chapter 2 basic managerial accounting concepts copyright © 2012 nelson education ltd

Chapter 2 Basic Managerial Accounting

Concepts

Chapter 2 Basic Managerial Accounting

Concepts

COPYRIGHT © 2012 Nelson Education Ltd.

2-22-2

Learning ObjectivesLearning Objectives

1. Explain the meaning of cost and how costs are assigned to products and services

2. Define the various costs of manufacturing products and providing services as well as the costs of selling and administration

3. Prepare income statements for manufacturing and service organizations


OBJECTIVE OBJECTIVE 11

Explain the meaning of cost and how costs are assigned to products

and services


2-42-4

CostCost

• Amount of cash or cash equivalent sacrificed for goods and/or services

• Expected to bring a current or future benefit to organization

Let’s look at an example


A furniture manufacturer buys lumber for $10,000

Cost of the lumber is the amount given up…$10,000

2-52-5

ExpensesExpenses

As costs are used up in production of revenues, they expire

Expired costs are called expenses


2-62-6

Cost vs. PriceCost vs. Price

Be careful!

Cost and Price are not the same thing

Cost Price

Amount we chargeour customers forour products or

services

What we pay for something


2-72-7

Accumulating CostsAccumulating Costs

Received telephone bill

Recorded in Telephone Expense account

Telephone Expense

+ $150Bal. $800

$950

$150

Phone Bill


2-82-8

Accumulating CostsAccumulating Costs

Telephone Expense

+ $150Bal. $800

$950

This is helpful but managers also need to

know which departments used the $950 in

Telephone Expense

In other words, managers want to know how costs are

assigned to cost objects


2-92-9

Cost ObjectsCost Objects

• Any item for which costs are measured and assigned

• Examples:– Products– Customers– Departments– Regions


2-102-10

Assigning CostsAssigning Costs

Let’s say the Telephone Expense was incurred by the Sales and the Manufacturing

Departments

The Sales and Manufacturing departments

are cost objects

Sales Dept.

Manufacturing Dept.


2-112-11


Sales Dept.

Manufacturing Dept.

Telephone Expense

+ $150

Bal. $800

$950

$350

$600

The accountant assigns the Telephone Expense to the two cost objects


2-122-12


• Costs can be assigned in a number of ways• Some methods are more accurate, but time

consuming• Others are simple, but not as precise

These methods will be discussed further in upcoming chapters


2-13

Cost ClassificationCost Classification

• Different costs are used for different purposes

• Classification helps make sense of great variety of costs

2-142-14

Tracing Direct CostsTracing Direct Costs

Direct Costs:• Easily and accurately

traced to a cost object• Relationship between

the cost and the object can be physically observed


Indirect Costs:• Cannot be easily

traced to a cost object• Relationship between

the cost and the object not easily observed

• Assigned through allocation

2-152-15

Other Categories of CostOther Categories of Cost

• Variable Cost – increases in total as output increases and

decreases in total as output decreases

• Fixed Cost – total does not increase as output increases and

does not decrease as output decreases

• Opportunity Cost – benefit given up or sacrificed when one alternative

is chosen over another


OBJECTIVE OBJECTIVE 22Define the various costs of

producing products and services, as well as the costs of selling and administration


2-172-17

OutputOutput

One of the most important cost objects of a company is its output

Two types of output:

Products Services


2-182-18

Output ContinuedOutput Continued

Products:• Goods produced by converting raw materials

through use of labour and capital inputs• Produced by manufacturing organizations

Services:• Tasks or activities performed for a customer or an

activity performed by a customer using an organization’s products or facilities

• Produced by services organizations


2-192-19

Cost TypesCost Types

• Product (manufacturing) costs– Associated with the manufacture of goods or

the provision of services• Nonproduction costs

– All other costs


2-202-20

Nonproduction CostsNonproduction Costs

Examples:

• Designing

• Developing

• General Administration

• Distribution

• Customer Service

• Marketing


These are Selling costsThese are Administrative costs

2-212-21

Product Cost ClassificationsProduct Cost Classifications

Only three cost elements can be assigned to products for financial reporting:

DirectMaterials

DirectLabour

Overhead


2-222-22

Direct Materials & LabourDirect Materials & Labour

Direct Materials:• Part of final product • Directly traced to goods and services being produced

Direct Labour:• Directly traced to goods or services being produced


2-232-23

Manufacturing OverheadManufacturing Overhead

All product costs other than direct materials or direct labour:

Supplies

Utilities

Indirect Materials

Indirect Labour


2-242-24

Total Product CostTotal Product Cost

Direct Materials

+Direct Labour

Manufacturing Overhead

+Total Product Cost

=


2-252-25

Product Cost Per UnitProduct Cost Per Unit

Total Product Cost

Number of Units Produced

Unit Cost =

Let’s work through an example


2-262-26

Cornerstone 2-1Cornerstone 2-1

How to Calculate Product Cost in Total and Per Unit


• BlueDenim Company makes blue jeans. Last week:– Direct materials (denim, thread, zippers, and rivets)

costing $48,000 were put into production– Direct labour of $30,000 (50 workers × 40 hours × $15

per hour) was incurred• Overhead equals $72,000• By the end of the week, the company had manufactured

30,000 pairs of jeans

Information:

2-272-27

ExampleExample

• Calculate the total product cost for last week• Calculate the cost of one pair of jeans that were

produced last week

Required:

Now that we know what we

have to do, let’s get started!


