1. Managerial Accounting Concepts and Principles
Chapter 18
Managerial Accounting Concepts and Principles
Chapter 18: Managerial Accounting Concepts and Principles

2. Managerial Accounting Basics
Managerial accounting provides financial and
nonfinancial information
for managers of an organization and other
decision makers.
Financial accounting provides general
purpose financial
information to those who are outside the organization.
Managerial accounting is an activity that provides financial and nonfinancial information to an organization’s managers and other internal decision makers. The main purpose of the financial accounting system is to prepare general purpose financial statements.
The purpose of both managerial and financial accounting is providing useful information to decision makers. Both areas of accounting report monetary information, although managerial accounting includes the practice of reporting nonmonetary information.

3. Purpose of Managerial Accounting
Planning is the process of setting goals and making plans to achieve them. Strategic plans usually set a firm’s long-term direction by developing a road map based on opportunities such as new products, new markets, and capital investments. Medium- and short-term plans are more operational in nature. They translate the strategic plans into actions. A short-term plan often covers a one-year period that, when translated into monetary terms is known as a budget.
Control is the process of monitoring planning decisions and evaluating an organization’s activities and employees. It includes the measurement and evaluation of actions, processes, and outcomes. Feedback provided by the control system allows managers to revise their plans and take corrective actions to avoid undesirable outcomes.

4. Nature of Managerial Accounting
Here we see a detailed comparison of financial accounting and managerial accounting. In addition to the focus on internal decisions, note particularly that managerial accounting information may follow a flexible format, involves frequent, timely reports, and may contain more estimates and projections than financial accounting.

5. Managerial Accounting
There is an increased emphasis on customers as the most important constituent of a business. Customers expect to derive a certain value for the money they spend to buy products and services. Specifically, they expect that their suppliers will offer them the right service (or product) at the right time and the right price. This implies that companies accept the notion of customer orientation, which means that employees understand the changing needs and wants of their customers and align their management and operating practices accordingly. The central focus is always on the customer. Continuous improvement rejects the notion of “good enough” or “acceptable” and challenges employees and managers to continuously experiment with new and improved business practices. This has led to adopting practices such as total quality management and just-in-time manufacturing.

6. Total Quality Management
C 6
Quality improvement
applied to all aspects of
business activities.
Seek and uncover
waste.
Constant Focus on Higher Standards
Total quality management focuses on quality improvement and applies this standard to all aspects of business activities. In doing so, managers and employees seek to uncover waste in business activities including accounting activities such as payroll and disbursements. Total quality management focuses on quality improvement and applies this standard to all aspects of business activities. Awards such as the Malcolm Baldrige National Quality Awards encourage an emphasis on quality.
Employees encouraged to try new methods to improve quality.
Company emphasizes value of quality through quality awards.

7. Just-In-Time (JIT) Manufacturing
Receive customer orders.
Complete products just-in-time to ship to customers.
Schedule
Production.
Just-in-time manufacturers acquire inventories and produces goods only when needed. Companies manufacture products only after they receive an order (a demand-pull system) and then deliver customers’ orders on time. To be successful JIT manufacturers, companies must improve processes to eliminate delays and inefficiencies, and they must establish good relations with suppliers to ensure on-time deliveries of high quality supplies and components.
Receive materials just-in-time for production.
Complete parts just-in-time for assembly into products.

8. Implications for Managerial Accounting
Price paid is an important determinant of value
Understand the nature and sources of cost
Measure value provided to customers
Managerial accounting has an important role to play by providing accurate cost and performance information. Companies must understand the nature and sources of cost and develop systems that capture costs accurately. Developing such a system is important to measuring the “value” provided to customers. The price that customers pay is an important determinant of value. In turn, the costs a company incurs are key determinants of price. All else being equal, the better a company is at controlling its costs, the better its performance.

