1. Lesson 13 Managerial Accounting: Concepts and Principles Task Team of FUNDAMENTAL ACCOUNTING School of Business, Sun Yat-sen University

2. Outline What is managerial accounting? Comparison between managerial accounting and financial accounting Cost classifications in different ways Flow of manufacturing activities Job order cost accounting systems and process cost accounting systems Cost allocation 2

3. Introduction The previous 12 chapters focus on the financial accounting topics – Please summarize the basic points of financial accounting Users/ Time focus/ Emphasis/ Importance/ Subject focus/ Requirements – Thinking Is the information provided by financial accounting enough for an enterprise to conduct its operation and management? If not, how to satisfy this demand for the internal used information? Have you ever heard “managerial accounting”? 3

4. What is Managerial Accounting? An activity that provides financial and nonfinancial information to managers and other internal decision makers Is quite important to planning, control, and decision making activities 4

5. The Environment of Managerial Accounting 5 Complexity and size of organizations Development of technology technology Regulatory environment CompetitionCompetition Emphasis on quality Environment of Managerial Accounting

6. Managerial Accounting and Financial Accounting 6

7. Cost Classifications Costs can be classified by: – Relevance – Behaviour – Controllability – Traceability – Function 7

8. Costs Classification by Relevance Relevant – If costs influence a decision Costs that are applicable to a particular decision. Costs that should have a bearing on which alternative a manager selects. Costs that are avoidable. Future costs that differ between alternatives. Irrelevant – If costs do not influence a decision 8

9. Costs Classification by Relevance Sunk Costs – All costs incurred in the past that cannot be changed by any decision made now or in the future. – should not be considered in decisions. – Irrelevant – Example: You bought an automobile that cost $30,000 two years ago. The $30,000 cost is sunk because whether you drive it, park it, trade it, or sell it, you cannot change the $30,000 cost. 9

10. Costs Classification by Relevance Out-of-pocket costs – require future outlays of cash – associated with a particular decision – relevant for future decisions – Example: Considering the decision to take a vacation or stay at home, if you choose a vacation, you will only have travel costs (out-of-pocket costs). 10

11. Costs Classification by Relevance Opportunity Costs – The potential benefit that is given up when one alternative is selected over another. – Example: If you were not attending college or university, you could be earning $25,000 per year. Your opportunity cost of attending college or university for one year is $25,000. 11

12. Costs Classification by Behavior Cost behavior refers to – how a cost will react to changes in the level of business activity. Fixed costs – do not change when activity changes. Variable costs – change in proportion to changes in the volume of activity 12

13. Costs Classification by Behavior 13 Total fixed costs remain unchanged when activity changes within a relevant range. Fixed costs per unit decline as activity increases. Volume of Activity Fixed costs per unit Volume of Activity Total fixed costs

14. Costs Classification by Behaviour 14 Total variable costs change when activity changes. Variable costs per unit do not change as activity increases. Volume of activity Total variable costs Volume of activity Variable costs per unit

15. Costs Classification by Behavior Mixed costs – contain a combination of fixed and variable costs. 15 Variable Sales Commissions Sales Total Compensation Total mixed cost Fixed Monthly salary

16. Costs Classification by Behaviour Step-Wise Costs – remain fixed over limited ranges of volumes but increase by a lump sum when volume increases beyond maximum amounts. – Example: additional production supervisors must be added when another shift is added. 16 Supervisory Salaries Production Volume

17. Costs Classification by Controllability Controllable vs. not controllable – depends upon the employee’s responsibilities. – Example: A lower level manager may have control over overtime costs but not over the purchase of high-cost machinery. 17

18. Costs Classification by Traceability Management often traces costs to cost objects – To obtain a better measure of their total cost – Cost objects include Products Services Departments Divisions Customer groups 18

19. Costs Classification by Traceability Traceable costs are classified as – Direct costs can be conveniently traced to a unit of product or other cost objective. Examples: salaries of production workers, salary of maintenance department employees. – Indirect costs must be allocated to a unit of product or other cost objective. Examples: factory rent, factory light and heat, factory accounting costs. 19

20. Costs Classification by Function Manufacturing Costs – are necessary and integral to the production of finished goods. – Examples: direct labour, direct materials, and manufacturing overhead. Non-Manufacturing Costs – are not integral to the manufacture of finished goods. – Examples: selling and administrative expenses. 20

21. Costs Classification by Function 21 ManufacturingCostsManufacturingCosts Direct Material Direct Labour ManufacturingOverheadManufacturingOverhead

