Managerial Accounting Basics

ACCT 102- Managerial Accounting Lecture Notes – Chapter 14: MANAGERIAL ACCOUNTING CONCEPTS AND PRINCIPLES MANAGERIAL ACCOUNTING BASICS Purpose of Managerial Accounting In ACCT 101, we learned the basics of financial reporting. The remainder of this course, except for financial statement analyses topics in Chapter 13, will look at how to gather and report information for managers in making planning and control decisions. Much of this learning will use manufacturing companies as the setting. Exhibit 14.2 contrasts seven different characteristics of financial accounting compared to managerial accounting. (See separate handout.) The most important of these are: 1. Users and decision makers a. In financial—Investors, creditors and other users external to the organization. b. In managerial—Managers, employees and decision makers internal to the organization. 2. Purpose of information a. In financial—Assist external users in making investment, credit and other decisions. b. In managerial—Assist managers in making planning and control decisions. 3. Flexibility of practice a. In financial—Structured and often controlled by GAAP. b. In managerial—Relatively flexible (no GAAP constraints). Other items are timeliness, time dimensions, focus, and nature of the information. Fraud & Ethics – Read these sections in your book. Make sure you know the parts of the fraud triangle. We will not spend much class time on this, but the concepts may be covered on the first exam. Career Paths – If this of interest to you, check them out! Managerial Cost Concepts Product costs and period costs An important part of this chapter is to understand that manufacturing companies must classify their costs into two distinct areas: product costs and period costs. Product costs are capitalized (treated as inventory, which is an asset). Period costs are charged to expense as incurred. 1 Product costs Product costs include direct materials, direct labor, and factory overhead costs. Let’s assume we are manufacturing men’s long-sleeved, button-down shirts. The types of costs classified as product costs would be: o Direct materials (DM): the materials included in the final product. In this case, that would be the fabric and buttons. (Thread used is probably not expensive enough to warrant tracking and would be part of factory overhead). o Direct labor (DL): the wages of the employees who had a “hands on” role in making the shirts, such as the employees who sewed the shirts or placed the fabric over the pattern. o Factory overhead (FOH): all other manufacturing costs. Factory overhead consists of costs that cannot be traced to a single product. Examples are superintendents’ salaries; repair and maintenance costs; factory rent; depreciation on factory equipment; and utilities costs to run the factory. In a modern factory, using robotics in place of human labor, factory overhead is the largest product cost. Period costs Period costs are those costs referred to in ACCT 101 as operating expenses. They are not directly involved in manufacturing product, nor are they factory overhead. Period costs are usually classified as either administrative or selling expenses. Selling expenses are those costs incurred in the selling or marketing functions. Examples include salesperson’s salaries or commissions, and advertising expense. All other operating expenses, such as the controller’s salary, legal expense, and office costs, would be classified as administrative expenses. Other important managerial cost concepts Much of this chapter introduces us to various terms used in managerial accounting. Following is a list of many important terms. A. Cost behavior—At a basic level, a cost can be classified as fixed or variable or mixed. 1. Fixed cost—cost does not change with changes in the volume of an activity (within a certain range of activity known as an activity's relevant range). 2. Variable cost—cost changes in proportion to changes in the volume of an activity. 3. Mixed—combination of fixed and variable costs. 2 B. Traceability—cost is traced to a cost object (a product, process, department or customer to which costs are assigned). Cost is classified as either a direct or indirect cost. To classify must identify the cost object. 1. Direct costs—those traceable to a single cost object. 2. Indirect costs—are those that cannot be traced to a single cost object. C. Controllability—costs can be defined as controllable or not controllable and this classification is dependent on employee’s responsibilities (hierarchical levels). D. Relevance—costs classified by identifying it as either a sunk cost or an out-of- pocket cost. 1. Sunk cost—already incurred and cannot be avoided or changed. These costs are irrelevant to future decisions. 2. Out-of-pocket cost—requires a future outlay of cash and is relevant for decision making. 3. Opportunity cost—is the potential benefit lost by choosing a specific action from two or more alternative. E. Prime costs: direct materials costs plus direct labor costs. F. Conversion costs: direct labor costs plus factory overhead costs. Reporting Manufacturing Activities Balance sheet Manufacturing companies typically have three different inventory accounts: 1. Raw Materials Inventory—goods acquired to use in making products. Two types are: a. Direct materials—physically become part of the product and are clearly identified with specific units or batches of product. b. Indirect Materials—used in support of the production process. Generally, do not become a part of a product. Exception: materials that do become part of product, but have low or insignificant cost, and traceability to product is not economically sound (application of materiality principle). 2. Goods in Process Inventory—better known as work in process inventory or WIP. These are products in the process of being manufactured but not yet complete. 3. Finished Goods Inventory—consists of completed products ready for resale. Income statement (emphasis) A manufacturing company calculates cost of goods sold as: Beginning finished goods inventory + cost of goods manufactured – ending finished goods inventory. Both the beginning and ending finished goods balances can be obtained from the Finished Goods account in the general ledger. The challenge is in calculating cost of goods manufactured. The 3 summarized form of a Manufacturing Statement, which calculates cost of goods manufactured, is: Direct materials used $XXX ** Direct labor incurred + XXX Factory overhead + XXXX =Total manufacturing costs $XXXX Add: goods in process, beginning of period + XX Less: goods in process, end of period - XX = Cost of goods manufactured $XXXX ** Direct materials used is calculated as follows: Raw materials inventory, beginning of period Raw material purchases + = Raw materials available for use Less raw materials inventory, end of period = Direct materials used $XXX XXXX XXXX XX $XXX Trends in Managerial Accounting These evolve every year. Take a look at this section and expect a multiple choice question. We will spend significant time in class working out exercises and problems that focus on identifying and classifying different types of cost. Also we will spend significant time discussing how to prepare the Statement of Cost of Goods Manufactured and how this statement is used to support the income statement. The preparation of these statements will be emphasized on your first exam. 4