Fundamental accounting principles 20th ed j wild, shaw chaippetta Part 2

wiL10874_ch09_358-391.indd Page 365 8/2/10 8:50:37 PM user-f500 /Users/user-f500/Desktop Chapter Accounting for Receivables 365 Recording Bad Debts Expense The allowance method estimates bad debts expense at the end of each accounting period and records it with an adjusting entry TechCom, for instance, had credit sales of $300,000 during its first year of operations At the end of the first year, $20,000 of credit sales remained uncollected Based on the experience of similar businesses, TechCom estimated that $1,500 of its accounts receivable would be uncollectible This estimated expense is recorded with the following adjusting entry Dec 31 Bad Debts Expense Allowance for Doubtful Accounts To record estimated bad debts 1,500 1,500 The estimated Bad Debts Expense of $1,500 is reported on the income statement (as either a selling expense or an administrative expense) and offsets the $300,000 credit sales it helped produce The Allowance for Doubtful Accounts is a contra asset account A contra account is used instead of reducing accounts receivable directly because at the time of the adjusting entry, the company does not know which customers will not pay After the bad debts adjusting entry is posted, TechCom’s account balances (in T-account form) for Accounts Receivable and its Allowance for Doubtful Accounts are as shown in Exhibit 9.5 Accounts Receivable Dec 31 Dec 31 1,500 The Allowance for Doubtful Accounts credit balance of $1,500 has the effect of reducing accounts receivable to its estimated realizable value Realizable value refers to the expected proceeds from converting an asset into cash Although credit customers owe $20,000 to TechCom, only $18,500 is expected to be realized in cash collections from these customers In the balance sheet, the Allowance for Doubtful Accounts is subtracted from Accounts Receivable and is often reported as shown in Exhibit 9.6 Current assets Accounts receivable Less allowance for doubtful accounts Point: Credit approval is usually not assigned to the selling dept because its goal is to increase sales, and it may approve customers at the cost of increased bad debts Instead, approval is assigned to a separate credit-granting or administrative dept EXHIBIT 9.5 Allowance for Doubtful Accounts 20,000 Assets Liabilities Equity 21,500 21,500 General Ledger Entries after Bad Debts Adjusting Entry Point: Bad Debts Expense is also called Uncollectible Accounts Expense The Allowance for Doubtful Accounts is also called Allowance for Uncollectible Accounts EXHIBIT 9.6 $20,000 1,500 Balance Sheet Presentation of the Allowance for Doubtful Accounts $18,500 Sometimes the Allowance for Doubtful Accounts is not reported separately This alternative presentation is shown in Exhibit 9.7 (also see Appendix A) Current assets Accounts receivable (net of $1,500 doubtful accounts) EXHIBIT 9.7 Alternative Presentation of the Allowance for Doubtful Accounts $18,500 Writing Off a Bad Debt When specific accounts are identified as uncollectible, they are written off against the Allowance for Doubtful Accounts To illustrate, TechCom decides that J Kent’s $520 account is uncollectible and makes the following entry to write it off Jan 23 Allowance for Doubtful Accounts Accounts Receivable — J Kent To write off an uncollectible account 520 520 Posting this write-off entry to the Accounts Receivable account removes the amount of the bad debt from the general ledger (it is also posted to the accounts receivable subsidiary ledger) The general ledger accounts now appear as in Exhibit 9.8 (assuming no other transactions affecting these accounts) Accounts Receivable Dec 31 Dec 31 Jan 23 520 Jan 23 520 Point: The Bad Debts Expense account is not debited in the write-off entry because it was recorded in the period when sales occurred EXHIBIT 9.8 Allowance for Doubtful Accounts 20,000 Assets Liabilities Equity 1520 2520 1,500 General Ledger Entries after Write-Off wiL10874_ch09_358-391.indd Page 366 8/2/10 8:50:37 PM user-f500 /Users/user-f500/Desktop 366 Chapter Accounting for Receivables Point: In posting a write-off, the ledger’s Explanation column indicates the reason for this credit so it is not misinterpreted as payment in full The write-off does not affect the realizable value of accounts receivable as shown in Exhibit 9.9 Neither total assets nor net income is affected by the write-off of a specific account Instead, both assets and net income are affected in the period when bad debts expense is predicted and recorded with an adjusting entry EXHIBIT 9.9 Realizable Value before and after Write-Off of a Bad Debt Before Write-Off After Write-Off $ 20,000 1,500 $18,500 $ 19,480 980 $18,500 Accounts receivable Less allowance for doubtful accounts Estimated realizable accounts receivable When a customer fails to pay and the account is written off as uncollectible, his or her credit standing is jeopardized To help restore credit standing, a customer sometimes volunteers to pay all or part of the amount owed A company makes two entries when collecting an account previously written off by the allowance