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Course Title: Managerial Accounting 6th Edition

Module 2- Basic Managerial Accounting Concepts

Module Learning Outcomes

By the end of this module, you should be able to:
 Explain the meaning of cost and how costs are
assigned to products and services.
 Defined the various costs of manufacturing products
and providing services as well as the costs of selling
and administration.
 Prepare income statement for manufacturing and
service organizations

Introduction/Overview
Accounting is the system of recording and keeping track
of financial transactions in a business and summarizing
this information in reports. These reports provide
information to people who are interested in knowing
about the financial aspects of a business. The information
guides business managers, investors, and creditors in
planning and decision making. In fact, accounting is often
referred to as “the language of business” because
business people communicate, evaluate performance, and
determine value using dollars and amounts generated by
the accounting process.
Financial accounting involves producing periodic
reports called financial statements to inform such external
groups as investors, boards of directors, creditors, and
government/tax agencies about a company’s financial
performance and status. The income statement, retained
earnings statement, balance sheet, and statement of cash
flows are published at fixed intervals to summarize the
historical earnings performance and current financial
position of a company. Financial statements are prepared
according to Generally Accepted Accounting Principles
(GAAP), which helps ensure the information
is relevant (useful and timely for making
decisions), reliable (accurate and
unbiased), consistent (prepared the same way each time
information is reported), and comparable (prepared the
same way by different companies).
Managerial accounting is targeted more toward a
company’s managers and employees. The information
gathered and summarized for these internal groups is
customized to provide feedback for planning, decision
making, and evaluation purposes. Managerial reports do
not necessarily follow any particular format, but instead
are uniquely designed to meet the needs of specific users.
Analyses are often focused on targeted segments of a
business rather than on a company as a whole.
Information may be published over periodic time intervals
or on an as- need basis. Managerial accounting involves
not only actual financial data from past periods, but also
current estimates and future projections.
A manager’s responsibilities in a business include
making decisions related to planning (identifying goals
and strategies for accomplishing them), leading (directing
daily operations and carrying out plans), and controlling
(comparing expected and actual results and taking action
for improvement). Since human, financial, and time
resources are limited, managers must select from among
many alternatives, foregoing other options. They try to
optimize the collective outcome of their choices.
Managerial accounting provides timely and relevant
financial information that contributes to effective decision
making.
A business’s operations are classified as one of three
types - service, merchandising, or manufacturing -
depending on what it has for sale. A service business sells
expertise, advice, assistance, professional skills, or an
experience rather than a physical product. A
merchandising business purchases finished and packaged
products from other companies, marks up the costs of
these items, and sells them to customers. A manufacturing
business assembles and packages products for sale to
merchandisers or end users.
Managerial accounting is relevant to all three types of
businesses. In this document, we will focus on
manufacturing since that type of business involves the
most in-depth facets and examples of managerial
accounting. We will also discuss managerial accounting
for service businesses where appropriate. Topics will fall
into four broad categories: accumulating costs, analyzing
costs, evaluating performance, and comparing
alternatives.
The goal of a business is to generate profit, which is the
difference between income and costs in a particular time
period. Costs are the result of paying cash or committing
to pay cash in the future in order to earn revenue. Costs
may be accumulated for a product, sales territory,
department, or activity. It is critical to analyze costs
because controlling them directly impacts profitability.
Costs are also used to determine selling prices of
products, and they are monitored over time to evaluate
progress and discover irregularities.
Accumulating Costs
Costs must be determined and recorded accurately,
systematically, and on a timely basis. Unless cost
information is correct and reliable, it is not very useful to
managers who depend on it to make effective plans and
informed decisions. Job order costing and process
costing are two methods of systematically accumulating
costs on manufactured products. Activity-based
costing is a system that is combined with the other two
methods to identify and measure costs more specifically.
Analyzing Costs
Not all costs are created equal. Some are unavoidable;
others are somewhat controllable. Separating them out
allows managers to focus on controllable costs that should
be monitored in order to contain or lower them. Costs
may also be used to mathematically determine sales
required to achieve desired levels of volume and
profitability. Break even analysis and other cost
relationships, as well as variable costing, will address
these issues.
Evaluating Performance
Planning involves looking into the future and estimating
what a business’s financial activities will look like. This
process is called budgeting and projects what sales, costs,
production, cash flows, etc. will be in at a future point in
time. Controlling methods such as variance
analysis compare expected outcomes to actual results and
analyze overall progress in meeting goals.
Comparing Alternatives
Managerial decision making includes choosing one option
over others, such as whether to make or buy a component
part or whether to continue manufacturing a product or
not. Differential analysis compares alternatives to
determine which choice will yield either the greatest
benefit or the least cost. Capital investment analysis is a
type of differential analysis that involves evaluating
proposed investments in property, plant, and equipment
that a company will use in its operations.

