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CHAPTER 9

INTRODUCTION TO MANAGEMENT
ACCOUNTING:

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Management Accounting:-
• The process of preparing and provide accurate and
timely financial and statistical information required by
managers to make day-to-day and short term
decisions.
• Management accounting generates monthly or weekly
reports for an organization’s internal users such as
department managers and the chief executive officer.
• These reports may typically show the amount of
available cash, sales revenue generated, state of
accounts payable and accounts receivable, outstanding
debts, raw material and inventory.
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Management Accounting:
The three basic importance of management accounting
information are:

help to identify who has authority over assets.

supports planning and decision-making.

provide a means of monitoring, evaluating, and


rewarding performance.

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Comparing Financial Accounting and
Management Accounting
• both financial accounting and management accounting
are all about allocating scarce resources.
• Financial accounting is the principle source of
information for decisions of how to allocate resources
among companies, whereas
• Management accounting is the principle source of
information for decisions of how to allocate resources
within a company.
• Management accounting provides information that helps
managers control activities within the firm, and to decide
what products to sell, where to sell them, how to source
those products, and so on.

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Management Accounting
Financial Accounting
• Mostly optional.
• Mandatory for most companies
• Follows GAAP • No GAAP. Companies often
develop management accounting
• Backward looking: focuses system and measurement rules
mostly on reporting past that are unique and company
specific
performance
• Emphasis on reliability of the • Forward-looking: including
estimates and predications of
information future events and transactions
• Provides general purpose • Can include many subjective
information. Investors, creditors, estimates
regulators use the information
• Provides many reports modified
• Provides a high-level summary to specific users
of the business
• Can provides a great deal of
• Reports almost exclusively in detail
dollar denominated amounts
• Communicates many
nonfinancial measures of
performance, particularly
operational data such as units
produced and sold by product
type. 5
Cost Accounting Concepts
• Cost accounting is the process of accounting for
costs.
• It holds the accounting procedures relating to
recording of all income and expenditure and the
preparation of periodical statements and reports
with the object of ascertaining and controlling
costs.
• On the other hand, management accounting
involves collecting, analyzing, interpreting and
presenting all accounting information, which is
useful to the management.
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Cost Terms (concepts)
• Different categories of
cost terms are merely
Behavior
different ways to look at
costs or to segment and Traceability
cut up cost information.

• They are not necessarily Relevance


complementary to or
mutually exclusive of
other cost categories. Function

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Classification by Behavior
Cost behavior means how a cost will react to
changes in the level of business activity.
 Total fixed costs: costs that do not change (in total) relative to
changes in business activity

Do not change when activity changes.


 Total variable costs: Variable costs: costs that increase or
decrease (in total) relative to increases or decreases in the level of
business activity.

Change in proportion to activity changes.

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Classification by Behavior
• Total fixed costs do
not change when activity
Cost

changes.

Activity

 Total variable costs


Cost

change in proportion
to activity changes.

Activity 9
Classification by Traceability
Direct costs: costs that Indirect costs: costs that are
are directly traceable NOT directly traceable to a product,
to some object such activity or department.
as a product, activity • Costs incurred for the
or department. benefit of more than one
 Examples: material and cost object.
labor cost for a product.
 Example: maintenance
expenditures benefiting
two or more departments.

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Classification by Relevance:
A. Opportunity Costs
The potential benefit that is given up when one
alternative is selected over another.
The potential benefits foregone when a
decision is made.

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.

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B. Sunk Costs
Sometimes called “past costs.” These costs are
NOT relevant to the decision making process.

All costs incurred in the past that cannot be changed by any


decision made now or in the future.

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.

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Classification by Function:

1. Product Costs and

2. Period costs

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1. Product Costs
• Product Costs: Include all costs that are required to
make a product
• Product costs are: Direct Material, Direct Labour,
Manufacturing Overhead
• They are included as part of inventory and shown on the
balance sheet until the product is sold.
• Product costs are often called “inventoriable costs” or
“manufacturing costs”.
• When the product is sold, the costs are “matched” to the
sales revenue and reported on the income statement as
cost of goods sold
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Product Costs

Direct Direct Manufacturing


Labor Material Overhead

The
Product

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2. Period costs
• Period costs are selling and general
administrative expenses identified with
the accounting period in which they are
incurred, and charged against sales
revenue in the same period.
• They are also called period expense.

