1. Managerial Accounting Concepts and Principles
Chapter 14
Managerial Accounting Concepts and Principles
Previous chapters focused on the financial accounting system, whose main purpose is to prepare general-purpose financial statements. However, this information is incomplete for internal decision makers who manage organizations. This chapter discusses the purpose of managerial accounting, cost concepts, and reporting of manufacturing activities. We also look at how these concepts help managers gather, organize, and use this information.

2. Conceptual Learning Objectives
C1: Explain the purpose and nature of managerial accounting.
C2: Describe the lean business model.
C3: Describe fraud and the role of ethics in managerial accounting.
C4: Describe accounting concepts useful in classifying costs.
C5: Define product and period costs and explain how they impact financial statements.
C6: Explain how the balance sheets and income statements for manufacturing and merchandising companies differ.
C7: Explain manufacturing activities and the flow of manufacturing costs.
In this chapter, you will learn the following conceptual objectives:
C1: Explain the purpose and nature of managerial accounting.
C2: Describe the lean business model.
C3: Describe fraud and the role of ethics in accounting.
C4: Describe accounting concepts useful in classifying costs.
C5: Define product and period costs and explain how they impact financial statements.
C6: Explain how the balance sheets for manufacturing and merchandising companies differ.
C7: Explain manufacturing activities and the flow of manufacturing costs.

3. Analytical Learning Objectives
A1: Compute cycle time and cycle efficiency, and explain their importance to production management.
In this chapter, you will learn the following analytical objectives:
A1: Compute cycle time and cycle efficiency, and explain their importance to production management.

4. Procedural Learning Objectives
P1: Compute cost of goods sold for a manufacturer.
P2: Prepare a manufacturing statement and explain its purpose and links to financial statements.
In this chapter, you will learn the following procedural objectives:
P1: Compute cost of goods sold for a manufacturer.
P2: Prepare a manufacturing statement and explain its purpose and links to financial statements.

5. Managerial and Financial Accounting
Managerial accounting provides financial and
non-financial information
for managers of an organization and other
decision makers
Financial accounting provides general
purpose financial
information to those who are outside the organization.
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 non-monetary information. The focus of managerial and financial accounting are different, however.

6. 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.

7. Lean Business Model Customer Orientation Global Economy
By meeting customer needs in an efficient manner, a lean business model provides a positive return to its owners. Today’s customers have many choices, both domestic and foreign. To be successful, a business must deliver quality products and services to customers in a cost efficient manner.
Elimination of Waste
Satisfy the Customer
Positive Return

8. Customer Orientation in a Global Economy
Lean Practices
C 2
Customer Orientation in a Global Economy
Lean business practices include total quality management and just-in-time manufacturing. 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.

9. Total Quality Management
C 2
Quality improvement
applied to all aspects of
business activities.
Seek and uncover
waste. on
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.

10. Just-In-Time (JIT) Manufacturing
Receive customer orders.
Complete products just in time to ship to customers.
Schedule production.
A just-in-time manufacturer acquires inventories and produces goods only when needed. Companies manufacture products only after they receive an order (a demand-pull system) and then deliver the customer’s requirements on time.
Receive materials just in time for production.
Complete parts just in time for assembly into products.

11. Just-In-Time (JIT) Manufacturing
To accomplish just-in-time manufacturing:
Processes must be aligned to eliminate delays and inefficiencies
Companies must establish good relations with suppliers

12. Implications of Lean Manufacturing
Determine price customers pay
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.

13. Fraud in Accounting
C 3
Fraud is the use of one’s job for personal gain through the deliberate misuse of the employer’s assets.
It is estimated that 5% of annual revenues are lost to fraud.
All fraud is committed to provide direct or indirect benefit to the perpetrator, violates the employee’s duty to his/her employer, costs the employer money, and is carried out in secret.
Fraud, and the role of ethics in reducing fraud, are important factors in running business operations. The most common type of fraud, where employees steal or misuse the employer’s resources results in an average loss of $150,000 per occurrence. There are many types of fraud. In all cases, fraud increases a business’s costs.

14. Ethics in Accounting
C 3
Ethics are beliefs that distinguish right from wrong. They are accepted standards of good and bad behavior.
The IMA’s Statement of Ethical Professional Practice requires management accountants to be competent, maintain confidentiality, act with integrity, and communicate information in a fair and credible manner.
The Sarbanes-Oxley Act requires each issuer of
securities to disclose whether it has adopted a code of ethics for its senior officers and the content of that code.
Combating fraud and other dilemmas requires ethics in accounting. Identifying the correct ethical path can be difficult. The preferred path is a course of action that avoids casting doubt on one’s decisions. A code of ethical belief’s can be used to resolve ethical conflicts.

15. Managerial Cost Concepts
Behavior
Traceability
Controllability
Relevance
Function
Managers often need different cost classifications for different decisions. We will discuss each of these types of cost classifications individually.

