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Jamil Ahmed

Assistant Professor

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Managerial Accounting – A

Preamble

1-2

1. Definition of accounting

The process of identifying, measuring and communicating

economic information to permit informed judgements anddecisions by users of the information.

2. Users of accounting information can be divided into

two categories:

(i) external parties outside the organization (financial accounting)

(ii) internal parties within the organization (management/Cost

accounting)

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1-3

3. Major differences between financial

and management accounting: Statutory requirement for public companies to produce annual financial

accounts, whereas there is no legal requirement for management accounting.

Financial accounting reports describe the whole of the organization, whereas

management accounting focuses on reporting information for different parts of

the business.

Financial accounting reports must be prepared in accordance with generally

accepted accounting principles (e.g. SSAPs).

Financial accounting reports historical information, whereas managementaccounting places greater emphasis on reporting estimated future costs and

revenues.

Management accounting reports are produced at more frequent intervals.

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1-4

Managerial versus Financial Accounting

Managerial Accounting Financial Accounting

Users of Information Managers, within the organization. Interested parties, outside the organization.

Regulation Not required and unregulated, since it is intended

only for management.

Required and must conform to generally accepted

accounting principles. Regulated by the Financial

Accounting Standards Board, and, to a lesser

degree, the Securities and ExchangeCommission.Source of Data The organization's basic accounting system, plus

various other sources, such as rates of effective

products manufactured, physical quantities of

material and labor used in production, occupancy

rates in hotels and hospitals, and average take-offdela s in airlines.

Almost exclusively drawn from the organization's

basic accounting system, which accumulates

financial information.

Nature of Reports and

Procedures

Reports often focus on subunits within the

organization, such as departments, divisions,

geographical regions, or product lines. Based on a

combination of historical data, estimates, and

projections of future events.

Reports focus on the enterprise in its entirety.

Based almost exclusively on historical transaction

data.

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1-5

1. Inventory valuation for internal and external profit measurement

Allocate costs between products sold and fully and partly completed

products that are unsold.

2. Provide relevant information to help managers make better decisions

profitability analysis

product pricing

make or buy (outsourcing)

product mix and discontinuation

Primary functions of cost/management

accounting systems

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1-6

3. Provide information for planning, control and performance

measurement

Long-term and short-term planning (budgeting)

Periodic performance reports for feedback control

Performance reports also widely used to evaluate managerial

performance

Note that costs should be assembled in different ways to meet the

above three requirements.

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The Product

Direct

Materials

Direct

Labor

Manufacturing

Overhead

Manufacturing Costs

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Direct Materials

Raw materials that become an integral part of the product and that can be conveniently traced

directly to it.

Example: A radio installed in an automobile

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Direct Labor

Those labor costs that can be easily traced toindividual units of product.

Example: Wages paid to automobile assembly workers

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Manufacturing costs that cannot be traced directlyto specific units produced.

Manufacturing Overhead

Examples: Indirect labor and indirect materials

Wages paid to employees whoare not directly involved in

production work.Examples: maintenance

workers, janitors and securityguards.

Materials used to support theproduction process.

Examples: lubricants andcleaning supplies used in theautomobile assembly plant.

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Non-manufacturing Costs

Selling

Costs

Costs necessary to get the

order and deliver theproduct.

Administrative

Costs

All executive,

organizational, andclerical costs.

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Product Costs Versus Period

Costs

Product costs include

direct materials, direct

labor, and manufacturing

overhead.

Period costs include all

selling costs and

administrative costs.

Inventory Cost of Good Sold

Balance

Sheet

Income

Statement

Sale

Expense

Income

Statement

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Quick Check

Which of the following costs would be considered a

period rather than a product cost in a manufacturing

company?

A. Manufacturing equipment depreciation.B. Property taxes on corporate headquarters.

C. Direct materials costs.

D. Electrical costs to light the productionfacility.

E. Sales commissions.

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Quick Check

Which of the following costs would be considered a

period rather than a product cost in a manufacturing

company?

A. Manufacturing equipment depreciation.B. Property taxes on corporate headquarters.

C. Direct materials costs.

D. Electrical costs to light the productionfacility.

E. Sales commissions.

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Classifications of Costs

DirectMaterial

DirectLabor

ManufacturingOverhead

Prime

Cost

Conversion

Cost

Manufacturing costs are often

classified as follows:

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Comparing Merchandising and

Manufacturing Activities

Merchandisers . . . Buy finished goods.

