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Chapter 2 Basic Managerial Accounting
Concepts
Chapter 2 Basic Managerial Accounting
Concepts
COPYRIGHT © 2012 Nelson Education Ltd.
2-22-2
Learning ObjectivesLearning Objectives
1. Explain the meaning of cost and how costs are assigned to products and services
2. Define the various costs of manufacturing products and providing services as well as the costs of selling and administration
3. Prepare income statements for manufacturing and service organizations
COPYRIGHT © 2012 Nelson Education Ltd.
OBJECTIVE OBJECTIVE 11
Explain the meaning of cost and how costs are assigned to products
and services
COPYRIGHT © 2012 Nelson Education Ltd.
2-42-4
CostCost
• 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
COPYRIGHT © 2012 Nelson Education Ltd.
A furniture manufacturer buys lumber for $10,000
Cost of the lumber is the amount given up…$10,000
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ExpensesExpenses
As costs are used up in production of revenues, they expire
Expired costs are called expenses
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Cost vs. PriceCost vs. Price
Be careful!
Cost and Price are not the same thing
Cost Price
Amount we chargeour customers forour products or
services
What we pay for something
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Accumulating CostsAccumulating Costs
Received telephone bill
Recorded in Telephone Expense account
Telephone Expense
+ $150Bal. $800
$950
$150
Phone Bill
COPYRIGHT © 2012 Nelson Education Ltd.
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Accumulating CostsAccumulating Costs
Telephone Expense
+ $150Bal. $800
$950
This is helpful but managers also need to
know which departments used the $950 in
Telephone Expense
In other words, managers want to know how costs are
assigned to cost objects
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Cost ObjectsCost Objects
• Any item for which costs are measured and assigned
• Examples:– Products– Customers– Departments– Regions
COPYRIGHT © 2012 Nelson Education Ltd.
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Assigning CostsAssigning Costs
Let’s say the Telephone Expense was incurred by the Sales and the Manufacturing
Departments
The Sales and Manufacturing departments
are cost objects
Sales Dept.
Manufacturing Dept.
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Assigning CostsAssigning Costs
Sales Dept.
Manufacturing Dept.
Telephone Expense
+ $150
Bal. $800
$950
$350
$600
The accountant assigns the Telephone Expense to the two cost objects
COPYRIGHT © 2012 Nelson Education Ltd.
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Assigning CostsAssigning 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.
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Cost ClassificationCost Classification
• Different costs are used for different purposes
• Classification helps make sense of great variety of costs
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Tracing Direct CostsTracing Direct Costs
Direct Costs:• Easily and accurately
traced to a cost object• Relationship between
the cost and the object can be physically observed
COPYRIGHT © 2012 Nelson Education Ltd.
Indirect Costs:• Cannot be easily
traced to a cost object• Relationship between
the cost and the object not easily observed
• Assigned through allocation
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Other Categories of CostOther 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.
OBJECTIVE OBJECTIVE 22Define the various costs of
producing products and services, as well as the costs of selling and administration
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OutputOutput
One of the most important cost objects of a company is its output
Two types of output:
Products Services
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Output ContinuedOutput 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
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Cost TypesCost Types
• Product (manufacturing) costs– Associated with the manufacture of goods or
the provision of services• Nonproduction costs
– All other costs
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Nonproduction CostsNonproduction Costs
Examples:
• Designing
• Developing
• General Administration
• Distribution
• Customer Service
• Marketing
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These are Selling costsThese are Administrative costs
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Product Cost ClassificationsProduct Cost Classifications
Only three cost elements can be assigned to products for financial reporting:
DirectMaterials
DirectLabour
Overhead
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Direct Materials & LabourDirect Materials & Labour
Direct Materials:• Part of final product • Directly traced to goods and services being produced
Direct Labour:• Directly traced to goods or services being produced
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Manufacturing OverheadManufacturing Overhead
All product costs other than direct materials or direct labour:
Supplies
Utilities
Indirect Materials
Indirect Labour
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Total Product CostTotal Product Cost
Direct Materials
+Direct Labour
Manufacturing Overhead
+Total Product Cost
=
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Product Cost Per UnitProduct Cost Per Unit
Total Product Cost
Number of Units Produced
Unit Cost =
Let’s work through an example
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Cornerstone 2-1Cornerstone 2-1
How to Calculate Product Cost in Total and Per Unit
COPYRIGHT © 2012 Nelson Education Ltd.