9. Fraud and Ethics in Managerial Accounting
Involves the use of one’s job for personal gain through the deliberate misuse of the employer’s assets.
Is done to provide direct or indirect benefit to the employee.
Violates the employees’ duties to his employer.
Costs the employer money.
Is secret.
Increases business costs.
Fraud involves the use of one’s job for personal gain through the deliberate misuse of the employer’s assets. There are many types of fraud, but common characteristics of all fraud are that it:
Is done to provide direct or indirect benefit to the employee.
Violates the employees’ duties to his employer.
Costs the employer money.
Is secret.
Fraud increases business costs.
Management relies on internal control systems to monitor business activities and on accounting systems to track costs and identify unexpected amounts.
Ethics are beliefs that distinguish right from wrong. They are accepted standards of good and bad behavior. The Institute of Management Accountants has issued a code of ethics to help accountants involved in solving ethical dilemmas.
The Institute of Management Accountants has issued a code of ethics to help accountants involved in solving ethical dilemmas.

10. Types of Cost Classifications Classification by Behavior
Activity
Cost
Cost behavior refers to how a cost will react to changes in the level of business activity.
Total fixed costs do not change when activity changes.
Total variable costs change in proportion to activity changes.
Mixed costs are combinations of fixed and variable costs.
Activity
Cost
Cost behavior refers to how a cost will react to changes in the level of business activity. Total fixed costs do not change when activity changes. Total variable costs change in proportion to activity changes. Mixed costs are combinations of fixed and variable costs. Classification of costs by behavior is helpful in cost-volume-profit analyses and short-term decision making.
Activity
Cost

11. Types of Cost Classifications Classification by Traceability
Direct costs
Costs traceable to a single cost object.
Examples: material and labor cost for a product.
Indirect costs
Costs that cannot be traced to a single cost object.
Example: A maintenance expenditure benefiting two or more departments.
Cost objects may be products, services, departments, or customers to which costs are assigned. Direct costs can be traced to a single cost object. Examples of direct costs are material and labor costs for a product. Indirect costs cannot be traced to a single cost object. An example of an indirect cost is a maintenance expenditure that benefits two or more departments.

12. Types of Cost Classifications Classification by Controllability
The degree of control depends on the level of management in the organization.
Managers at higher levels in the organization have a greater degree of control over costs than do managers at lower levels in the organization. Classifying costs by controllability is an important part of assigning cost, responsibility, and evaluating a manager’s cost control performance.

13. Types of Cost Classifications Classification by Relevance
Sunk costs have already been incurred and cannot be avoided or changed. Sunk costs should not be considered in decisions.
Example: An automobile purchased two years ago cost $15,000. The $15,000 cost is sunk because whether the car is driven, sold, traded, or abandoned, the cost will not change.
Out-of-pocket costs require future outlays of cash and should be considered in decisions.
Example: You plan on buying a new car for $25,000 next month. The cost of the new car is an out-of-pocket cost because you can choose to spend or not to spend the $25,000 next month.
Sunk costs have already been incurred and cannot be avoided or changed. Sunk costs are never relevant to current and future decisions. Example: An automobile purchased two years ago cost $15,000. The $15,000 cost is sunk because whether the car is driven, sold, traded, or abandoned, the cost will not change.
Out-of-pocket costs require future outlays of cash and are always relevant to current and future decisions. Example: You plan on buying a new car for $25,000 next month. The cost of the new car is an out-of-pocket cost because you can choose to spend or not to spend the $25,000 next month.

14. Types of Cost Classifications Classification by Relevance
An opportunity cost is the potential benefit lost by choosing a specific action from two or more alternatives
Example: If you were not attending college, you could be earning $20,000 per year. Your opportunity cost of attending college for one year is $20,000.
An opportunity cost is the potential benefit lost by choosing a specific action from two or more alternatives. Opportunity costs are always relevant to a selection decision. Example: If you were not attending college, you could be earning $20,000 per year. Your opportunity cost of attending college for one year is $20,000.

