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CHAPTER 1 MANAGERIAL ACCOUNTING AND COST CONCEPTS

Key Terms and Concepts to Know
Major Management Activities Planning- formulating long and short-term plans Directing and Motivating- implementing plans Controlling- measuring performance; comparing actual to planned performance Manufacturing or Product Costs Direct Costs can be easily and conveniently traced to the finished product: o Direct Materials includes material costs which are an integral part of the finished product o Direct Labor includes labor costs used to make the finished product Indirect Costs- cannot be easily and conveniently traced to specified cost objects: o Manufacturing Overhead includes all costs of manufacturing except direct materials and direct labor; i.e., only those costs associated with operating the factory are included in manufacturing overhead. Prime Costs are direct materials + direct labor Conversion Costs are direct labor +manufacturing overhead Nonmanufacturing or Period Costs Period costs, generally named Selling and Administrative Costs, consist of all other costs not included in product costs. Period costs are expensed in the period incurred. Cost Classifications for Predicting Cost Behavior In addition to classifying costs by function (manufacturing vs. nonmanufacturing), costs may be classified by how they behave in total when the activity level changes:

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Variable Cost Fixed Cost Mixed Cost (introduced in Chapter 5)

In Total Varies The same Varies

Per Unit The same Varies inversely Varies (often inversely)

The relevant range is the range of activity levels throughout which the assumptions for cost behavior are valid. Outside the relevant range, total fixed costs may change and/or variable costs per unit may change. Cost Classifications on the Balance Sheet Manufacturing companies have three inventory accounts which appear as current assets on the balance sheet: Raw Materials, Work in Process, Finished Goods. These accounts replace Merchandise Inventory which is used in a retailing company. Finished goods account is most similar to the merchandise inventory account because it contains the value of goods to be sold to customers. However, the purchases added to merchandise inventory are replaced by the cost of goods manufactured when dealing with a manufacturing rather than a retailing company because the goods to be sold are manufactured, not purchased. Rather than purchasing inventory to sell, manufacturing companies purchase raw materials which will be used to produce finished goods. Cost Classifications on the Income Statement Certain activities in these accounts appear on the Income Statement as Cost of Goods Sold or Cost of Goods Manufactured, a component of Cost of Goods Sold.

Key Topics to Know

Analyzing General Ledger Account Activity
All general ledger accounts have four basic components: beginning balance Additions or inflows Withdrawals or outflows ending balance

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Revised Summer 2010 Debit balance account Begin balance Additions Withdrawals End balance

Credit balance account Begin balance Withdrawals Additions End balance

Since inventory is a current asset account with a normal debit balance, the basic equation for all inventory accounts is: Beginning balance + Additions = Ending balance + Withdrawals OR Beginning balance + Additions - Withdrawals = Ending balance OR Beginning balance + Additions - Ending balance = Withdrawals OR Withdrawals + Ending balance - Beginning balance = Additions OR Withdrawals + Ending balance Additions = Beginning balance Example #1 The finished goods inventory of company XYZ on May 1 was $ 40,000. During May, $100,000 of completed goods was added. The balance on May 31 was $30,000. Determine the value of goods sold from the finished goods inventory during May. Solution #1 Beginning balance Cost of goods manufactured Goods available Deduct: Ending inventory Cost of goods sold during May $40,000 100,000 140,000 30,000 $110,000

Flow of Costs Through Inventory Accounts

Raw materials inventory may contain both direct materials and indirect materials waiting to be used Work-in-process inventory is the manufacturing or production account because this account accumulates direct materials used and the addition of conversion costs (direct labor and overhead costs incurred) to complete the manufacturing process. After the goods have been manufactured, the Cost of Goods Manufactured is transferred from work-in-process inventory to finished goods inventory. The cost of completed or finished goods remains in finished goods inventory until the goods are sold, at which time the cost of goods is transferred from finished goods inventory to cost of goods sold.

