Ch 2: Building Blocks of Managerial Accounting

A merchandiser's balance sheet has just one inventory account called

"Inventory" or "Merchandise Inventory."

In contrast, all period costs are expensed as

"operating expenses" in the period in which they are incurred.

Even merchandising firms are getting into the _____.

"service game." retailers often sell extended warranties on products ranging from furniture and major appliances to sporting equipment and consumer electronics.

What are the 3 types of inventory in a manufacturing company?

(1) Raw materials inventory (2) Work in progress inventory (3) Finished goods inventory

Prime and Conversion Costs

** Labor Includes ''burden'' beyond salary costs: i.e. Vacation, pension, health insurance contributions, payroll taxes - 35% ''burden'' on top of gross salary and wages

Chapter 2 Checklist:

1) Read the book - highlight for record 2) Powerpoint in class 3) translate PPT to Quizlet 3.1) Check Quizlet against book detail 4) Class Notes to Quizlet 5) Handouts to Quizlet 6) Class Problems to Quizlet 7) Pearson Assignments 8) Voice Record

Manufacturing Overhead (MOH)

All manufacturing costs other than direct materials and direct labor; •Indirect materials, indirect labor, and indirect manufacturing costs

What business activities add value to companies?

All of the elements of the value chain, including the following: R&D Design Production or purchases Marketing Distribution Customer service

Raw materials inventory:

All raw materials that will be used in manufacturing. including other physical materials used in the plant, such as machine lubricants and janitorial supplies.

Periodic Inventory

An inventory system in which Cost of Goods Sold is calculated at the end of the period rather than every time a sale is made The company's records only show products scanned during checkout => must account for breakage, theft, input errors, obsolescence

Perpetual Inventory

An inventory system in which Cost of Goods Sold is calculated at the end of the period rather than every time a sale is made: "beep" to scan Reflects the price paid by the buyer and the product cost

Cost Object

Anything for which managers want to know the cost Individual units (a specific, custom-ordered Prius) Different models (the Prius, Rav4, and Corolla) Alternative marketing strategies (television advertising, sponsorship of athletic events) Geographic segments of the business (United States, Europe, Japan)

Cost of Goods Available for Sale (CGAFS)

BI - FG + CGM Beginning finished goods inventory + Cost of Goods Manufactured

calculate net inventory (FG or RM or WIP)

BI beginning inventory <EI ending inventory>

(Calculation of) Direct Materials used

Beginning Raw Materials Inventory Plus: Purchases of direct materials, freight-in, and import duties = Materials Avail. for Use Less: Ending Raw Materials Inventory = _____

Controllable Costs

Costs that can be influenced or changed by management

Uncontrollable Costs

Costs that cannot be changed or influenced in the short run by management Ex. Property tax, insurance costs To see immediate changes, managers must change controllable costs For example, management can control costs of research and development, design, and advertising.

Variable Costs

Costs that change in total in direct proportion to changes in volume

Fixed Costs

Costs that stay constant in total despite wide changes in volume

calculate total manufacturing costs (product costs)

DL + DM + MOH Direct labor + direct materials + manufacturing overhead (IM + IL)

Teacher Tip: Know your cost buckets

DM DL IL IM Other MOH Period Costs Product Costs

Operating Income

Earnings generated from the company's primary ongoing operations; the company's earnings before interest and taxes

Work in process inventory:

Goods that are partway through the manufacturing process but not yet complete. At Toyota, the work in process inventory consists of partially completed vehicles.

calculate Manufacturing Overhead (MOH)

IM + IL + Other Indirect materials + indirect labor + other expenses untraceable

Triple Bottom Line

Idea that a company's performance is evaluated based on its economic, social, and environmental impacts

Calculate Average Cost

Managers like to operate at near 100% capacity in order to spread fixed costs over more units. By doing so, they are able to reduce the average cost per unit. The average cost per unit is valid at only ONE level of output-the level used to compute the average cost per unit. Teacher tip : Average cost p/unit CANNOT be used to predict future costs at a different level of output

Which costs are useful for internal decision making, and how are costs classified for external reporting?

Managers use total costs for internal decision making. However, GAAP requires companies to distinguish between product costs and period costs for external reporting purposes.

•Manufacturing companies have______ Inventory.

Raw Materials, Work in Process, and Finished Goods Inventory.

What is the difference between raw materials, direct materials, and indirect materials?

Raw materials are materials that have not yet been used. Once used, materials can be classified as direct or indirect.