15. Types of Cost Classifications Classification by Function
Direct Labor
Direct Material
Manufacturing Overhead
Product
Period costs are expenses not attached to the product.
Administrative costs are non-manufacturing costs of staff support and administrative functions.
Selling costs are incurred to obtain orders and to deliver finished goods to customers.
Product costs are incurred to manufacture a product. Product costs are not expensed as they are incurred. Instead, they are assigned to inventory and do not become expenses until the product is sold. Inventory is reported at cost as an asset on the balance sheet.
Period costs are expensed in the period incurred. Period costs are not assigned to inventory with the product. They are non-manufacturing costs usually grouped into two broad categories: selling and administrative. Selling costs are incurred to obtain customer orders and to deliver finished goods to customers. Examples are advertising and shipping costs. Administrative costs are non-manufacturing costs of staff support and administrative functions. Examples are accounting, data processing, personnel, and research and development.

16. Period and Product Costs in Financial Statements
Starting on the left side of this flow chart of costs, we see that costs incurred during 2011 are categorized as either period costs or product costs. Period costs flow directly to the current year’s income statement as they are expensed in the period incurred. Product costs are first assigned to the inventory account. Later, when the inventory is sold, product costs flow from the inventory account to cost of goods sold on the income statement for the year in which the products are sold.

17. Identifications of Cost Classifications
It is important to understand that a cost can be classified using any one (or combination) of the three different cost classifications. Proper allocation of these costs and the managerial decisions based on cost data depend on a correct cost classification.
Here are some examples of costs classified according to three of the means that we have discussed: behavior, traceability, and function.

18. Cost Concepts for Service Companies
The cost concepts described are generally applicable to service organizations.
For example, the cost of beverages for passengers of Southwest Airlines is a variable cost based on number of passengers.
The cost concepts described are generally applicable to service organizations. For example, consider Southwest Airlines. Its cost of beverages for passengers is a variable cost based on number of passengers. The cost of leasing an aircraft is fixed with respect to number of passengers. We can also trace a flight crew’s salary to a specific flight whereas we likely cannot trace wages for the ground crew to a specific flight. Classification by function (such as product versus period costs) is not relevant to service companies because services are not inventoried. Instead, costs incurred by a service firm are expensed in the reporting period when incurred.
Managers in service companies must understand and apply cost concepts. They seek and rely on accurate cost estimates for many decisions. For example, an airline manager must often decide between canceling or rerouting flights. The manager must also be able to estimate costs saved by canceling a flight versus rerouting. Knowledge of fixed costs is equally important.

19. Reporting Manufacturing Activities
Merchandisers . . .
Buy finished goods.
Sell finished goods.
Manufacturers . . .
Buy raw materials.
Produce and sell finished goods.
Merchandisers buy goods that are already completed and make them available to customers. Manufacturers buy raw materials and convert the raw materials into completed goods for their customers.
SaleMart

20. Manufacturer’s Balance Sheet
Raw Materials
Goods in Process
Finished Goods
Partially complete products.
Material to which some labor and/or overhead have been added.
Completed products for sale.
Materials waiting to be processed.
Can be direct
or indirect.
Manufacturers have three major inventory categories: raw materials, goods in process, and finished goods.
Raw materials can be direct or indirect. Direct materials are used directly in a product. Materials not clearly identified with specific units or batches of product are indirect materials. Goods in process are partially complete products to which some material, labor and/or overhead have been added. Finished goods are completed products awaiting sale.

21. Manufacturer’s Balance Sheet
MERCHANDISER
Current Assets
Cash
Receivables
Merchandise Inventory
MANUFACTURER
Current Assets
Cash
Receivables
Inventories
Raw Materials
Goods in Process
Finished Goods
The primary difference in the Balance Sheet of a Merchandiser and a Manufacturer is the presentation of Inventory under the Current Assets section. Merchandisers have one category of inventory called Merchandise Inventory. Manufacturers have three major categories of inventory: Raw Materials, Goods in Process, and Finished Goods.
The primary difference is inventory.