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Raw Materials Beginning Balance -DM Usage +Purchases Work in Process Beginning Balance +DM Usage +DL Usage +MOH Incurred =Ending Balance -COGM +COGM -COGS +COGS Finished Goods Beginning Balance Cost of Goods Sold Beginning Balance

=Ending Balance

=Ending Balance

=Ending Balance

Schedule of Cost of Goods Sold

In Financial Accounting, cost of goods sold was based on merchandise inventory which was purchased and then to customers. For manufacturing companies, the finished goods inventory account replaces the merchandise inventory account. Rather than being purchased, finished goods are the end-product of the manufacturing process and are transferred into the finished goods account from the work-in-process inventory account. Example #2A: The Tartan Company has provided the following financial information for last year. Raw materials inventory, January 1 Work in process inventory, January 1 Finished goods inventory, January 1 Direct labor incurred Raw materials purchases Finished goods inventory, December 31 Raw materials inventory, December 31 Rent expense, factory Indirect labor expense Depreciation expense, factory Utilities expense, factory Prepaid insurance Work in process inventory, December 31 Note: all balances are normal balances Required: Prepare a schedule of cost of goods sold.
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$20,000 40,000 70,000 110,000 80,000 30,000 10,000 50,000 20,000 10,000 10,000 38,000 60,000

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Solution #2A: Schedule of Cost of Goods Sold Beginning finished goods inventory $70,000 Add: Cost of goods manufactured 270,000 Goods available for sale 340,000 Deduct: Ending finished goods inventory 30,000 Cost of goods sold $310,00

Schedule of Cost of Goods Manufactured

The value of the goods transferred from work-in-process to finished goods is called Cost of Goods Manufactured. Work in process and raw materials accounts are used to determine cost of goods manufactured Example #2B: Using the data in Example 2A, prepare a cost of goods manufactured schedule.

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Solution #2B:

Schedule of Cost of Goods Manufactured Direct materials: Beginning raw materials inventory $20,000 Add: Purchases of raw materials 80,000 Raw materials available for use 100,000 Deduct: Ending raw materials inventory 10,000 Raw (direct) materials used production Direct labor Manufacturing overhead: Rent, factory 50,000 Indirect labor 20,000 Depreciation, factory 10,000 Utilities, factory 10,000 Total manufacturing overhead cost Total manufacturing cost Add: Beginning work in process inventory Deduct: Ending work in process inventory Cost of goods manufactured

$90,000 110,000

90,000 290,000 40,000 330,000 60,000 $270,000

Cost Classifications for Decision Making Differential Costs and Revenues differ among alternatives Opportunity Costs are the potential benefits given up by making a decision Sunk Cost is a cost previously incurred; it cannot be changed by a present or future decision

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Example #3 Classify the following costs according to the cost terms. 1. Wood used for making tables. 2. Wages of the assembly workers in a furniture factory. 3. Salary of the factory supervisor. 4. Electricity to run factory equipment. 5. Janitorial salaries. 6. Rent on a factory building. 7. Plastic parts used to make toys. 8. Glue used to make toys. 9. Lubricants on production machines. Solution #3 1. 2. 3. 4. 5. 6. 7. 8. 9.
*

Cost Behavior Variable Fixed X X X X X X X X X

To Units of Production Direct Indirect X X X X X X X X* X

These materials would usually be considered indirect. They are insignificant in amount and it would not be cost-effective to trace them to individual products.

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Practice Problems
Practice Problem #1: The Art Factory has provided the following financial information for 2009. Raw materials inventory, January 1 Work in process inventory, January 1 Finished goods inventory, January 1 Direct labor incurred Accumulated depreciation Indirect materials purchases Direct materials purchases Indirect materials used Sales commissions expense Finished goods inventory, December 31 Raw materials inventory, December 31 Rent expense, sales offices Rent expense, factory Indirect labor expense Rent expense, corporate office Depreciation expense, factory Utilities expense, factory Utilities expense, corporate office Utilities expense, sales offices Prepaid insurance Work in process inventory, December 31 $40,000 20,000 70,000 110,000 40,000 15,000 80,000 10,000 100,000 30,000 10,000 35,000 50,000 20,000 50,000 10,000 10,000 10,000 10,000 38,000 60,000