• 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
Information:
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ExampleExample
• Calculate the total product cost for last week• Calculate the cost of one pair of jeans that were
produced last week
Required:
Now that we know what we
have to do, let’s get started!
COPYRIGHT © 2012 Nelson Education Ltd.
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Total Product CostTotal Product Cost
Direct Materials
30,000Direct Labour
Overhead
$48,000
Direct Materials + Direct Labour + Overhead
72,000
Total Product Cost $150,000
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30,000
Per-Unit Product CostPer-Unit Product Cost
Total Product Cost
Number of Units Produced
$5 per pair of jeans
=$150,000
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Cornerstone 2-2Cornerstone 2-2
How to Calculate Prime Cost and Conversion Cost in Total and Per Unit
COPYRIGHT © 2012 Nelson Education Ltd.
• 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
Information:
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ExampleExample
• 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
Required:
Now that we know what we have to do, let’s get
started!
COPYRIGHT © 2012 Nelson Education Ltd.
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Prime CostsPrime Costs
Prime Costs per unit
+
Direct Labour
$2.60
+Direct
Materials
=
$48,000 $30,000
$78,000
30,000=
Units produced
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Conversion CostsConversion Costs
cost of converting raw materials into a final productConversion Costs = Direct Labour + Overhead
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Conversion Costs per unit
+
$3.40=
$30,000 $72,000
$102,000
30,000=
Units produced
OverheadDirect Labour
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Period CostsPeriod 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
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Selling CostsSelling Costs
Costs necessary to market, distribute, and service a product or service
Examples:
Salaries and commissions
of sales people Advertising
Warehousing
ShippingCustomer Service
COPYRIGHT © 2012 Nelson Education Ltd.
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Administrative CostsAdministrative Costs
All costs associated with research, development, and general administration of the organization that cannot be assigned to
selling or production
Examples:
General Accounting
Top Executive Salaries
Legal FeesExpenses of printing the
annual report
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OBJECTIVE OBJECTIVE 33
Prepare income statements for manufacturing and service organizations
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Financial Statements for Manufacturing OperationsFinancial Statements for Manufacturing Operations
Business operations can be classified as:• Service• Merchandising • Manufacturing
COPYRIGHT © 2012 Nelson Education Ltd.
Text focuses on manufacturing businesses• Most managerial accounting concepts also apply to service and merchandising businesses
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Direct Materials & LabourDirect 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.
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Factory Overhead Cost (Manufacturing Overhead)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 productExamples: heat and light for the factory, power to run the machines
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Balance Sheet for a Manufacturing BusinessBalance Sheet for a Manufacturing Business
• Three types of inventory:1. Materials
2. Work in Process (WIP)
3. Finished Goods
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Income Statement for a Manufacturing BusinessIncome Statement for a Manufacturing Business
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Cost of Goods ManufacturedCost 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.
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Direct Materials UsedDirect 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
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Cornerstone 2-3Cornerstone 2-3
How to Calculate the Direct Materials Used in Production
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• 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
Information:
Required:Calculate the direct materials used in production for May
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Materials Used in
Production
Direct MaterialsDirect Materials
Purchases =Ending
Materials Inventory
-Beginning Materials Inventory
+
$68,000 $210,000 $22,000‒+ = $256,000
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Work in ProcessWork 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
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Cornerstone 2-4Cornerstone 2-4
How to Calculate Cost of Goods Manufactured (COGM)
COPYRIGHT © 2012 Nelson Education Ltd.
