Basic Accounting Slides Part 2

Managerial Accounting
and Cost Concepts

Chapter 2
© 2012 McGraw-Hill Education (Asia)

Work of Management
Planning
Directing and
Motivating
Controlling
McGraw-Hill Education (Asia) Garrison, Noreen, Brewer, Cheng & Yuen Slide 2
Planning
Identify
alternatives.
Select alternative that does

the best job of furthering
organization’s objectives.
Develop budgets to guide

progress toward the
selected alternative.
Directing and Motivating
Directing and motivating involves managing

day-to-day activities to keep the organization running
smoothly.
 Employee work assignments.
 Routine problem solving.
 Conflict resolution.
 Effective communications.
Controlling
The control function ensures
that plans are being followed.
Feedback in the form of performance reports

that compare actual results with the budget
are an essential part of the control function.
Planning and Control Cycle
Formulating long-
Begin
and short-term plans
(Planning)
Comparing actual
Implementing
to planned Decision plans (Directing
performance Making and Motivating)
(Controlling)
Measuring
performance
(Controlling)
Learning Objective 1
Identify the major

differences and similarities
between financial and
managerial accounting.
Comparison of Financial and Managerial
Accounting
Financial Accounting Managerial Accounting
1. Users External persons who Managers who plan for
make financial decisions and control an organization
2. Time focus Historical perspective Future emphasis
3. Verifiability Emphasis on Emphasis on relevance
versus relevance verifiability for planning and control
4. Precision versus Emphasis on Emphasis on
timeliness precision timeliness
5. Subject Primary focus is on Focuses on segments
the whole organization of an organization
6. GAAP Must follow GAAP Need not follow GAAP
and prescribed formats or any prescribed format
7. Requirement Mandatory for Not
external reports Mandatory
Identify and give examples

of each of the three basic
manufacturing cost
categories.
Manufacturing Costs
Direct Direct Manufacturing

Materials Labor Overhead
The Product
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
Direct Labor
Those labor costs that can be easily

traced to individual units of product.
Example: Wages paid to automobile assembly workers
Manufacturing Overhead
Manufacturing costs that cannot be traced
directly to specific units produced.
Examples: Indirect materials and indirect labor
Materials used to support Wages paid to employees

the production process. who are not directly
involved in production
Examples: lubricants and work.
cleaning supplies used in the Examples: maintenance
automobile assembly plant. workers, janitors and
security guards.
Nonmanufacturing Costs
Selling Administrative
Costs Costs
Costs necessary to All executive,

secure the order and organizational, and
deliver the product. clerical costs.
Distinguish between
product costs and period
costs and give examples
of each.
Product Costs Versus Period Costs
Product costs include Period costs include all

direct materials, direct selling costs and
labor, and administrative costs.
manufacturing
overhead.
Inventory Cost of Good Sold Expense
Sale
Balance Income Income

Sheet Statement Statement
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 production
facility.
E. Sales commissions.
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 production
facility.
E. Sales commissions.
Classifications of Costs
Manufacturing costs are often

classified as follows:
Direct Direct Manufacturing
Material Labor Overhead
Prime Conversion
Cost Cost
Comparing Merchandising and
Manufacturing Companies
Merchandisers . . . Manufacturers . . .
 Buy finished goods.  Buy raw materials.
 Sell finished goods.  Produce and sell
finished goods.
MegaLoMart
McGraw-Hill Education (Asia)

McGraw-Hill/Irwin Garrison, Noreen, Brewer, Cheng & Yuen
Balance Sheet
Merchandiser Manufacturer
Current assets Current Assets
 Cash  Cash
 Receivables  Receivables
 Merchandise Inventory  Inventories
• Raw Materials
• Work in Process
• Finished Goods
Balance Sheet
Merchandiser Manufacturer
Current assets Current Assets
 Cash  Cash
Materials waiting to
 Receivables  Receivables
be processed.
 Merchandise Inventory  Inventories
Partially complete
products – some • Raw Materials
material, labor, or • Work in Process
overhead has been • Finished Goods
added.
Completed products
awaiting sale.
Prepare an income
statement including
calculation of the cost of
goods sold.
The Income Statement
Cost of goods sold for manufacturers differs only
slightly from cost of goods sold for merchandisers.
Merchandising Company Manufacturing Company

