1. Copyright © 2007 Prentice-Hall. All rights reserved 1 Building Blocks of Management Accounting Chapter 2

2. Copyright © 2007 Prentice-Hall. All rights reserved 2 Objective 1 Distinguish among service, merchandising, and manufacturing companies

3. Copyright © 2007 Prentice-Hall. All rights reserved 3 Service Companies Sell services No inventory or cost of goods sold accounts Labor costs – incurred to develop new services, advertise, provide customer service

4. Copyright © 2007 Prentice-Hall. All rights reserved 4 Merchandising Companies Purchase inventory from suppliers; resell to customers Retailers and wholesalers One inventory account – includes all costs to acquire and get inventory ready for sale Labor costs – identify new products and locations for stores, advertising, selling, customer service

5. Copyright © 2007 Prentice-Hall. All rights reserved 5 Manufacturing Companies Use labor, plant, and equipment to convert raw materials into finished products Three inventory accounts –Raw Materials inventory –Work in process inventory –Finished goods inventory

6. Copyright © 2007 Prentice-Hall. All rights reserved 6 Objective 2 Describe the value chain and its elements

7. Copyright © 2007 Prentice-Hall. All rights reserved 7 Value Chain Activities that add value to products and services R&DDesign Production/ Purchases MarketingDistribution Customer Service

8. Copyright © 2007 Prentice-Hall. All rights reserved 8 E2-16 Samsung Electronics Cost Classification Production R & DDesign Direct Mat. Direct LaborMOHMarket.Distrib. Cust. Service Salaries of telephone salespeople $ 5 Depreciation on P&E $65 Exterior case $ 6 Scientists’ salaries $12 Delivery expense $ 7 Transmitters 61 Rearrange process $ 2 Assembly-line workers’ wages $10 Tech support hotline $ 3 Toll free line for customer orders 1 Total costs $12$ 2 $67$10$65$ 6$ 7$ 3

9. Copyright © 2007 Prentice-Hall. All rights reserved 9 Objective 3 Distinguish between direct and indirect costs and identify the inventoriable product costs and period costs of merchandising and manufacturing firms

10. Copyright © 2007 Prentice-Hall. All rights reserved 10 Cost Object Anything for which managers want a separate measurement of cost –Direct cost – can be traced directly to cost object –Indirect cost – can not be traced directly to cost object

11. Copyright © 2007 Prentice-Hall. All rights reserved 11 Determining Total Costs Assign direct and indirect costs to cost object Trace direct costs Allocate indirect costs

12. Copyright © 2007 Prentice-Hall. All rights reserved 12 Product Costs Two definitions 1. Full product costs (internal decision making) - all resources used throughout value chain 2. Inventoriable product costs (external reporting) – costs incurred during production or purchases stage of value chain

13. Copyright © 2007 Prentice-Hall. All rights reserved 13 Inventoriable Product Costs R&DDesign MarketingDistribution Customer Service Production/ Purchases Inventoriable Product Costs Period Costs

14. Copyright © 2007 Prentice-Hall. All rights reserved 14 2007 Product costs 2007 Income Statement Operating expenses

15. Copyright © 2007 Prentice-Hall. All rights reserved 15 2007 Product costs 2007 Income Statement Inventory sold in 2007 Cost of goods sold Inventory 2007 Balance Sheet 2008 Income Statement Inventory sold in 2008

16. Copyright © 2007 Prentice-Hall. All rights reserved 16 Merchandising Company Product Costs Purchase price plus cost of getting merchandise ready for sale

17. Copyright © 2007 Prentice-Hall. All rights reserved 17 Manufacturing Company Product Costs Direct materials Direct labor Manufacturing overhead Direct Costs Indirect Costs

18. Copyright © 2007 Prentice-Hall. All rights reserved 18 Manufacturing Overhead Indirect costs related to manufacturing operations –Generally all manufacturing costs that are not direct costs –Indirect materials –Indirect labor

19. Copyright © 2007 Prentice-Hall. All rights reserved 19 Prime and Conversion Costs Direct Materials Direct Labor Manufacturing Overhead Prime Costs Conversion Costs

20. Copyright © 2007 Prentice-Hall. All rights reserved 20 Direct & Indirect Labor Compensation Salaries & wages Fringe benefits Payroll taxes

21. Copyright © 2007 Prentice-Hall. All rights reserved 21 E2-19 DMDLIMIL Other MOH Period a. Airplane seats250 b. Depr. on admin offices 60 c. Assembly workers’ wages 600 d. Plant utilities120 e. Prod. supervisors’ salaries 100 f. Jet engines1,000 g. Machine lubricants15 h. Depreciation on forklifts 50

22. Copyright © 2007 Prentice-Hall. All rights reserved 22 E2-19 DMDLIMIL Other MOH Period i. Prop tax on corp marketing offices 25 j. Cost of warranty repairs 225 k. Factory janitors’ wages 30 l. Designing new plant layout 175 m. Machine operators health insurance 40 TOTAL1,25064015130170485