Sell finished goods.

Manufacturers . . . Buy raw materials.

Produce and sell finished

goods.

MegaLoMart

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Balance Sheet

Merchandiser

Current assets

Cash

Receivables

Prepaid Expenses

Merchandise

Inventory

Manufacturer

Current Assets

Cash

Receivables

Prepaid Expenses

Inventories

• Raw Materials

• Work in Process

• Finished Goods

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Merchandiser

Current assets

Cash

Receivables

Prepaid Expenses

Merchandise

Inventory

Manufacturer

Current Assets

Cash

Receivables

Prepaid Expenses

Inventories

• Raw Materials

• Work in Process

• Finished Goods

Balance Sheet

Partially completeproducts – some

material, labor, oroverhead has been

added.

Completed productsawaiting sale.

Materials waiting to beprocessed.

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Learning Objective 3

Prepare an income statement

including calculation of thecost of goods sold.

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The Income Statement

Cost of goods sold for manufacturers differs only slightlyfrom cost of goods sold for merchandisers.

Manufacturing Company

Cost of goods sold: Beg. finished

goods inv. 14,200$

+ Cost of goods

manufactured 234,150

Goods available

for sale 248,350$- Ending

finished goods

inventory (12,100)

= Cost of goods

sold 236,250$

Merchandising Company

Cost of goods sold: Beg. merchandise

inventory 14,200$

+ Purchases 234,150

Goods available

for sale 248,350$

- Ending merchandise

inventory (12,100)

= Cost of goods

sold 236,250$

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Basic Equation for Inventory

AccountsBeginning

balance

Additions

to inventory+ =Ending

balance

Withdrawals

from

inventory-

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Quick Check

If your inventory balance at the beginning of the month

was $1,000, you bought $100 during the month, and sold

$300 during the month, what would be the balance at the

end of the month?

A. $1,000.

B. $ 800.

C. $1,200.

D. $ 200.

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Quick Check

If your inventory balance at the beginning of the month

was $1,000, you bought $100 during the month, and sold

$300 during the month, what would be the balance at the

end of the month?

A. $1,000.

B. $ 800.

C. $1,200.

D. $ 200.

$1,000 + $100 = $1,100

$1,100 - $300 = $800

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Schedule of Cost of Goods

Manufactured

Calculates the cost of raw

material, direct labor and

manufacturing overhead used in

production.

Calculates the manufacturingcosts associated with goods that

were finished during the period.

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Manufacturing Work

Raw Materials Costs In Process

Beginning raw Direct materials

materials inventory

+ Raw materials purchased

= Raw materials

available for use

in production

– Ending raw materials

inventory= Raw materials used

in production

As items are removed from raw

materials inventory and placed into the

production process, they are

called direct materials.

Product Cost Flows

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Manufacturing Work


Beginning raw Direct materials

materials inventory + Direct labor

+ Raw materials + Mfg. overhead purchased = Total manufacturing

= Raw materials costs

available for use

in production



in production

Conversion costs

are costs incurred

to convert the

direct material

into a finished

product.

Product Cost Flows

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Manufacturing Work


Beginning raw Direct materials Beginning work in

materials inventory + Direct labor process inventory

+ Raw materials + Mfg. overhead + Total manufacturing purchased = Tota l manufacturing costs

= Raw materials costs = Total work in

available for use process for the

in production period



in production

Product Cost Flows

All manufacturing costs incurred duringthe period are added to the beginning

balance of work in process.

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Manufacturing Work


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 – Ending work in

inventory process inventory= Raw materials used = Cost of goods

in production manufactured

Product Cost Flows

Costs associated with the goods that arecompleted during the period are

transferred to finished goods inventory.

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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

Product Cost Flows

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Manufacturing Cost Flows

FinishedGoods

Cost of

GoodsSold

Selling and

Administrative

Period CostsSelling andAdministrative

Manufacturing

Overhead

Work in

Process

Direct Labor

Balance SheetCosts Inventories

IncomeStatement

ExpensesMaterial Purchases Raw Materials

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Quick Check

Beginning raw materials inventory was $32,000. During

the month, $276,000 of raw material was purchased. A

count at the end of the month revealed that $28,000 of

raw material was still present. What is the cost of direct

material used?

A. $276,000

B. $272,000

C. $280,000

D. $ 2,000

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Quick Check

Beginning raw materials inventory was $32,000. During

the month, $276,000 of raw material was purchased. A

count at the end of the month revealed that $28,000 of

raw material was still present. What is the cost of direct

material used?

