Principles of financial accounting 12e by needles crosson chapter 17

C HAP TE R

17

Managerial Accounting and
Cost Concepts

Principles of
Accounting
12e
Needles
Powers
Crosson
©human/iStockphoto


The Role of Managerial Accounting
 The role of managerial accounting is to enable
managers and people throughout an organization to:
– make informed decisions
– be more effective at their jobs
– improve the organization’s performance

 The Institute of Management Accountants (IMA)
defines managerial accounting (or management
accounting) as a profession that involves partnering
in management decision making, devising planning
and performance management systems, and
providing expertise in financial reporting and control
to assist management in the formulation and
implementation of an organization’s strategy.

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Cost Measurement
 Managers measure costs by tracing them to cost
objects, such as products or services, sales
territories, departments, or operating activities.
– In service organizations, costs can be traced to a specific
service, such as preparation of tax returns in an accounting
firm.
– In retail organizations, costs can be traced to a department,
such as the produce department in a grocery store.
– In manufacturing organizations, costs can be traced to a
product, such as the candy produced by a candy company.
– Direct costs are costs that can be measured conveniently
and economically by tracing them to a cost object.
– Indirect costs are costs that cannot be measured
conveniently and economically by tracing them to a cost
object. They are included in the cost of a product or service
by using formulas.

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Financial Reporting
 Period costs (or noninventoriable costs) are
costs of resources that are not assigned to
products. They are recognized as operating
expenses on the income statement.

 Product costs (or inventoriable costs) include
direct materials, direct labor, and overhead
(indirect costs). They are recognized on the
income statement as cost of goods sold and on
the balance sheet as inventory.
 Product unit cost is the cost of manufacturing
a single unit of a product.
 Service unit cost is the cost to perform one
service.
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Financial Reporting
 The three elements of product or service cost are:
- Direct materials costs: the costs of materials that can
be conveniently and economically measured when
making specific units of the product
- Direct labor costs: the costs of the hands-on labor
needed to make a product or service that can be
measured when making specific units
- Overhead costs (or service overhead, factory
overhead, factory burden, manufacturing overhead, or
indirect production costs): the costs that cannot be
practically or conveniently measured directly to an end
product or service. These include:
 Indirect materials costs, such as the costs of nails,
rivets, lubricants, and small tools
 Indirect labor costs, such as the costs of labor for
maintenance, inspection, engineering design, supervision,
and materials handling

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Financial Reporting
 The three elements of product cost can
also be grouped into prime costs and
conversion costs.
– Prime costs: the primary costs of
production. They are the sum of the direct
materials costs and direct labor costs.
– Conversion costs: the costs of converting
or processing direct materials into a
finished product. They are the sum of direct
labor costs and overhead costs.

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Cost Behavior
 A variable cost is a cost that changes in direct
proportion to a change in productive output.
 A fixed cost is a cost that remains constant within a
defined range of activity or time period.
– Examples of variable and fixed costs:
 Service organization: For an airline, the cost of peanuts and
beverages is a variable cost, while the depreciation on the
planes and the salaries and benefits of the crews are fixed costs.
 Retail organization: For a grocery store, variable costs include
the cost of groceries sold, while fixed costs include the costs of
building rental, depreciation on equipment, and the manager’s

salary.
 Manufacturing organization: Variable costs include direct
materials, direct labor, indirect materials, and indirect labor.
Fixed costs include the costs of supervisors’ salaries and
depreciation on buildings.

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Value-Adding versus Non-Value-Adding Costs
 Costs can also be classified as value-adding or
non-value-adding.
– A value-adding cost is the cost of an activity that
increases the market value of a product or service.
– A non-value-adding cost is the cost of an activity
that adds cost to a product or service but does not
increase its market value.

 Managers examine the value-adding attributes
of their company’s operating activities and,
wherever possible, reduce or eliminate
activities that do not directly add value to a
company’s products or services.

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The Manufacturing Cost Flow
 Manufacturing cost flow is the flow of direct
materials, direct labor, and overhead through the

Materials Inventory, Work in Process Inventory, and
Finished Goods Inventory accounts into the Cost of
Goods Sold account.
– The Materials Inventory account shows the balance of the
cost of unused materials—in other words, the cost of materials
that have been purchased but not used in the production
process.
– The Work in Process Inventory account shows the
manufacturing costs that have been incurred and assigned to
partially completed units of product—in other words, the costs
involved with manufacturing the unfinished product.
– The Finished Goods Inventory account shows the costs
assigned to all completed products that have not been sold.

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Work in Process Inventory
 The Work in Process Inventory account
records the balance of partially completed
units of the product.
– As direct materials and direct labor enter the
production process, their costs are added to the
Work in Process Inventory account. The cost of
overhead for the current period is also added.
– The total costs of direct materials, direct labor,
and overhead incurred and transferred to the
Work in Process Inventory account during a period
are called total manufacturing costs (or
current manufacturing costs).