23. Copyright © 2007 Prentice-Hall. All rights reserved 23 E2-19 2) Total manufacturing overhead costs = IM +IL + Other MOH= $15 + 130 + 170 = $315 3) Total inventoriable product costs = DM + DL +MOH = $1,250 + 640 +315 = $2,205

24. Copyright © 2007 Prentice-Hall. All rights reserved 24 E2-19 4) Total prime costs= DM + DL = $1,250 + 640 = $1,890 5) Total conversion costs = DL + MOH = $640 + 315 = $955 6) Total period costs = $485

25. Copyright © 2007 Prentice-Hall. All rights reserved 25 Objective 4 Prepare the financial statements for service, merchandising, and manufacturing companies

26. Copyright © 2007 Prentice-Hall. All rights reserved 26 Service Company All costs are period costs Operating income = Service revenue – operating expenses

27. Copyright © 2007 Prentice-Hall. All rights reserved 27 Merchandising Company – Income Statement Sales - Cost of goods sold Gross profit - Operating expenses Operating income

28. Copyright © 2007 Prentice-Hall. All rights reserved 28 Merchandising Company –. Income Statement Cost of goods sold: Beginning inventory + Purchases + Freight-in Cost of goods available for sale - Ending inventory Cost of goods sold

29. Copyright © 2007 Prentice-Hall. All rights reserved 29 Manufacturing Companies – Income Statement Sales - Cost of goods sold Gross profit - Operating expenses Operating income

30. Copyright © 2007 Prentice-Hall. All rights reserved 30 Manufacturing Company – Income Statement Cost of goods sold: Beginning finished goods inventory + Cost of goods manufactured Cost of goods available for sale - Ending finished goods inventory Cost of goods sold

31. Copyright © 2007 Prentice-Hall. All rights reserved 31 Manufacturing Company – Income Statement Cost of goods manufactured: Beginning work in process inventory + Direct materials used + Direct labor + Manufacturing overhead Total manufacturing costs to account for - Ending work in process inventory Cost of goods manufactured

32. Copyright © 2007 Prentice-Hall. All rights reserved 32 Manufacturing Company – Income Statement Direct materials used: Beginning materials inventory + Purchases of direct materials + Freight in Materials available for use - Ending materials inventory Direct materials used

33. Copyright © 2007 Prentice-Hall. All rights reserved 33 Manufacturing Companies Product & Period Costs Materials Inventory Finished Goods Inventory Sales Cost of Goods Sold INCOME STATEMENT Operating Expenses Inventoriable Product Costs BALANCE SHEET = Operating Income when sales occur - - Work in Process Inventory Period Costs

34. Copyright © 2007 Prentice-Hall. All rights reserved 34 Manufacturing Companies Inventory Accounts Materials Inventory Beginning inventory Purchases & freight Ending inventory Materials used

35. Copyright © 2007 Prentice-Hall. All rights reserved 35 Manufacturing Companies Inventory Accounts Work in Process Inventory Materials used Direct labor Manufacturing overhead Beginning inventory Ending inventory Cost of goods manufactured

36. Copyright © 2007 Prentice-Hall. All rights reserved 36 Manufacturing Companies Inventory Accounts Finished Goods Inventory Beginning inventory Ending inventory Cost of goods sold Cost of goods manufactured Income Statement

37. Copyright © 2007 Prentice-Hall. All rights reserved 37 E2-21 Strike Company Statement of Cost of Goods Manufactured For Year Ended December 31, 2007 Beginning work in process inventory$50,000 Direct materials used: Beginning materials inventory$25,000 Purchases of direct materials78,000 Materials available for use$103,000 Ending materials inventory(28,000)75,000 Direct labor82,000 Manufacturing overhead (see schedule)41,000(see schedule) Total manufacturing costs to account for$248,000 Ending work in process inventory(35,000) Cost of goods manufactured$213,000

38. Copyright © 2007 Prentice-Hall. All rights reserved 38 E2-21 Schedule of manufacturing overhead costs Indirect labor$15,000 Insurance on plant9,000 Depreciation on plant building & equipment13,000 Repairs & maintenance-plant4,000 Total manufacturing overhead$41,000 Back to statement

39. Copyright © 2007 Prentice-Hall. All rights reserved 39 E2-21 Cost of goods sold: Finished goods inventory, January 1$18,000 Cost of goods manufactured213,000 Goods available for sale$231,000 Finished goods inventory, December 31(25,000) Cost of goods sold$206,000

40. Copyright © 2007 Prentice-Hall. All rights reserved 40 E2-22 Strike Marine Company Income Statement For Year Ended December 31, 2007 Sales$384,000 Cost of goods sold206,000 Gross profit$178,000 Operating expenses: Marketing expenses$77,000 General and administrative expenses29,000106,000 Income before income tax$72,000 Income tax expense23,000 Net income$49,000

