MANAGEMENT ACCOUNTING Chapter 16 MANAGEMENT ACCOUNTING A BUSINESS PARTNER Chapter 16: Management Accounting, A Business Partner

Learning Objective To explain the three principles guiding the design of management accounting systems. Learning objective number 1 is to explain the three principles guiding the design of management accounting systems. LO1

Management Accounting: Basic Framework We expect a good management accounting system to clearly identify who has responsibility for the use of assets. This use includes planning and decision making about how the assets will be utilized to earn profits for the company. We use the management accounting system to monitor, evaluate and reward performance.

Management Accounting System Framework Top Management Actual Results: Current Support Decision Making Budget Plans: Future Performance Evaluation: Past Evaluate Decision Making Part I Top management of a company plans for the future and prepares budgets to quantify its plans. The budgets are based on information supplied by managers who are close to the production process. Part II As time passes, actual results are compared to budgeted plans and corrective action is taken when necessary. Part III Budget and actual results are critical parts of the input in performance evaluation. For example, during your career, you will be evaluated by your superiors within an organization. The study of managerial accounting will help you understand how some information enters into this evaluation process. Assign Decision Making

Comparing Financial Accounting and Management 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, involve frequent, timely reports, and may contain more estimates and projections than financial accounting.

To describe the three basic types of manufacturing costs. Learning Objective To describe the three basic types of manufacturing costs. Learning objective number 2 is to describe the three basic types of manufacturing costs. LO2

Accounting for Manufacturing Operations The cost to produce a unit of product includes: Direct material Direct labor Manufacturing overhead Managers control costs by managing activities. Understanding the relationship between activities and costs will result in better decisions to control costs. Manufacturing costs include direct material, direct labor, and manufacturing overhead.

Can be traced directly and conveniently to products. Direct Materials Raw materials & component parts that become an integral part of finished products. Can be traced directly and conveniently to products. Part I Direct materials can be separately and readily traced to the individual units of product being manufactured. Direct materials are sufficiently significant in amount to justify the separate tracing. Part II Some materials used in the manufacturing process cannot be directly traced to individual units of output. These indirect materials are considered part of manufacturing overhead. If materials cannot be traced directly to products, the materials are considered indirect and are part of manufacturing overhead.

Includes the payroll cost of direct workers. Direct Labor Includes the payroll cost of direct workers. Those employees who work directly on the goods being manufactured. Part I Direct labor is the effort of employees who actually convert materials into a finished product. Direct labor costs are the wages of direct labor employees. Direct labor costs can be separately and readily traced to the individual units of product being manufactured. Part II The labor costs of some employees are considered indirect labor when we cannot trace the labor costs directly to a particular unit of output, but the employee is needed to keep the production process on track. For example, the cost of maintenance employees who work on the equipment used to produce our product is considered indirect labor. Indirect labor is part of manufacturing overhead. The cost of employees who do not work directly on the goods is considered indirect labor and is part of manufacturing overhead.

Manufacturing Overhead All manufacturing costs other than direct materials and direct labor. Includes: Indirect materials. Indirect labor. Machinery and equipment costs. Cost of regulatory compliance. Part I Besides indirect materials and indirect labor, we have other manufacturing overhead costs. Such costs include power for the factory equipment, depreciation on factory equipment, and the like. Part II Selling and general expenses and administrative expenses are considered period costs and are not charged to the product. These expenses cannot be part of manufacturing overhead. Does not include selling or general and administrative expenses.

Flow of Physical Goods in Production Direct Materials Purchased Direct Materials Used Finished Goods Direct Labor Manufacturing Overhead Goods Sold MegaLoMart A company purchases direct materials. Direct materials, direct labor, and manufacturing overhead are charge to the product. When the product is complete it is transferred to finished goods inventory. When the goods are sold, they are removed from finished goods inventory and charged to cost of goods sold.

Accounting for Manufacturing Operations Manufacturing costs are often combined as follows: Direct Materials Direct Labor Manufacturing Overhead Direct labor and direct materials are often called the prime costs of manufacturing. Both direct materials and direct labor can be traced to units of production. Direct labor and manufacturing overhead are called conversion costs. Direct labor and manufacturing overhead are the costs we incur to convert the direct materials into finished goods. Prime Cost Conversion Cost

To distinguish between product and period costs. Learning Objective To distinguish between product and period costs. Learning objective number 3 is to distinguish between product and period costs. LO3

Product Costs versus Period Costs Balance Sheet Product Costs (manufacturing costs) Current assets and finished goods inventory Income Statement Revenue COGS Gross margin Period expenses Operating profit When goods are sold as incurred Product costs flow through direct materials inventory, work in process inventory, and finished goods inventory prior to being sold. Once sold, the product costs become part of cost of goods sold. Period costs, or expenses, are charged to income in the period incurred. Period Costs (operating expenses and income taxes) as incurred

Ethics, Fraud, and Corporate Governance Product costs are capitalized as part of inventory and only charged to expense when the inventory is sold. Period costs are charged to expense as incurred. Product costs are capitalized as part of inventory and only charged to expense when the inventory is sold. Period costs are charged to expense as incurred. Income will be artificially inflated if period costs are capitalized. Income will be artificially inflated if period costs are capitalized.

