Chapter 2 Basic Managerial Accounting Concepts

Chapter 2 Basic Managerial Accounting Concepts
COPYRIGHT © 2012 Nelson Education Ltd.

COPYRIGHT © 2012 Nelson Education Ltd.
Learning Objectives Explain the meaning of cost and how costs are assigned to products and services Define the various costs of manufacturing products and providing services as well as the costs of selling and administration Prepare income statements for manufacturing and service organizations COPYRIGHT © 2012 Nelson Education Ltd.

Cost Amount of cash or cash equivalent sacrificed for goods and/or services Expected to bring a current or future benefit to organization Let’s look at an example A furniture manufacturer buys lumber for $10,000 Cost of the lumber is the amount given up…$10,000 COPYRIGHT © 2012 Nelson Education Ltd.

Expenses As costs are used up in production of revenues, they expire
Expired costs are called expenses COPYRIGHT © 2012 Nelson Education Ltd.

Cost vs. Price Be careful! Cost and Price are not the same thing Cost
Amount we charge our customers for our products or services What we pay for something COPYRIGHT © 2012 Nelson Education Ltd.

Accumulating Costs Received telephone bill
Telephone Expense Bal. $800 + $150 Phone Bill $950 Recorded in Telephone Expense account $150 COPYRIGHT © 2012 Nelson Education Ltd.

Accumulating Costs This is helpful but managers also need to know which departments used the $950 in Telephone Expense Telephone Expense Bal. $800 + $150 $950 In other words, managers want to know how costs are assigned to cost objects COPYRIGHT © 2012 Nelson Education Ltd.

Assigning Costs Sales Dept. Let’s say the Telephone Expense was incurred by the Sales and the Manufacturing Departments Manufacturing Dept. The Sales and Manufacturing departments are cost objects COPYRIGHT © 2012 Nelson Education Ltd.

Assigning Costs Sales Dept. Telephone Expense $350 Bal. $800 + $150 $950 Manufacturing Dept. $600 The accountant assigns the Telephone Expense to the two cost objects COPYRIGHT © 2012 Nelson Education Ltd.

Assigning Costs Costs can be assigned in a number of ways Some methods are more accurate, but time consuming Others are simple, but not as precise These methods will be discussed further in upcoming chapters COPYRIGHT © 2012 Nelson Education Ltd.

Cost Classification Different costs are used for different purposes
Classification helps make sense of great variety of costs Cost groups: Direct costs (material & labour) Indirect costs (material and labour) Prime costs Conversion costs Product costs Period costs Variable costs (step costs and not) Fixed costs (committed and discretionary) Mixed costs Selling costs Administrative costs

Tracing Direct Costs Direct Costs: Easily and accurately traced to a cost object Relationship between the cost and the object can be physically observed Indirect Costs: Cannot be easily traced to a cost object Relationship between the cost and the object not easily observed Assigned through allocation COPYRIGHT © 2012 Nelson Education Ltd.

Other Categories of Cost
Variable Cost increases in total as output increases and decreases in total as output decreases Fixed Cost total does not increase as output increases and does not decrease as output decreases Opportunity Cost benefit given up or sacrificed when one alternative is chosen over another COPYRIGHT © 2012 Nelson Education Ltd.

Output Continued Products: Goods produced by converting raw materials through use of labour and capital inputs Produced by manufacturing organizations Services: Tasks or activities performed for a customer or an activity performed by a customer using an organization’s products or facilities Produced by services organizations COPYRIGHT © 2012 Nelson Education Ltd.

Nonproduction Costs Examples: Designing Distribution Customer Service Developing General Administration Marketing These are Selling costs These are Administrative costs COPYRIGHT © 2012 Nelson Education Ltd.

Product Cost Classifications
Only three cost elements can be assigned to products for financial reporting: Overhead Direct Materials Direct Labour COPYRIGHT © 2012 Nelson Education Ltd.

Direct Materials & Labour
Part of final product Directly traced to goods and services being produced Direct Labour: Directly traced to goods or services being produced COPYRIGHT © 2012 Nelson Education Ltd.

Manufacturing Overhead
All product costs other than direct materials or direct labour: Indirect Materials Supplies Indirect Labour Utilities COPYRIGHT © 2012 Nelson Education Ltd.

Cornerstone 2-1 How to Calculate Product Cost in Total and Per Unit Information: BlueDenim Company makes blue jeans. Last week: Direct materials (denim, thread, zippers, and rivets) costing $48,000 were put into production Direct labour of $30,000 (50 workers × 40 hours × $15 per hour) was incurred Overhead equals $72,000 By the end of the week, the company had manufactured 30,000 pairs of jeans COPYRIGHT © 2012 Nelson Education Ltd.

