets. The cost of goods sold is computed with the aid of a schedule of costs of goods manufactured, which takes into account changes in inventories. The schedule of cost of goods manufactured is not ordinarily included in external financial reports, but must be compiled by accountants within the company in order to arrive at the cost of goods sold. We will learn more about a schedule of costs of goods manufactured later in this chapter.
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15. Basic Equation for Inventory Accounts
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Basic Equation for Inventory Accounts
Beginning
balance
Additions to inventory + =
Ending
Withdrawals from
inventory
The computation of Cost of Goods Sold relies on this basic equation for inventory accounts. The logic underlying this equation applies to any inventory account. Any units that are in inventory at the beginning of the period appear as the beginning balance. During the period, additions are made to the inventory through purchases or other means. The sum of the beginning balance and the additions to the account is the total amount of inventory available. During the period, withdrawals are made from inventory. The ending balance is whatever is left at the end of the period after the withdrawals.
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16. Schedule of Cost of Goods Manufactured
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Schedule of Cost of Goods Manufactured
Calculates the cost of raw material, direct labor, and manufacturing overhead used in production.
Calculates the manufacturing costs associated with goods that were finished during the period.
The schedule of cost of goods manufactured contains the three elements of costs mentioned previously, namely direct materials, direct labor, and manufacturing overhead. It calculates the cost of raw material, direct labor and manufacturing overhead used in production. It also calculates the manufacturing costs associated with goods that were finished during the period.
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17. Manufacturing Cost Flows
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Manufacturing Cost Flows
Income Statement Expenses
Balance Sheet Costs Inventories
Material Purchases
Raw Materials
Manufacturing Overhead
Work in Process
Direct Labor
Finished Goods
Cost of Goods Sold
Part I
All raw materials, work in process, and unsold finished goods at the end of the period are shown as inventoriable costs in the asset section of the balance sheet.
Part II
As finished goods are sold, their costs are transferred to cost of goods sold in the income statement.
Part III
Selling and administrative expenses are not involved in making the product; therefore, they are treated as period costs and reported in the income statement for the period the cost is incurred.
Selling and Administrative
Period Costs
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18. Cost Classifications for Predicting Cost Behavior
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Cost Classifications for Predicting Cost Behavior
How a cost will react to changes in the level of activity within the relevant range.
Total variable costs change when activity changes.
Total fixed costs remain unchanged when activity changes.
Quite frequently, it is necessary to predict how a certain cost will behave in response to a change in activity. For example, a manager may want to estimate the impact that a 5% increase in sales would have on the company’s total electric bill. Cost behavior refers to how a cost will react to changes in the level of activity within the relevant range. The most commonly used classifications of cost behavior are variable and fixed costs.
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19. Your total texting bill is based on how many texts you send.
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Variable Cost
Your total texting bill is based on how many texts you send.
Number of Texts Sent
Total Texting Bill
A variable cost varies in direct proportion to changes in the level of activity. For example, if you don’t have a texting plan on your cell phone, text messaging costs 5 cents per text. Your total texting bill increases with the number of texts you send.
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20. The cost per text sent is constant at
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Variable Cost Per Unit
The cost per text sent is constant at
5 cents per text.
Number of Texts Sent
Cost Per Text Sent
Although variable costs change in total as the activity level rises and falls, variable cost per unit is constant. For example, the cost per text message sent is constant at 5 cents per text.
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21. 3-21
Fixed Cost
Your monthly contract fee for your cell phone is fixed for the number of monthly minutes in your contract. The monthly contract fee does not change based on the number of calls you make.
Number of Minutes Used Within Monthly Plan
Monthly Cell Phone Contract Fee
A fixed cost is constant within the relevant range. In other words, fixed costs do not change for changes in activity that fall within the “relevant range.” For example, your monthly contract fee for your cell phone is a fixed amount for a certain number of minutes. The monthly contract fee does not change based on the number of calls you make.
Of course, if you go over your monthly minutes allotment, you have exceed the relevant range for your monthly contract and will be charged above and beyond your monthly contract fee.
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Fixed Cost Per Unit
Within the monthly contract allotment, the average fixed cost per cell phone call made decreases as more calls are made.
Number of Minutes Used Within Monthly Plan
Monthly Cell Phone Contract Fee
However, when expressed on a per unit basis, a fixed cost is inversely related to activity—the per unit cost decreases when activity rises and increases when activity falls. For example, the average fixed cost per cell phone call made decreases as more calls are made in the month.
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23. Cost Classifications for Predicting Cost Behavior
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Cost Classifications for Predicting Cost Behavior
It is helpful to think about variable and fixed cost behavior in a 2x2 matrix, as illustrated here. Take a few minutes and review this summary of cost behavior for variable and fixed costs.
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24. End of Chapter 2
End of chapter 2.
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