2-282-28

Total Product CostTotal Product Cost

Direct Materials

30,000Direct Labour

Overhead

$48,000

Direct Materials + Direct Labour + Overhead

72,000

Total Product Cost $150,000


2-292-29

30,000

Per-Unit Product CostPer-Unit Product Cost

Total Product Cost

Number of Units Produced

$5 per pair of jeans

=$150,000


2-302-30


How to Calculate Prime Cost and Conversion Cost in Total and Per Unit


• Again, looking at BlueDenim Company. Last week:– Direct materials (denim, thread, zippers, and rivets)

costing $48,000 were put into production– Direct labour of $30,000 (50 workers × 40 hours × $15

per hour) was incurred• Overhead equals $72,000• By the end of the week, the company had manufactured

30,000 pairs of jeans

Information:

2-312-31

ExampleExample

• Calculate the total prime cost for last week• Calculate the per-unit prime cost• Calculate the total conversion cost for last week• Calculate the per-unit conversion cost

Required:

Now that we know what we have to do, let’s get

started!


2-322-32

Prime CostsPrime Costs

Prime Costs per unit

+

Direct Labour

$2.60

+Direct

Materials

=

$48,000 $30,000

$78,000

30,000=

Units produced


2-332-33

Conversion CostsConversion Costs

cost of converting raw materials into a final productConversion Costs = Direct Labour + Overhead


Conversion Costs per unit

+

$3.40=

$30,000 $72,000

$102,000

30,000=

Units produced

OverheadDirect Labour

2-342-34

Period CostsPeriod Costs

Unlike product costs which are carried in inventory; period costs are expensed in

the period in which they are incurred

Two categories of period costs: Selling Costs and

Administrative Costs


2-352-35

Selling CostsSelling Costs

Costs necessary to market, distribute, and service a product or service

Examples:

Salaries and commissions

of sales people Advertising

Warehousing

ShippingCustomer Service


2-362-36

Administrative CostsAdministrative Costs

All costs associated with research, development, and general administration of the organization that cannot be assigned to

selling or production

Examples:

General Accounting

Top Executive Salaries

Legal FeesExpenses of printing the

annual report


OBJECTIVE OBJECTIVE 33

Prepare income statements for manufacturing and service organizations


2-382-38

Financial Statements for Manufacturing OperationsFinancial Statements for Manufacturing Operations

Business operations can be classified as:• Service• Merchandising • Manufacturing


Text focuses on manufacturing businesses• Most managerial accounting concepts also apply to service and merchandising businesses

2-392-39

Direct Materials & LabourDirect Materials & Labour

Direct Materials Cost:• Part of final product • Directly traced to goods and services being produced

Direct Labour Cost:• Directly traced to goods or services being produced


2-402-40

Factory Overhead Cost (Manufacturing Overhead)Factory Overhead Cost (Manufacturing Overhead)

• Costs other than direct materials and direct labour cost

• Incurred in manufacturing process • Combined and classified as factory

overhead cost• All factory overhead costs are indirect

costs of the productExamples: heat and light for the factory, power to run the machines

2-412-41

Balance Sheet for a Manufacturing BusinessBalance Sheet for a Manufacturing Business

• Three types of inventory:1. Materials

2. Work in Process (WIP)

3. Finished Goods

2-422-42

Income Statement for a Manufacturing BusinessIncome Statement for a Manufacturing Business

2-432-43

Cost of Goods ManufacturedCost of Goods Manufactured

• Step 1– Determine the cost of direct materials

used• Step 2

– Determine the total manufacturing costs incurred.

• Step 3– Determine the cost of goods

manufactured.

2-442-44

Direct Materials UsedDirect Materials Used

• Only the amount used on products produced during the current period

• Consider beginning and ending inventory levels

• Key point: Purchases do not equal materials used

Let’s go through an example


2-452-45


How to Calculate the Direct Materials Used in Production


• On May 1, BlueDenim had $68,000 of materials in inventory• During the month of May, the company purchased $210,000

of materials• On May 31, materials inventory equalled $22,000

Information:

Required:Calculate the direct materials used in production for May

2-462-46

Materials Used in

Production

Direct MaterialsDirect Materials

Purchases =Ending

Materials Inventory

-Beginning Materials Inventory

+

$68,000 $210,000 $22,000‒+ = $256,000


2-472-47

Work in ProcessWork in Process

• Second type of inventory• Cost of partially completed goods that are still on

the factory floor at the end of the period• Units are started, but not finished• Included direct materials, direct labour, and

overhead costs

Let’s continue our example


2-482-48


How to Calculate Cost of Goods Manufactured (COGM)