A. $276,000

B. $272,000

C. $280,000

D. $ 2,000

Beg. raw materials 32,000$

+ Raw materials

purchased 276,000

= Raw materials available

for use in production 308,000$ – Ending raw materials

inventory 28,000

= Raw materials used

in production 280,000$

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Quick Check

Direct materials used in production totaled$280,000. Direct labor was $375,000 andfactory overhead was $180,000. What were

total manufacturing costs incurred for themonth?

A. $555,000

B. $835,000C. $655,000

D. Cannot be determined.

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Direct materials used in production totaled$280,000. Direct labor was $375,000 andfactory overhead was $180,000. What were

total manufacturing costs incurred for themonth?

A. $555,000

B. $835,000C. $655,000

D. Cannot be determined.

Direct Materials 280,000$

+ Direct Labor 375,000

+ Mfg. Overhead 180,000

= Mfg. Costs Incurred for the Month 835,000$

Quick Check

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Quick Check

Beginning work in process was $125,000.Manufacturing costs incurred for the monthwere $835,000. There were $200,000 of

partially finished goods remaining in workin process inventory at the end of the month.What was the cost of goods manufacturedduring the month?

A. $1,160,000B. $ 910,000C. $ 760,000D. Cannot be determined.

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Beginning work in process was $125,000.Manufacturing costs incurred for the monthwere $835,000. There were $200,000 of

partially finished goods remaining in workin process inventory at the end of the month.What was the cost of goods manufacturedduring the month?

A. $1,160,000B. $ 910,000C. $ 760,000D. Cannot be determined.

Quick Check

Beginning work in process inventory 125,000$

+ Mfg. costs incurred for the period 835,000

= Total work in process during the period 960,000$

–Ending work in process inventory 200,000

= Cost of goodsmanufactured 760,000$

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Quick Check

Beginning finished goods inventory was$130,000. The cost of goods manufactured forthe month was $760,000. And the ending

finished goods inventory was $150,000. Whatwas the cost of goods sold for the month?

A. $ 20,000.

B. $740,000.

C. $780,000.

D. $760,000.

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Quick Check

Beginning finished goods inventory was$130,000. The cost of goods manufactured forthe month was $760,000. And the ending

finished goods inventory was $150,000. Whatwas the cost of goods sold for the month?

A. $ 20,000.

B. $740,000.

C. $780,000.

D. $760,000.

$130,000 + $760,000 = $890,000

$890,000 - $150,000 = $740,000

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Cost Classifications for Predicting

Cost Behavior

How a cost will react tochanges in the level of

activity within the relevant

range. Total variable costs change

when activity changes.

Total fixed costs remain

unchanged when activitychanges.

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Variable Cost

Your total long distance telephone bill is basedon how many minutes you talk.

Minutes Talked

T o t a l L o n g D i s t a n c e

T e l e p h o n e B i l l

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Variable Cost Per Unit

Minutes Talked

P e r M i n u t e

T e l e p

h o n e C h a r g e

The cost per long distance minute talked is

constant. For example, 10 cents per minute.

Fi d C

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Fixed Cost

Your monthly basic telephone bill probablydoes not change when you make more local

calls.

Number of Local Calls

M o n t h l y B a s i c

T e l e p h o n e B i l l

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Fixed Cost Per Unit

Number of Local Calls M o n t h l y B

a s i c T e l e p h o n e B i l l

p e r L o c a l C a l l

The average fixed cost per local call decreases asmore local calls are made.

C t Cl ifi ti f

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Cost Classifications for

Predicting Cost Behavior

Behavior of Cost (within the relevant range)

Cost In Total Per Unit

Variable Total variable cost changes Variable cost per unit remainsas activity level changes. the same over wide ranges

of activity.

Fixed Total fixed cost remains Average fixed cost per unit goes

the same even when the down as activity level goes up.

activity level changes.

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Quick Check

Which of the following costs would be variable with

respect to the number of cones sold at a Baskins &

Robbins shop? (There may be more than one correct

answer.)

A. The cost of lighting the store.

B. The wages of the store manager.

C. The cost of ice cream.

D. The cost of napkins for customers.

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Quick Check

Which of the following costs would be variable with

respect to the number of cones sold at a Baskins &

Robbins shop? (There may be more than one correct

answer.)