• 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
Information:
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ExampleExample
May 1 May 31
Work in Process
Materials $68,00050,000
$22,000
Inventory is as follows:
16,000
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• 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
Required:
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(16,000)
$541,000
OverheadDirect labour
$256,000
150,000
Total Manufacturing CostWork in Process, May 1
Per unit Cost of Goods Manufactured
135,000
50,000
Direct materials
Cost of Goods Manufactured
BlueDenim CompanyCost of Goods Manufactured
For the Month of May
BlueDenim CompanyCost of Goods Manufactured
For the Month of May
$575,000
$575,000
115,000 units= $5
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Work in Process, May 31
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Cornerstone 2-5Cornerstone 2-5
How to Calculate Cost of Goods Sold (COGS)
COPYRIGHT © 2012 Nelson Education Ltd.
• 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
Information:
• Calculate the cost of goods sold for May• Calculate the number of jeans that were sold in May
Required:
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Cost of Goods SoldCost 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
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$495,000
Finished goods, May 31
Finished goods, May 1
$575,000
(130,000)
Cost of Goods Sold
50,000
Cost of goods manufactured
BlueDenim CompanyCost of Goods Sold
For the Month of May
BlueDenim CompanyCost of Goods Sold
For the Month of May
Reported as an expense on the Income Statement
COPYRIGHT © 2012 Nelson Education Ltd.
Reported as an asset on the
Balance Sheet
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Finished goods inventory, May 31
Units finished during May
10,000
(26,000)
Units sold during May
115,000
Finished goods inventory, May 1
99,000
Units SoldUnits Sold
Number of units sold:
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Cornerstone 2-6Cornerstone 2-6
How to Prepare an Income Statement for a Manufacturing Firm
COPYRIGHT © 2012 Nelson Education Ltd.
• 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
Information:
Required:Prepare an income statement for BlueDenim for May
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Cost of goods sold$792,000
Less:
495,000Sales revenue
BlueDenimIncome Statement
For the Month of May
BlueDenimIncome Statement
For the Month of May
$297,000Gross margin
Selling expense:Commissions $ 79,200Fixed selling expense 120,000
Administrative expense199,200
85,000Operating income $ 12,800
$792,000 × 10%
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99,000 pairs of Jeans × $8
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Cornerstone 2-7Cornerstone 2-7
How to Calculate the Percentage of Sales Revenue for Each Line on the
Income Statement
COPYRIGHT © 2012 Nelson Education Ltd.
Let’s continue our example
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Cost of goods sold
$792,000
Less:
495,000Sales revenue
BlueDenim CompanyIncome Statement
For the Month of May
BlueDenim CompanyIncome Statement
For the Month of May
$297,000Gross margin
Selling expense:
Commissions $ 79,200Fixed selling expense 120,000
Administrative expense 199,20085,000Operating income
$ 12,800
Each item is divided by
Sales revenue e.g. $792,000/
$792,000 = 100%
%100.0
COPYRIGHT © 2012 Nelson Education Ltd.
2-592-59
Cost of goods sold
$792,000
Less:
495,000Sales revenue
BlueDenim CompanyIncome Statement
For the Month of May
BlueDenim CompanyIncome Statement
For the Month of May
$297,000Gross margin
Selling expense:
Commissions $ 79,200Fixed selling expense 120,000
Administrative expense 199,20085,000Operating income
$ 12,800
%100.0
COPYRIGHT © 2012 Nelson Education Ltd.
$495,000/$792,000 = 62.5%
62.5
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Cost of goods sold
$792,000
Less:
495,000Sales revenue
BlueDenim CompanyIncome Statement
For the Month of May
BlueDenim CompanyIncome Statement
For the Month of May
$297,000Gross margin
Selling expense:
Commissions $ 79,200Fixed selling expense 120,000
Administrative expense 199,20085,000Operating income
$ 12,800
COPYRIGHT © 2012 Nelson Education Ltd.
%100.0
62.5
37.5
25.2
10.71.6
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Cornerstone 2-8Cornerstone 2-8
How to Prepare an Income Statement for a Service Organization
COPYRIGHT © 2012 Nelson Education Ltd.
• 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
Information:
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107,000
Less operating expensesSales Revenues: $130,000
Software licensingService technicians
Administrative expense5,000
R&D
$ 5,00035,000
Selling expenses
$23,000
Komala Information SystemsIncome StatementFor the Past Month
Komala Information SystemsIncome StatementFor the Past Month
55,000
Operating income
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7,000
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Income Statement:Service FirmIncome 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.