The Meaning and Uses of Cost

Cost – is the amount of cash or cash equivalent
sacrificed for goods and/or services that are
expected to bring a current or future benefit to the
organization.
Cost are incurred to produce future benefits.
Expired costs are called expenses.
The revenue per unit is called price

Accumulating and Assigning Costs

Accumulating costs – is the way that costs are
measured and recorded.

Assigning Costs is the way that a cost is linked to

some cost object.

A cost object is something for which a company

wants to know the cost.

Assigning costs tells the company why the money

was spent.

Cost Objects

A cost object is any item such as a product,

customer, department, project, geographic region,
plant, and so on, for which costs are measured and
assigned.

Which cost objects would you select as critical to the

company’s success?

Like any company, an airline can identify and

manage any cost objects it so desires. Sometimes
the most difficult part of effective cost management
is the first step-deciding on the exact items for which
one needs to understand the cost. Mistakes in
selecting the cost objects almost always lead to poor
decisions and subpar performance.

Assigning Cost to Cost Objects

Direct Costs- are those cost that can be easily and

accurately traced to a cost object. When we say that
a cost and the object can be physically observed and
is easy to track.

Indirect Costs are costs that cannot be easily and

accurately trace to a cost object.

Allocation means that an indirect cost is assigned to

a cost object by using a reasonable and convenient
method.

Ethical Decisions
Tracking costs can also act as an early warning
system for unauthorized activity and possible ethical
problems.

A variable cost is one that increases in total as

output increases and decreases in total as output
 decreases. For example, the denim used in making
jeans is a variable cost. As the company makes more
jeans it needs more denim.

A fixed cost is a cost that does not increase in total

as output increases and does not decrease in total as
output decreases. For example, the cost of property
taxes on the factory building stays the same no
matter how many pairs of jeans the company makes.

An opportunity cost is the benefit given up or

sacrificed when one alternative is chosen over
another. For example, an opportunity cost of you
participating in a summer study abroad might
include the wages you would have earned during
that time if you had stayed home to work rather
than preparing in the overseas program.

Opportunity cost differs from accounting costs in

that the opportunity cost is never included in the
accounting records because it is the cost of
something that did not occur.

Product and Service Costs

 Products are goods produced by converting raw
materials through the use of labor and indirect
 manufacturing resources, such as manufacturing
plant, land, and ,machinery.
 Services are task or activities performed for a
customer or an activity performed by a customer
using an organization’s products or facilities.

Organizations that produce products are called

manufacturing organizations.

Organizations that provide services are called service

organizations.

Services differ from products in many ways.

 Services are intangible: The buyers of services
cannot see, feel, hear, or taste a service before it is
bought.
 Services are perishable: Services cannot be stored
for future use by a consumer but must be consumed
when performed.
 Services require direct contact between providers
and buyers.

Providing Cost Information

Managerial accountants must decide what types of
managerial accounting information to provide to
managers, how to measure such information, and when
and to whom to communicate the information. For
example, when making most strategic and operating
decisions, managers typically rely on managerial
accounting information that is prepared in whatever
manner the managerial accountant believes provides the
best analysis for the decision on hand.

However, there is one major exception. Managerial

accountants must follow specific external reporting
rules(i.e., generally accepted accounting principles) when
their companies provide outside parties with cost
information about the amount of ending inventory on
the balance sheet and the cost of goods sold on the
income statement.