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Practice Problem #2 Black Company has provided the following information regarding activity in the inventory and expense accounts during the year: Raw Materials $100 4,200 $800 Work-inProcess Finished Goods $2,700 13,300 Cost of Goods Sold $0 6,000

Balance January 1 Additions Withdrawals Balance December 31

$0

Required: Determine the missing information

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Sample True / False Questions

1. Managerial accounting must follow GAAP. True False 2. Financial accounting reports to those inside the organization. True False 3. Managerial accounting emphasizes decisions affecting the future. True False 4. Manufacturing costs are product costs. True False 5. Period costs include direct materials, direct labor and manufacturing overhead. True False 6. Period costs are expensed in the period incurred. True False 7. Direct materials and direct labor are also called prime costs. True False 8. Conversion costs are manufacturing costs. True False 9. Sales commissions are a product cost. True False 10. Manufacturing companies have one inventory account. True False 11. Variable costs per unit remain constant. True False 12. Fixed costs vary in total. True False 13. A direct cost cannot be easily traced to a cost object. True False 14. A cost that differs between two alternatives is a sunk cost. True False 15. A common cost is a type of indirect cost. True False
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16. Selling and administrative expenses are included in the schedule of cost of goods manufactured. True False 17. Factory rent is part of manufacturing overhead. True False 18. Depreciation on administrative offices equipment is a product cost. True False 19. Finished goods inventory consists of units completed that have not been sold to a customer. True False 20. Raw materials can be direct or indirect. True False

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Sample Multiple Choice Questions

1. Which of the following is not a characteristic of managerial accounting: a) Emphasizes decisions affecting the future b) Mandatory for external reports c) Need not follow GAAP d) Reports to those inside the organization 2. Which of the following is not a manufacturing cost: a) Direct materials b) Manufacturing overhead c) Administrative costs d) Direct labor 3. How many classes of inventory accounts do manufacturing companies have: a) One b) Three c) Two d) Four 4. Costs that are taken directly to the income statement as expenses in the period in which they are incurred are: a) Product costs b) Prime costs c) Sunk costs d) Period costs 5. The potential benefit given up when one alternative is selected over another is a: a) Prime cost b) Sunk cost c) Opportunity cost d) Direct cost 6. A direct cost is one which: a) Is not worth the effort of tracing to a specific cost object b) Remains constant no matter the activity level c) Can be easily and conveniently traced to a specific cost object d) Always sunk

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7. At production level of 2000 units a cost is $20,000; at production level of 4500 units the same cost is $45,000. This is an example of a: a) Variable cost b) Direct cost c) Fixed cost d) Sunk cost 8. Which of the following is an example of a fixed cost in a manufacturing company: a) The cost of raw materials b) The cost of electricity for running machines c) Wages of assembly line workers d) Depreciation on factory equipment 9. Mary works at a convenience store and is paid $400 a week. She considers enrolling in a college to earn a degree. She thinks she will have to quit her job if she goes to college. The wages that she will lose if she chooses college are: a) Sunk cost b) Opportunity cost c) Indirect cost d) Prime cost 10. Which cost is not relevant to the decision whether to purchase a new chocolate dipping machine or continue using the old one: a) The cost of the new machine b) Lower maintenance costs for the new machine c) The cost of the old machine d) Additional training required for operating the new machine

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11. At the end of June XYZ company had the following balances: Direct materials used $30,000 Direct labor 18,000 Factory rent 7,000 Indirect materials 5,000 Salary of production supervisor 4,000 Advertising costs 12,000 Rent on administrative office 3,500 Depreciation on factory equipment 6,100 The total manufacturing cost was: a) $85,600 b) $70,100 c) $48,000 d) $68,600 12. Company ABC had the following balances for the month of April: Finished goods, April 1 $45,000 Cost of goods manufactured 20,000 Finished goods, April 30 14,000 The cost of goods sold for April is: a) $ 51,000 b) $ 20,000 c) $34,000 d) $ 65,000 13. Conversion costs consist of: a) Direct materials and direct labor b) Direct materials and manufacturing overhead c) Manufacturing and nonmanufacturing costs d) Direct labor and manufacturing overhead 14. A cost that goes into Work in Process inventory and then into the Finished Goods inventory before appearing on the income statement as cost of goods sold is a: a) Period cost b) Fixed cost c) Opportunity cost d) Product cost