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Accounting for Manufacturing
Operations
Steps in the Manufacturing Process:
Convert raw Sell
Buy raw
materials into finished
materials.
finished goods. goods.

Direct Direct labor and Cost of


materials manufacturing goods
costs. overhead costs. sold.
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Direct Materials
Raw materials
& component Can be traced
parts that directly and
become an conveniently
integral part to products.
of finished
products.

If materials cannot be traced directly to products,


the materials are considered indirect and are part
of manufacturing overhead.
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Direct Labor

Includes the payroll cost of direct workers.

Direct labor Wage


×
hours rate
Those employees
The cost of employees who who work directly
do not work directly on the on the goods being
goods is considered manufactured.
indirect labor and is part of
manufacturing overhead.
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Manufacturing Overhead
All manufacturing costs other than direct
materials and direct labor.

Includes:
• Indirect materials.
• Indirect labor. Does not include
selling or general
• Machinery and and administrative
equipment costs. expenses.
• Cost of regulatory
compliance.
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Cost to produce a product

The cost to produce a unit of product includes:

Direct material + Direct labor + Manufacturing overhead

Manufacturing overhead must be mathematically allocated to


each unit of product using a predetermined overhead
application rate.

Ove rhe a d Estima te d Estima te d Units


Applica tion = Ove rhe a d ÷ in the Activity
Ra te Costs Ba se

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Example:
• Big “T” Company produces engines for big trucks.
Total overhead for 2002 is estimated to be
$2,600,000. Big “T” applies overhead based on
machine hours. Big “T” estimates machine hours
for 2002 to be 162,500 hours.
• Compute Big “T’s” predetermined overhead rate for
2002.

Overhead Estimated Estimated


Application = Overhead ÷ Units in the
Rate Costs Activity Base
= $ 2,600,000 ÷ 162,500
= $ 16.00 per hour

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Inventories of a Manufacturing
Business
Raw materials - inventory on
hand and available for use.

Work in
process -
partially
Finished completed
goods- goods.
completed
goods awaiting
sale.
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The Flow of Manufacturing
Costs Example

Pure-Ice company had $52,000 of inventory in


direct materials inventory on January 1, 2002.
During the year, Pure-Ice purchased $586,000 of
additional direct materials. At December 31,
2002, $78,000 of the direct materials were still on
hand.
How much direct material was placed into
production during 2002?
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The Flow of Manufacturing
Costs Example
Beginning materials
inventory $ 52,000
+ Materials purchased 586,000
Materials available to be
=
placed into production 638,000
Materials placed into

production ??
Ending materials
=
inventory $ 78,000

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The Flow of Manufacturing
Costs Example
Beginning materials
inventory $ 52,000
+ Materials purchased 586,000
Materials available to be
=
placed into production 638,000
Materials placed into

production 560,000
Ending materials
=
inventory $ 78,000

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The Flow of Manufacturing
Costs Example
In addition to the direct materials, Pure-
Ice incurred $306,000 of direct labor cost
during 2002. Manufacturing overhead for
2002 was $724,000.
Pure-Ice started 2002 with $132,000 work
in process. During 2002, units costing
$1,480,000 were transferred to finished
goods inventory.
What is the ending balance in work
in process at December 31, 2002?
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The Flow of Manufacturing
Costs Example
Beginning work in
process inventory $ 132,000
+ Manufacturing costs
added 1,590,000
= Total costs in process
during
Direct the year $ 560,000 1,722,000
Materials
–Direct
CostLabor
of goods 306,000
completed during the
Manufacturing
year (1,480,000)
Overhead 724,000
= Ending work in
Total costs added
process inventory ?
during the year $ 1,590,000
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The Flow of Manufacturing
Costs Example
Beginning work in
process inventory $ 132,000
+ Manufacturing costs
added 1,590,000
= Total costs in process
during the year 1,722,000
– Cost of goods
completed during the
year (1,480,000)
= Ending work in
process inventory $ 242,000

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Determining the Cost of
Finished Goods Manufactured

A schedule of the cost of finished goods


manufactured is prepared to assist managers
in understanding and evaluating the overall
cost of manufacturing products.