Determining Product Cost

Product (Manufacturing) costs are those costs, both
direct and indirect, of producing a product in a
manufacturing firm or of acquiring a product in a
merchandising firm and preparing it for sale.

Direct materials are those materials that are a part of the

final product and can be directly traced to the goods
being produced.
Direct Labor is the labor that can be directly traced to the
goods being produced.

Manufacturing Overhead
All product costs other than direct materials and direct
labor are put into a category called manufacturing
overhead.

The important thing to remember is that all costs in the

factory are classified as direct materials, direct labor, or
manufacturing overhead.

Total Product Cost. The total product cost equals the sum
of direct materials, direct labor, and manufacturing
overhead:

Total Product Cost+ Direct Materials + Direct Labor +

Manufacturing Overhead

Per-Unit Product Cost= Total Product Cost

Number of Units Produced

Cornerstone 2.1
Calculating Product Cost in Total and Per Unit
Why:
Product costs are essential to management control and
decision making. Managers use product costs to create
budgets and analyses. Product costs within
manufacturing can then be contrasted with period costs
incurred outside of manufacturing.

Information:
Blue Denim Company makes jeans. Last week, direct
materials (denim, thread, zippers and rivers) costing
P48,000 were put into production. Direct labor of
P30,000 (50 workers x 40 hours x P515 per hour) was
incurred. Manufacturing overhead equaled P72,000. By
the end of the week, Blue Denim had manufactured
30,000 pairs of jeans.

Required:
1. Calculate the total product cost for last week
2. Calculate the cost of one pair of jeans that was
produced last week.

Solution:
1.
Direct materials P48,000
Direct labor 30,000
Manufacturing overhead 72,000
Total product cost P150,000
 2.
Per Unit Product Cost = P150,000/30,000=P5
Product cost include direct materials, direct labor, and
manufacturing overhead. Once the product is finished,
no more costs attach to it. That is, any costs associated
with storing, selling, and delivering the product are not
product cost, but instead are period costs.

Prime and Conversion costs

 Prime cost is the sum of direct materials cost and
direct labor cost:
Prime Cost = Direct Materials + Direct Labor

 Conversion Cost is the sum of direct labor cost and

manufacturing overhead cost
Conversion cost = direct labor + Manufacturing
overhead

For manufacturing firm, conversion cost can be

interpreted as the cost of converting raw materials
into a final product.
 Cornerstone 2.2
Calculating Prime Cost and Conversion Cost in Total
and Per Unit.

Why:
Managers often categorize product costs into either
prime or conversion in nature to compare the
relative cost of manufacturing inputs (i.e., direct
materials and direct labor) versus processing (i.e.
direct labor and manufacturing overhead).

Information:
Refer to the information in Cornerstone 2.1 for Blue
Denim Company

Required:
1. Calculate the total prime cost for last week
2. Calculate the per-unit prime cost
3. Calculate the total conversion cost for last week
4. Calculate the per-unit conversion cost.

Solution:
1
Direct materials P48,000
Direct labor 30,000
Total prime cost P78,000
2 Per Unit Prime Cost = P78,000/30,000 = P2.60
3
Direct labor P30,000
Manufacturing overhead 72,000
Total conversion cost P102,000
4 Per unit Conversion Cost = P102,000/30,000 units
=P3.40

The Impact of Product versus Period Costs on the

Financial Statements

Cost

Product Period

Balance Inventory Capitalize

Sheet (Asset) (asset)

Income COGS Depreciation

Statement Expense Period Exp

Selling Costs. Those cost necessary to market, distribute,

and service a product or service are called selling costs.
Administrative costs. All costs associated with research,
development, and general administration of the
organization that cannot reasonably be assigned to
either selling or production are administrative costs.

Direct and Indirect Period Costs. As with product costs, it

is often helpful to distinguish between direct period
period costs and indirect period costs.

Preparing Income Statements

Cost of Goods Manufactured
The cost of goods manufactures represents the total
product cost of goods completed during the current
period and transferred to finished goods inventory.

