PRINCIPLES of ACCOUNTING-2

Chapter 18
Managerial Accounting Concepts
and Principles

Nurcan Kilinc Ata, PhD

Planning Ahead — Chapter 18 Study
Questions
 Managerial Accounting

 Managers make numerous decisions during the day-to-day

operations of a business and in planning for the future.
Managerial accounting provides much of the information used
for these decisions.

 Accounting information is often divided into two types:

financial and managerial.

 Exhibit 1 shows the relationship between financial accounting

and managerial accounting.
 Financial Accounting
 Financial accounting information is reported at fixed intervals
(monthly, quarterly, yearly) in general-purpose financial
statements. T

 Financial statements -the income statement, retained earnings

statement, balance sheet, and statement of cash flows- are
prepared according to generally accepted accounting principles
(GAAP). These statements are used by external users such as the
following:
1. Shareholders
2. Creditors
3. Government agencies
4. The general public
 Managerial Accounting

 Managers of a company also use general-purpose financial

statements. For example, in planning future operations, managers
often begin by evaluating the current income statement and
statement of cash flows.

 Managerial accounting information is designed to meet the

specific needs of a company’s management. This information
includes the following:
1. Historical data, which provide objective measures of past operations
2. Estimated data, which provide subjective estimates about future
decisions
 Managerial Accounting
 Management uses both types of information in directing daily operations,
planning future operations, and developing business strategies.

 Unlike the financial statements prepared in financial accounting,

managerial accounting reports do not always have to be:
1. Prepared according to generally accepted accounting principles. This is
because only the company’s management uses the information.

2. Prepared at fixed intervals (monthly, quarterly, yearly). Although some

management reports are prepared at fixed intervals, most reports are
prepared as management needs the information.

3. Prepared for the business as a whole. Most management reports are

prepared for products, projects, sales territories, or other segments of the
company.
 The Management Accountant in the
Organization

 In most companies, departments or similar organizational units

are assigned responsibilities for specific functions or activities.

 The operating structure of a company can be shown in an

organization chart.

 Exhibit 2 is a partial organization chart for Callaway Golf

Company
Partial Organizational Chart
 The departments in a company can be viewed as having either
of the following:
1. Line responsibilities
2. Staff responsibilities

 A line department is directly involved in providing goods or

services to the customers of the company.
1. Senior Vice President—Equipment
2. Plant Manager—Chicopee, MA Plant
3. Senior Vice President—Callaway Brand
4. Managing Director, Callaway Golf Europe
 A staff department provides services, assistance, and advice to
the departments with line or other staff responsibilities. A staff
department has no direct authority over a line department. The
following occupy staff positions:
1. Senior Vice President—Chief Administrative Officer
2. Vice President, Human Resources
3. Chief Financial Officer
4. Controller
 The chief financial officer (CFO) and the controller occupy staff
positions. In most companies, the controller is the chief management
accountant.

 The controller’s staff consists of a variety of other accountants who

are responsible for specialized accounting functions such as the
following:
1. Systems and procedures
2. General accounting
3. Budgets and budget analysis
4. Special reports and analysis
5. Taxes
6. Cost accounting
 Managerial Accounting in the
Management Process

 As a staff department, managerial accounting supports

management and the management process.

 The management process has the following five basic phases:

1. Planning
2. Directing
3. Controlling
4. Improving
5. Decision making

 As Exhibit 3 illustrates, the five phases interact with each other.

The Management Process
 Planning
 Management uses planning in developing the company’s
objectives and translating these objectives into courses of
action. For example, a company may set an objective to
increase market share by 15% by introducing three new
products. The actions to achieve this objective might be as
follows:

1. Increase the advertising budget

2. Open a new sales territory
3. Increase the research and development budget
 Classified of Planning

 Planning may be classified as follows:

1. Strategic planning, which is developing long-term actions to

achieve the company’s objectives. These long-term actions
are called strategies , which often involve periods of 5 to 10
years.

2. Operational planning, which develops short-term actions for

managing the day-to-day operations of the company.
 Directing

 The process by which managers run day-to-day operations is

called directing.

 An example of directing is a production supervisor’s efforts to

keep the production line moving without interruption
(downtime).