• During the month of May, the company purchased $210,000 of materials

• On May 31, materials inventory equaled $22,000• During the month of May, BlueDenim Company incurred:

– Direct labour cost of $135,000– Overhead of $150,000

Information:

2-492-49

ExampleExample

May 1 May 31

Work in Process

Materials $68,00050,000

$22,000

Inventory is as follows:

16,000


• Calculate the cost of goods manufactured for May• Calculate the cost of one pair of jeans assuming that

115,000 pairs of jeans were completed during May

Required:

2-502-50

(16,000)

$541,000

OverheadDirect labour

$256,000

150,000

Total Manufacturing CostWork in Process, May 1

Per unit Cost of Goods Manufactured

135,000

50,000

Direct materials

Cost of Goods Manufactured

BlueDenim CompanyCost of Goods Manufactured

For the Month of May

BlueDenim CompanyCost of Goods Manufactured


$575,000

$575,000

115,000 units= $5


Work in Process, May 31

2-512-51


How to Calculate Cost of Goods Sold (COGS)


• On May 1 BlueDenim Company had 10,000 units in finished goods inventory costing $50,000

• On May 31 the company had 26,000 units in finished goods inventory costing $130,000

Information:

• Calculate the cost of goods sold for May• Calculate the number of jeans that were sold in May

Required:

2-522-52

Cost of Goods SoldCost of Goods Sold

• Represent the total cost of units sold during a period

• Includes only product cost• Includes direct materials, direct labour, and

overhead• Reported as an expense on the income statement

“Sold” is the key word. Let’s continue with our example


2-532-53

$495,000

Finished goods, May 31

Finished goods, May 1

$575,000

(130,000)

Cost of Goods Sold

50,000

Cost of goods manufactured

BlueDenim CompanyCost of Goods Sold


BlueDenim CompanyCost of Goods Sold


Reported as an expense on the Income Statement


Reported as an asset on the

Balance Sheet

2-542-54

Finished goods inventory, May 31

Units finished during May

10,000

(26,000)

Units sold during May

115,000

Finished goods inventory, May 1

99,000

Units SoldUnits Sold

Number of units sold:


2-552-55


How to Prepare an Income Statement for a Manufacturing Firm


• BlueDenim Company sold 99,000 pairs of jeans in May at a total cost of $495,000

• Each pair sold at a price of $8• BlueDenim also incurred two types of selling costs:

– Commissions equal to 10% of the sales price– Other selling expense of $120,000

• Administrative expense totalled $85,000

Information:

Required:Prepare an income statement for BlueDenim for May

2-562-56

Cost of goods sold$792,000

Less:

495,000Sales revenue

BlueDenimIncome Statement


BlueDenimIncome Statement


$297,000Gross margin

Selling expense:Commissions $ 79,200Fixed selling expense 120,000

Administrative expense199,200

85,000Operating income $ 12,800

$792,000 × 10%


99,000 pairs of Jeans × $8

2-572-57


How to Calculate the Percentage of Sales Revenue for Each Line on the

Income Statement


Let’s continue our example

2-582-58

Cost of goods sold

$792,000

Less:


BlueDenim CompanyIncome Statement





Selling expense:

Commissions $ 79,200Fixed selling expense 120,000

Administrative expense 199,20085,000Operating income

$ 12,800

Each item is divided by

Sales revenue e.g. $792,000/

$792,000 = 100%

%100.0


2-592-59

Cost of goods sold

$792,000

Less:







Selling expense:



$ 12,800

%100.0


$495,000/$792,000 = 62.5%

62.5

2-602-60

Cost of goods sold

$792,000

Less:







Selling expense:



$ 12,800


%100.0

62.5

37.5

25.2

10.71.6

2-612-61


How to Prepare an Income Statement for a Service Organization


• Komala Information Systems designs and installs software• Last month, Komala had costs of:

– Materials, $5,000– Direct labour, $35,000– Overhead, $55,000– Selling expenses, $5,000– Administrative expenses, $7,000

• Sales totalled $130,000

Information:

2-622-62

107,000

Less operating expensesSales Revenues: $130,000

Software licensingService technicians

Administrative expense5,000

R&D

$ 5,00035,000

Selling expenses

$23,000

Komala Information SystemsIncome StatementFor the Past Month

Komala Information SystemsIncome StatementFor the Past Month

55,000

Operating income


7,000

2-632-63

Income Statement:Service FirmIncome Statement:Service Firm

• Cost of services sold is typically made up of:– Materials– Labour– Overhead

• No beginning or ending inventories• cost of services sold will always equal cost of

services manufactured


chapter 2 basic managerial accounting concepts copyright © 2012 nelson education ltd

Documents

nelson education

notfixed costs

expensesas costs

meaning of cost

cost objectscopyright

cost objectrelationship

cost groups

cost objectsany item