Example Required: Calculate the total product cost for last week Calculate the cost of one pair of jeans that were produced last week Now that we know what we have to do, let’s get started! COPYRIGHT © 2012 Nelson Education Ltd.

Cornerstone 2-2 How to Calculate Prime Cost and Conversion Cost in Total and Per Unit Information: Again, looking at BlueDenim Company. Last week: Direct materials (denim, thread, zippers, and rivets) costing $48,000 were put into production Direct labour of $30,000 (50 workers × 40 hours × $15 per hour) was incurred Overhead equals $72,000 By the end of the week, the company had manufactured 30,000 pairs of jeans COPYRIGHT © 2012 Nelson Education Ltd.

Example Required: Calculate the total prime cost for last week Calculate the per-unit prime cost Calculate the total conversion cost for last week Calculate the per-unit conversion cost Now that we know what we have to do, let’s get started! COPYRIGHT © 2012 Nelson Education Ltd.

Conversion Costs Conversion Costs = Direct Labour + Overhead
cost of converting raw materials into a final product Direct Labour Overhead $30,000 + $72,000 Conversion Costs per unit $102,000 = = $3.40 30,000 Units produced COPYRIGHT © 2012 Nelson Education Ltd.

Period Costs Unlike product costs which are carried in inventory; period costs are expensed in the period in which they are incurred Two categories of period costs: Selling Costs and Administrative Costs COPYRIGHT © 2012 Nelson Education Ltd.

Selling Costs Costs necessary to market, distribute, and service a product or service Examples: Salaries and commissions of sales people Warehousing Advertising Customer Service Shipping COPYRIGHT © 2012 Nelson Education Ltd.

Administrative Costs All costs associated with research, development, and general administration of the organization that cannot be assigned to selling or production Examples: Legal Fees General Accounting Expenses of printing the annual report Top Executive Salaries COPYRIGHT © 2012 Nelson Education Ltd.

Financial Statements for Manufacturing Operations
Business operations can be classified as: Service Merchandising Manufacturing Text focuses on manufacturing businesses Most managerial accounting concepts also apply to service and merchandising businesses COPYRIGHT © 2012 Nelson Education Ltd.

Direct Materials & Labour
Direct Materials Cost: Part of final product Directly traced to goods and services being produced Direct Labour Cost: Directly traced to goods or services being produced COPYRIGHT © 2012 Nelson Education Ltd.

Factory Overhead Cost (Manufacturing Overhead)
Costs other than direct materials and direct labour cost Incurred in manufacturing process Combined and classified as factory overhead cost All factory overhead costs are indirect costs of the product Examples: heat and light for the factory, power to run the machines Other examples include: salaries for factory supervisors, factory caretaking wages, equipment repair and maintenance, property taxes on factory buildings and land, insurance on factory buildings, amortization of factory plant and equipment

Balance Sheet for a Manufacturing Business
Three types of inventory: Materials Work in Process (WIP) Finished Goods

Income Statement for a Manufacturing Business

Cost of Goods Manufactured
Step 1 Determine the cost of direct materials used Step 2 Determine the total manufacturing costs incurred. Step 3 Determine the cost of goods manufactured.

Direct Materials Used Only the amount used on products produced during the current period Consider beginning and ending inventory levels Key point: Purchases do not equal materials used Let’s go through an example COPYRIGHT © 2012 Nelson Education Ltd.

Cornerstone 2-3 How to Calculate the Direct Materials Used in Production Information: On May 1, BlueDenim had $68,000 of materials in inventory During the month of May, the company purchased $210,000 of materials On May 31, materials inventory equalled $22,000 Required: Calculate the direct materials used in production for May COPYRIGHT © 2012 Nelson Education Ltd.

Work in Process Second type of inventory Cost of partially completed goods that are still on the factory floor at the end of the period Units are started, but not finished Included direct materials, direct labour, and overhead costs Let’s continue our example COPYRIGHT © 2012 Nelson Education Ltd.

Cornerstone 2-4 How to Calculate Cost of Goods Manufactured (COGM) Information: During the month of May, the company purchased $210,000 of materials On May 31, materials inventory equaled $22,000 During the month of May, BlueDenim Company incurred: Direct labour cost of $135,000 Overhead of $150,000 COPYRIGHT © 2012 Nelson Education Ltd.

Example Inventory is as follows: May 1 May 31 Materials $68,000 $22,000 Work in Process 50,000 16,000 Required: Calculate the cost of goods manufactured for May Calculate the cost of one pair of jeans assuming that 115,000 pairs of jeans were completed during May COPYRIGHT © 2012 Nelson Education Ltd.

