Chapter 1 Managerial Accounting Concepts

Chapter Outline

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Principles

I. Managerial Accounting Basics also called management accounting which is an activity that provides financial and nonfinancial information to an organizations managers and other decision makers. A. Purpose of Managerial Accounting to provide useful information to decision makers of an organization. 1. Cost of products and services this information is very important to managers when making planning and control decisions. This includes predicting the future costs of a product or service. Predicted costs are used in: a. product pricing. b. profitability analysis. c. deciding whether to make or buy a product or component. 2. Planning is the process of setting goals and making plans to achieve them. a. Strategic plans usually set the long-term direction of a firm based on opportunities such as new products, new markets, and capital investments. b. Medium and short-term plans often cover a one-year period which, when translated in monetary terms, is known as the budget. 3. Control is the process of monitoring planning decisions and evaluating the organization's activities and employees. a. Control includes measurement and evaluation of actions, processes and outcomes. b. Feedback allows managers to take timely corrective actions to avoid undesirable outcomes. B. Nature of Managerial Accounting illustrated by comparing the seven key differences between managerial to financial accounting: 1. Users and decision makers a. In financial investors, creditors, analysts, regulators and other users external to the organization. b. In managerial managers, employees and decision makers internal to the organization who are responsible for making and implementing company decisions. 2. Purpose of information a. In financial assist external users in making investment, credit and other decisions. b. In managerial assist managers in making planning and control decisions.

3. Flexibility of practice a. In financial relies on structured principles often controlled by GAAP. b. In managerial systems are relatively flexible (no GAAP) to assist in planning, decision-making, and control. 4. Timeliness of information a. In financial often available only after the audit is complete which is usually several weeks after period-end. b. In managerial available quickly without the need to wait for an audit. Internal auditing evaluates the flow of information inside and outside the company and is responsible for preventing and detecting fraudulent company activities. 5. Time dimension a. In financial provides primarily historical information with only limited predictions. b. In managerial includes many projections and estimates; historical information is also presented. 6. Focus of information a. In financial emphasis on whole organization. b. In managerial emphasis on organization's specific activities, projects, processes and subdivisions. Nature of information a. In financial monetary information. b. In managerial mostly monetary; but also nonmonetary information.

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C. Managerial Decision Making managerial accounting information is primarily used for internal decisions about a company's activities but financial and managerial accounting are not entirely separate since both can affect people's decisions and actions. D. Fraud and Ethics in Managerial Accounting are important factors in running a business. Fraud involves the use of ones job for personal gain, through deliberate misuse of the employers assets. The most common type of fraud involves employees who steal or misuse the employers resources. All fraud is done to provide direct or indirect benefit to the employee; violates the employees duties to his employer; costs the employer money; and is secret. 1. Implications for Managerial Accounting fraud increases a businesss costs which can result in poor pricing decisions, improper product mix, and faulty performance evaluations. Managers rely upon an internal control system to monitor and control business activities. An internal control system is the policies and procedures managers use to urge adherence to company policies; promote efficient operations; ensure reliable accounting; and protect assets.

Ethics are beliefs that distinguish right from wrong. They are accepted standards of good and bad behavior. The Institute of Management Accountants (IMA) has issued a Statement of Ethical Professional Practice which provides a road map for resolving ethical conflicts. II. Managerial Cost Concepts A. Types of Cost Classifications - Costs can be classified based on any one or combination of the five classifications listed below. 1. Behavior at a basic level, a cost can be classified as fixed, variable or mixed. 1. Fixed cost cost does not change with changes in the volume of an activity (within a certain range of activity known as an activity's relevant range). 2. Variable cost cost changes in proportion to changes in the volume of activity. 3. Mixed combination of fixed and variable costs. 2. Traceability cost is traced to a cost object (a product, process, department or customer). Cost is classified as either a direct or indirect cost. To classify, must identify the cost object. 1. Direct costs traceable to a single cost object. 2. Indirect costs not traceable to a single cost object 3. Controllability costs can be defined as controllable or not controllable. Classification is dependent on employees responsibilities to the hierarchical levels in management. 4. Relevance costs classified by identifying it as either a sunk cost or an out-ofpocket cost. a. Sunk cost already incurred and cannot be avoided or changed. Irrelevant to future decisions. b. Out-of-pocket cost requires a future outlay of cash and is relevant for decision making. c. Opportunity cost is the potential benefit lost by choosing a specific action from two or more alternatives. 5. Function costs classified as capitalized inventory (product) or expensed (period) as incurred. a. Product costs expenditures necessary and integral to finished products. Includes direct materials, direct labor, and overhead costs. First assigned to inventory (on the balance sheet) and flow to the income statement when they become part of cost of goods sold. b. Period costs - expenditures identified more with a time period than finished products. Include selling and general administrative expenses. Reported on income statement as expenses.

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Identification of Cost Classification. Must be able to identify the activity for behavior, cost object for traceability, management hierarchical level for controllability, opportunity cost for relevance, and benefit period for function. Cost Concepts for Service Companies. The concepts are also applicable to service organizations. Classification by function is not relevant to service companies because services are not inventoriable.

