2. CHAPTER 20 MANAGEMENT ACCOUNTING: The Manufacturing Business

3. MANAGEMENT ACCOUNTING The Basics MANAGEMENT ACCOUNTING The Basics Management Accounting (CMAs) Financial Accounting (CAs) External users (Public) Classified Financial Statements To provide general all-purpose info for all users Issued Annually Past orientation: historical cost data Pertains to entity as a whole and is very condensed Reporting standards are GAAPs Annual independent audit required Internal users (officers, management, Dept. Heads, etc.) Internal reports To provide specific information for internal management/decision makers Issued as frequently as needed Future orientation: budgets & projections as well as historical cost Pertains to departments and divisions and may be very detailed Reporting standard is relevance to the decision to be made No independent audits

4. The notes for this chapter are broken down into the four functions that Management Accountants perform. They: 1.Determine which costs are involved in manufacturing, and report them in the financial statements. 2.Establish the cost of manufactured items (for controlling, reporting, and for setting selling price-levels) 3.Provide information on where and why costs are changing (for decision making purposes). 4.Evaluate cost behaviour in a company as production levels change (i.e. Economies of Scale). MANAGEMENT ACCOUNTING The Functions of Management Accountants MANAGEMENT ACCOUNTING The Functions of Management Accountants

5. MANAGEMENT ACCOUNTING 1.Determine which costs are involved in manufacturing, and report them in the Financial Statements.

6. MANAGEMENT ACCOUNTING 1.Determine which costs are involved in manufacturing MANAGEMENT ACCOUNTING 1.Determine which costs are involved in manufacturing The Product’s Cost (Steel) Direct MaterialsDirect LabourOverhead

7. MANAGEMENT ACCOUNTING 1.Determine which costs are involved in manufacturing MANAGEMENT ACCOUNTING 1.Determine which costs are involved in manufacturing

8. Direct Materials: Raw materials that can be physically and conveniently associated with the finished product during the manufacturing process. Those that cannot be easily associated become part of overhead. MANAGEMENT ACCOUNTING 1.Determine which costs are involved in manufacturing MANAGEMENT ACCOUNTING 1.Determine which costs are involved in manufacturing Direct Labour: The work of factory employees that can be physically and conveniently associated with converting raw materials into finished goods. Labour that cannot be easily associated with the production process becomes part of overhead

9. Overhead: Consists of costs that are indirectly associated with the manufacture of the finished product. Manufacturing overhead includes 1.Indirect materials; 2.Indirect labour; 3.Amortization on factory buildings and machinery; and 4.Insurance, taxes, and maintenance on factory facilities. MANAGEMENT ACCOUNTING 1.Determine which costs are involved in manufacturing MANAGEMENT ACCOUNTING 1.Determine which costs are involved in manufacturing

10. MANAGEMENT ACCOUNTING 1.Determine which costs are involved in manufacturing MANAGEMENT ACCOUNTING 1.Determine which costs are involved in manufacturing Direct Materials Direct Labour Overhead Administrative Expenses Selling Expenses

11. MANAGEMENT ACCOUNTING 1.Determine which costs are involved in manufacturing MANAGEMENT ACCOUNTING 1.Determine which costs are involved in manufacturing Cost Flow in a Manufacturing Business So now we know what is involved in the cost of manufactured products. (DM, DL, OH) The next thing we have to look at is how these Manufacturing Costs flow from the Balance Sheet (as inventory items) to the Income Statement (as Cost of Goods Sold). We’ll then look at how this “Flow” is shown on the financial statements.