Cost of goods sold: Cost of goods sold:
Beg. merchandise Beg. finished
inventory $ 14,200 goods inv. $ 14,200
+ Purchases 234,150 + Cost of goods
Goods available manufactured 234,150
for sale $ 248,350 Goods available
- Ending for sale $ 248,350
merchandise - Ending
inventory (12,100) finished goods
= Cost of goods inventory (12,100)
sold $ 236,250 = Cost of goods
sold $ 236,250
Basic Equation for Inventory Accounts
Withdrawals
Beginning Additions Ending
balance + to inventory = balance + from
inventory
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.
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.
$1,000 + $100 = $1,100
C. $1,200. $1,100 - $300 = $800
D. $ 200.
Prepare a schedule of cost

of goods manufactured.
Schedule of Cost of Goods Manufactured
Calculates the cost of raw

material, direct labor, and
manufacturing overhead
used in production.
Calculates the manufacturing

costs associated with goods
that were finished during the
period.
Product Cost Flows
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
As items are removed from raw
in production materials inventory and placed into
the production process, they are
called direct materials.
Product Cost Flows
Manufacturing Work
Conversion
Beginning raw Direct materials
materials inventory + Direct labor
costs are costs
+ Raw materials + Mfg. overhead incurred to
purchased = Total manufacturing convert the
= Raw materials costs
direct material
available for use
in production into a finished
– Ending raw materials product.
inventory
= Raw materials used
in production
Product Cost Flows
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
inventory All manufacturing costs incurred
= Raw materials used during the period are added to the
in production
beginning balance of work in
process.
Product Cost Flows
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
Costs associated with the goods that process inventory
= Raw materials used = Cost of goods
areincompleted
production
during the period are manufactured
transferred to finished goods
inventory.
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
Manufacturing Cost Flows
Balance Sheet Income
Costs Inventories Statement
Expenses
Material Purchases Raw Materials
Direct Labor Work in

Process
Manufacturing
Overhead Cost of
Finished
Goods
Goods
Sold
Selling and Period Costs Selling and

Administrative Administrative
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
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
Beg.used?
raw materials $ 32,000
+ Raw materials
A. $276,000 purchased 276,000
B. $272,000 = Raw materials available
for use in production $ 308,000
C. $280,000 – Ending raw materials
D. $ 2,000 = Rawinventory
materials used
28,000
in production $ 280,000
Quick Check 
Direct materials used in production totaled

$280,000. Direct labor was $375,000 and
factory overhead was $180,000. What were total
manufacturing costs incurred for the month?
A. $555,000
B. $835,000
C. $655,000
D. Cannot be determined.
Quick Check 
Direct materials used in production totaled

$280,000. Direct labor was $375,000 and
factory overhead was $180,000. What were total
manufacturing costs incurred for the month?
A. $555,000
B. $835,000
C. $655,000 Direct Materials $ 280,000
D. Cannot be+determined.
Direct Labor 375,000
+ Mfg. Overhead 180,000
= Mfg. Costs Incurred
for the Month $ 835,000
Quick Check 
Beginning work in process was $125,000.

Manufacturing costs incurred for the month
were $835,000. There were $200,000 of
partially finished goods remaining in work in
process inventory at the end of the month.
What was the cost of goods manufactured
during the month?
A. $1,160,000
B. $ 910,000
C. $ 760,000
Quick Check 
Beginning work in process was $125,000.

Manufacturing costs incurred for the month
were $835,000. There were $200,000 of
partially finished goods remaining in work in
process inventory at the end of the
Beginning workmonth.
in
process inventory $ 125,000
What was the cost of goods manufactured
+ Mfg. costs incurred
during the month? for the period 835,000
A. $1,160,000 = Total work in process

during the period $ 960,000
B. $ 910,000 – Ending work in
C. $ 760,000 = Costprocess inventory
of goods
200,000
manufactured $ 760,000
Quick Check 
Beginning finished goods inventory was

$130,000. The cost of goods manufactured for
the month was $760,000. And the ending
finished goods inventory was $150,000. What
was the cost of goods sold for the month?
A. $ 20,000.
B. $740,000.
C. $780,000.
D. $760,000.
Quick Check 
Beginning finished goods inventory was