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Statement of Cost of Goods Manufactured
 The cost of goods manufactured is
calculated in the statement of cost of
goods manufactured, which
summarizes the flow of all
manufacturing costs incurred during
the period.

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Cost of Goods Sold and a Manufacturer’s
Income Statement
 The total amount of the cost of goods
manufactured is carried over to the
income statement, where it is used to
compute the cost of goods sold.

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Computing Product Unit Cost
 Product unit cost is the cost of
manufacturing a single unit of a
product.
– It is made up of the cost of goods

manufactured costs of direct materials,
direct labor, and overhead.
 These three cost elements are accumulated as a
batch of products is being produced.
 When the batch has been completed, the product
unit cost is computed.

©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.


Product Cost Measurement Methods
 How products flow physically and how
costs are incurred does not always
match.
 Managers may need to use estimates
or predetermined standards to compute
product costs during the period.
– At the end of the period, these estimates
are reconciled with the actual product
costs.

©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.


Actual Costing Method
 The actual costing method uses the actual
costs of direct materials, direct labor, and
overhead to calculate the product unit cost.
(These costs, however, may not be known
until the end of the period.)

– Suppose Choice Candy produced 3,000 candy bars
for a customer. The company accountant calculated
the actual costs for the order as follows: direct
materials, $540; direct labor, $420; overhead, $240.
The actual product unit cost for the order was $0.40,
calculated as follows.

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Normal Costing Method
 The normal costing method combines the
easy-to-track actual direct costs of materials
and labor with estimated overhead costs to
determine product unit cost.
– For Choice Candy, suppose that the company accountant
used normal costing to price the order for 3,000 candy
bars and that overhead was applied to the product’s cost
using an estimated rate of 50 percent of direct labor costs.
The costs for the order would include the actual direct
materials cost of $540, the actual direct labor cost of
$420, and an estimated overhead cost of $210 ($420 X
50%). The product unit cost would be $0.39:

©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.


Standard Costing Method
 The standard costing method uses
estimated or standard costs of direct

materials, direct labor, and overhead to
calculate the product unit cost.
– This method is useful when product cost information is
needed before the accounting period begins.
– Suppose that Choice Candy is placing a bid to
manufacture 2,000 candy bars for a new customer. From
standard cost information, the accountant estimates the
following costs: $0.20 per unit for direct materials, $0.15
per unit for direct labor, and $0.09 per unit for overhead.
The standard cost per unit would be $0.44.

©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.


Computing Service Unit Cost
 Services are labor-intensive processes
supported by indirect materials or supplies,
indirect labor, and other overhead costs.
– The most important cost in a service organization
is the direct cost of labor that can be traceable to
the service rendered.
– The indirect costs incurred in performing a service
are similar to those incurred in manufacturing a
product. They are classified as overhead.
– These service costs appear on service
organizations’ income statements as cost of sales.

©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Planning
(slide 1 of 2)

 The overriding goal/vision of a business is to increase
the value of the stakeholders’ interest in the business.
 The fundamental way in which the company will
achieve this goal/vision is described in its mission
statement.
 The planning process must consider how to add value
through strategic, tactical, and operating objectives.
– Strategic objectives—broad, long-term goals that determine
the fundamental nature and direction of a business and that
serve as a guide for decision making
– Tactical objectives—mid-term goals that position an
organization to achieve its long-term strategies
– Operating objectives—short-term goals that outline
expectations for the performance of day-to-day operations

©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.


Planning
(slide 2 of 2)

 A business plan is a comprehensive
statement of how a company will achieve its
strategic, tactical, and operating objectives.
– It provides a full description of the business,
including a complete operating budget for the first
two years of operations.

 The budget must include a forecasted income
statement, a forecasted statement of cash flows, and a
forecasted balance sheet.

– The business plan often includes performance
goals for individuals, teams, products, or services.

©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.


Performing
 Critical to managing any retail business
is a thorough understanding of the
supply chain (or supply network)—the
path that leads from the suppliers to
the final customers.
– Knowledge of the supply chain allows
managers to coordinate deliveries from
growers and suppliers so that they can
meet customers’ demands without having
too much or too little inventory on hand.

©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.


Evaluating and Communicating
 Managers evaluate operating results by comparing
the organization’s actual performance with the
performance levels established in the planning
stage.

– They earmark any significant variations for further
analysis so that they can correct the problems.
– If the problems are the result of a change in the
organization’s operating environment, the managers may
revise their original estimates and/or objectives.

 Whether accounting reports are prepared for
internal or external use, they must provide
accurate information and clearly communicate this
information.

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Standards of Ethical Conduct
 Managers consider the interests of external parties
(customers, owners, suppliers, governmental
agencies, and the local community) when they make
decisions. When ethical conflicts arise, management
accountants have a responsibility to help managers
balance those interests.
 To provide guidance, the Institute of Management
Accountants has issued standards of ethical conduct
for practitioners of managerial accounting and
financial management.
– Those standards emphasize that management accountants
have responsibilities in the areas of competence,
confidentiality, integrity, and credibility.

©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.