Chapter

16

Management Accounting:
A Business Partner

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Management Accounting: Basic Framework

Management accounting and assigning decision-making authority.
Accounting systems help to identify who has authority over assets.

Accounting information supports planning and decision-making. Accounting reports provide a means of monitoring, evaluating, and rewarding performance.
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Comparing Financial Accounting and Management Accounting

Financial Accounting Management Accounting Provide information about the Provide information for Purpose financial position and planning, evaluating, and performance of the company. rewarding performance. Balance sheet, income Types of statement, and statement of Various, non-standard reports. Reports cash flows. Standards GAAP None Reporting Usually, the company taken A component of the Entity as a whole. company's value chain. Time Usually a year, quarter, or a Any period. Periods month. Investors, creditors, and other Management, customers, and Users external parties. others in the value chain.
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Accounting for Manufacturing Operations

Steps in the Manufacturing Process:
Buy raw materials. Convert raw materials into finished goods. Sell finished goods.

Direct materials costs.

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Direct labor and manufacturing overhead costs.

Cost of goods sold.

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Direct Materials
Raw materials & component parts that become an integral part of finished products.
Can be traced directly and conveniently to products.

If materials cannot be traced directly to products, the materials are considered indirect and are part of manufacturing overhead.
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Direct Labor
Includes the payroll cost of direct workers.

Direct labor hours

Wage rate

Those employees who work directly on the goods being manufactured.

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Direct Labor
Includes the payroll cost of direct workers.

The cost of employees who do not work directly on the goods is considered indirect labor and is part of manufacturing overhead.
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Those employees who work directly on the goods being manufactured.

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Manufacturing Overhead
All manufacturing costs other than direct materials and direct labor.

Includes:
Indirect materials. Indirect labor. Machinery and equipment costs. Cost of regulatory compliance.

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Manufacturing Overhead
All manufacturing costs other than direct materials and direct labor.

Includes:
Indirect materials. Indirect labor. Machinery and equipment costs. Cost of regulatory compliance.

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Does not include selling or general and administrative expenses.

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Manufacturing Overhead
The cost to produce a unit of product includes: Direct material Direct labor Manufacturing overhead
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Manufacturing Overhead
The cost to produce a unit of product includes: Direct material Direct labor Manufacturing overhead
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Manufacturing overhead must be mathematically allocated to each unit of product using a predetermined overhead application rate. (This will be discussed later in this chapter.)
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Product Costs Versus Period Costs

Product Costs (manufacturing costs)
Balance Sheet Current assets and inventory Income Statement Revenue COGS Gross profit Expenses Net income.

as incurred

When goods are sold.

Period Costs (operating expenses and income taxes.)

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as incurred

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Inventories of a Manufacturing Business

Raw materials - inventory on hand and available for use.

Finished goodscompleted goods awaiting sale.

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Work in process partially completed goods.

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The Flow of Physical Goods

Direct materials purchased Materials Warehouse Direct materials used

Factory

Direct labor & Manufacturing overhead Finished goods Warehouse Finished goods

Goods sold
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The Flow of Manufacturing Costs

Direct materials purchased

Materials Inventory
$$$ $$$

Direct materials used

Work in Process Inventory

$$$ $$$

Direct labor & Manufacturing overhead Cost of Goods Sold $$$

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Finished Goods Inventory $$$ $$$

Cost of goods manufactured

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The Flow of Manufacturing Costs Example

Pure-Ice Inc. had $52,000 of inventory in direct materials inventory on January 1, 2002. During the year, Pure-Ice purchased $586,000 of additional direct materials. At December 31, 2002, $78,000 of the direct materials were still on hand.

How much direct material was placed into production during 2002?
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The Flow of Manufacturing Costs Example

Beginning materials inventory Materials purchased Materials available to be placed into production Materials placed into production Ending materials inventory

+ = =

52,000 586,000 638,000

? ?
$ 78,000

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The Flow of Manufacturing Costs Example

Beginning materials inventory Materials purchased Materials available to be placed into production Materials placed into production Ending materials inventory

+ = =

52,000 586,000 638,000 560,000

78,000

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The Flow of Manufacturing Costs Example

In addition to the direct materials, PureIce incurred $306,000 of direct labor cost during 2002. Manufacturing overhead for 2002 was $724,000. Pure-Ice started 2002 with $132,000 in work in process. During 2002, units costing $1,480,000 were transfered to finished goods inventory.

