1. Chapter 16 Introduction to Managerial Accounting

2. Learning Objectives
Define managerial accounting and understand how it is used
Describe the differences between service, merchandising, and manufacturing companies
Classify costs for service, merchandising, and manufacturing companies

3. Learning Objectives
Prepare an income statement and schedule of cost of goods manufactured for a manufacturing company and calculate cost per item
Calculate cost per service for a service company and cost per item for a merchandising company

4. Learning Objective 1
Define managerial accounting and understand how it is used

5. Why Is Managerial Accounting Important?
Members of the Pathway Commission created a vision model to help students and the public understand what accounting is. Accounting starts with economic activities that accountants review and evaluate using critical thinking and judgment to create useful information that helps individuals make good decisions. Good decisions influence accounting judgments and economic activity, thus creating a circular flow of cause and effect. Managerial accounting uses basic accounting concepts learned in previous chapters and introduces new tools that can be used to make good business decisions.

6. Financial Versus Managerial Accounting
Financial accounting:
Financial statements are used by investors, creditors, and government authorities.
Managerial accounting:
Reports are generated for planning.
One planning tool is the budget.
Controlling involves evaluating the plan and comparing the actual results to the budget.
Weighing the costs against the benefits is called cost/benefit analysis.
Planning means setting goals and deciding how to achieve them. A tool used by managers is a budget. A budget is a financial plan that managers use to coordinate a business’s activities. The budget is used to identify resources needed to achieved the business’s goals. Implementing plans and evaluating the results of the business operations by comparing the actual results to the budget is called controlling. Managers weigh the benefits of the system against the cost to develop and run the system. Weighting the costs against the benefits is called cost/benefit analysis.

7. Financial Versus Managerial Accounting
The primary users of financial accounting information are external users, such as investors, creditors, and government authorities. External users make investment and lending decisions based on the financial statements. Financial accounting reports the past results of the company, and the information must be prepared in accordance with Generally Accepted Accounting Principles (GAAP). Businesses prepare financial statements quarterly or annually.
Managerial accounting, on the other hand, focuses on internal users, such as managers and employees. The information reported is intended to help managers with planning and controlling. As such, the focus is on the future. Managerial accounting does not have to follow GAAP. Its reports are more detailed than financial accounting reports, providing information about product lines, departments, or territories. Reports generated by managerial accountants are used to help guide management decisions for the organization.

8. Management Accountability
Management accountability is the manager’s responsibility to the various stakeholders to wisely manage the organization’s resources.
Stakeholders have an interest in the business and include the following:
Customers
Creditors
Suppliers
Investors
Managers are responsible to the various stakeholders of the company to wisely manage the resources of the organization. Stakeholders include customers, creditors, supplies, and investors. Each stakeholder group has some sort of interest in the business.

9. Management Accountability
Suppliers provide products and services to the organization, and managers are responsible for making timely payments to these stakeholders. Managers are responsible for providing safe and productive work environments, along with competitive wages, to the employees. Managers are responsible for providing safe products and services, free from defects, to customers. Investors expect the company to provide a return on their investment, and managers must act in the best interest of the organization to generate profits. Management is responsible to creditors to make principle and interest payments on time.
The organization must obey laws and pay taxes. Managers are responsible to the community to operate in an ethical manner and minimize the company’s environmental impact.

10. Today’s Business Environment
Shift toward a service economy
Global competition
Time-based competition:
Enterprise Resource Planning (ERP) systems integrate companies data.
E-commerce allows companies to sell products to customers around the world.
Just-in-Time (JIT) Management is an inventory management tool.
The Office of the United States Trade Representative reports that service industries account for 68% of the U.S. gross domestic product and four out of five U.S. jobs. Services companies provide health care, communication, banking, and other important benefits to society.
Companies are moving operations to other countries to be closer to new markets and maintain competiveness. Time is the new competitive turf for world-class business. Enterprise Resource Planning (ERP) systems integrate all of a company’s worldwide functions, departments, and data. E-commerce allows companies to sell to customers around the world by providing 24/7 access to information and products. Managers can reduce the cost of inventory and minimize the risk of obsolescence by using Just-in-Time (JIT) Management systems. Using a JIT system means producing products just in time to satisfy customer needs.

11. Today’s Business Environment
Total Quality Management (TQM) is a philosophy of continuous improvement in products and processes.
Creates a culture of cooperation.
Each step adds value to the end product, and this is referred to as the value chain.
The economic, social, and environmental impact of doing business is referred to as the triple bottom line, which includes:
Profits
People
Planet
Total Quality Management (TQM) is a philosophy of continuous improvement in products and processes. Continuous improvement leads to fewer defects and higher customer satisfaction. TQM also emphasizes the importance of each person in the organization, creating a culture of cooperation across all business lines. Each step in the process adds value to the end product, and this is referred to as the value chain.
The triple bottom line refers to profits, people, and planet—the economic, social, and environmental impact of doing business. Companies are recognizing that they have multiple responsibilities and that generating profits for owners and investors is only one aspect of being a socially responsible organization.