Beginning Inventory Direct Materials Ending Inventory

Of materials + Purchases - Used in Production= of Materials

Cornerstone 2.3
Calculating the Direct Materials Used in Production
Why:
The primary use of calculating the direct materials used
in production, is to serve as the first number in
calculating the cost of goods manufactured. Direct
materials used in production also show managers the
difference between the amount of materials purchase,
and the amount of materials used in manufacturing for
the period.

Information:
Blue Denim Company makes blue jeans. On May 1, Blue
Denim had $68,000 of materials in inventory. During the
month of May, Blue Denim purchased $210,000 of
materials. On May 31, materials inventory equaled
$22,000.
Required:
Calculate the cost of direct materials used in production
for the month of May.

Solution:
Materials Inventory, May 1 $68,000
Purchases 210,000
Materials inventory, May 31 (22,000)
Direct materials used in production $256,000

Once the direct material are calculated, the direct labor

and manufacturing overhead for the time period can be
added to get the total manufacturing cost for the period.
Work in process (WIP) is the cost of the partially
completed goods that are still on the factory floor at the
end of a time period.

Cornerstone 2.4
Calculating Cost of Goods Manufactured
Why:
The primary use for the statement of cost of goods
manufactured is for external financial reporting.
Information:
Blue Denim Company makes blue jeans. During the
month of May, Blue Denim purchased $210,000 of
materials and incurred direct labor cost of $135,000 and
manufacturing overhead of $150,000. On May 31,
materials inventory equaled $22,000. Inventory
information is as follows:
May 1 May 31
Materials $68,000 $22,000
Work in process 50,000 16,000

Required:
Calculate the cost of goods manufactures for the month
of May.
Solution:
Direct materials used in production $256,000
Direct Labor 135,000
Manufacturing overhead 150,000
Total manufacturing cost for May $541,000
WIP, May 1 50,000
WIP, May 31 (16,000)
Cost of goods manufactured $575,000

Cornerstone 2.5
Calculating Cost of Goods Sold
Why:
The primary use for the statement of cost of goods sold
is for external financial reporting. It is a critical input to
the income statement.
Information:
Blue Denim Company makes blue jeans. During the
month of May, 115,000 pairs of jeans were completed at
a cost of goods manufactured of $575,000. Suppose that
on May 1 Blue Denim had 10,000 units in the finished
goods inventory costing $50,000 and on May 31, the
company had 26,000 units in the finished goods
inventory costing $130,000.

Required:
1. Prepare a cost of goods sold statement for the
month of May.
 2. Calculate the number of pairs of jeans that were sold
during May.
Solution:1.)
Blue Denim Company
Cost of Goods Sold Statement
For the Month of May

Cost of goods manufactured $575,000

Finished goods inventory, May 1 50,000
Finished goods inventory, May 31 (130,000)
Cost of goods sold $495,000

3. Number of units sold:

Finished goods inventory, May 1 10,000
Units finished during May 115,000
Finished goods inventory, May 31 (26,000)
Units sold during May 99,000

Cornerstone 2.6
Preparing an Income Statement for a Manufacturing Firm
Why:
The primary use for the income statement is for external
financial reporting. Investors and outside parties use it to
determine the financial health of a firm.
Information:
Recall that Blue Denim Company sold 99,000 pairs of
jeans during the month of May at a total cost of
$495,000. Each pair sold at a price of $8. Blue Denim also
incurred two types of selling costs: commissions equal to
10% of the sales price, and fixed selling expense of
$120,000. Administrative expense totaled $85,000.
Required:

Prepare an income statement for Blue Denim for the

month of May.

Solution:
Blue Denim Company
Income Statement
For the Month of May

Sales revenue (99,000 x $8) $792,000

Cost of goods sold __(495,000)
Gross margin $297,000
Less:
Selling expenses
Commissions ($792,000 x 0.10) $79,200
Fixed selling expenses 120,000 (199,200)
Administrative expenses ( 85,000)
Operating income $12,800
Sales Revenue= Price x Units Sold
Gross Margin is the difference between sales revenue
and cost of goods sold:
Gross Margin = Sales Revenue – Cost of Goods Sold

Cornerstone 2.7
Calculating the Percentage of Sales Revenue for Each
Line on the Income Statement
Why:
Calculating the percentage of revenue informs managers
of the size of each income statement line item relative to
sales revenue: This calculation also enables comparisons
between fiscal periods and with other firms in the
industry.
Information:
Refer to the income statement for Blue Denim Company
in Cornerstone
Required:
Calculate the percentage of sales revenue represented
by each line of the income statement.