What is the ending balance in work in process at December 31, 2002?

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The Flow of Manufacturing Costs Example

Beginning work in process inventory $ 132,000 + Manufacturing costs added 1,590,000 = Total costs in process during the year $ 560,000 1,722,000 Direct Materials CostLabor Direct of goods 306,000 completed during the Manufacturing year (1,480,000) Overhead 724,000 = Ending work in Total costs added process inventory ?

during the year

$ 1,590,000

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The Flow of Manufacturing Costs Example

Beginning work in process inventory Manufacturing costs added Total costs in process during the year Cost of goods completed during the year Ending work in process inventory $ 132,000 1,590,000 1,722,000

+ =

(1,480,000) $ 242,000
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Overhead Application Rates

The overhead application rate expresses an expected relationship between manufacturing overhead costs and some activity base related to the production process.

Overhead Application Rate

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Estimated = Overhead Costs

Estimated Units in the Activity Base

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Overhead Application Rates

Overhead costs are estimated based on budgets and using mathematical estimation techniques.

Overhead Application Rate

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Estimated = Overhead Costs

Estimated Units in the Activity Base

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Overhead Application Rates

The base is the activitiy that drives the cost, called the cost driver. Direct labor hours and machine hours are commonly used cost drivers.

Overhead Application Rate

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Estimated = Overhead Costs

Estimated Units in the Activity Base

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Overhead Application Rates Example

Big T Company produces engines for big trucks. Total overhead for 2002 is estimated to be $2,600,000. Big T applies overhead based on machine hours. Big T estimates machine hours for 2002 to be 162,500 hours.

Compute Big Ts predetermined overhead rate for 2002.

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Overhead Application Rates Example

Overhead Application Rate = Estimated Overhead Costs Estimated Units in the Activity Base

= $ 2,600,000 162,500 = $ 16.00 per hour

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Overhead Application Rates Example

Overhead Application Rate = Estimated Overhead Costs Estimated Units in the Activity Base 162,500

= $ 2,600,000 = $ 16.00 per hour

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Overhead Application Rates

Some companies use different cost drivers for different manufacturing activities, a process called ACTIVITY BASED COSTING.

Overhead Application Rate

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Estimated = Overhead Costs

Estimated Units in the Activity Base

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Determining the Cost of Finished Goods Manufactured

A schedule of the cost of finished goods manufactured is prepared to assist managers in understanding and evaluating the overall cost of manufacturing products.
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CONQUEST, INC. Schedule of the Cost of Finished Goods Manufactured For the Year Ended December 31, 2002 Work in process inventory, beg. $ Manufacturing cost assigned to production: Direct Materials $ 150,000 Direct Labor 300,000 Manufacturing overhead 360,000 Total manufacturing costs Total cost of all work in process during the year Less: Work in process inventory, end of year Cost of finished goods manufactured $
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30,000

810,000 840,000 (40,000) 800,000

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Beginning finished goods inventory Add: Cost of finished goods manufactured during the year CONQUEST, INC. Cost of finished Schedule of the Cost of Finished Goods Manufacturedgoods For the Year Ended December 31, 2001 available for sale Work in process inventory, beg. $ 30,000 Less: Ending finished goods Manufacturing cost assigned to production: inventory Direct Materials $ 150,000 Cost of Goods Sold Direct Labor 300,000
Manufacturing overhead 360,000 Total manufacturing costs Total cost of all work in process during the year $ Less: Work in process inventory, end of year Cost of finished goods manufactured $ 810,000 840,000 (40,000) 800,000

$ 150,000 800,000 950,000 168,000 $ 782,000

The cost of goods completed during the period is used to compute COGS for the period.
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The income statement is prepared using established financial accounting procedures.

CONQUEST, INC. Income Statement For the Year Ended December 31, 2002 Sales Cost of Goods Sold Gross profit on sales Operating expenses Income from operations Less: Interest expense Income before income taxes Income tax expense Net income $ 1,300,000 782,000 $ 518,000 400,000 $ 118,000 18,000 $ $ 100,000 30,000 70,000

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End of Chapter 16
This is a great job, but the overhead is killing my profit margin!

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