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Flow of Manufacturing Activities
Materials Production activity Sales activity
activity
Work in Process Finished Goods
Raw Beginning Inventory Beginning Inventory
Materials
Beginning Cost of Goods
Inventory Direct Labor
Manufactured
Factory Total costs
Raw
in process
Materials Overhead Finished Goods
Raw during the
Purchases year available for sale
Materials Raw Materials
Available Used
for use Finished
Goods Cost
Raw Materials Work in Process Ending of
Ending Inventory Ending Inventory Inventory Sales
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Statement of Cost of Goods
Manufactured
Cost of all goods completed and transferred
from work in process to finished goods during
a reporting period.

Direct Materials Used


+ Direct Labor
+ Factory Overhead
= Total Manufacturing Costs
+ Beginning Work in Process
= Total costs in process during the period
– Ending Work in Process
= Cost of Goods Manufactured 32
Product Cost Flows

Beginning raw Direct materials Beginning work in


materials inventory + Direct labor process inventory
+ Raw materials + Mfg. overhead + Total manufacturing
purchased = Total manufacturing costs
= Raw materials costs = Total work in
available for use process for the
in production period
– Ending raw materials
inventory
= Raw materials used
in production All manufacturing costs incurred
during the period are added to the
beginning balance of work in
process.
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Product Cost Flows

Manufacturing Work
Raw Materials Costs In Process

Beginning raw Direct materials Beginning work in


materials inventory + Direct labor process inventory
+ Raw materials + Mfg. overhead + Total manufacturing
purchased = Total manufacturing costs
= Raw materials costs = Total work in
available for use process for the
in production period
– Ending work in
process inventory
Costs associated with the goods that = Cost of goods
manufactured
are completed during the period are
transferred to finished goods
inventory. 34
Product Cost Flows

Work
In Process Finished Goods

Beginning work in Beginning finished


process inventory goods inventory
+ Manufacturing costs + Cost of goods
for the period manufactured
= Total work in process = Cost of goods
for the period available for sale
– Ending work in - Ending finished
process inventory goods inventory
= Cost of goods Cost of goods
manufactured sold

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Statement of Cost of Goods
Manufactured

Let’s take a look at Rocky Mountain Bikes’


Statement of Cost of Goods Manufactured.

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Statement of Cost of Goods
Manufactured

ROCKY MOUNTAIN BIKES


STATEMENT OF COST OF GOODS MANUFACTURED
FOR THE YEAR ENDED 31 DECEMBER 2006
Direct materials used in production $ 85,500
Direct labor 60,000
Total factory overhead costs 30,000
Total manufacturing costs for the period $ 175,500
Beginning work in process inventory 2,500
Total cost of work in process $ 178,000
Ending work in process inventory (7,500)
Cost of goods manufactured $ 170,500
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Statement of Cost of Goods
Computation of Cost of Direct Material Used

Manufactured
Beginning raw materials inventory
Add: Purchases of raw materials
$ 8,000Exh.
86,50018-16
Cost of raw materials available for use $ 94,500
Less: Ending raw materials inventory 9,000
Cost of direct materials used in production $ 85,500
ROCKY MOUNTAIN BIKES
STATEMENT OF COST OF GOODS MANUFACTURED
FOR THE YEAR ENDED 31 DECEMBER 2006
Direct materials used in production $ 85,500
Direct labor 60,000
Total factory overhead costs 30,000
Total manufacturing costs for the period $ 175,500
Beginning work in process inventory 2,500
Total cost of work in process $ 178,000
Ending work in process inventory (7,500)
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Cost of goods manufactured $ 170,500
Statement of Cost of Goods
Manufactured
Include all direct labor
costs incurred
ROCKY during
MOUNTAIN the
BIKES
current
STATEMENT OF COST OFperiod.
GOODS MANUFACTURED
FOR THE YEAR ENDED 31 DECEMBER 2006
Direct materials used in production $ 85,500
Direct labor 60,000
Total factory overhead costs 30,000
Total manufacturing costs for the period $ 175,500
Beginning work in process inventory 2,500
Total cost of work in process $ 178,000
Ending work in process inventory (7,500)
Cost of goods manufactured $ 170,500
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Computation of Total Manufacturing Overhead

