Accounting Principles, 5e

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CHAPTER
20
MANAGEMENT ACCOUNTING The Manufacturing Business
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MANAGEMENT ACCOUNTING The Basics
Financial Accounting (CAs)
Management Accounting (CMAs)
External users (Public)
Internal users (officers, management, Dept.
Heads, etc.)
Classified Financial Statements
Internal reports
Issued Annually
Issued as frequently as needed
To provide general all-purpose info for all users
To provide specific information for internal
management/decision makers
Pertains to entity as a whole and is very
condensed
Pertains to departments and divisions and may be
very detailed
Past orientation historical cost data
Future orientation budgets projections as well
as historical cost
Reporting standards are GAAPs
Reporting standard is relevance to the decision
to be made
Annual independent audit required
No independent audits
3
MANAGEMENT ACCOUNTING The Functions of Management
Accountants

• The notes for this chapter are broken down into
  the four functions that Management Accountants
  perform. They
• Determine which costs are involved in
  manufacturing, and report them in the financial
  statements.
• Establish the cost of manufactured items (for
  controlling, reporting, and for setting selling
  price-levels)
• Provide information on where and why costs are
  changing (for decision making purposes).
• Evaluate cost behaviour in a company as
  production levels change (i.e. Economies of
  Scale).

4
MANAGEMENT ACCOUNTING

• Determine which costs are involved in
  manufacturing, and report them in the Financial
  Statements.

5

• MANAGEMENT ACCOUNTING
• Determine which costs are involved in
  manufacturing

The Products Cost (Steel)
Direct Materials
Direct Labour
Overhead
6

• MANAGEMENT ACCOUNTING
• Determine which costs are involved in
  manufacturing

7

• MANAGEMENT ACCOUNTING
• Determine which costs are involved in
  manufacturing

• Direct Materials Raw materials that can be
  physically and conveniently associated with the
  finished product during the manufacturing
  process.
• Those that cannot be easily associated become
  part of overhead.

• Direct Labour The work of factory employees that
  can be physically and conveniently associated
  with converting raw materials into finished
  goods.
• Labour that cannot be easily associated with the
  production process becomes part of overhead

8

• MANAGEMENT ACCOUNTING
• Determine which costs are involved in
  manufacturing

• Overhead Consists of costs that are indirectly
  associated with the manufacture of the finished
  product.
• Manufacturing overhead includes
• Indirect materials
• Indirect labour
• Amortization on factory buildings and machinery
  and
• Insurance, taxes, and maintenance on factory
  facilities.

9

• MANAGEMENT ACCOUNTING
• Determine which costs are involved in
  manufacturing

Direct Materials

• Manufacturing Costs

Direct Labour

• Product Costs

Overhead
Administrative Expenses

• Operating Costs

Selling Expenses

• Period Costs

10

• MANAGEMENT ACCOUNTING
• Determine which costs are involved in
  manufacturing

• Cost Flow in a Manufacturing Business
• So now we know what is involved in the cost of
  manufactured products. (DM, DL, OH)
• The next thing we have to look at is how these
  Manufacturing Costs flow from the Balance Sheet
  (as inventory items) to the Income Statement (as
  Cost of Goods Sold).
• Well then look at how this Flow is shown on
  the financial statements.

11

• MANAGEMENT ACCOUNTING
• Determine which costs are involved in
  manufacturing

What is the Cost of Goods Sold?

• Recall the COGS for a Merchandise Business
• The cost of buying (and having shipped in) the
  items that were sold to customers.

Beginning Inventory
Ending Inventory
COST OF GOODS SOLD
Net Purchases
Cost of Goods Available for Sale
12

• MANAGEMENT ACCOUNTING
• Determine which costs are involved in
  manufacturing

What is the Cost of Goods Sold?

• The COGS for a Manufacturing Business
• COGS is still the cost of the items sold to
  customers. However, since WE make the products,
  COGS must include all Manufacturing Costs.
• The first thing you must realise, is that
  manufacturing businesses have three inventories
• Goods (and costs) move from one inventory to the
  other during the manufacturing process.
• (Incidentally, each of the three is valued
  according to FIFO, LIFO, or Average Cost too)!