12. Recall the COGS for a Merchandise Business: The cost of buying (and having shipped in) the items that were sold to customers. MANAGEMENT ACCOUNTING 1.Determine which costs are involved in manufacturing MANAGEMENT ACCOUNTING 1.Determine which costs are involved in manufacturing What is the Cost of Goods Sold? Cost of Goods Available for Sale Beginning Inventory Net Purchases Ending Inventory COST OF GOODS SOLD

13. MANAGEMENT ACCOUNTING 1.Determine which costs are involved in manufacturing MANAGEMENT ACCOUNTING 1.Determine which costs are involved in manufacturing What is the Cost of Goods Sold? The COGS for a Manufacturing Business: COGS is still the cost of the items sold to customers. However, since WE make the products, COGS must include all Manufacturing Costs. The first thing you must realise, is that manufacturing businesses have three inventories Goods (and costs) move from one inventory to the other during the manufacturing process. (Incidentally, each of the three is valued according to FIFO, LIFO, or Average Cost too)! Raw Materials Inventory (DM) Work in Process Inventory Finished Goods Inventory Direct Labour (DL) and Overhead (OH) are added here. (Also known as conversion costs)

14. MANAGEMENT ACCOUNTING 1.Determine which costs are involved in manufacturing MANAGEMENT ACCOUNTING 1.Determine which costs are involved in manufacturing What is Cost of Goods Sold? Beginning Raw Materials Inventory Ending Work in Process Inventory Ending Raw Materials Inventory Raw Materials Purchased Overhead Direct Materials Used Direct Labour Manufacturing Costs Beginning Work in Process Inventory Beginning Finished Goods Inventory COST OF GOODS SOLD Ending Finished Goods Inventory Cost of Goods Manufactured Finished Goods Inventory Work in Process Inventory Raw Materials Inventory Manufacturing Costs Are Added to the Value of Inventory

15. MANAGEMENT ACCOUNTING 1.Determine which costs are involved in manufacturing MANAGEMENT ACCOUNTING 1.Determine which costs are involved in manufacturing What is Cost of Goods Sold? $25,000 $35,000 $30,000 $100,000 $70,000 $95,000 $15,000 $180,000$15,000 $20,000 $170,000 $10,000 $160,000 Finished Goods Inventory Work in Process Inventory Raw Materials Inventory Manufacturing Costs Are Added to the Value of Inventory

16. MANAGEMENT ACCOUNTING 1.… and Report Them in the Financial Statements MANAGEMENT ACCOUNTING 1.… and Report Them in the Financial Statements Cost of Goods Sold Work in Process, Jan. 1 st Direct Labour Raw Materials Inventory, Jan. 1 st Total Raw Materials Available Add: Raw Materials Purchased Direct Materials Used Less: Raw Materials Inventory, Dec. 31 st Direct Materials Indirect Labour Overhead Factory Utilities Factory Repairs Total Manufacturing Costs Factory Amortization Total Overhead Less: Work in Process, Dec. 31 st Cost of Goods Manufactured Finished Goods Inventory, Jan. 1 st Less: Finished Goods Inventory, Dec. 31 st Cost of Goods Sold $20,000 $15,000 $25,000 $100,000 $125,000 $(30,000) $95,000 $15,000 $30,000 $5,000 $20,000 $70,000 $180,000 $160,000 $(35,000) $(10,000) $170,000 Finished Goods Inventory Work in Process Inventory Raw Materials Inventory

17. MANAGEMENT ACCOUNTING 1.… and Report Them in the Financial Statements MANAGEMENT ACCOUNTING 1.… and Report Them in the Financial Statements

18. Do Problems: BE20-9, 10 E20-2, -4, -6, -8 P20-4

19. MANAGEMENT ACCOUNTING 2.Establish the Cost of manufactured items (for controlling, reporting, and for setting selling price-levels)

20. Financial AccountingManagement Accounting MANAGEMENT ACCOUNTING 2.Establish the Costs of Manufactured Items MANAGEMENT ACCOUNTING 2.Establish the Costs of Manufactured Items Balance Sheet Income Statement Cash Flow Statement Journalizing Transactions Product Costing Budgeting and Forecasting Monitoring Variance from Budgets to Control Costs External Users via Annual Reports Management and Internal Users via Multiple Reports and Data COGS COGM

21. One of the most important jobs of management accounting is determining the cost of a product. Think about it: if you don’t know how much it costs, you can’t do any of the following: Determine a selling price that will cover all costs Decide how low a sales price or volume discount you can offer Determine how to control costs (ex: finding which materials are driving cost the most, etc.) The list goes on and on… MANAGEMENT ACCOUNTING 2.Establish the Costs of Manufactured Items MANAGEMENT ACCOUNTING 2.Establish the Costs of Manufactured Items