Solution:
Blue Denim Company
Income Statement
For the Month of May
Percent*
Sales revenue (99,000 x $8) $792,000 100.0
Cost of goods sold 495,000 62.5
Gross Margin $297,000 37.5
Less:
Selling expenses
Commissions($792,000x0.10) $79,200
Fixed Selling expenses 120,000 199,200 25.2
Administrative expenses 85,000 10.7
Operating Income $12,800 1.6

Steps in calculating percentage

1. Sales Revenue Percent= $792,000/$792,000=1.00 or 100% (sales revenue is always
100% of itself)
2. Cost of Goods Sold Percent= $495,000/$792,000=0..625, or 62.5%
3. Gross Margin Percent=$297,000/792,000=0.375 or 37.5%
4. Selling Expenses Percent=$199,200/$792,000=0.252 or 25.2% (rounded)
5. Administrative expense Percent=%85,000/$792,000 = 0.107nor 10.7% (rounded)
6. Operating Income Percent = $12,800/$792,000 = 0.016 or 1.6% (rounded)

Operating Income=Gross Margin-Selling and Administrative Expense

Income Statement: Service Firm

Cornerstone 2.8
Preparing an Income Statement for a Service Organization
Why:
The primary use for the income statement is for external financial
reporting. Investors and outside parties use it to determine the
financial health of a firm. Cost of goods sold typically does not exist on
the income statement because service organizations generate sales by
providing services rather than selling products.
Information:
Komala Information systems designs and installs human resources
software for small companies. Last month, Komala had software
licensing costs of $5,000, service technicians costs of $35,000, and
research and development costs of $55,000. Selling expenses were
$5,000, and administrative expenses equaled $7,000. Sales totaled
$130,000.
Required:
Prepare an income statement for Komala Information Systems for the
past month.

Komala Information System

Income Statement
For the Past Month

Sales revenues $130,000

Less: operating expenses
Software licensing $5,000
Service technicians 35,000
Research and development 55,000
Selling Expenses 7,000 107,000
Operating Income $23,000

Summary of Important Equations

1. Total product Cost= Direct Materials + Direct Labor + Manufacturing Overhead
2. Per-Unit Product Cost = Total Product Cost
Number of Units Produced
3. Prime Cost = Direct Materials + Direct Labor
4. Conversion Cost = Direct Labor + Manufacturing Overhead
5. Beginning Inventory of Materials + Purchases -Direct Materials Used in Production =
Ending Inventory of Materials
6. Gross Margin = Sales Revenue – Cost of Goods Sold
7. Operating Income = Gross Margin – Selling and Administrative Expense
 Summary of Learning Objectives
LO 1. Explain the meaning of cost and how costs are assigned to products and services.
 Cost is the cash or cash- equivalent value sacrificed for goods and services that are
expected to bring a current benefit to the organization.
 Managers use cost information to determine the cost of objects such as products,
projects, plants, and customers.
 Direct cost are traced to cost objects based on cause-and -effect relationships
 Indirect (i.e. overhead) costs are allocated too cost objects based on assumed
relationships and convenience.
LO 2. Define the various cost of manufacturing products and providing services as well as the
costs of selling and administration.
 Products are goods that either are purchased or produced by converting raw materials
through the use of labor and indirect manufacturing resources, such as plants, land, and
machinery. Services are tasks performed for a customer or activities performed by a
customer using an organization’s products or facilities.
 Product costs are those costs, both direct and indirect, of acquiring a product in a
merchandising business and preparing it for sale or of producing a product in a
manufacturing business. Product costs are classified as inventory on the balance sheet
and then expensed as cost of goods sold on the income statement when the inventory is
sold.
 Selling costs are those cost of marketing and distributing goods and services and
administrative costs are the costs of organizing and running a company.
 Both selling and administrative costs are period costs..


Thank You!!!!!!