22. Costs Classification by Function Direct materials – Materials that are clearly and easily identified with a particular product. – Example: Steel used to manufacture an automobile Direct labour – Labour costs that are clearly traceable to, or readily identifiable with, the finished product. – Example: Wages paid to an automobile assembly worker. 22

23. Costs Classification by Function Manufacturing overhead – All manufacturing costs except direct material and direct labour. – Manufacturing costs that cannot be traced directly to specific units produced. – Examples: Indirect labour – maintenance Indirect material – cleaning supplies Factory utility costs Supervisory costs 23

24. Costs Classification by Function 24 Manufacturing costs are often combined as follows: Direct Material Direct Labour Manufacturing Overhead Prime Cost Conversion Cost

25. Costs Classification by Function Non-Manufacturing costs (period costs) are expenses not charged to the product. – Selling Costs Costs incurred to obtain customer orders and to deliver finished goods to customers —advertising and shipping. – Administrative Costs Non-manufacturing costs of staff support and administrative functions —accounting, data processing, personnel, research and development. 25

26. Discussions ABC company manufactures a portable radio designed for mounting on the wall of the bathroom. The following list represents some of the different types of costs incurred in the manufacture of these radios: 1.The plant manager's salary. 2.The cost of heating the plant. 3.The cost of heating executive offices. 4.The cost of printed circuit boards used in the radios. 5.Salaries and commissions of company salespersons. 26

27. Discussions 6.Depreciation on office equipment used in the executive offices. 7.Depreciation on production equipment used in plant. 8.Wages of janitorial personnel who clean the plant. 9.The cost of insurance on the plant building. 10.The cost of electricity to light the plant. 11.The cost of electricity to power plant equipment. 12.The cost of maintaining and repairing equipment in the plant. 13.The cost of printing promotional materials for trade shows. 14.The cost of solder used in assembling the radios. 15.The cost of telephone service for the executive offices. 27

28. Discussions Required: – Classify each of the items above as product cost or period costs. 28

29. Discussions: the answer 1Product6Period11Product 2 7 12Product 3Period8Product13Period 4Product9 14Product 5Period10Product15Period 29

30. Flow of Manufacturing Activities 30 Raw Materials Beginning Inventory Raw Materials Purchases Goods in Process Beginning Inventory Finished Goods Beginning Inventory Raw Materials Used Direct Labour Used Materials Activity (raw materials) Financial Reports Raw Materials Ending Inv. (balance sheet) Production Activity (goods in process) Goods in Process Ending Inv. (balance sheet) Finished Goods Ending Inv. (balance sheet) Cost of Goods Sold (income statement) Marketing Activity (finished goods) Goods Manufactured Factory Overhead Used

31. Job Order Cost Accounting Systems – The production of products in response to special orders. – quite flexible in the number of products they can produce. Jobs involving the production of more than one unit of product are called job lots. 31

32. Job Order Cost Accounting Systems 32 Goods in Process Goods in Process Cost of Goods Sold LabourLabour MaterialsMaterials Indirect Indirect Finished Goods Factory Overhead DirectDirectAllocate Completed Delivered

33. Job Order Cost Accounting Systems 33 Direct Materials Cost per unit for Job No. 1 Direct Labour Factory Overhead Job No. 1 Finished Goods Finished Goods Job No. 2 Finished Goods Finished Goods Cost per unit for Job No. 2

34. Process Cost Accounting Systems – Used for production of small, identical, low- cost items. – Mass produced in automated continuous production process. – Costs cannot be directly traced to each unit of product. 34

35. Process Cost Accounting Systems 35 Direct Materials Finished Goods Direct Labour Factory Overhead Process 1 Process 2 Cost per equivalent unit for Process 1 Cost per equivalent unit for Process 2 Total cost per equivalent unit

36. Unit cost – To determine the cost of goods transferred from department to department and to finished goods, we need to calculate unit cost. – Unit cost is computed by dividing the accumulated costs by the number of equivalent units produced in the period. 36 Cost per equivalent unit = = Product costs for the period Equivalent units for the period Process Cost Accounting Systems

37. Costs are accumulated for a period of time by process or department. Equivalent units is a concept expressing a number of partially completed units as a smaller number of fully completed units. – Example: Three one-third full pitchers are equivalent to one full pitcher. – Equivalent units may be different for material and labour and overhead at different stages of a process. 37 Process Cost Accounting Systems

