chapter 20 management accounting: the manufacturing business

CHAPTERCHAPTER

2020

MANAGEMENT ACCOUNTING:MANAGEMENT ACCOUNTING: The Manufacturing BusinessThe Manufacturing Business

MANAGEMENT ACCOUNTINGMANAGEMENT ACCOUNTINGThe BasicsThe Basics

MANAGEMENT ACCOUNTINGMANAGEMENT ACCOUNTINGThe BasicsThe Basics

Management Accounting (CMAs)Financial Accounting (CAs)

External users (Public)

Classified Financial Statements

To provide general all-purpose info for all users

Issued Annually

Past orientation: historical cost data

Pertains to entity as a whole and is very condensed

Reporting standards are GAAPs

Annual independent audit required

Internal users (officers, management, Dept. Heads, etc.)

Internal reports

To provide specific information for internal management/decision makers

Issued as frequently as needed

Future orientation: budgets & projections as well as historical cost

Pertains to departments and divisions and may be very detailed

Reporting standard is relevance to the decision to be made

No independent audits

• The notes for this chapter are broken down into the four functions that Management Accountants perform. They:

1. Determine which costs are involved in manufacturing, and report them in the financial statements.

2. Establish the cost of manufactured items (for controlling, reporting, and for setting selling price-levels)

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

4. Evaluate cost behaviour in a company as production levels change (i.e. Economies of Scale).

MANAGEMENT ACCOUNTINGMANAGEMENT ACCOUNTINGThe Functions of Management AccountantsThe Functions of Management Accountants

MANAGEMENT ACCOUNTINGMANAGEMENT ACCOUNTINGThe Functions of Management AccountantsThe Functions of Management Accountants

MANAGEMENT ACCOUNTINGMANAGEMENT ACCOUNTINGMANAGEMENT ACCOUNTINGMANAGEMENT ACCOUNTING

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

MANAGEMENT ACCOUNTINGMANAGEMENT ACCOUNTING1.1. Determine which costsDetermine which costs are involved in manufacturing are involved in manufacturing


The Product’s Cost (Steel)

Direct Materials Direct Labour Overhead

• 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

• Overhead: Consists of costs that are indirectly associated with the manufacture of the finished product.

• Manufacturing overhead includes1. Indirect materials;

2. Indirect labour;

3. Amortization on factory buildings and machinery; and

4. Insurance, taxes, and maintenance on factory facilities.





Direct Materials

Direct Labour

Overhead

Administrative Expenses

Selling Expenses



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).

• We’ll then look at how this “Flow” is shown on the financial statements.

Recall the COGS for a Merchandise Business:• The cost of buying (and having shipped in) the items

that were sold to customers.



What is the Cost of Goods Sold?

Cost of Goods Available for Sale

Beginning Inventory Net Purchases

Ending Inventory

COST OF GOODS SOLD



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)!

Raw Materials Inventory (DM)

Work in Process Inventory

Finished Goods Inventory

Direct Labour (DL) and Overhead (OH) are

added here. (Also known as conversion costs)



What is Cost of Goods Sold?

Beginning Raw

Materials Inventory

Ending Work in Process Inventory

Ending Raw

Materials Inventory

Raw Materials Purchased

Overhead

Direct Materials

Used

Direct Labour

Manufacturing Costs

Beginning Work in Process Inventory

Beginning Finished Goods

Inventory

COST OF GOODS SOLD

Ending Finished Goods Inventory

Cost of Goods Manufactured

Finished Goods

Inventory

Work in Process

Inventory

Raw Materials Inventory

Manufacturing Costs Are Added to the Value

of Inventory



What is Cost of Goods Sold?

$25,000

$35,000

$30,000$100,000

$70,000

$95,000

$15,000

$180,000$15,000

$20,000

$170,000

$10,000

$160,000

Finished Goods

Inventory

Work in Process

Inventory


Manufacturing Costs Are Added to the Value

of Inventory

MANAGEMENT ACCOUNTINGMANAGEMENT ACCOUNTING1.1. … … and Report Them in the Financial Statementsand Report Them in the Financial StatementsMANAGEMENT ACCOUNTINGMANAGEMENT ACCOUNTING

1.1. … … and Report Them in the Financial Statementsand Report Them in the Financial Statements

Cost of Goods Sold

Work in Process, Jan. 1st

Direct Labour

Raw Materials Inventory, Jan. 1st

Total Raw Materials AvailableAdd: Raw Materials Purchased

Direct Materials UsedLess: Raw Materials Inventory, Dec. 31st

Direct Materials

Indirect Labour

Overhead

Factory UtilitiesFactory Repairs

Total Manufacturing Costs

Factory Amortization

Total Overhead

Less: Work in Process, Dec. 31st

Cost of Goods Manufactured

Finished Goods Inventory, Jan. 1st

Less: Finished Goods Inventory, Dec. 31st

Cost of Goods Sold

$20,000$15,000

$25,000$100,000$125,000$(30,000)

$95,000$15,000

$15,000$30,000

$5,000$20,000

$70,000$180,000

$160,000$(35,000)

$(10,000)

$170,000

Finished Goods Inventory

Work in Process Inventory


MANAGEMENT ACCOUNTINGMANAGEMENT ACCOUNTING1.1. … … and Report Them in the Financial Statementsand Report Them in the Financial StatementsMANAGEMENT ACCOUNTINGMANAGEMENT ACCOUNTING

1.1. … … and Report Them in the Financial Statementsand Report Them in the Financial Statements

Do Problems:

BE20-9, 10

E20-2, -4, -6, -8

P20-4


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

Financial Accounting Management Accounting

MANAGEMENT ACCOUNTINGMANAGEMENT ACCOUNTING2.2. Establish the CostsEstablish the Costs of Manufactured Items of Manufactured Items


Balance Sheet

Income Statement

Cash Flow Statement

Journalizing Transactions

Product Costing

Budgeting and Forecasting

Monitoring Variance from Budgets to Control Costs

External Users via Annual Reports

Management and Internal Users via Multiple Reports and Data

COGS

COGM

• One of the most important jobs of management accounting is determining the cost of a product.