12. Ethical Standards
The Institute of Management Accountants (IMA) developed standards managerial accountants should follow when they face ethical challenges. The IMA’s Statement of Ethical Professional Practice requires accountants to maintain professional competence, preserve confidentiality, and act with integrity and credibility.

13. Learning Objective 2
Describe the differences between service, merchandising, and manufacturing companies

14. How Do Service, Merchandising, and Manufacturing Companies Differ?
Service companies sell their time, skill, and knowledge.
All of their costs are period costs and are expensed in the period incurred.
Merchandising companies resell products they previously bought from suppliers.
Cost of goods sold is an inventoriable product cost, also called a product cost.
Manufacturing companies create products customers want.
Businesses can be classified as service, merchandising, or manufacturing companies.
The three categories of businesses differ in what they offer to the customer. A service company offers its time, skills, and knowledge for a fee. All of a services company’s operating expenses are period costs, which means the expenses are recorded in the period incurred.
Merchandisers buy products from suppliers and then resell them to customers. Merchandisers keep an inventory of products. Inventoriable product costs are referred to as product costs in this textbook.
A manufacturer produces goods by converting raw materials into a finished product.

15. Manufacturing Companies
Manufacturing companies convert raw materials into finished products.
The three types of inventory are:
Raw Materials Inventory (RM)
Materials used to manufacture a product.
Work-in-Process Inventory (WIP)
Goods that have been started but are not compete.
Finished Goods Inventory (FG)
Completed goods that have not yet been sold.
Manufacturing companies use labor, equipment, supplies, and facilities to convert raw materials into finished products. Manufacturing companies track costs on three kinds of inventory: Raw Materials Inventory (RM), Work-in-Process Inventory (WIP), and Finished Goods Inventory (FG). Raw Materials Inventory is materials used to manufacture a product. Work-in-Process Inventory consists of goods that have been started in the manufacturing process but are not yet complete. Finished Goods Inventory represents completed goods that have not yet been sold.

16. How Do Service, Merchandising, and Manufacturing Companies Differ?
The income statements and balance sheets for service, merchandising, and manufacturing companies differ slightly. Service companies do not report inventory. Merchandising companies report one type of inventory, Merchandise Inventory. Manufacturing companies report Raw Materials Inventory, Work-in-Process Inventory, and Finished Goods Inventory.

17. Learning Objective 3
Classify costs for service, merchandising, and manufacturing companies

18. How Are Costs Classified?
Product Costs
Direct costs
Traced to a cost object
Direct materials
Direct labor
Indirect costs
Not traced to a cost object
Manufacturing overhead
Costs can be classified as either direct or indirect. A direct cost is easily and cost-effectively traced to a cost object. A cost object is anything for which managers need a separate breakdown of its component costs. Some examples of cost objects are a product, a department, a sales territory, or an activity. In manufacturing, cost objects are usually units of product.
Indirect costs, on the other hand, cannot be easily or cost-effectively traced to a cost object. The salary of the production supervisor is an example of an indirect cost. The production supervisor manages the factory operations for all of the products the company manufactures. Therefore, it is difficult to trace the cost of the supervisor to a specific product.
A manufacturer’s product costs include both direct and indirect costs.

19. Product Costs Direct materials (DM) Direct labor (DL)
Raw materials used in production
Direct labor (DL)
Labor of employees working on the products
Manufacturing overhead (MOH)
The indirect product costs associated with production, including:
Indirect materials
Indirect labor
Factory costs for rent, utilities, insurance, etc.
Product costs are classified into three categories for manufacturing companies: direct materials (DM), direct labor (DL), and manufacturing overhead (MOH).
Direct materials consists of raw materials that are converted into a finished product. Direct materials can be easily and cost-effectively traced to the product, so they are considered to be direct costs.
Direct labor is the labor of employees who convert raw materials into finished products. Direct labor is also a direct cost because it, too, can be easily and cost-effectively traced to the product.
Manufacturing overhead refers to indirect manufacturing costs that cannot be easily traced to specific products. Manufacturing overhead includes all manufacturing costs other than direct materials and direct labor. In other words, it includes all of the supporting production activities. Manufacturing overhead is also called factory overhead or indirect manufacturing costs.
It is important to be able to distinguish between direct and indirect materials and direct and indirect labor. Indirect materials are materials used in making a product but whose cost either cannot be conveniently traced directly to specific finished products or are not large enough to justify tracing to a specific product. Indirect labor is labor costs for activities that support the production process but either cannot be conveniently traced directly to specific products or are not large enough to justify tracing to a specific product.