A. The cost of lighting the store.

B. The wages of the store manager.

C. The cost of ice cream.

D. The cost of napkins for customers.

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Learning Objective 6

Understand the differences

between direct and indirect

costs.

A i i C t t C t Obj t

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Assigning Costs to Cost Objects

Direct costs

Costs that can beeasily and convenientlytraced to a unit of product

or other cost object. Examples: direct material

and direct labor

Indirect costs

Costs that cannot be easilyand conveniently traced to aunit of product or other cost

object. Example: manufacturing

overhead

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Learning Objective 7Define and give examples of

cost classifications used in

making decisions:differential costs, opportunity

costs, and sunk costs.

Cost Classifications for Decision

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Every decision involves a choice between at least

two alternatives.

Only those costs and benefits that differ between

alternatives are relevant in a decision. All other

costs and benefits can and should be ignored.

Cost Classifications for Decision

Making

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Differential Cost and Revenue

Costs and revenues that differ amongalternatives.

Example: You have a job paying $1,500 per month in yourhometown. You have a job offer in a neighboring city that

pays $2,000 per month. The commuting cost to the city is

$300 per month.

Differential revenue is: $2,000 – $1,500 = $500

Differential cost is:

$300

Opportunity Cost

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Opportunity Cost

The potential benefitthat is given up when

one alternative isselected over another.

Example: If you were

not attending college,

you could be earning

$15,000 per year.Your opportunity cost

of attending college for

one year is $15,000.

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Sunk Costs

Sunk costs have already been incurred andcannot be changed now or in the future.They should be ignored when making

decisions.Example: You bought an automobile that cost $10,000two years ago. The $10,000 cost is sunk because whether

you drive it, park it, trade it, or sell it, you cannot change

the $10,000 cost.

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Quick Check

Suppose you are trying to decide whether to drive or take

the train to Portland to attend a concert. You have ample

cash to do either, but you don’t want to waste money

needlessly. Is the cost of the train ticket relevant in this

decision? In other words, should the cost of the train

ticket affect the decision of whether you drive or take the

train to Portland?

A. Yes, the cost of the train ticket is relevant.B. No, the cost of the train ticket is not relevant.

Q i k Ch k

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Quick Check




needlessly. Is the cost of the train ticket relevant in this

decision? In other words, should the cost of the train

ticket affect the decision of whether you drive or take the

train to Portland?

A. Yes, the cost of the train ticket is relevant.B. No, the cost of the train ticket is not relevant.

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Quick Check




needlessly. Is the annual cost of licensing your car

relevant in this decision?

A. Yes, the licensing cost is relevant.

B. No, the licensing cost is not relevant.

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Quick Check




needlessly. Is the annual cost of licensing your car

relevant in this decision?

A. Yes, the licensing cost is relevant.

B. No, the licensing cost is not relevant.

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Quick Check

Suppose that your car could be sold now for $5,000. Is

this a sunk cost?

A. Yes, it is a sunk cost.

B. No, it is not a sunk cost.

Q i k Ch k

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Quick Check

Suppose that your car could be sold now for $5,000. Is

this a sunk cost?

A. Yes, it is a sunk cost.

B. No, it is not a sunk cost.

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Learning Objective 8(Appendix 2A)

Properly account for laborcosts associated with idle

time, overtime, and fringe

benefits.

Idle Time

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Idle Time

The labor costs incurred during

idle time are ordinarily treated as

manufacturing overhead.

MachineBreakdowns

MaterialShortages

Power Failures

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OvertimeThe overtime premiums for all factoryworkers are usually considered to be part of

manufacturing overhead.

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Labor Fringe BenefitsFringe benefits include employer paid costs forinsurance programs, retirement plans,

supplemental unemployment programs, Social

Security, Medicare, workers’ compensation andunemployment taxes.

Some companies includeall of these costs in

manufacturing

overhead.

Other companies treatfringe benefit expenses

of direct laborers as

additional direct labor

costs.

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Learning Objective 9(Appendix 2B)

Identify the four types ofquality costs and explain how

they interact.

Q lit f C f

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Quality of Conformance

When the overwhelming majority ofproducts produced conform to design

specifications and are free from defects.