 A credit manager’s development of guidelines for assessing

the ability of potential customers to pay their bills is also an
example of directing.
 Controlling

 Monitoring operating results and comparing actual results

with the expected results is controlling.

 This feedback allows management to isolate areas for further

investigation and possible remedial action. It may also lead to
revising future plans.

 This philosophy of controlling by comparing actual and

expected results is called management by exception.
 Improving

 Feedback is also used by managers to support continuous

process improvement. Continuous process improvement is the
philosophy of continually improving employees, business
processes, and products.

 The objective of continuous improvement is to eliminate the

source of problems in a process. In this way, the right products
(services) are delivered in the right quantities at the right time.
 Decision Making

 Inherent in each of the preceding management processes is

decision making.

 In managing a company, management must continually decide

among alternative actions.

 For example, in directing operations, managers must decide on an

operating structure, training procedures, and staffing of day-to-
day operations.

 Managerial accounting supports managers in all phases of the

management process.
 Example Exercise 18-1 Management
Process

 Three phases of the management process are planning,

controlling, and improving. Match the following descriptions to
the proper phase:
 Managerial Account: Cost

 A cost is a payment of cash or the commitment to pay cash in the

future for the purpose of generating revenues. For example, cash (or
credit) used to purchase equipment is the cost of the equipment.

 In managerial accounting, costs are classified according to the

decision-making needs of management. For example, costs are often
classified by their relationship to a segment of operations, called a
cost object. A cost object may be a product, a sales territory, a
department, or an activity, such as research and development.

 Costs identified with cost objects are either direct costs or indirect
costs.
 Direct Costs

 Direct costs are identified with and can be traced to a cost

object.

 For example, the cost of wood (materials) used by Legend

Guitars in manufacturing a guitar is a direct cost of the guitar.
 Indirect Costs

 Indirect costs cannot be identified with or traced to a cost

object.

 For example, the salaries of the Legend Guitars production

supervisors are indirect costs of producing a guitar.
 Classifying Direct and Indirect Costs

 Depending on the cost object, a cost may be either a direct or

an indirect cost. This process of classifying a cost as direct or
indirect is illustrated in below.
 Manufacturing Costs

 The cost of a manufactured product includes the cost of

materials used in making the product. In addition, the cost of a
manufactured product includes the cost of converting the
materials into a finished product. Manufacturing cost are;
1. Direct materials cost
2. Direct labor cost
3. Factory overhead cost
 Direct Materials Cost
 Manufactured products begin with raw materials that are
converted into finished products. The cost of any material that
is an integral part of the finished product is classified as a
direct materials cost.

 To be classified as a direct materials cost, the cost must be

both of the following:
1. An integral part of the finished product
2. A significant portion of the total cost of the product
 Direct Labor Cost

 Most manufacturing processes use employees to convert

materials into finished products. The cost of employee wages
that is an integral part of the finished product is classified as
direct labor cost .

 Like a direct materials cost, a direct labor cost must be both of

the following:
1. An integral part of the finished product
2. A significant portion of the total cost of the product
 Factory Overhead Cost
 Costs other than direct materials cost and direct labor cost that are
incurred in the manufacturing process are combined and classified as
factory overhead cost.

 Factory overhead is sometimes called manufacturing overhead or

factory burden.

 All factory overhead costs are indirect costs of the product. Some
factory overhead costs include the following:
1. Heating and lighting the factory
2. Repairing and maintaining factory equipment
3. Property taxes on factory buildings and land
4. Insurance on factory buildings
5. Depreciation on factory plant and equipment
 Example Exercise 18-2 Direct Materials,
Direct Labor, and Factory Overhead

 Identify the following costs as direct materials (DM), direct

labor (DL), or factory overhead (FO) for a baseball glove
manufacturer.

a. Leather used to make a baseball glove (DM)

b. Coolants for machines that sew baseball gloves (FO)
c. Wages of assembly line employees (DL)
d. Ink used to print a player’s autograph on a baseball glove (FO)
 Prime Costs and Conversion Costs

 Direct materials, direct labor, and factory overhead costs may be grouped
together for analysis and reporting. Two such common groupings are as
follows:

1. Prime costs, which consist of direct materials and direct labor costs
2. Conversion costs, which consist of direct labor and factory overhead costs

 Conversion costs are the costs of converting the materials into a finished
product.

