1. Accounting Principles Second Canadian Edition Prepared by: Carole Bowman, Sheridan College Weygandt · Kieso · Kimmel · Trenholm

2. MANAGERIAL ACCOUNTING CHAPTER 20

3. CHAPTER 20 MANAGERIAL ACCOUNTING After studying this chapter, you should be able to: 1 Explain the distinguishing features of managerial accounting. 2 Identify the 3 broad functions of management. 3 Define the 3 classes of manufacturing costs. 4 Distinguish between product and period costs. 5 Explain the difference between a merchandising and a manufacturing income statement.

4. CHAPTER 20 MANAGERIAL ACCOUNTING After studying this chapter, you should be able to: 6 Indicate how cost of goods manufactured is determined. 7 Explain the difference between a merchandising and a manufacturing balance sheet. 8 Prepare a work sheet and closing entries for a manufacturing company.

5. PREVIEW OF CHAPTER 20 MANAGERIAL ACCOUNTING Managerial Accounting Basics   Comparing managerial and financial accounting Ethical standards Management functions  Managerial Cost Concepts   Manufacturing costs Product versus period costs

6. PREVIEW OF CHAPTER 20 MANAGERIAL ACCOUNTING Manufacturing Costs in Financial Statements   Income statement Balance sheet Cost Concepts: a review  Contemporary Developments in Managerial Accounting  Accounting in service industries

7. STUDY OBJECTIVE 1 Explain the distinguishing features of managerial accounting.

8.  Managerial accounting (management accounting) is a field of accounting that provides economic and financial information for managers and other internal users.  The activities that are part of managerial accounting are as follows: 1 Explaining manufacturing and nonmanufacturing costs and how they are reported in the financial statements. 2 Computing the cost of rendering a service or manufacturing a product. 3 Determining the behaviour of costs and expenses as activity levels change and analysing cost-volume- profit relationships within a company. MANAGERIAL ACCOUNTING BASICS

9. 4 Assisting management in profit planning and formalizing the plans in the form of budgets. 5 Providing a basis for controlling costs and expenses by comparing actual results with planned objectives and standard costs. 6 Accumulating and presenting relevant data for management decision making. MANAGERIAL ACCOUNTING BASICS

10. ILLUSTRATION 20-1 DIFFERENCES BETWEEN FINANCIAL AND MANAGERIAL ACCOUNTING FINANCIAL ACCOUNTING Primary Users of Reports  External users, who are stockholders, creditors, and regulatory agencies. Types and Frequency of Reports  Classified financial statements.  Issued quarterly and annually. Purpose of Reports  To provide general-purpose information for all users.

11. ILLUSTRATION 20-1 DIFFERENCES BETWEEN FINANCIAL AND MANAGERIAL ACCOUNTING FINANCIAL ACCOUNTING Content of Reports  Pertains to entity as a whole and is highly aggregated (condensed).  Limited to double-entry accounting system and cost data.  Reporting standard is generally accepted accounting principles. Verification Process  Annual independent audit by certified public accountant.

12. ILLUSTRATION 20-1 DIFFERENCES BETWEEN FINANCIAL AND MANAGERIAL ACCOUNTING MANAGERIAL ACCOUNTING Primary Users of Reports  Internal users, who are officers, department heads, managers, and supervisors in the company. Types and Frequency of Reports  Internal reports.  Issued as frequently as the need arises. Purpose of Reports  To provide special-purpose information for a particular user for a specific decision.

13. ILLUSTRATION 20-1 DIFFERENCES BETWEEN FINANCIAL AND MANAGERIAL ACCOUNTING MANAGERIAL ACCOUNTING Content of Reports  Pertains to subunits of the entity and may be very detailed.  May extend beyond double-entry accounting system to any type of relevant data.  Reporting standard is relevance to the decision to be made. Verification Process  No independent audits.

14. ETHICAL STANDARDS FOR MANAGERIAL ACCOUNTANTS  Managerial accountants recognize that they have an ethical obligation to their companies and the public.  To provide guidance for managerial accountants in the performance of their duties, the Institute of Management Accountants (IMA) has developed a code of ethical standards, entitled Standards of Ethical Conduct for Management Accountants.  This code divides the managerial accountant’s responsibilities into 4 areas: 1 competence, 2 confidentiality, 3 integrity, and 4 objectivity.

15. STUDY OBJECTIVE 2 Identify the three broad functions of management.

16. MANAGEMENT FUNCTIONS The management of an organization performs 3 broad functions: 1 Planning 2 Organizing and Directing 3 Controlling

17. MANAGEMENT FUNCTIONS PLANNING  Planning requires management to 1 look ahead and 2 establish objectives.  These objectives are usually quite diverse, but a key modern management objective appears to be to add value to the business under its control.  Value is normally measured by 1 the trading price of the company’s stock and 2 the potential selling price of the company.

18. MANAGEMENT FUNCTIONS ORGANIZING AND DIRECTING  Organizing and directing involves coordinating diverse activities and human resources to produce a smooth-running operation.  This function relates to the implementation of planned objectives.  Most companies prepare organization charts to show 1 the interrelationship of activities and 2 the delegation of authority and responsibility within the company.