Direct Labour (DL) and Overhead (OH) are added
here. (Also known as conversion costs)
Raw Materials Inventory (DM)
Work in Process Inventory
Finished Goods Inventory
13

• MANAGEMENT ACCOUNTING
• Determine which costs are involved in
  manufacturing

What is Cost of Goods Sold?
Raw Materials Inventory
Finished Goods Inventory
Beginning Raw Materials Inventory
Ending Raw Materials Inventory
Raw Materials Purchased
Direct Materials Used
Beginning Finished Goods Inventory
Direct Labour
Overhead
Work in Process Inventory
Beginning Work in Process Inventory
Manufacturing Costs
Ending Work in Process Inventory
Cost of Goods Manufactured
Ending Finished Goods Inventory
Manufacturing Costs Are Added to the Value of
Inventory
COST OF GOODS SOLD
14

• MANAGEMENT ACCOUNTING
• Determine which costs are involved in
  manufacturing

What is Cost of Goods Sold?
Raw Materials Inventory
Finished Goods Inventory
25,000
100,000
30,000
95,000
15,000
20,000
70,000
Work in Process Inventory
35,000
180,000
15,000
160,000
10,000
Manufacturing Costs Are Added to the Value of
Inventory
170,000
15

• MANAGEMENT ACCOUNTING
• and Report Them in the Financial Statements

Cost of Goods Sold
Finished Goods Inventory, Jan. 1st
20,000
Work in Process, Jan. 1st
15,000
Direct Materials
Raw Materials Inventory, Jan. 1st
25,000
100,000
Add Raw Materials Purchased
Total Raw Materials Available
125,000
Less Raw Materials Inventory, Dec. 31st
(30,000)
Direct Materials Used
95,000
Direct Labour
15,000
Overhead
Factory Amortization
15,000

• Manufacturing Costs

Factory Utilities
30,000
Factory Repairs
5,000
Indirect Labour
20,000
Total Overhead
70,000
Total Manufacturing Costs
180,000
Less Work in Process, Dec. 31st
(35,000)
Cost of Goods Manufactured
160,000
(10,000)
Less Finished Goods Inventory, Dec. 31st
Cost of Goods Sold
170,000
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• MANAGEMENT ACCOUNTING
• and Report Them in the Financial Statements

17
Do Problems BE20-9, 10 E20-2, -4, -6, -8 P20-4
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MANAGEMENT ACCOUNTING

• Establish the Cost of manufactured items (for
  controlling, reporting, and for setting selling
  price-levels)

19

• MANAGEMENT ACCOUNTING
• Establish the Costs of Manufactured Items

Balance Sheet
Income Statement
Product Costing
Budgeting and Forecasting
Journalizing Transactions
Cash Flow Statement
Monitoring Variance from Budgets to Control Costs
External Users via Annual Reports
Management and Internal Users via Multiple
Reports and Data
20

• MANAGEMENT ACCOUNTING
• Establish the Costs of Manufactured Items

• One of the most important jobs of management
  accounting is determining the cost of a product.
• Think about it if you dont know how much it
  costs, you cant do any of the following
• Determine a selling price that will cover all
  costs
• Decide how low a sales price or volume discount
  you can offer
• Determine how to control costs (ex finding which
  materials are driving cost the most, etc.)
• The list goes on and on

21

• MANAGEMENT ACCOUNTING
• Establish the Costs of Manufactured Items

Activity Based Costing

• A popular method for determining cost is ABC
  Costing.
• The hardest part of finding the cost of a product
  is assigning overhead costs in a reliable and
  meaningful way.
• ABC Costing applies overhead based on those
  things that actually drive costs (called cost
  drivers)
• For example, if a product requires a lot of
  machining, machine hours will drive costs.
• So you find overhead/machine hour, and apply
  costs based on how many machine hours a product
  uses.

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• MANAGEMENT ACCOUNTING
• Establish the Costs of Manufactured Items

Activity Based Costing

• The steps are as follows
• Find all costs (DM, DL, OH)
• Determine the Overhead Cost/Driver
• To do this, first find the quantity of each
  driver (i.e. number of machine hours used in
  the period)
• Then find the all the costs of running the
  factory machines during the period (including
  Amortization)
• Then divide to find the Overhead Cost/Driver
• Apply the Overhead Cost/Driver rate to each
  product, for each driver.