22. MANAGEMENT ACCOUNTING 2.Establish the Costs of Manufactured Items MANAGEMENT ACCOUNTING 2.Establish the Costs of Manufactured Items A popular method for determining cost is ABC Costing. The hardest part of finding the cost of a product is assigning overhead costs in a reliable and meaningful way. ABC Costing applies overhead based on those things that actually drive costs (called cost drivers) For example, if a product requires a lot of machining, “machine hours” will drive costs. So you find $overhead/machine hour, and apply costs based on how many machine hours a product uses. Activity Based Costing

23. MANAGEMENT ACCOUNTING 2.Establish the Costs of Manufactured Items MANAGEMENT ACCOUNTING 2.Establish the Costs of Manufactured Items The steps are as follows: 1.Find all costs 1.Find all costs (DM, DL, OH) 2.Determine the Overhead Cost/Driver a)To do this, first find the quantity of each “driver” (i.e. number of machine hours used in the period) b)Then find the all the costs of running the factory & machines during the period (including Amortization) c)Then divide to find the Overhead Cost/Driver 3.Apply the Overhead Cost/Driver rate 3.Apply the Overhead Cost/Driver rate to each product, for each driver. Activity Based Costing

24. Total Overhead Machining Finishing Shipping $200,000 $320,000 $150,000 MANAGEMENT ACCOUNTING 2.Establish the Costs of Manufactured Items MANAGEMENT ACCOUNTING 2.Establish the Costs of Manufactured Items An example: Your company manufactures two models of Widgets: Generic, and Deluxe Activity Based Costing Find All Costs Step 1: Find All Costs DeluxeGeneric Direct Materials ($40/kg) Direct Labour ($10/hour) Overhead (Indirect) 0.5 kg0.6 kg 3.0 hrs6.0 hrs $670,000 $20$24 $30$60

25. Machining Finishing Shipping Units to be Made DeluxeGenericDriver Total Drivers MANAGEMENT ACCOUNTING 2.Establish the Costs of Manufactured Items MANAGEMENT ACCOUNTING 2.Establish the Costs of Manufactured Items Activity Based Costing Determine the Overhead Cost/Driver Step 2: Determine the Overhead Cost/Driver a)Find the quantity of each “driver” $200,000 $320,000 $150,000 $670,000 10,0005,000 Hrs/Widget # of Shipments 1 2 100 150 2 4 Total Overhead 20,000 hrs 40,000 hrs 250 Shpmts Cost per Driver $10/Hr $8/Hr $6/$18 per W b)Find the costs of running the factory and machinesc)Divide to find the Overhead Cost/Driver (10,000W x 1hr) + (5,000W x 2hrs)($200,000 / 20,000 Hours)($320,000 / 40,000 Hours)(10,000W x 2hrs) + (5,000W x 4hrs) $150,000 / 250 Shipments = $600 / Shipment ($600 x 100S)/10,000 Generic = $6/Widget ($600 x 150S)/5,000 Deluxe = $18/Widget

26. Recall from Step 2: DeluxeGeneric MANAGEMENT ACCOUNTING 2.Establish the Costs of Manufactured Items MANAGEMENT ACCOUNTING 2.Establish the Costs of Manufactured Items Activity Based Costing Apply the Overhead Cost/Driver rate Step 3: Apply the Overhead Cost/Driver rate Machining Finishing Shipping 1hr 2hrs $6 $18 2hrs 4hrs Direct Labour Direct Materials Overhead (Indirect) $20$24 $30$60 $10/Hr $8/Hr Per Widget DeluxeGeneric Cost per Driver Drivers $10 $16 $6 $20 $32 $18 Total Product Cost$82$154 Recall from Step 1: GenericDeluxe Drivers Cost per Driver $40/Kg $10/Hr 0.5kg 6.0hrs 3.0hrs 0.6kg