$130,000. The cost of goods manufactured for
the month was $760,000. And the ending
finished goods inventory was $150,000. What
was the cost of goods sold for the month?
A. $ 20,000.
B. $740,000.
$130,000 + $760,000 = $890,000
C. $780,000.
$890,000 - $150,000 = $740,000
D. $760,000.
Understand the
differences between
variable costs and fixed
costs.
Cost Classifications for Predicting Cost
Behavior
How a cost will react to

changes in the level of
activity within the
relevant range.
 Total variable costs
change when activity
changes.
 Total fixed costs remain
unchanged when activity
changes.
Variable Cost
Your total texting bill is based on how

many texts you send.
Total Texting Bill
Number of Texts Sent
Variable Cost Per Unit
The cost per text sent is constant at

5 cents per text.
Cost Per Text Sent

Number of Texts Sent
Fixed Cost
Your monthly contract fee for your cell phone is fixed
for the number of monthly minutes in your contract.
The monthly contract fee does not change based on
the number of calls you make.
Monthly Cell Phone
Contract Fee
Number of Minutes Used

Within Monthly Plan
Fixed Cost Per Unit
Within the monthly contract allotment, the average

fixed cost per cell phone call made decreases as
more calls are made.
Monthly Cell Phone

Contract Fee
Number of Minutes Used
Within Monthly Plan
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 remains
as 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.
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.
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.
Understand the
differences between direct
and indirect costs.
Assigning Costs to Cost Objects
Direct costs Indirect costs
 Costs that can be  Costs that cannot be
easily and easily and
conveniently traced conveniently traced
to a unit of product to a unit of product
or other cost object. or other cost object.
 Examples: direct  Example:
material and direct manufacturing
labor overhead
McGraw-Hill Education (Asia)

McGraw-Hill/Irwin Garrison, Noreen, Brewer, Cheng & Yuen
Define and give examples
of cost classifications used
in making decisions:
differential costs,
opportunity costs, and
sunk costs.
Cost Classifications for Decision Making
 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.
Differential Cost and Revenue
Costs and revenues that differ

among alternatives.
Example: You have a job paying $1,500 per month in
your hometown. 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: Differential cost is:

$2,000 – $1,500 = $500 $300
Opportunity Cost
The potential benefit that is given
up when one alternative is selected
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.
Sunk Costs
Sunk costs have already been incurred and cannot

be changed now or in the future. These costs
should be ignored when making decisions.
Example: You bought an automobile that cost

$10,000 two 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.
Quick Check 
Suppose you are trying to decide whether to

drive or take the train to Kuala Lumpur 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 Kuala Lumpur?
A. Yes, the cost of the train ticket is relevant.
B. No, the cost of the train ticket is not relevant.
Quick Check 

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 Kuala Lumpur?
A. Yes, the cost of the train ticket is relevant.
B. No, the cost of the train ticket is not relevant.
Quick Check 

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.
Quick Check 

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.
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.
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.
Summary of the Types of Cost
Classifications
Financial Predicting Cost

Reporting Behavior
Assigning Costs Making Business

to Cost Objects Decisions
Further Classification of Labor Costs
Appendix 2A

(Appendix 2A)
Properly account for labor
costs associated with idle
time, overtime, and fringe
benefits.
Idle Time
Machine Material
Breakdowns Shortages
Power
Failures
The labor costs incurred

during idle time are ordinarily
treated as manufacturing
overhead.
Overtime
The overtime premiums for all factory workers are
usually considered to be part of manufacturing
overhead.
What if a company consistently has overtime ?

Can the overtime costs be part of labor expenses?
Labor Fringe Benefits
Fringe benefits include employer paid

costs for insurance programs, retirement
plans, supplemental unemployment
programs, Social Security, Medicare,
workers’ compensation, and
unemployment taxes.
Some companies Other companies treat

include all of these fringe benefit
costs in expenses of direct
manufacturing laborers as additional
overhead. direct labor costs.
Cost of Quality
Appendix 2B

(Appendix 2B)
Identify the four types of
quality costs and explain
how they interact.
Quality of Conformance
When the overwhelming majority of products

produced conform to design specifications
and are free from defects.
Prevention and Appraisal Costs
Support activities
Prevention whose purpose is to
Costs reduce the number of
defects
Incurred to identify
defective products
Appraisal Costs before the products are
shipped to customers
Internal and External Failure Costs
Incurred as a result of
Internal Failure
identifying defects
Costs before they are shipped
Incurred as a result of
External Failure defective products
Costs being delivered to
customers
Examples of Quality Costs
Appraisal Costs
Prevention Costs
• Testing and inspecting
• Quality training
incoming materials
• Quality circles
• Final product testing
• Statistical process
• Depreciation of testing
control activities
equipment
External Failure Costs