BlueDenim Company Cost of Goods Manufactured For the Month of May
Direct materials $256,000 Direct labour 135,000 Overhead 150,000 Total Manufacturing Cost $541,000 Work in Process, May 1 50,000 Work in Process, May 31 (16,000) Cost of Goods Manufactured $575,000 Per unit Cost of Goods Manufactured $575,000 = $5 115,000 units COPYRIGHT © 2012 Nelson Education Ltd.

Cornerstone 2-5 How to Calculate Cost of Goods Sold (COGS) Information: On May 1 BlueDenim Company had 10,000 units in finished goods inventory costing $50,000 On May 31 the company had 26,000 units in finished goods inventory costing $130,000 Required: Calculate the cost of goods sold for May Calculate the number of jeans that were sold in May COPYRIGHT © 2012 Nelson Education Ltd.

Cost of Goods Sold Represent the total cost of units sold during a period Includes only product cost Includes direct materials, direct labour, and overhead Reported as an expense on the income statement “Sold” is the key word. Let’s continue with our example COPYRIGHT © 2012 Nelson Education Ltd.

BlueDenim Company Cost of Goods Sold For the Month of May
Cost of goods manufactured $575,000 Finished goods, May 1 50,000 Finished goods, May 31 (130,000) Cost of Goods Sold $495,000 Reported as an asset on the Balance Sheet Reported as an expense on the Income Statement COPYRIGHT © 2012 Nelson Education Ltd.

Units Sold Number of units sold: Finished goods inventory, May 1 10,000 Units finished during May 115,000 Finished goods inventory, May 31 (26,000) Units sold during May 99,000 COPYRIGHT © 2012 Nelson Education Ltd.

Cornerstone 2-6 How to Prepare an Income Statement for a Manufacturing Firm Information: BlueDenim Company sold 99,000 pairs of jeans in May at a total cost of $495,000 Each pair sold at a price of $8 BlueDenim also incurred two types of selling costs: Commissions equal to 10% of the sales price Other selling expense of $120,000 Administrative expense totalled $85,000 Required: Prepare an income statement for BlueDenim for May COPYRIGHT © 2012 Nelson Education Ltd.

BlueDenim Income Statement For the Month of May
99,000 pairs of Jeans × $8 Sales revenue $792,000 Cost of goods sold 495,000 Gross margin $297,000 Less: $792,000 × 10% Selling expense: Commissions $ 79,200 Fixed selling expense 120,000 199,200 Gross Margin is the difference between sales revenue and cost of goods sold Administrative expense 85,000 Operating income $ 12,800 COPYRIGHT © 2012 Nelson Education Ltd.

BlueDenim Company Income Statement For the Month of May
% $792,000 100.0 Sales revenue 495,000 Cost of goods sold Gross margin $297,000 Each item is divided by Sales revenue e.g. $792,000/ $792,000 = 100% Less: Selling expense: Commissions $ 79,200 Fixed selling expense 120,000 Administrative expense 199,200 85,000 Operating income $ 12,800 COPYRIGHT © 2012 Nelson Education Ltd.

% $792,000 100.0 Sales revenue 495,000 62.5 Cost of goods sold Gross margin $297,000 Less: $495,000/$792,000 = 62.5% Selling expense: Commissions $ 79,200 Fixed selling expense 120,000 Administrative expense 199,200 85,000 Operating income $ 12,800 COPYRIGHT © 2012 Nelson Education Ltd.

% $792,000 100.0 Sales revenue 495,000 62.5 Cost of goods sold Gross margin $297,000 37.5 Less: Selling expense: Commissions $ 79,200 Fixed selling expense 120,000 How would an Income Statement for a service business be different that this Income Statement? 25.2 Administrative expense 199,200 85,000 Operating income 10.7 $ 12,800 1.6 COPYRIGHT © 2012 Nelson Education Ltd.

Cornerstone 2-8 How to Prepare an Income Statement for a Service Organization Information: Komala Information Systems designs and installs software Last month, Komala had costs of: Materials, $5,000 Direct labour, $35,000 Overhead, $55,000 Selling expenses, $5,000 Administrative expenses, $7,000 Sales totalled $130,000 COPYRIGHT © 2012 Nelson Education Ltd.

Komala Information Systems Income Statement For the Past Month
Sales Revenues: $130,000 Less operating expenses Software licensing $ 5,000 Service technicians 35,000 R&D 55,000 5,000 Selling expenses 7,000 107,000 Administrative expense $23,000 Operating income COPYRIGHT © 2012 Nelson Education Ltd.

Income Statement: Service Firm
Cost of services sold is typically made up of: Materials Labour Overhead No beginning or ending inventories cost of services sold will always equal cost of services manufactured COPYRIGHT © 2012 Nelson Education Ltd.

Chapter 2 Basic Managerial Accounting Concepts

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