27. DeluxeGeneric Machining Finishing Shipping Direct Labour Direct Materials Overhead (Indirect) $20$24 $30$60 $10 $16 $6 $20 $32 $18 Total Product Cost$82$154 MANAGEMENT ACCOUNTING 2.Establish the Costs of Manufactured Items MANAGEMENT ACCOUNTING 2.Establish the Costs of Manufactured Items How do you use this information? Pricing products Can’t set appropriate price without knowing product cost Determining Contribution Margin Once you know cost, you can determine the Contribution Margin each product will make to gross profit BEP = Operating Costs / Contribution Margin per Item Set Budgets and Monitor for variance Once you know cost info, you can predict sales, costs and then monitor regularly for variance. This allows you to identify and control problems in a business. Break-even Analysis Knowing the contribution margin per product sold will allow you to calculate how many units you need to sell to cover non-product costs (i.e. operating costs) and break even. BEP is when Operating Costs = (X)[% a (M a ) + % b (M b ) + % c (M c )] Where % a is total of all units sold that are product A, M a is the contribution margin per unit of product A, and X is the total number of units sold of ALL types.

28. Do Problems: See the handout

29. MANAGEMENT ACCOUNTING 3.Provide information on where and why costs are changing (for decision making purposes)

30. MANAGEMENT ACCOUNTING 3.Provide Information on Where and Why Costs are Changing MANAGEMENT ACCOUNTING 3.Provide Information on Where and Why Costs are Changing Balance Sheet Income Statement Cash Flow Statement Journalizing Transactions Product Costing Budgeting and Forecasting Monitoring Variance from Budgets to Control Costs Financial AccountingManagement Accounting External Users via Annual Reports Management and Internal Users via Multiple Reports and Data Cost per Driver COGS COGM

31. MANAGEMENT ACCOUNTING 3.Provide Information on Where and Why Costs are Changing MANAGEMENT ACCOUNTING 3.Provide Information on Where and Why Costs are Changing Budget Variance Analysis Once you've determined products costs and set budgets, the management accountant’s role is to analyze why actual costs differ from budgeted costs (and they always do). This is important information for managers to have They need it in order to determine why costs are rising or falling This enables them to isolate any problems, and deal with them if possible. This is the purpose of completing a Budget Variance Analysis: to find problems.

32. BudgetedActual MANAGEMENT ACCOUNTING 3.Provide Information on Where and Why Costs are Changing MANAGEMENT ACCOUNTING 3.Provide Information on Where and Why Costs are Changing Consider the cost data from the previous ABC Costing example (just for Deluxe Widgets). Our budgets predicted the following: Deluxe Widgets to be made5,000 Direct Materials ($24 per Widget) $120,000$105,000 If actual costs turned out to be $105,000 what would that tell you? How about now? 3,000 Budget Variance Analysis

33. MANAGEMENT ACCOUNTING 3.Provide Information on Where and Why Costs are Changing MANAGEMENT ACCOUNTING 3.Provide Information on Where and Why Costs are Changing Budget Variance Analysis The fact is you have absolutely no idea what the number “$105,000” tells you. That isn’t enough to isolate what caused the variance and solve the problem (if there even is one). To do this, you require the following info: 1.Production volume 2.Efficiency – Units of input per unit of output (i.e. how much material per widget made) 3.Cost of a unit of input

34. MANAGEMENT ACCOUNTING 3.Provide Information on Where and Why Costs are Changing MANAGEMENT ACCOUNTING 3.Provide Information on Where and Why Costs are Changing Budget Variance Analysis $40/kg 0.6kg 5,000 $40/kg 0.6kg 3,000 $40/kg 0.7kg 3,000 $50/kg 0.7kg 3,000 $120,000 $72,000 $84,000 $105,000 ($48,000) $12,000$21,000 Lower Production WastagePrice Increases Cause: Material Cost Material Usage Production Volume TOTALS This variance is due to the fact that the actual volume of widgets produced was less than what was planed. This variance results from using more material for the actual production volume than what the budget allows for. This variance is due to a change in the budgeted price paid for the actual quantities used.