Manufacturing Statement
Indirect labor
Factory supervision
$ 9,000
6,000
Factory utilities 2,600
Property taxes, factory building 1,900
Factory supplies usedROCKY MOUNTAIN BIKES 600
Factory insurance expired 1,100
STATEMENT OF COST OF GOODS MANUFACTURED
Depreciation, building and equipment 5,300
FOR THE YEAR ENDED 31 DECEMBER 2006
Other factory overhead 3,500
Total factory
Direct overhead
materials usedcosts
in production $ 30,000 $ 85,500
Direct labor 60,000
Total factory overhead costs 30,000
Total manufacturing costs for the period $ 175,500
Beginning work in process inventory 2,500
Total cost of work in process $ 178,000
Ending work in process inventory (7,500)
Cost of goods manufactured $ 170,500
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Statement of Cost of Goods
Manufactured
Beginning work in
process inventory is
ROCKY MOUNTAIN BIKES
carried over from the
STATEMENT OF COST OF GOODS MANUFACTURED
prior period.
FOR THE YEAR ENDED 31 DECEMBER 2006
Direct materials used in production $ 85,500
Direct labor 60,000
Total factory overhead costs 30,000
Total manufacturing costs for the period $ 175,500
Beginning work in process inventory 2,500
Total cost of work in process $ 178,000
Ending work in process inventory (7,500)
Cost of goods manufactured $ 170,500
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Statement of Cost of Goods
Manufactured
Ending work in process inventory
contains the cost ofBIKES
ROCKY MOUNTAIN unfinished goods,
STATEMENTand
OF is reported
COST in the
OF GOODS current assets
MANUFACTURED
section
FOR THE YEAR ENDEDof 31
theDECEMBER
balance sheet.
2006
Direct materials used in production $ 85,500
Direct labor 60,000
Total factory overhead costs 30,000
Total manufacturing costs for the period $ 175,500
Beginning work in process inventory 2,500
Total cost of work in process $ 178,000
Ending work in process inventory (7,500)
Cost of goods manufactured $ 170,500
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Balance Sheet of a Manufacturer
Manufacturing Inventory Classifications

Work in
Raw Process Finished
Materials Goods

Partially complete
products.

Materials Material to which Completed


waiting to be some labor and/or products
processed. overhead have for sale.
been added.
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Balance Sheet of a

MERCHANDISER MANUFACTURER

Current Assets Current Assets


 Cash  Cash
 Receivables  Receivables
 Merchandise  Inventories
Inventory Raw Materials
Work in Process
Finished Goods

The only difference is inventory. 44


Income Statement of
Merchandiser Manufacturer

Beginning Beginning
Merchandise Finished Goods
Inventory Inventory
+ +
Cost of Goods The major Cost of Goods
Purchased difference Manufactured
_ _
Ending Ending
Merchandise Finished Goods
Inventory Inventory

= Cost of Sales = 45
Income Statement for Manufacturer
• Sales x
(-) COGS
Beginning Finished goods x
COGM x
CGAFS x
(-) Ending finished goods (x)
COGS (x)
Gross Profit x
Operating expenses (x)
Net Profit x 46
Income Statement for merchandiser
• Sales x
(-) COGS
Beginning merchandise Inventory x
Merchandise purchased x
CGAFS x
(-) Ending merchandise Inventory (x)
(-) COGS (x)
Gross Profit x
Operating expenses (x)
Net Profit x

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