16. Classification by Behavior
Cost behavior means how a cost will react to changes in the level of business activity.
A fixed cost does not change with changes in the volume of activity. Example: Depreciation of Equip, Plant Rent
A variable cost changes in proportion to changes in the volume of activity: Example: Sales Commission based on % of Sales
Classification of costs by behavior is helpful in cost-volume-profit analyses and short-term decision making. These are discussed in future chapters.
A mixed cost refers to a combination of fixed and variable. Example: Equipment Rental: $10K + $1

17. 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: -maintenance expenditures benefiting two or more departments.
-Production Floor Supplies
Cost objects may be products, services, departments, or customers to which costs are assigned

18. Classification by Controllability
The degree of control depends on the level of management in the organization. Investment in Equipment, Labor Overtime
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.
More Control
More Control
Very little control

19. Classification by Relevance: Sunk Costs
All costs incurred in the past that cannot be avoided or changed.
Sunk costs should not be considered in decisions.
Example: You bought an automobile that cost $15,000 two years ago. The $15,000 cost is sunk because whether you drive it, park it, trade it, or sell it, you cannot change the $15,000 cost.
Costs can be classified by relevance by identifying it as a sunk cost or an out-of-pocket cost

20. Classification by Relevance: Out-of-Pocket Costs
A cost that requires a future outlay of cash.
Out-of-pocket costs 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 the $25,000 or not in the future

21. Classification by Relevance: Opportunity Costs
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.
Opportunity costs are always relevant to a selection decision.

22. Classification by Function: Product Costs –Capitalized in Inventory
Direct Labor
Direct Material
Manufacturing Overhead
The Product
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.

23. Product vs. Period Costs
Product Cost: Identifiable with the product. Capitalized in Inventory. Example: DM, DL, OH
Period Cost: Expenses identified more with the time period than with the product. Example: Selling & Admin Expenses

24. Period and Product Costs in Financial Statements
2010 Income
Statement
Period Costs (Expenses)
Operating
Expenses
2010 Costs Incurred
Cost of
Goods Sold
Inventory Sold in 2010
Period costs are expensed in the period incurred. They are non-manufacturing costs usually grouped into two broad categories: selling and administrative.
Starting on the left side of this flow chart of costs, we see that costs incurred 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.
Product Costs (Inventory)
2010 Balance
Sheet Inventory
2011 Income
Statement
Raw Materials
Goods in Process
Finished Goods
Inventory Not Sold in 2010
Cost of
Goods Sold

25. Exercise 6 (Page 620) Exercise 8 (Page 620)

26. Balance Sheet of a Manufacturer
Goods in Process
Raw Materials
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.
Raw materials can be direct or indirect. Direct materials are used directly in a product. Materials not clearly identified with a specific units or batches of product are indirect materials.

27. Income Statement of a ManufacturerP1
Merchandiser
Manufacturer
Beginning Merchandise Inventory
Beginning Finished Goods Inventory + +
The major difference
Cost of Goods Purchased
Cost of Goods
Manufactured _ _
The finished goods inventory of a manufacturer is the equivalent of a merchandiser’s merchandise 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 buys 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.
Ending Merchandise Inventory
Ending
Finished Goods Inventory
Cost of Goods Sold = =

28. Income Statement of a ManufacturerP1
Cost of goods (CGS) sold for manufacturers differs only slightly from CGS 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.

29. Exercise 10 (page 621)

30. Income Statement of a Manufacturer
Direct Materials
Materials that are separately and readily traced to a particular product.
Example:
Steel used to manufacture the automobile.
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.

31. Income Statement of a Manufacturer
Direct Labor
Labor costs that are separately and readily traced to finished product.
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.
Example:
Wages paid to an automobile assembly worker.

32. Income Statement of a Manufacturer
Factory Overhead
All manufacturing costs except direct material and direct labor
Factory costs that cannot be separately or readily traced directly to products.
Factory overhead is all manufacturing costs other than direct material and direct labor. Factory overhead costs are indirect manufacturing costs that support the major manufacturing activities. As indirect costs, they cannot be separately and readily traced to the individual units of product.
Examples:
Indirect labor – maintenance
Indirect material – cleaning supplies Factory utility costs Supervisory costs

33. Income Statement of a Manufacturer
Manufacturing costs are often combined as follows:
Direct Material
Direct Labor
Manufacturing Overhead
Direct labor and direct material are called the prime costs of manufacturing. Direct labor and manufacturing overhead are called conversion costs.
Prime Cost
Conversion Cost

34. Flow of Manufacturing Activities
Production activity -WIP Inventory
Sales activity
Materials activity
Finished Goods Beginning Inventory
Goods in Process Beginning Inventory
Raw Materials
Beginning Inventory
Direct Labor
Cost of Goods Manufactured
Raw Materials Purchases
Factory Overhead
Finished Goods Ending Inventory
Cost of Goods Sold
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.
Raw Materials Used
Raw Materials Ending Inventory
Goods in Process Ending Inventory

35. Manufacturing StatementP2
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.

36. Manufacturing StatementP2
The information for Rocky Mountain Bikes is taken from your textbook.
Here you see the manufacturing statement for Rocky Mountain bikes in a highly summarized form. We will build each of the major parts of the statement starting with materials.

37. P2
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.

38. Manufacturing StatementP2
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.

39. Manufacturing StatementP2
Factory overhead costs are indirect manufacturing costs that support the manufacturing activities. The eight factory overhead items in this example, totaling thirty thousand dollars, are commonly encountered in many manufacturing companies.

40. Manufacturing StatementP2
Beginning work in process inventory is carried over from the prior period.
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.

41. Manufacturing StatementP2
Ending work in process inventory contains the cost of unfinished goods, and is reported in the current assets section of the balance sheet.
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.

42. Exercise 13 (Page 622) Exercise 14 (page 622)
Now that we have mastered some of the basic concepts and principles of managerial accounting, we are ready to put this knowledge to work.