• Think about it: if you don’t know how much it costs, you can’t 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…





• 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.

Activity Based Costing



The steps are as follows:1.1. Find all costsFind all costs (DM, DL, OH)2.2. Determine the Determine the Overhead Cost/DriverOverhead Cost/Driver

a) To do this, first find the quantity of each “driver” (i.e. number of machine hours used in the period)

b) Then find the all the costs of running the factory & machines during the period (including Amortization)

c) Then divide to find the Overhead Cost/Driver

3.3. Apply the Apply the Overhead Cost/DriverOverhead Cost/Driver rate rate to each product, for each driver.


Total OverheadMachining

Finishing

Shipping

$200,000

$320,000

$150,000



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


Step 1: Find All CostsFind All Costs

DeluxeGeneric

Direct Materials ($40/kg)

Direct Labour ($10/hour)

Overhead (Indirect)

0.5 kg 0.6 kg

3.0 hrs 6.0 hrs

$670,000

$20 $24

$30 $60

Machining

Finishing

Shipping

Units to be MadeDeluxeGenericDriver

Total Drivers




Step 2: Determine the Determine the Overhead Cost/DriverOverhead Cost/Drivera) Find the quantity of each “driver”

$200,000

$320,000

$150,000

$670,000

10,000 5,000

Hrs/Widget

Hrs/Widget

# of Shipments

1

2

100 150

2

4

Total Overhead

20,000 hrs

40,000 hrs

250 Shpmts

Cost per Cost per DriverDriver

$10/Hr

$8/Hr

$6/$18 per W

b) Find the costs of running the factory and machinesc) Divide to find the Overhead Cost/Driver

(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)

$150,000 / 250 Shipments = $600 / Shipment

($600 x 100S)/10,000 Generic = $6/Widget

($600 x 150S)/5,000 Deluxe = $18/Widget

Recall from Step 2:DeluxeGeneric




Step 3: Apply the Apply the Overhead Cost/DriverOverhead Cost/Driver rate rate

Machining

Finishing

Shipping

1hr

2hrs

$6 $18

2hrs

4hrs

Direct Labour

Direct Materials

Overhead (Indirect)

$20 $24

$30 $60

$10/Hr

$8/Hr

Per Widget

DeluxeGenericCost per Cost per DriverDriver

Drivers

$10$16

$6

$20$32$18

Total Product Cost $82 $154

Recall from Step 1:

Generic DeluxeDriversCost per Cost per

DriverDriver

$40/Kg

$10/Hr

0.5kg

6.0hrs3.0hrs

0.6kg

DeluxeGeneric

Machining

Finishing

Shipping

Direct Labour

Direct Materials

Overhead (Indirect)

$20 $24

$30 $60

$10$16

$6

$20$32$18

Total Product Cost $82 $154



How do you use this information? • Pricing products

• Can’t 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 profitDeluxe Widgets-$200 Retail

$24

$60

$70

$46

Materials Labour Overhead Cont. Margin

BEP = Operating Costs / Contribution Margin per Item

• 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.

• 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.

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.

Do Problems:

See the handout


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

MANAGEMENT ACCOUNTINGMANAGEMENT ACCOUNTING3.3. Provide InformationProvide Information on Where and Why Costs are Changing on Where and Why Costs are Changing


Balance Sheet

Income Statement

Cash Flow Statement

Journalizing Transactions

Product Costing

Budgeting and Forecasting

Monitoring Variance from Budgets to Control Costs

Financial Accounting Management Accounting

External Users via Annual Reports

Management and Internal Users via Multiple Reports and Data

Cost per

Cost per

DriverDriver

COGS

COGM



Budget Variance Analysis

• Once you've determined products costs and set budgets, the management accountant’s 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.

Budgeted Actual



• 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

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?

3,000





• The fact is you have absolutely no idea what the number “$105,000” tells you.

• That isn’t enough to isolate what caused the variance and solve the problem (if there even is one).

• To do this, you require the following info:1. Production volume

2. Efficiency – Units of input per unit of output (i.e. how much material per widget made)

3. Cost of a unit of input




$40/kg

0.6kg

5,000

$40/kg

0.6kg

3,000

$40/kg

0.7kg

3,000

$50/kg

0.7kg

3,000

$120,000 $72,000 $84,000 $105,000

($48,000) $12,000 $21,000

Lower Production Wastage Price IncreasesCause:

Material Cost

Material Usage

Production Volume

TOTALS

BUGETEDVolume Variance

Bugeted Cost at Actual Volume

Levels

Efficiency Variance

Bugeted Cost at Actual Levels of Volume and

Efficiency

Price Variance

ACTUAL

Projected Cost Projected Cost Projected Cost Actual Cost

Projected Efficiency Projected Efficiency Actual Efficiency Actual Efficiency

Projected Volume Actual Volume Actual Volume Actual Volume

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.

chapter 20 management accounting: the manufacturing business

Documents

manufacturing slide

manufacturing business

manufacturing process

manufacturing direct

cost behaviour

indirect materials

raw materials

historical cost data