Merchandising companies:

Resell tangible products purchased ready-made from suppliers Have only one category of inventory

What costs are treated as product costs under GAAP?

Service companies: Usually no product costs since they don't carry inventory Merchandising companies: The cost of merchandise purchased for resale plus all of the costs of getting the merchandise to the company's place of business (for example, freight-in and import duties) Manufacturing companies: Direct materials, direct labor, and manufacturing overhead

Calculate Cost of Goods Sold—Merchandising Company

Start with beginning inventory, add the companies' product costs for the period. This gives you cost of goods available for sale. Then subtract ending inventory to get cost of goods sold.

Calculating COGS

Step 1:Calculate the cost of the direct materials used during the year Step 2:Calculate the cost of goods manufactured Step 3:Calculate the cost of goods sold

Value Chain

The activities that add value to a firm's products and services includes R&D, design, production or purchases, marketing, distribution, and customer service

Conversion Costs

The combination of direct labor and manufacturing overhead costs

Prime Costs

The combination of direct material and direct labor costs

Total Cost

The cost of all resources used throughout the value chain •Must ensure price covers all costs plus returns a profit

Direct Labor (DL)

The cost of compensating employees who physically convert raw materials into the company's products; labor costs that are directly traceable to the finished product Also includes wages and benefits Can be calculated by how much time someone spends working on a vehicle => direct cost of the vehicle

Marginal Cost

The cost of making one more (additional) unit unless the plant is operating at 100% capacity, the marginal cost of a unit is simply its variable cost.

What is Cost of Goods Manufactured (CGM)

The cost of manufacturing the goods that were finished during the period; the cost of goods that have been moved to Finished Goods Inventory

Product Costs

The costs incurred by manufacturers to produce their products or incurred by merchandisers to purchase their products; for external financial reporting •Relate to obtaining inventory GAAP requires that these costs be assigned to inventory until the products are sold, at which point, they are expensed as Cost of Goods Sold

Period Costs

The costs incurred by the company to operate the business that do not get treated as inventory, but rather are expensed immediately in the period in which they are incurred these costs do not relate to manufacturing or purchasing product •Incurred in other functions of the value chain Often called operating expenses, or selling, general, and administrative expenses (costs)

Differential Cost

The difference in cost between two alternative courses of action

manufacturing company - income statement

The income statement for a manufacturer is essentially identical to a merchandising company. The only difference is the calculation of Cost of Goods Sold

Average Cost

The total cost divided by the number of units produced

Trace

To assign a direct cost to a cost object This results in a very precise cost figure cannot trace indirect costs, such as utilities, to specific products

Allocate

To assign an indirect cost to a cost object - assign indirect costs among all of the products produced at the plant results in a less precise cost figure being assigned to each product think of allocation as dividing up the total indirect costs over all of the units produced

Assign

To attach a cost to a cost object If a company wants to know the total cost attributable to a cost object, it must assign all direct and indirect costs to the cost object.

Manufacturing companies:

Use labor, plant, and equipment to transform raw materials into new finished products Have three categories of inventory: Raw materials inventory Work in process inventory Finished goods inventory

Managers define costs based on how the information will be used.

Will the information be used for 1) internal decision making, or for 2) external reporting?

The cost of labor, in all areas of the value chain, includes more than the salaries and wages paid to employees. The cost also includes

company-paid fringe benefits such as health insurance, retirement plan contributions, payroll taxes, and paid vacations. -expensed as period costs for all non-manufacturing employees. (product cost if they relate to employees working in the manufacturing plant)

Cost of Goods Manufactured represents the cost of those goods that were

completed and moved to Finished Goods Inventory during the period.

In the long run, most costs are

controllable, meaning management is able to influence or change them.

The value chain activities also _____.

cost money. EX: Toyota must consider all of the costs incurred along the value chain, not just the costs incurred in manufacturing vehicles.

all operating expenses (all period costs) are

deducted to arrive at the company's operating income.

•Distribution:

delivery of products or services to customers

•Design :

detailed engineering of products and services and the processes for producing them

Relevant Costs

differential costs, differ between alternatives When managers make decisions, they focus on only those costs and revenues that are relevant to the decision.

If a company can trace the time each of these employees spends working on specific units or batches of products, the cost of this labor is considered a

direct cost of the product

If a company can trace the cost of these materials (including freight-in and any import duties) to specific units or batches of products they are considered

direct costs of the product

In order to calculate Cost of Goods Sold, a manufacturer must first figure out the amount of

direct materials used and the Cost of Goods Manufactured.