19. MANAGEMENT FUNCTIONS CONTROLLING  Controlling is the process of keeping the firm’s activities on track.  In controlling operations, management determines 1 whether planned goals are being met and 2 what changes are necessary when there are deviations from targeted objectives. Controlling Organizing and Directing Planning Decision Making

20. MANAGERIAL COST CONCEPTS To perform the three management functions effectively, management needs information. One very important type of information is related to costs. For example, the following questions need answering: 1 What costs are involved in making the product? 2 If production volume is decreased, will costs decrease? 3 What impact will automation have on total costs? 4 How can costs best be controlled in the organization?

21. STUDY OBJECTIVE 3 Define the three classes of manufacturing costs.

22. MANAGERIAL COST CONCEPTS Manufacturing consists of activities and processes that convert raw materials into finished goods. Manufacturing costs are usually classified as follows: 1 direct materials, 2 direct labour, and 3 manufacturing overhead.

23. ILLUSTRATION 20-2 CLASSIFICATIONS OF MANUFACTURING COSTS Direct Materials Direct Labour Manufacturing Overhead

24. MANUFACTURING COSTS DIRECT MATERIALS  Raw materials represent the basic materials and parts that are to be used in the manufacturing process.  Raw materials that can be physically and conveniently associated with the finished product during the manufacturing process are termed direct materials.  Some raw materials cannot be easily associated with the finished product, and are therefore considered indirect materials – which are accounted for as part of manufacturing overhead and 1 do not physically become part of the finished product or 2 cannot be traced because their physical association with the finished product is too small in terms of cost. Materials

25. MANUFACTURING COSTS DIRECT LABOUR  Direct labour is the work of factory employees that can be physically and conveniently associated with converting raw materials into finished goods.  The wages of maintenance people, timekeepers, and supervisors are normally categorized as indirect labour – since their efforts have no physical association with the finished product.  Like indirect materials, indirect labour is part of manufacturing overhead. Factory labour

26. MANUFACTURING COSTS MANUFACTURING OVERHEAD  Manufacturing overhead consists of costs that are indirectly associated with the manufacture of the finished product.  These costs may also be defined as manufacturing costs that cannot be classified as either direct materials or direct labour.  Manufacturing overhead includes 1 indirect materials; 2 indirect labour; 3 depreciation on factory buildings and machinery; and 4 insurance, taxes, and maintenance on factory facilities. Manufacturing Overhead

27. ILLUSTRATION 20-3 PRODUCT COST COMPONENTS BY INDUSTRY The magnitude of the 3 different product costs in terms of the total product cost is provided the chart below, which covers 7 industries. Note that the direct labour component is the smallest. This component of product cost is dropping substantially due to automation. In some companies, direct labour has become as little as 5% of the total cost.

28. STUDY OBJECTIVE 4 Distinguish between product and period costs.

29. PRODUCT COSTS VERSUS PERIOD COSTS  Product costs include each of the manufacturing cost elements (direct materials, direct labour, and manufacturing overhead); they are costs that are a necessary and integral part of producing the finished product.  These costs are not expensed to cost of goods sold under the matching principle until the finished goods inventory is sold.  Direct materials and direct labour are often referred to as prime costs due to their direct association with the manufacturing of the finished product.  Direct labour and manufacturing overhead are often referred to as conversion costs since they are incurred in converting raw materials into finished goods.  Period costs: a are identifiable with a specific time period, b relate to nonmanufacturing noninventoriable costs, and c include selling and administrative expenses.

30. ILLUSTRATION 20-4 PRODUCT VERSUS PERIOD COSTS Prime Costs Conversion Costs Product Costs Direct Materials Direct labour Manufacturing Overhead Period Costs Selling Expenses Administrative Expenses The foregoing relationships and cost terms are summarized in this illustration. The main concern in this presentation is with product costs. { { { Manufacturing Costs { Nonmanufacturing Costs

31. STUDY OBJECTIVE 5 Explain the difference between a merchandising and a manufacturing income statement.

32. Under a periodic inventory system, the income statements of a merchandising company and a manufacturing company differ in the cost of goods sold section. For a merchandising company, cost of goods sold is calculated by adding the beginning merchandise inventory and the cost of goods purchased and subtracting the ending merchandise inventory. For a manufacturing company, cost of goods sold is calculated by adding the beginning finished goods inventory and the cost of goods manufactured and subtracting the ending finished goods inventory. ILLUSTRATION 20-5 COST OF GOODS SOLD COMPONENTS

33. Cost of Goods Sold Manufacturing Company Merchandising Company Beginning Merchandise Inventory Beginning Finished Goods Inventory Ending Merchandise Inventory Ending Finished Goods Inventory Cost of Goods Purchased Cost of Goods Manufactured + + - - = = ILLUSTRATION 20-5 COST OF GOODS SOLD COMPONENTS

34. ILLUSTRATION 20-6 COST OF GOODS SOLD SECTIONS OF MERCHANDISING AND MANUFACTURING COMPANIES The cost of goods sold sections for merchandising and manufacturing enterprises that are presented illustrate the different presentations:

35. ILLUSTRATION 20-6 COST OF GOODS SOLD SECTIONS OF MERCHANDISING AND MANUFACTURING COMPANIES

36. STUDY OBJECTIVE 6 Indicate how cost of goods manufactured is determined.

37. ILLUSTRATION 20-7 COST OF GOODS MANUFACTURED FORMULA =- Total Cost of Work in Process Ending Work in Process Inventory Cost of Goods Manufactured Beginning Work in Process Inventory += Total Current Manufacturing Costs Total Cost of Work in Process  The total cost of work in process for the year is equal to the sum of: 1 the cost of the beginning work in process inventory and 2 the total manufacturing costs for the current period.  To find the cost of goods manufactured, we subtract the cost of the ending work in process inventory from the total cost of work in process.  The total cost of work in process for the year is equal to the sum of: 1 the cost of the beginning work in process inventory and 2 the total manufacturing costs for the current period.  To find the cost of goods manufactured, we subtract the cost of the ending work in process inventory from the total cost of work in process.

38. ILLUSTRATION 20-8 COST OF GOODS MANUFACTURED SCHEDULE To eliminate excessive detail, it is customary to present, in the income statement, only the total cost of goods manufactured and to show the details in a Cost of Goods Manufactured Schedule – as shown on the right. It is an internal financial schedule that shows each of the cost elements explained in Illustration 20-7.

39. STUDY OBJECTIVE 7 Explain the difference between a merchandising and a manufacturing balance sheet.

40. ILLUSTRATION 20-9 CURRENT ASSETS SECTIONS OF MERCHANDISING AND MANUFACTURING BALANCE SHEETS Unlike the balance sheet for a merchandising company, which shows just one inventory category, the balance sheet of a manufacturing company may have 3 inventory accounts: 1 Finished Goods Inventory – shows the cost of completed goods on hand, 2 Work in Process Inventory – shows the cost applicable to units that have been started into production but are only partially completed, and 3 Raw Materials Inventory – shows the cost of raw materials on hand. The current assets sections illustrated on the next two slides contrast the presentation of inventories of a merchandising company with those of a manufacturing company.

41. ILLUSTRATION 20-9 CURRENT ASSETS SECTIONS OF MERCHANDISING AND MANUFACTURING BALANCE SHEETS

43. ILLUSTRATION 20-10 ASSIGNMENT OF COSTS TO COST CATEGORIES The manufacturing and selling costs can be assigned to the various categories shown below.

44. ILLUSTRATION 20-11 COMPUTATION OF TOTAL MANUFACTURING COST Total manufacturing costs are the sum of the product costs – direct materials, direct labour, and manufacturing overhead costs. Northridge Company produces 10,000 pre-hung wooden doors the first year. The total manufacturing costs are:

45. CONTEMPORARY DEVELOPMENTS IN MANAGERIAL ACCOUNTING  Due to increased global competition from such countries as Japan and Germany, contemporary business managers demand from managerial accountants different and better information than they needed just a few years ago.  The following factors contribute to the expanding role of managerial accounting as we look toward the next century: 1 Importance of quality. Many companies have installed a total quality control (TQC) system to reduce defects in finished products. 2 Automation in the manufacturing process. Through computer-integrated manufacturing (CIM), many companies can now manufacture products that are untouched by human hands.

46. CONTEMPORARY DEVELOPMENTS IN MANAGERIAL ACCOUNTING 3 Expanded use of electronic data processing. The widespread use of computers has greatly reduced the cost of accumulating, storing, and reporting managerial accounting information. 4 Innovative inventory systems. Many companies have changed to inventory systems that significantly lower inventory levels and costs. 5 Focus on activities for overhead costs. In order to obtain more accurate product costs, many companies are accounting for overhead costs by the activities used in making the product. 6 Service industry needs. Managers in service industries are under increasing pressure to determine the cost of their services and to establish prices that are competitive.

47. CONTEMPORARY DEVELOPMENTS IN MANAGERIAL ACCOUNTING  Traditionally, the managerial accountant has been primarily engaged in cost accounting – collecting and reporting manufacturing costs to management.  The managerial accountant’s responsibilities now extend to cost management – providing managers with data on the efficient use of company resources in both manufacturing and service industries.

48. ILLUSTRATION 20-12 SERVICE INDUSTRIES AND COMPANIES Service Industry Needs Managerial Accounting Service industries and companies include the following:

49. ILLUSTRATION 20-12 SERVICE INDUSTRIES AND COMPANIES Service Industry Needs Managerial Accounting Service industries and companies include the following:

50. STUDY OBJECTIVE 8 Prepare a work sheet and closing entries for a manufacturing company.

51. APPENDIX ACCOUNTING CYCLE FOR A MANUFACTURING COMPANY  The accounting cycle is the same for a manufacturer as it is for a merchandiser when inventory is valued periodically.  The 1 journalizing and posting of transactions and adjustments, and 2 trial balance is the same except for additional manufacturing inventories and cost accounts.  There are some changes in the preparation of the work sheet and closing entries.

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53. CHAPTER 20 MANAGERIAL ACCOUNTING