20. Product Costs
Exhibit 16-6 provides some examples of period and product costs for Smart Touch Learning.

21. Prime and Conversion Costs
Prime costs combine direct costs of direct materials and direct labor.
Conversion costs are the costs to convert raw materials into finished goods: direct labor plus manufacturing overhead.
To make cost information more useful, product costs for manufacturing companies are sometimes combined in different ways, depending on the managers’ needs. Prime costs combine the costs of direct materials and direct labor. Prime costs are used by managers in organizations where the majority of the cost is associated with labor instead of machine hours. Conversion costs are a combination of direct labor and manufacturing overhead. When the manufacturing process is machine intensive, managers may want to focus on the total conversion costs rather than track direct labor and manufacturing overhead separately.

22. Learning Objective 4
Prepare an income statement and schedule of cost of goods manufactured for a manufacturing company and calculate cost per item

23. How Do Manufacturing Companies Determine the Cost of Manufactured Products?
Income statement
Calculating cost of goods sold
The Finished Goods Inventory account provides information for the cost of goods sold section of the income statement
Gross profit
Gross profit = Net Sales Revenue – Cost of Goods Sold
Operating income
Operating income = Gross profit – sales and administrative expenses
The Finished Goods Inventory account provides the information for the cost of goods sold section of the income statement. The cost of goods sold is subtracted from net sales revenue to determine gross profit. The next step is to subtract the period costs—the selling and administrative expenses—to determine the operating income.

24. Calculating Cost of Goods Sold
Exhibit 16-8 shows the income statement for Smart Touch Learning once the company started producing its own touch screen tablet computers. The activity that occurred in the Finished Goods Inventory account provides the information needed for the cost of goods sold calculation. Cost of goods sold is a product cost. It is subtracted from net sales revenue to determine gross profit. Then, selling and administrative expenses are subtracted to determine the operating income. The selling and administrative expenses are period costs.

25. Calculating Cost of Goods Manufactured
Cost of goods manufactured is the manufacturing costs of the goods that finished the production process in a given accounting period.
Costs are determined from activities that took place in the past.
The term cost of goods manufactured is in the past tense. It is the manufacturing costs of the goods that a company completed in the past. The cost of goods manufactured summarizes the activities and the costs that take place in a manufacturing plant during the accounting period.

26. Calculating Cost of Goods Manufactured
In order to understand how to calculate the cost of goods manufactured, it is important to understand the flow of product costs for a manufacturer. The flow of product costs begins with the purchase of raw materials. The manufacturer then uses direct labor and manufacturing overhead to convert these materials into Work-in-Process Inventory. When the manufacturing process is completed, the costs are transferred to Finished Goods Inventory. The direct materials, direct labor, and manufacturing overhead are all product costs because they are required for the production process. The Finished Goods Inventory is the only category of inventory that is ready to sell. The cost of the finished goods the manufacturer sells becomes its Cost of Goods Sold on the income statement. Product costs remaining in inventory accounts stay on the balance sheet until the product is sold.

27. Calculating Cost of Goods Manufactured
Exhibit shows a schedule of cost of goods manufactured for Smart Touch Learning. The company computed its cost of goods manufactured for 2018 to be $660,000. This is the cost of making 2,200 touch screen tablet computers that Smart Touch Learning finished during 2018.
Smart Touch Learning used $355,000 of direct materials, $169,000 of direct labor, and $83,000 of manufacturing overhead. The total manufacturing costs incurred during the year are the sum of these three amounts, $607,000. Adding total manufacturing costs for the year to the beginning Work-in-Process Inventory (WIP) of $80,000 gives the manufacturing cost to account for, $687,000. At December 31, 2018, unfinished tablets costing only $27,000 remained in WIP. The company finished 2,200 tablets and sent them to Finished Goods Inventory (FG). Cost of goods manufactured for the year was $660,000.

28. Flow of Costs Through the Inventory Accounts
Exhibit is a diagram of the flow of costs through Smart Touch Learning’s inventory accounts.

29. Calculating Unit Product Cost
Managers make decisions on pricing products based on unit cost.
Cost per unit is found by dividing cost of goods manufactured by total units produced.
The cost per unit is used to determine the Cost of Goods Sold for the units sold to customers.
Knowing the unit product cost helps managers decide on the prices to charge for each product to ensure that each product is profitable. The unit product costs do not take into consideration the period costs incurred by the company. To find the cost per unit, divide the cost of goods manufactured by the total units produced. The cost per unit is used to determine the Cost of Goods Sold when products are sold to customers.

30. Learning Objective 5
Calculate cost per service for a service company and cost per item for a merchandising company

31. How Is Managerial Accounting Used in Service and Merchandising Companies?
Managers of service and merchandising organizations make decisions on pricing based on cost per service or cost per item.
Knowing the unit cost per service helps managers decide on the prices to charge for each service provided. Service companies do not have product costs, so operating expenses are considered in calculating the cost per service.
Merchandising companies need to know which products are most profitable, and this information helps managers establish selling prices. The unit cost per item is found by dividing the total cost of goods sold by the total number of items sold.