Irrelevant Costs

do not differ among alternatives

•Merchandising companies _______ Inventory.

have Inventory or Merchandise Inventory.

Period costs are often called "operating expenses" or "selling, general, and administrative expenses" (SG&A) on the company's__________.

income statement.

Manufacturing Overhead (MOH)

indirect materials and indirect labor OTHER THAN TRACEABLES and other (hint: if it says plant / factory and it isn't traced to an indiv product) utilities for the factory salary for quality control plant supervisor

what is the primary output of a service company

intangible services

PERIOD costs do not relate to _____ or _____ product.

manufacturing or purchasing Rather, they include costs incurred in every other function of the value chain, including R&D, design, marketing, distribution, and customer service.

COGS is a major expense in what type of company

merchandise

what type of inventory does a merch company hold

merchandise inventory (for sale)

what is the primary output of a manufacturing company

new tangible products made from raw materials, labor, production equip

•Service companies have _____ inventory.

no inventory.

Service Companies have no

no product costs Service Company Income Statement

what type of inventory does a service company hold

none

Fixed costs will not change when Toyota makes __________ unless the plant is operating at 100% capacity and simply cannot _______

one more vehicle make one more unit.

merchandisers also incur costs to

operate their retail stores and websites, advertise, research new products and new store locations, and provide customer service.

what is considered Other in the Manufacturing Overhead (MOH)

pant related costs taxes insurance depreciation maintenance utilities

any cost that is not treated as inventory, is treated as a

period cost. costs of operating the business over a specific period of time. "operating expenses" or "selling, general, and administrative expenses" (SG&A).

PRODUCT costs are incurred in the _____ or _____ function of the value chain

production or purchases GAAP requires that these costs be assigned to inventory until the related products are sold.

•Marketing:

promotion and advertising of products or services

When making decisions, management must also consider

qualitative factors, such as effect on employee morale, in addition to differential costs.

•Research and Development:

researching and developing new or improved products services and the processes for producing them

•Production or Purchasing:

resources used by manufacturers to produce a product or merchandising companies purchasing finished merchandise for resale

Despite different operating activities, restaurants are considered to be in the _____ sector.

service

Step 2:Calculate the cost of goods manufactured Step 2 simply analyzes what happened in the Work in Process account during the year

start with the beginning balance in Work in Process and then add to it all three manufacturing costs that were incurred during the year (direct materials used, direct labor, and materials overhead). Finally, by subtracting out the goods still being worked on at year-end (ending Work in Process Inventory), we are able to back into the Cost of Goods Manufactured (CGM). This figure represents the cost of manufacturing the units that were completed and sent to Finished Goods Inventory during the year.

Managers often have trouble ignoring

sunk costs when making decisions, even though they should.

•Customer Service :

support provided for customers after sale

what is the primary output of a merch company

tangible products purchased from manufacturers and suppliers

The cost of inventory includes the cost merchandisers pay for

the goods plus all costs necessary to get the merchandise in place and ready to sell, such as freight-in costs and any import duties or tariffs paid on merchandise purchased from overseas suppliers.

All product costs remain in inventory accounts until

the merchandise is sold; then, these costs become the cost of goods sold.

Whether a cost is direct or indirect depends on

the specified cost object

Service companies incur costs

to provide services, advertise, and develop new services. For many service providers, salaries and benefits make up the majority of their costs.

calculate Cost of Goods Manufactured (CGM)

total manufacturing costs + net WIP inventory

direct labor is generally treated as a

variable cost

At a manufacturer, materials are considered to be

variable costs

Step 1:Calculate the cost of the direct materials used during the year Step 1 simply analyzes what happened in the Raw Materials Inventory account during the year.

we start with the beginning balance in the Raw Materials Inventory account and add to it all of the direct materials purchased during the year, including any freight-in and import duties. This tells us the cost of materials that were available for use during the year. Finally, by subtracting out the ending balance of Raw Materials Inventory, we are able to back into the cost of the direct materials that were used.9

Step 3:Calculate the cost of goods sold Step 3 simply analyzes what happened in the Finished Goods Inventory account during the year

we start with the beginning balance of Finished Goods Inventory and add to it the product that was manufactured during the year (CGM) to arrive at the cost of the total goods available for sale. Finally, just like with a merchandiser, we subtract what was left in Finished Goods Inventory to back into the Cost of Goods Sold.

Costs for Internal Decision Making

•Consider all costs incurred across the value chain - TOTAL COSTS

Indirect Labor

•Indirect labor includes the cost of all employees working in the plant other than those directly converting the raw materials into finished product; salaries, wages, and benefits of plant forklift operators, plant security officers, plant janitors, and plant supervisors.