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• MANAGEMENT ACCOUNTING
• Establish the Costs of Manufactured Items

Activity Based Costing

• An example Your company manufactures two models
  of Widgets Generic, and Deluxe

Step 1 Find All Costs
Direct Materials (40/kg)
0.5 kg
0.6 kg
Direct Labour (10/hour)
3.0 hrs
6.0 hrs
Overhead (Indirect)
670,000
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• MANAGEMENT ACCOUNTING
• Establish the Costs of Manufactured Items

Activity Based Costing
Step 2 Determine the Overhead Cost/Driver

• Find the quantity of each driver

• Find the costs of running the factory and machines

• Divide to find the Overhead Cost/Driver

150,000 / 250 Shipments 600 / Shipment
Total Overhead
Cost per Driver
(600 x 100S)/10,000 Generic 6/Widget
(600 x 150S)/5,000 Deluxe 18/Widget
10,000
5,000
Hrs/Widget
200,000
1
2
20,000 hrs
10/Hr
Hrs/Widget
320,000
2
4
40,000 hrs
8/Hr
of Shipments
150,000
100
6/18 per W
150
250 Shpmts
(10,000W x 1hr) (5,000W x 2hrs)
(200,000 / 20,000 Hours)
(320,000 / 40,000 Hours)
(10,000W x 2hrs) (5,000W x 4hrs)
670,000
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• MANAGEMENT ACCOUNTING
• Establish the Costs of Manufactured Items

Activity Based Costing
Step 3 Apply the Overhead Cost/Driver rate
Direct Materials
20
24
0.5kg
0.6kg
Direct Labour
30
60
3.0hrs
6.0hrs
Overhead (Indirect)
10
20
1hr
Machining
2hrs
10/Hr
16
32
Finishing
2hrs
4hrs
8/Hr
6
18
Shipping
6
Per Widget
18
Total Product Cost
82
154
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• MANAGEMENT ACCOUNTING
• Establish the Costs of Manufactured Items

• How do you use this information?
• Pricing products
• Cant set appropriate price without knowing
  product cost
• Determining Contribution Margin
• Once you know cost, you can determine the
  Contribution Margin each product will make to
  gross profit

• Break-even Analysis
• Knowing the contribution margin per product sold
  will allow you to calculate how many units you
  need to sell to cover non-product costs (i.e.
  operating costs) and break even.

• Set Budgets and Monitor for variance
• Once you know cost info, you can predict sales,
  costs and then monitor regularly for variance.
  This allows you to identify and control problems
  in a business.

BEP is when Operating Costs (X)a(Ma) b(Mb)
c(Mc) Where a is total of all units sold
that are product A,
Ma is the contribution
margin per unit of product A, and

X is the total number of units
sold of ALL types.
BEP Operating Costs / Contribution Margin per
Item
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Do Problems See the handout
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MANAGEMENT ACCOUNTING

• Provide information on where and why costs are
  changing (for decision making purposes)

29

• MANAGEMENT ACCOUNTING
• Provide Information on Where and Why Costs are
  Changing

Balance Sheet
Income Statement
Cost per Driver
Product Costing
Budgeting and Forecasting
Journalizing Transactions
Cash Flow Statement
Monitoring Variance from Budgets to Control Costs
External Users via Annual Reports
Management and Internal Users via Multiple
Reports and Data
30

• MANAGEMENT ACCOUNTING
• Provide Information on Where and Why Costs are
  Changing

Budget Variance Analysis

• Once you've determined products costs and set
  budgets, the management accountants role is to
  analyze why actual costs differ from budgeted
  costs (and they always do).
• This is important information for managers to
  have
• They need it in order to determine why costs are
  rising or falling
• This enables them to isolate any problems, and
  deal with them if possible.
• This is the purpose of completing a Budget
  Variance Analysis to find problems.

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• MANAGEMENT ACCOUNTING
• Provide Information on Where and Why Costs are
  Changing

Budget Variance Analysis

• Consider the cost data from the previous ABC
  Costing example (just for Deluxe Widgets).
• Our budgets predicted the following

Deluxe Widgets to be made
5,000
3,000
Direct Materials (24 per Widget)
120,000
105,000
If actual costs turned out to be 105,000 what
would that tell you?
How about now?
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• MANAGEMENT ACCOUNTING
• Provide Information on Where and Why Costs are
  Changing

Budget Variance Analysis

• The fact is you have absolutely no idea what the
  number 105,000 tells you.
• That isnt enough to isolate what caused the
  variance and solve the problem (if there even is
  one).
• To do this, you require the following info
• Production volume
• Efficiency Units of input per unit of output
  (i.e. how much material per widget made)
• Cost of a unit of input

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This variance is due to the fact that the actual
volume of widgets produced was less than what was
planed.
This variance results from using more material
for the actual production volume than what the
budget allows for.
This variance is due to a change in the budgeted
price paid for the actual quantities used.

• MANAGEMENT ACCOUNTING
• Provide Information on Where and Why Costs are
  Changing

Budget Variance Analysis
40/kg
40/kg
50/kg
0.6kg
0.7kg
0.7kg
3,000
3,000
3,000
72,000
105,000
120,000
84,000
(48,000)
12,000
21,000
Cause
Lower Production
Wastage
Price Increases