Learning Objective To describe how manufacturing costs flow through perpetual inventory accounts. Learning objective number 4 is to describe how manufacturing costs flow through perpetual inventory accounts. LO4

Inventories of a Manufacturing Business Work in process - partially completed goods. Raw materials - inventory on hand and available for use. Finished goods- completed goods awaiting sale. Part I. This schematic shows the flow of costs through the three inventories beginning with the raw materials inventory account.. Part II. Materials are first transferred to work in process inventory as we begin the production process. Part III. When the production is complete, the costs are transferred to finished goods inventory.

Flow of Costs Associated With Production Direct materials purchased Materials Inventory $$$ Direct materials used Work in Process Inventory $$$ Direct labor & Manufacturing Overhead Cost of goods manufactured Finished Goods Inventory $$$ Part I Direct materials are purchased and placed into Materials Inventory. The increase in inventory is shown with the black dollar signs, and transfers out are shown in red. As materials are used, direct materials are charged to Work In Process Inventory and indirect materials are charged to Manufacturing Overhead. Part II As units are completed, their costs are transferred out of Work In Process Inventory and into Finished Goods Inventory. Finished Goods Inventory contains the Cost of Goods Manufactured. Part III Finally, when the units produced are sold, the costs are transferred out of Finished Goods Inventory and into Cost of Goods Sold. Let’s take some of the concepts we have been discussing and work a problem. Cost of Goods Sold $$$

Flow of Costs Associated With Production Pure-Ice Inc. had $52,000 of inventory in direct materials inventory on January 1, of this year. During the year, Pure-Ice purchased $586,000 of additional direct materials. At December 31 of this year $78,000 of the direct materials were still on hand. How much direct material was placed into production during the year? Let’s see if we can calculate the dollar value of direct materials placed into production during the year for Pure-Ice, Incorporated. At the beginning of the year, the company had direct materials inventory of $52,000. During the year, Pure-Ice purchased an additional $586,000 of direct materials. At the end of the year, there are $78,000 direct materials still on hand.

Flow of Costs Associated With Production ? We have placed the given information in this table. Can you solve for the question marked “materials placed into production” during the year?

Flow of Costs Associated With Production ! Pure-Ice placed $560,000 of direct materials into production during the year.

Flow of Costs Associated With Production In addition to the direct materials, Pure-Ice incurred $306,000 of direct labor cost during the year. Manufacturing overhead for the year was $724,000. Pure-Ice started the year with $132,000 in work in process. During the year, units costing $1,480,000 were transferred to finished goods inventory. What is the balance in work in process at the end of the year? Now let’s see if you can apply the same concept to work in process inventory at the end of the year. Pure-Ice incurred $306,000 of direct labor costs during the year. Manufacturing overhead amounted to $724,000 during the year. On January first, Pure-Ice showed a work in process inventory of $132,000. During the year, production costing $1,480,000 was transferred out of work in process inventory and into finished goods inventory. We will carry forward the $560,000 cost of direct materials placed into production that we found previously.

Flow of Costs Associated With Production The manufacturing costs for the year amounted to $1,590,000. The manufacturing costs include direct materials cost, direct labor cost, and manufacturing overhead. Recall that we started the year with a work in process inventory of $132,000.

Flow of Costs Associated With Production ! We add together beginning work in process inventory and total manufacturing costs added during the year. Next, we subtract the cost of goods completed and transferred into finished goods inventory, leaving our ending work in process inventory. How did you do? It might be a good idea to back up and review this computation again.

To distinguish between direct and indirect costs. Learning Objective To distinguish between direct and indirect costs. Learning objective number 5 is to distinguish between direct and indirect costs. LO5

Direct Costs and Indirect Costs Costs that can be easily and conveniently traced to a unit of product or other cost objective. Examples: direct material and direct labor Indirect costs Costs cannot be easily and conveniently traced to a unit of product or other cost object. Example: manufacturing overhead Sometimes you’ll hear costs referred to as direct costs and indirect costs. Direct costs refer to direct materials and direct labor. Indirect costs refer to manufacturing overhead.

To prepare a schedule of the cost of finished goods manufactured. Learning Objective To prepare a schedule of the cost of finished goods manufactured. Learning objective number 6 is to prepare a schedule of the cost of finished goods manufactured. LO6

Determining the Cost of Finished Goods Manufactured A schedule of the cost of finished goods manufactured is prepared to provide managers with an overview of manufacturing activities during a period. We prepare a schedule of the cost of finished goods manufactured during the period to help managers plan and control the manufacturing activities of a company.

Here is a schedule of cost of finished goods manufactured Here is a schedule of cost of finished goods manufactured. The three product costs are totaled and added to the beginning balance of the work in process inventory account. Subtracting the ending balance of the work in process account from this total results in the cost of finished goods manufactured for the period.

To arrive at cost of goods sold, we add together beginning finished goods inventory and cost of finished goods manufactured during the period. When we subtract ending finished goods inventory from the total, we arrive at cost of goods sold. The cost of goods completed during the period is used to compute COGS for the period.

The income statement is prepared using established financial accounting procedures. As you know from your study of financial accounting, cost of goods is part of the income statement for the period. Sales revenue less cost of goods sold equals gross profit on sales.

Manufacturers have three inventory accounts. A manufacturer has at three inventories accounts: materials, work in process and finished goods. Materials inventory contains materials waiting to be processed into a finished good. Work in process consists of items that we’ve started to manufacture, but have not completed. Finished goods are completed products that are awaiting sale. Manufacturers have three inventory accounts.

End of Chapter 16 End of Chapter 16.