41. Copyright © 2007 Prentice-Hall. All rights reserved 41 E2-19 a. __________ can be traced to cost objects. b. ____________ are expensed when incurred. c. _____ are the combination of direct materials and direct labor. d.Compensation includes wages, salaries, and _________________. Prime Direct costs Period costs fringe benefits

42. Copyright © 2007 Prentice-Hall. All rights reserved 42 E2-18 e. ________________________ are treated as _______until sold. f. ________________________ include costs from only the production or purchases element of the value chain. g. _____________are allocated to cost objects. h. Both direct and indirect costs are ______ to ________________. Inventoriable product costs assets Inventoriable product costs Indirect costs assigned cost objects

43. Copyright © 2007 Prentice-Hall. All rights reserved 43 E2-18 i.__________________ include costs from every element of the value chain. j.__________________ are the combination of direct labor and manufacturing overhead. k._________________________ are expensed as __________________when sold. Full product costs Conversion costs Inventoriable product costs cost of goods sold

44. Copyright © 2007 Prentice-Hall. All rights reserved 44 E2-18 l. Manufacturing overhead includes all ______________ of production. indirect costs

45. Copyright © 2007 Prentice-Hall. All rights reserved 45 Objective 5 Describe costs that are relevant and irrelevant for decision making

46. Copyright © 2007 Prentice-Hall. All rights reserved 46 Controllable vs Uncontrollable Costs Controllable – management can influence or change cost Uncontrollable – management cannot change or influence cost in the short-run

47. Copyright © 2007 Prentice-Hall. All rights reserved 47 Relevant and Irrelevant Costs Relevant – costs that differ between alternatives – differential costs Irrelevant – costs that do not differ –Sunk costs

48. Copyright © 2007 Prentice-Hall. All rights reserved 48 Objective 6 Classify costs as fixed or variable and calculate total and average costs at different volumes

49. Copyright © 2007 Prentice-Hall. All rights reserved 49 Cost Behavior Variable costs Fixed costs

50. Copyright © 2007 Prentice-Hall. All rights reserved 50 Total Variable Costs Assume we pay 5% sales commissions on all sales. The cost of sales commissions increase proportionately with increases in sales.

51. Copyright © 2007 Prentice-Hall. All rights reserved 51 Total Fixed Costs

52. Copyright © 2007 Prentice-Hall. All rights reserved 52 Total Cost Total fixed costs + Variable cost per unit x number of units Total Cost

53. Copyright © 2007 Prentice-Hall. All rights reserved 53 Average Cost Total cost ÷ number of units

54. Copyright © 2007 Prentice-Hall. All rights reserved 54 Marginal Cost Cost of making one more unit

55. Copyright © 2007 Prentice-Hall. All rights reserved 55 E2-24 a.Managers cannot influence __________ _____ in the short-run. b.Total _____________ decrease when production volume decreases. c.For decision-making purposes, costs that do not differ between alternatives are ________________. d.Costs that have already been incurred are called ____________. uncontrollable costs variable costs irrelevant costs sunk costs

56. Copyright © 2007 Prentice-Hall. All rights reserved 56 E2-24 e.Total ___________ stay constant over a wide range of production volume. f.The _______________ is the difference in cost between two alternative courses of action. g.The product’s ____________ is the cost of making one more unit. fixed costs differential cost marginal cost

57. Copyright © 2007 Prentice-Hall. All rights reserved 57 E2-24 h.A product’s ____________ and ____________, not the product’s ___________, should used to forecast total costs at different production volumes. fixed costs variable costs average cost

58. Copyright © 2007 Prentice-Hall. All rights reserved 58 E2-25 a. Total product cost = $1 x 20,000,000$20,000,000 5,000,000 $25,000,000 b. Average cost = $25,000,000/20,000,000 = $1.25

59. Copyright © 2007 Prentice-Hall. All rights reserved 59 E2-25 c. Fixed cost per unit = $5,000,000 ÷ 20,000,000 = $.25 d. Forecasted product cost = $1 x 25,000,000$25,000,000 5,000,000 $30,000,000

60. Copyright © 2007 Prentice-Hall. All rights reserved 60 E2-25 e. Forecasted average product cost = $30,000,000 ÷ 25,000,000$1.20 f. Forecasted fixed cost $5,000,000 ÷ 25,000,000$.20

61. Copyright © 2007 Prentice-Hall. All rights reserved 61 E2-25 g. The average product cost decreases as production volume increases because the company is spreading its fixed costs over 5 million more units. The company will be operating more efficiently, so the average cost of making each unit decreases.

62. Copyright © 2007 Prentice-Hall. All rights reserved 62 End of Chapter 2