22. Manufacturer’s Income Statement
P 1
The finished goods inventory of a manufacturer is the equivalent of a merchandiser’s inventory account. Items in this inventory account are complete and awaiting sale. The major difference is that the manufacturer manufactures the items in the finished goods account, while the merchandiser purchases the items in the merchandise inventory account. When items are sold from these inventory accounts, the cost of inventory, whether purchased or manufactured, becomes cost of goods sold on the income statement.

23. Cost of Goods sold for a Merchandiser and Manufacturer
P 1
Cost of Goods sold for a Merchandiser and Manufacturer
Cost of goods sold for manufacturers differs only slightly from cost of goods sold for merchandisers.
The inventory cost flows are similar for both merchandisers and manufacturers. Beginning inventory plus additions equals goods available for sale. Subtracting ending inventory from goods available for sale results in cost of goods sold. As you can see, the primary difference is between cost of merchandise purchased on the merchandising company’s income statement and the cost of goods manufactured on the income statement of the manufacturing company.

24. Steel used in the frame of a mountain bike.
Direct Materials
P 1
Direct material costs are the expenditures for direct materials that are separately and readily traced through the manufacturing process to finished goods.
Example:
Steel used in the frame of a mountain bike.
Direct material costs are the expenditures for direct materials that are separately and readily traced through the manufacturing process to finished goods. Examples of direct materials in manufacturing a mountain bike include its tires, seat, frame, pedals, brakes, cables, gears, and handlebars.

25. Wages paid to a mountain bike assembly worker.
Direct Labor
P 1
Direct labor costs are the wages and salaries for direct labor that are separately and readily traced through the manufacturing process to finished goods.
Example:
Wages paid to a mountain bike assembly worker.
Direct labor refers to the efforts of employees who physically convert materials to finished product. Direct labor costs are the wages and salaries for direct labor that are separately and readily traced through the manufacturing process to finished goods. Examples of direct labor in manufacturing a mountain bike include operators directly involved in converting raw materials into finished products (welding, painting, forming) and assembly workers who attach materials such as tires, seats, pedals, and brakes to the bike frames. Costs of other workers on the assembly line who assist direct laborers are classified as indirect labor costs. Indirect labor refers to manufacturing workers’ efforts not linked to specific units or batches of the product.

26. Factory Overhead
P 1
Factory overhead consists of all manufacturing costs that are not direct materials or direct labor and the costs cannot be separately or readily traced to finished goods.
Examples:
Indirect labor – maintenance
Indirect material – cleaning supplies Factory utility costs Supervisory costs
Factory overhead consists of all manufacturing costs that are not direct materials or direct labor. Factory overhead costs cannot be separately or readily traced to finished goods. These costs include indirect materials and indirect labor, costs not directly traceable to the product. Overtime paid to direct laborers is also included in overhead because overtime is due to delays, interruptions, or constraints not necessarily identifiable to a specific product or batches of product. Factory overhead costs also include maintenance of the mountain bike factory, supervision of its employees, repairing manufacturing equipment, factory utilities (water, gas, electricity), production manager’s salary, factory rent, depreciation on factory buildings and equipment, factory insurance, property taxes on factory buildings and equipment, and factory accounting and legal services. Factory overhead does not include selling and administrative expenses because they are not incurred in manufacturing products. These expenses are called period costs and are recorded as expenses on the income statement when incurred.

27. Prime and Conversion Costs
Manufacturing costs are often combined as follows:
Direct Material
Direct Labor
Manufacturing Overhead
Prime costs are expenditures directly associated with the manufacture of finished goods, which includes both direct material costs and direct labor costs. Conversion costs are expenditures incurred in the process of converting raw materials to finished goods, which includes both direct labor costs and manufacturing overhead costs. Notice that direct labor costs are considered both prime costs and conversion costs.
Prime Cost
Conversion Cost

28. Activities and Cost Flows in Manufacturing
Starting on the left side of this flow chart, we see that material purchases are combined with the materials beginning inventory. Materials are then either used or they remain in inventory. In the center portion of the flow chart, we see the materials being used are combined with labor, overhead, and the goods in process beginning balance. As goods are finished, they are transferred out of the goods in process inventory account into the finished goods inventory account. The cost of the goods finished in the period is called cost of goods manufactured. Finished goods are either sold, called cost of goods sold, or they remain in the finished goods inventory account.