 Direct labor is both a prime cost and a conversion cost, as shown in Exhibit
6 in next slide.
Prime Costs and Conversion Costs
 Example Exercise 18-3 Prime and
Conversion Costs

 Identify the following costs as a prime cost (P), conversion cost

(C), or both (B) for a baseball glove manufacturer.

a. Leather used to make a baseball glove (P)

b. Coolants for machines that sew baseball gloves (C)
c. Wages of assembly line employees ( B)
d. Ink used to print a player’s autograph on a baseball glove (C )
 Product Costs and Period Costs

 For financial reporting purposes, costs are classified as product costs or period
costs.

1. Product costs consist of manufacturing costs: direct materials, direct labor,

and factory overhead.
2. Period costs consist of selling and administrative expenses. Selling expenses
are incurred in marketing the product and delivering the product to
customers.

 Administrative expenses are incurred in managing the company and are not
directly related to the manufacturing or selling functions.

 Examples of product costs and period costs for Legend Guitars are presented
in Exhibit 7 in next slide.
Examples of Product Costs and Period Costs-
Legend Guitars
 Product Costs, Period Costs, and the
Financial Statements
 To facilitate control, selling and
administrative expenses may be
reported by level of responsibility.

 The impact on the financial

statements of product and period
costs is summarized in Figure.

 As product costs are incurred,

they are recorded and reported
on the balance sheet as inventory
 Example Exercise 18-4 Product and
Period Costs

 Identify the following costs as a product cost or a period cost

for a baseball glove manufacturer.

a. Leather used to make a baseball glove (Product Cost)

b. Cost of endorsement from a professional baseball player (Period Cost)
c. Office supplies used at the company headquarters (Period Cost)
d. Ink used to print a player’s autograph on the baseball glove (Product
Cost)
 Balance Sheet for a Manufacturing
Business

 A manufacturing business reports three types of inventory on its balance

sheet as follows:

1. Materials inventory (sometimes called raw materials inventory). This

inventory consists of the costs of the direct and indirect materials that have
not entered the manufacturing process.

2. Work in process inventory. This inventory consists of the direct materials,

direct labor, and factory overhead costs for products that have entered the
manufacturing process, but are not yet completed (in process).

3. Finished goods inventory. This inventory consists of completed (or finished)

products that have not been sold.
 Income Statement for a
Manufacturing Company

 The income statements for merchandising and manufacturing

businesses differ primarily in the reporting of the cost of
merchandise (goods) available for sale and sold during the
period. These differences are shown below.
 Merchandising Business

 A merchandising business purchases merchandise ready for

resale to customers.

 The total cost of the merchandise available for sale during the
period is determined by adding the beginning merchandise
inventory to the net purchases.

 The cost of merchandise sold is determined by subtracting the

ending merchandise inventory from the cost of merchandise
available for sale.
 Manufacturing Business
 The total cost of making products that are available for sale during the period is
called the cost of goods manufactured.

 The cost of finished goods available for sale is determined by adding the
beginning finished goods inventory to the cost of goods manufactured during
the period.

 The cost of goods sold is determined by subtracting the ending finished goods
inventory from the cost of finished goods available for sale.

 Cost of goods manufactured is required to determine the cost of goods sold ,

and thus to prepare the income statement.

 The cost of goods manufactured is often determined by preparing a statement

of cost of goods manufactured.
Statement of Cost of Goods
Manufactured
 Statement of Cost of Goods
Manufactured

 The statement of cost of goods manufactured is prepared using

the following three steps:

 Step 1. Determine the cost of materials used .

 Step 2. Determine the total manufacturing costs incurred
 Step 3. Determine the cost of goods manufactured .
Flow of Manufacturing Costs
 Example Exercise 18-5 Cost of Goods
Sold, Cost of Goods Manufactured

 Gauntlet Company has the following information for January:

 For January, determine (a) the cost of goods manufactured

and (b) the cost of goods sold.
a. The cost of goods manufactured:

b. The cost of goods sold:

Thank you 