Most Common Business Sectors

•Service companies •Merchandising companies •Manufacturing companies Teacher Tip: With each problem, wrap your head around whether it is a service, merchandising, or manufacturing company you are dealing with

Service company - Income Statement

•Simplest income statement. •In this example, no inventory so no product costs. Therefore, also no Cost of Goods Sold. •All costs are period costs, so they are expensed in the current period as operating expenses. Service revenue - Operating expenses = Operating income.

Comparing Balance Sheets

•The only difference relates to how inventory is shown in the current asset section Teacher Tip - pay attention to the balance sheet, it is a good indicator on what type of company you are dealing with.Helpful for working problems

Other Indirect Manufacturing Costs

Plant-related costs like insurance and depreciation, property taxes, repairs and maintenance, and utilities

Direct Materials (DM)

Primary raw materials that become a physical part of a finished product and whose costs are traceable to the finished product

How are product costs treated on the financial statements?

Product costs are initially treated as an asset (inventory) on the balance sheet. These costs are expensed (as cost of goods sold) on the income statements when the products are sold.

Service companies:

Provide customers with intangible services Have no inventories on the balance sheet

what type of inventory does a manufacturing company hold

3 types: raw materials, work in process, finished goods

Merchandising Company

A company that resells tangible products previously bought from suppliers Retailers vs. Wholesalers Carry substantial amount of inventory Ex. Walmart and Best Buy

Service Company

A company that sells intangible services rather than tangible products Ex. Healthcare, insurance, banking, consulting Makes up largest sector of U.S. Economy No inventory or COGS account minimal supplies inventory

Manufacturing Company

A company that uses labor, plant, and equipment to convert raw materials into finished products 3 types of inventory Ex. Toyota converts steel, tires, etc. into vehicles using labor and equipment

Direct Cost

A cost that can be traced to a cost object Readily associate the cost with the cost object EX: the cost of four tires with one specific Prius

Sunk Cost

A cost that has already been incurred, and therefore cannot be changed regardless of which future action is taken

Indirect Cost

A cost that relates to the cost object but cannot be traced specifically to it These costs are shared by all of the products produced in the plant during the period. Ex. Plant - utilities, property taxes, depreciation Ex. Plant manager's wages, lubricant costs, etc.

What costs should be assigned to cost objects such as products, departments, and geographic segments?

Both direct and indirect costs are assigned to cost objects. Direct costs are traced to cost objects, whereas indirect costs are allocated to cost objects.

calculate Cost of Goods Sold (COGS)

CGAFS <EI - FG> Cost of Goods Avail for Sale - ending finished goods inventory

Finished goods inventory:

Completed goods that have not yet been sold. EX: Toyota is in business to sell completed cars, not work in process. Once the vehicles are completed, they are no longer considered work in process, but rather they become part of finished goods inventory.

Indirect Materials

Materials used in the plant that are not easily traced to individual units; cost of tracing the object to the particular finished product outweighs the benefit EX janitorial supplies, oil, lubricants for the machines, etc. any physical components of the finished product that are very inexpensive.

Wholesaler

Merchandising companies that buy in bulk from manufacturers, mark up the prices, and sell those products to retailers; also called "middlemen"

Merchandising Companies' Total Costs

Merchandising companies' product costs include only the cost of purchasing inventory from suppliers plus costs to get the merchandise ready for sale. these charges become part of the cost of their inventory. EX: FREIGHT IN, IMPORT DUTIES, TARIFFS

Retailer

Merchandising company that sells to consumers

The average cost per unit is valid only at

ONE level of output—the level used to compute the average cost per unit. NEVER use average costs to forecast costs at different output levels; if you do, you will miss the mark.

Manufacturing Companies' Product Costs

Only those costs related to products and making them: direct materials, direct labor, and manufacturing overhead.

Total costs are recorded in what type of account until it sells the merchandise

an asset account—Inventory then takes the cost out of its inventory account and records it as an expense—the cost of goods sold. The company expenses all other costs incurred during the period, such as salaries, utilities, advertising, and property lease payments, as "operating expenses."

GAAP requires that certain costs of the company be

attached, or assigned, to units of product in inventory, while other costs are treated as operating expenses of the period.

Product costs are costs assigned to the company's inventory on the __________.

balance sheet.

in the short run,

companies are often locked in to certain costs arising from previous decisions. These are called uncontrollable costs