29. Manufacturing Statement
P 2
Summarizes the types and amounts of costs
incurred in a company’s manufacturing process.
Direct Materials Used
+ Direct Labor
+ Factory Overhead
= Total Manufacturing Costs
+ Beginning Work in Process
– Ending Work in Process
= Cost of Goods Manufactured
The production activities in the center portion of the preceding flow chart can be summarized in a manufacturing statement. The three product costs are totaled and added to the beginning balance of the goods in process inventory account. Subtracting the ending balance of the goods in process account from this total results in the cost of goods manufactured for the period.

30. Manufacturing Statement
P 2
Consider the Manufacturing Statement for Rocky Mountain Bikes which is presented in a highly summarized form. In the next few slides, we will illustrate how the amounts for each of the line items were obtained.

31. Manufacturing Statement
P 2
Material purchases for the current year are added to the beginning balance of materials inventory. The beginning balance of materials inventory for the current year is the ending balance of materials inventory from last year. Materials are either used or they remain in inventory. Subtracting the amount of materials on hand in inventory at the end of the year results in the cost of materials used for the current year.

32. Manufacturing Statement
P 2
Include all direct labor costs incurred during the current period.
Direct labor costs are the wages of direct labor employees who actually convert materials into a finished bike.

33. Manufacturing Statement
P 2
Factory overhead costs are indirect manufacturing costs that support the manufacturing activities. The various factory overhead items in this example, totaling thirty thousand dollars, are commonly encountered in many manufacturing companies.

34. Manufacturing Statement
P 2
Total manufacturing costs for the current period are added to the beginning balance of goods in process. The beginning balance of goods in process for the current year is the ending balance of goods in process from last year. Subtracting the ending balance of the goods in process account from the total cost of goods in process results in the cost of goods manufactured for the current year. Cost of goods manufactured is cost of goods completed and transferred to finished goods for the current year.

35. Overhead Cost Flows Across Accounting Reports
A managerial accounting system records costs and reports them in various reports that eventually determine financial statements. The statements on this slide show how overhead costs flow through the system: from an initial listing of specific costs, to a section of the manufacturing statement, to the reporting on the income statement and the balance sheet. Management uses information in the manufacturing statement to plan and control the company’s manufacturing activities. To provide timely information for decision making, the statement is often prepared monthly, weekly, or even daily. In anticipation of release of its much hyped iPad, Apple grew its inventory of critical components and its finished goods inventory. The manufacturing statement contains information useful to external users but is not a general-purpose financial statement. Companies rarely publish the manufacturing statement because managers view this information as proprietary and potentially harmful to them if released to competitors.

36. Cycle Time and Cycle Efficiency
Order Received
Production Started
Goods Shipped
Process Time + Inspection Time + Move Time + Queue Time
Wait Time
Manufacturing Cycle Time
Total cycle time is the elapsed time from when a customer order is received to when the completed order is shipped. The manufacturing cycle time is the amount of time required to turn raw materials into completed products. This includes process time, inspection time, move time, and queue time. Process time is the only value-added activity of the four times mentioned.
Total Cycle Time
Process time is the only value-added time.

37. Cycle Time and Cycle Efficiency
Order Received
Production Started
Goods Shipped
Process Time + Inspection Time + Move Time + Queue Time
Wait Time
Manufacturing Cycle Time
Manufacturing cycle efficiency (MCE) is computed by dividing value-added time by manufacturing cycle (throughput) time. An MCE ratio of less than one indicates that non-value-added time is present in the production process.
Total Cycle Time
Manufacturing
Cycle
Efficiency
Value-added time Manufacturing cycle time =

38. End of Chapter 18
End of Chapter 18.