P ti d A i l C t

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Prevention and Appraisal Costs

Prevention CostsSupport activities whose

purpose is to reduce the

number of defects

Appraisal CostsIncurred to identify

defective products before

the products are shipped

Internal and External Failure

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Internal and External Failure

Costs

Internal Failure

Costs

Incurred as a result of

identifying defects before

they are shipped

External Failure

Costs

Incurred as a result of

defective products being

delivered to customers

E l f Q lit C t

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Examples of Quality Costs

Prevention Costs• Quality training

• Quality circles

• Statistical process

control activities

Appraisal Costs• Testing & inspecting

incoming materials

• Final product testing

• Depreciation of testing

equipment

Internal Failure Costs• Scrap

• Spoilage

• Rework

External Failure Costs

• Cost of field servicing &handling complaints

• Warranty repairs

• Lost sales

Distrib tion of Q alit Costs

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Distribution of Quality Costs

When quality of conformance is low, total quality

cost is high and consists mostly of internal andexternal failure.

Total quality costs drop rapidly as the quality of

conformance increases.

Companies reduce their total quality costs by

focusing their efforts on prevention and

appraisal because the cost savings from

reduced defects usually overwhelm the costs of

additional prevention and appraisal.

Total quality costs are minimized when the quality

of conformance is slightly less than 100%.

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Learning Objective 10(Appendix 2B)

Prepare and interpret aquality cost report.

Year 2 Year 1

Quali ty Cost ReportFor Years 1 and 2

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Quality cost

reports provide

an estimate of

the financialconsequences of

the company’s

current defect

rate.

Amount Percent* Amount Percent*

Prevention costs:

Systems development 400,000$ 0.80% 270,000$ 0.54%

Quality training 210,000 0.42% 130,000 0.26%

Supervision of prevention activities 70,000 0.14% 40,000 0.08%

Quality improvement 320,000 0.64% 210,000 0.42%Total prevention cost 1,000,000 2.00% 650,000 1.30%

Appraisal costs:

Inspection 600,000 1.20% 560,000 1.12%

Reliability testing 580,000 1.16% 420,000 0.84%

Supervision of testing and inspection 120,000 0.24% 80,000 0.16%

Depreciation of test equipment 200,000 0.40% 140,000 0.28%

Total appraisal cost 1,500,000 3.00% 1,200,000 2.40%

Internal failure costs:

Net cost of scrap 900,000 1.80% 750,000 1.50%

Rework labor and overhead 1,430,000 2.86% 810,000 1.62%

Downtime due to defects in quality 170,000 0.34% 100,000 0.20%

Disposal of defective products 500,000 1.00% 340,000 0.68%

Total internal failure cost 3,000,000 6.00% 2,000,000 4.00%

External failure costs:

Warranty repairs 400,000 0.80% 900,000 1.80%

Warranty replacements 870,000 1.74% 2,300,000 4.60%

Allowances 130,000 0.26% 630,000 1.26%

Cost of field servicing 600,000 1.20% 1,320,000 2.64%

Total external failure cost 2,000,000 4.00% 5,150,000 10.30%

Total quality cost 7,500,000$ 15.00% 9,000,000$ 18.00%

* As a percentage of total sales. In each year sales totaled $50,000,000.

Quality Cost Reports in Graphic

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Quality Cost Reports in Graphic

Form$10

9

8

7

6

5

4

3

2

1 Appraisal

0 Prevention Prevention

1 2

Year

Q u a l i t y C o s t ( i n m

i l l i o n s )

Appraisal

Internal

Failure

External

Failure

Internal

Failure

External

Failure

20

18

16

14

12

10

8

6

4

2 Appraisal

0 Prevention Prevention

1 2

Year

Q u a l i

t y C o s t a s a P e r c e n t a g e o f S a l e s

Appraisal

Internal

Failure

External

Failure

Internal

Failure

External

Failure

Quality

reports

can also

be

prepared

in graphic

form.

Uses of Quality Cost Information

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Uses of Quality Cost Information

Help managers see thefinancial significance of

defects.

Help managers identify therelative importance of the

quality problems.

Help managers see whether

their quality costs are poorly

distributed.

Limitations of Quality Cost

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Q y

Information

Simply measuring qualitycost problems does not solve

quality problems.

Results usually lag behind

quality improvement

programs.

The most important quality

cost, lost sales, is often

omitted from quality cost

reports.

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ISO 9000 StandardsISO 9000 standards have become

international measures of quality.

To become ISO 9000 certified, a company

must demonstrate:

1. A quality control system is in use, and the

system clearly defines an expected level of

quality.

2. The system is fully operational and is backed up

with detailed documentation of quality controlprocedures.

3. The intended level of quality is being achieved

on a sustained basis.

Documents

cost 1.pdf