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III. Reporting Manufacturing Activities financial statements for manufacturing companies have some unique features resulting from their activity of producing goods from materials and labor. A. Manufacturers Balance Sheet carry several unique assets and usually reports these three inventories: 1. Raw Materials Inventory goods a company acquires to Two types are: use in making products

a. Direct materials physically become part of the product and are clearly identified with specific units or batches of product. b. Indirect Materials used in support of the production process. Generally, do not become a part of a product. Exception: materials that do become part of a product, but have low or insignificant cost, and traceability is not economically sound (application of materiality principle). 1. Goods in Process Inventory (or work in process inventory) consists of products in the process of being manufactured but not yet complete. 2. Finished Goods Inventory consists of completed products ready for sale. B. Manufacturers Income Statement the main difference between a merchandisers and manufacturers income statement is in items that make up cost of goods sold (COGS). 1. Merchandiser computes COGS: Beginning merchandise inventory plus cost of goods purchased minus ending merchandise inventory. 2. Manufacturer computes COGS: Beginning finished goods inventory plus cost of goods manufactured minus ending finished goods inventory. 3. Cost of goods manufactured is the sum of direct materials, direct labor, and overhead costs incurred in producing the products. a. Direct materials costtangible components of a finished product; separately and readily traced through the manufacturing process to finished goods. b. Direct labor costswages and salaries for direct labor that are separately and readily traced through the manufacturing process to finished goods.

c. Indirect labor costscosts of other workers efforts not linked to specific units or batches of product. Part of overhead costs. d. Factory overhead costsall manufacturing costs that cannot be separately or readily traced to finished goods. Include indirect materials and indirect labor and other costs associated with the factory. e. Prime and conversion costs -- direct materials and direct labor are also called prime costs and are expenditures directly associated with the manufacturing of finished goods. Direct labor costs and overhead costs are also called conversion costs and are expenditures incurred in the process of converting raw materials to finished goods. C. Flow of Manufacturing Activitiesthe three manufacturing activities are: 1. Materials activities manufacturers start a period with some beginning raw materials inventory and then acquire additional raw materials. When these purchases are added to beginning inventory, we get the total raw materials available for use in production. These raw materials are then either used in are then either used in production during the year or remain on hand at the end of the period for use in future periods. 2. Production activities four factors come together in production: a. Beginning goods in process inventory consists of partly produced goods from the previous period. b. Direct materials used traceable materials added during the period. c. Direct labor used traceable labor added during period. d. Overhead used nontraceable manufacturing costs added during the period. 3. Note: The production activity results in goods either finished or unfinished. Both groups represent product costs. The cost of finished goods make up the cost of goods manufactured for the year. Unfinished goods are identified as ending goods in process inventory. 4. Sales activities newly completed units are combined with beginning finished goods inventory to make up total finished goods available for sale. The cost of those goods that are sold during the year is reported on the income statement as cost of goods sold.

D. Manufacturing Statement (also called the schedule of manufacturing activities or the schedule of cost of goods manufactured) summarizes the types and amounts of costs incurred in the manufacturing process. Contains information used by management for planning and control. It is not a general purpose financial statement. It is divided into four parts: 1. Direct material used determined by adding the beginning raw materials inventory to the current period's materials purchases to obtain total raw materials available for use during year and then subtracting ending raw materials inventory determined from a physical count.

2. Direct labor incurred includes payroll taxes and fringe benefits and is taken directly from the direct labor account balance. 3. Overhead costs generally lists each important factory overhead item along with its cost. If a summary number is used, a separate detailed schedule is usually prepared. 4. Computation of cost of goods manufactured as follows: a. Total manufacturing costs (total of 1, 2 and 3 above) are added to beginning goods in process inventory to get total cost of goods in process inventory for the year. b. Compute cost of goods manufactured (or completed) for year by subtracting the cost of ending goods in process inventory (determined separately) from the total cost of goods in process for the year.

E. Trends in Managerial Accounting the importance of managerial accounting analytical tools has increased as a result of the following changes in the business environment: 1. Customer orientation increased emphasis on customers. This results in customer orientation whereby employees understand the changing needs and wants of their customers and align their management and operating practices accordingly. 2. Lean practices, that follow an underlying philosophy of continuous improvement, include: a. Total quality management (TQM) focuses on quality improvement and applies this standard to all aspects of business activities. b. Just-in-time manufacturing (JIT) a system that acquires inventory and produces only when needed as orders are received a demand-pull system. c. Implications for Managerial Accounting following the lean business model means that a company must completely realign its systems and procedures. Managerial accounting provides accurate cost and performance information. A company uses this information to assist in cost control and improved performance. F. Global Economy our global economy expands competitive boundaries providing customers more choices. G. E-Commerce people have become increasingly interconnected via electronic applications. Many businesses have expanded their websites to allow for online transactions. H. Service Economy businesses that provide services are an ever-growing part of our economy. Service businesses typically account for 60-70 percent of total economic activity. I. Value Chain refers to the series of activities that add value to a companys products or services. Companies can use lean practices

IV. Global View Manufacturing accounting is more flexible than financial accounting and does not follow a set of rules. Many international businesses use managerial accounting concepts and principles outlined in this chapter. V. Decision AnalysisCycle Time and Cycle Efficiency A. Cycle time equals process time plus inspection time plus move time plus wait time. 1. Process time is the time spent producing the product. 2. Inspection time is the time spent inspecting (1) raw materials when received, (2) goods in process while in production, and (3) finished goods prior to shipment. 3. Move time is the time spent moving (1) raw materials from storage to production, and (2) goods in process from factory location to another factory location. 4. Wait time is the time that an order or job sits with no production applied to it. B. Process time is considered value-added time because it is the only activity in cycle time that adds value to the product from the customers perspective. C. The other three costs are considered non-value added time because they add no value to the customer. D. Companies strive to reduce non-value-added time to improve cycle efficiency which is the ratio of value-added time to total cycle time.