38. Comparing Job Order and Process Production Similarities – Same objective to determine the cost of products – Same inventory accounts raw materials, goods in process, and finished goods – Same overhead assignment method predetermined rate times actual activity 38

39. Comparing Job Order and Process Production Job Order Systems – Custom orders – Heterogeneous products – Low output volume – High flexibility – Low to medium standardization Process Systems – Repetitive production – Homogeneous offerings – High output volume – Low product flexibility – High standardization 39 DifferencesDifferences

40. Cost Allocation – Plant-wide Overhead Rate – Two-stage Cost Allocation – Activity-based Costing 40 Methods of Overhead Cost Allocation Methods of Overhead Cost Allocation Low High Low High Complexity

41. Cost Allocation Plant-wide Overhead Rate – A single plant-wide overhead rate is relatively easy to use – but may result in inaccurate product costs 41

42. Cost Allocation 42 Two-stage Cost Allocation More accurate method than plant-wide Stage 1: Allocate service department costs to production departments. Service department costs are assigned to operating (or production) departments. Stage 2: Allocate production department costs to cost objects. Costs accumulated within operating (or production) departments are assigned to cost objects.

43. Cost Allocation 43 MaintenanceFactory Accounting Janitorial Machining Department Assembly Department Stage 1 Service Departments Stage 2 Job 236Job 237Job 238

44. Cost Allocation Activity-based Costing – Attempts to better allocate costs to the desired cost objects by focusing on activities consumed by the cost objects. – Many activities within a department drive overhead costs. Products require activities. Activities consume resources. 44

45. Cost Allocation 45 Overhead Actual Rate Activity × Rate = Estimated overhead costs in activity cost pool Estimated number of activity units Allocate overhead cost: Activity-based Costing: Procedures Identify activities that consume resources. Assign costs to a cost pool for each activity. Identify cost drivers associated with each activity. Compute overhead rate for each cost pool.

46. Cost Allocation Activity-based Costing: Identifying Cost Drivers – Most cost drivers are related to either volume or complexity of production. – Examples: purchasing, invoicing, quality inspection, product design. – Three factors in choosing a cost driver: Causal relationship Benefits received Reasonableness. 46

47. Cost Allocation CostCost Driver Materials purchasingNumber of purchase orders Materials handlingNumber of materials requisitions PersonnelNumber of employees Equipment amortizationNumber of products produced or hours of use Quality inspectionNumber of units inspected Indirect labour in setting up equipment Number of setups required 47 Activity-based Costing: Cost and Cost Driver

48. Cost Allocation Activity-based Costing: Benefits – More detailed measures of costs – Better understanding of activities – More accurate product costs for... Pricing decisions Product elimination decisions Managing activities that cause costs – Benefits should always be compared with costs of implementation 48

49. Summary Managerial accounting is quite important to planning, control, and decision making activities. Managerial accounting and financial accounting are different in users, time focus, requirements, etc. Costs can be classified by relevance, behaviour, controllability, traceability, and function. Flow of manufacturing activities. Similarities and differences between job order and process cost accounting systems The methods of cost allocation: p lant-wide overhead rate, two stage cost allocation, activity-based costing 49

50. Case Study ABC Company acquired its factory building about 25 years ago. For a number of years, the company has rented out a small, unused part of the building. The renter's lease will expire soon. Rather than renewing the lease, ABC Company is considering using the space itself to manufacture a new product. Under this option, the unused space will continue to be depreciated on a straight-line basis, as in past years. 50

51. Case Study Direct materials and direct labour cost for the new product is $45 per unit. In order to store finished units of the new product, the company will rent a small warehouse nearby. The rental cost is $1,800 per month. It will cost the company an additional $3,500 each month to advertise the new product. A new production supervisor, hired to oversee production of the new product, will be paid $2,500 per month. The company will pay a sales commission of $12 for each unit of product that is sold. 51

52. Case Study Required: – Complete the chart below (in the next page) by placing an "  " under each column heading that helps to identify the costs listed to the left. You can place an "  " under more than one heading for a single cost: for example, a cost may be a product cost, an opportunity cost, and a sunk cost; you would place an "  " under each of these headings on the answer sheet opposite the cost. 52

53. Case Study Opportunity Cost Sunk CostVariable Cost Fixed Cost Product Cost Selling & Administration Cost Rent on unused factory space depreciation Direct material + direct labour Rental cost of warehouse Advertising cost Supervisor’s salary Sales commissions 53

54. The End of Lesson 13