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15. Fixed cost: a) Remains the same per unit b) Decreases per unit as the activity level rises c) Increases per unit as the activity level rises d) Varies in total 16. The following information was taken from company XYZs records for the current month. Raw materials used in production $ 35,000 ($25,000 direct, $10,000 indirect); direct labor costs incurred $20,000; selling expenses $5,000; insurance on factory $4,000; administrative salaries $12,000; Rent $15,000 (80% factory, 20% administrative offices). The total inventoriable costs for the current month were: a) $88,000 b) $61,000 c) $71,000 d) $74,000 17. Period costs are reported: a) On the balance sheet b) On the income statement c) As part of the schedule of cost of goods manufactured d) When the related products are sold 18. Commissions paid to salespersons ($10 per unit sold) are: a) Fixed cost b) Variable cost c) Sunk cost d) Differential cost 19. Which of the following statements is true: a) Product costs are expensed as incurred. b) Selling costs are considered sunk costs. c) Manufacturing overhead is a prime cost. d) Product costs are sometimes called inventoriable costs. 20. An a) b) c) d) increase in cost between two alternatives is a: Direct cost Sunk cost Incremental cost Period cost

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Solutions to Practice Problems

Practice Problem #1: Schedule of Cost of Goods Sold Beginning finished goods inventory $70,000 Add: Cost of goods manufactured 285,000 Goods available for sale 355,000 30,000 Deduct: Ending finished goods inventory Cost of goods sold $325,000 Schedule of Cost of Goods Manufactured Direct materials: Beginning raw materials inventory $40,000 Add: Purchases of raw materials 80,000 Purchases of indirect materials 15,000 Raw materials available for use 135,000 Deduct: Ending raw materials inventory 10,000 Raw materials used Less: Indirect materials used Direct materials used in production Direct labor Manufacturing overhead: Indirect materials used 10,000 Rent, factory 50,000 Indirect labor 20,000 Depreciation, factory 10,000 Utilities, factory 10,000 Total manufacturing overhead cost Total manufacturing cost Add: Beginning work in process inventory Deduct: Ending work in process inventory Cost of goods manufactured

$125,000 10,000 115,000 110,000

100,000 325,000 20,000 345,000 60,000 $285,000

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Practice Problem #2 Balance January 1 Additions Withdrawals Balance December 31 (1) (2) (3) (4) (5) (6) (7) Raw Work-inFinished Materials Process Goods $100 $0 $2,700 $4,200 (7) $13,300 $13,300 (1) $3,500 (6) $13,300 (4) $6,000 $800 $0 (5) $10,000 Cost of Goods Sold $0 $6,000 (2) $0 (3) $6,000

$100 + $4,200 - $800 = $3,500 $0 since there were no sales returns $0 + $6,000 - $0 = $6,000 $6,000 from Cost of Goods Sold $2,700 + $13,300 - $6,000 = $10,000 $13,300 from cost of goods manufactured in Finished Goods $13,300 as beginning and ending account balances are equal

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Solutions to True / False Problems

1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. 18. 19. 20. False because managerial accounting may use financial and non-financial information. False because financial accounting has an external focus. True True False period costs are non-manufacturing costs such as selling such as selling and administrative expenses. True True True False because sales commissions are a selling expense. False because manufacturing companies have three inventory accounts: Direct materials, Work in Process, Finished Goods. True False because fixed costs are constant in total. False because direct costs have a direct and easily traceable relationship to cost objects. False because costs that differ among alternatives are differential costs. True False because only product costs are included in the schedule of cost of goods manufactured (selling and administrative expenses are period costs). True False because administrative costs are never product costs. True True

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Solutions to Multiple Choice Questions

1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. 18. 19. 20. B C B D C C A D B C B A D D B C B B D C

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