Internal Failure Costs
• Cost of field servicing and
• Scrap
handling complaints
• Spoilage
• Warranty repairs
• Rework
• Lost sales
Distribution of Quality Costs
(Appendix 2B)
Prepare and interpret a
quality cost report.
Quality Cost Report
For Years 1 and 2
Year 2 Year 1
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%
Quality cost
Reliability testing
Supervision of testing and inspection
580,000
120,000
1.16%
0.24%
420,000
80,000
0.84%
0.16%
reports provide
Depreciation of test equipment 200,000 0.40% 140,000 0.28% an estimate of
Total appraisal cost 1,500,000 3.00% 1,200,000 2.40%
the financial
Internal failure costs:
Net cost of scrap 900,000 1.80% 750,000 1.50% consequences
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% of the
Disposal of defective products
Total internal failure cost
500,000
3,000,000
1.00%
6.00%
340,000
2,000,000
0.68%
4.00% company’s
External failure costs:
current defect
Warranty repairs
Warranty replacements
400,000
870,000
0.80%
1.74%
900,000
2,300,000
1.80%
4.60%
rate.
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.

McGraw-Hill Education (Asia) Slide 80
Quality Cost Reports in Graphic Form
$10 20
9
Quality 18
Quality Cost as a Percentage of Sales

8
reports 16
Quality Cost (in millions)
7
External External
can also 14
External External
6 Failure Failure be 12 Failure Failure
5 prepared 10
4 Internal
Failure
in 8 Internal
Failure
3 Internal
Failure
graphic 6 Internal
Failure
2
Appraisal form. 4
Appraisal
Appraisal Appraisal
1 2
Prevention Prevention Prevention Prevention
0 0
1 2 1 2
Year Year
Uses of Quality Cost Information
Help managers see the

financial significance of
defects.
Help managers identify

the relative importance
of the quality problems.
Help managers see
whether their quality
costs are poorly
distributed.
Limitations of Quality Cost Information
Simply measuring and
reporting quality cost
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.
ISO 9000 Standards
ISO 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 control procedures.
3. The intended level of quality is being
achieved on a sustained basis.
End of Chapter 2

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Managerial Accounting

and Cost Concepts

© 2012 McGraw-Hill Education (Asia)

Select alternative that does

Develop budgets to guide

Directing and motivating involves managing

Feedback in the form of performance reports

Identify the major

Identify and give examples

Direct Direct Manufacturing

Raw materials that become an integral

Example: A radio installed in an automobile

Those labor costs that can be easily

Example: Wages paid to automobile assembly workers

Examples: Indirect materials and indirect labor

Materials used to support Wages paid to employees

Costs necessary to All executive,

Product costs include Period costs include all

Inventory Cost of Good Sold Expense

Balance Income Income

Which of the following costs would be considered a

Which of the following costs would be considered a

Manufacturing costs are often

McGraw-Hill Education (Asia)

Merchandising Company Manufacturing Company

If your inventory balance at the beginning of the

If your inventory balance at the beginning of the

Prepare a schedule of cost

Calculates the cost of raw

Calculates the manufacturing

Beginning raw Direct materials

Beginning raw Direct materials Beginning work in

Beginning raw Direct materials Beginning work in

Beginning work in Beginning finished

Direct Labor Work in

Selling and Period Costs Selling and

Beginning raw materials inventory was $32,000.

Beginning raw materials inventory was $32,000.

Direct materials used in production totaled

Direct materials used in production totaled

Beginning work in process was $125,000.

Beginning work in process was $125,000.

A. $1,160,000 = Total work in process

Beginning finished goods inventory was

Beginning finished goods inventory was

How a cost will react to

Your total texting bill is based on how

Number of Texts Sent

The cost per text sent is constant at

Cost Per Text Sent

Number of Minutes Used

Within the monthly contract allotment, the average

Monthly Cell Phone

Behavior of Cost (within the relevant range)

Which of the following costs would be variable

Which of the following costs would be variable

McGraw-Hill Education (Asia)

 Every decision involves a choice

 Only those costs and benefits

Costs and revenues that differ

Differential revenue is: Differential cost is:

Example: If you were

Sunk costs have already been incurred and cannot