method The first is to reverse the write-off and reinstate the customer’s account The second entry records the collection of the reinstated account To illustrate, if on March 11 Kent pays in full his account previously written off, the entries are Recovering a Bad Debt Assets Liabilities Equity 1520 2520 Mar 11 Assets Liabilities Equity 1520 2520 Mar 11 Example: If TechCom used a collection agency and paid a 35% commission on $520 collected from Kent, how is this recorded? Answer: Cash 338 Collection Expense 182 Accts Recble — J Kent 520 Accounts Receivable — J Kent Allowance for Doubtful Accounts To reinstate account previously written off Cash Accounts Receivable — J Kent 520 520 520 520 To record full payment of account In this illustration, Kent paid the entire amount previously written off, but sometimes a customer pays only a portion of the amount owed A question then arises as to whether the entire balance of the account or just the amount paid is returned to accounts receivable This is a matter of judgment If we believe this customer will later pay in full, we return the entire amount owed to accounts receivable, but if we expect no further collection, we return only the amount paid Decision Insight Decision Insight 1,200 MBNA 65 72 PayPal 56 American Express 53 Discover 680 VISA Master Card 30 JP Morgan Global accounts (in mil.) PayPal PayPal is legally just a money transfer agent, but it is increasingly challenging big credit card brands—see chart PayPal is successful because: (1) online credit card processing fees often exceed $0.15 per dollar, but PayPal’s fees are under $0.10 per dollar (2) PayPal’s merchant fraud losses are under 0.2% of revenues, which compares to nearly 2% for online merchants using credit cards ■ Estimating Bad Debts—Percent of Sales Method P2 Apply the allowance method and estimate uncollectibles based on sales and accounts receivable The allowance method requires an estimate of bad debts expense to prepare an adjusting entry at the end of each accounting period There are two common methods One is based on the income statement relation between bad debts expense and sales The second is based on the balance sheet relation between accounts receivable and the allowance for doubtful accounts The percent of sales method, also referred to as the income statement method, is based on the idea that a given percent of a company’s credit sales for the period is uncollectible To illustrate, assume that Musicland has credit sales of $400,000 in year 2011 Based on past experience, wiL10874_ch09_358-391.indd Page 367 8/2/10 8:50:39 PM user-f500 /Users/user-f500/Desktop Chapter Accounting for Receivables 367 Musicland estimates 0.6% of credit sales to be uncollectible This implies that Musicland expects $2,400 of bad debts expense from its sales (computed as $400,000 0.006) The adjusting entry to record this estimated expense is Point: Focus is on credit sales because cash sales not produce bad debts If cash sales are a small or stable percent of credit sales, total sales can be used Dec 31 Bad Debts Expense Allowance for Doubtful Accounts To record estimated bad debts 2,400 2,400 The allowance account ending balance on the balance sheet for this method would rarely equal the bad debts expense on the income statement This is so because unless a company is in its first period of operations, its allowance account has a zero balance only if the prior amounts written off as uncollectible exactly equal the prior estimated bad debts expenses (When computing bad debts expense as a percent of sales, managers monitor and adjust the percent so it is not too high or too low.) Assets Liabilities Equity 22,400 22,400 Point: When using the percent of sales method for estimating uncollectibles, the estimate of bad debts is the number used in the adjusting entry Estimating Bad Debts—Percent of Receivables Method The accounts receivable methods, also referred to as balance sheet methods, use balance sheet relations to estimate bad debts — mainly the relation between accounts receivable and the allowance amount The goal of the bad debts adjusting entry for these methods is to make the Allowance for Doubtful Accounts balance equal to the portion of accounts receivable that is estimated to be uncollectible The estimated balance for the allowance account is obtained in one of two ways: (1) computing the percent uncollectible from the total accounts receivable or (2) aging accounts receivable The percent of accounts receivable method assumes that a given percent of a company’s receivables is uncollectible This percent is based on past experience and is impacted by current conditions such as economic trends and customer difficulties The total dollar amount of all receivables is multiplied by this percent to get the estimated dollar amount of uncollectible accounts—reported in the balance sheet as the Allowance for Doubtful Accounts To illustrate, assume that Musicland has $50,000 of accounts receivable on December 31, 2011 Experience suggests 5% of its receivables is uncollectible This means that after the adjusting entry is posted, we want the Allowance for Doubtful Accounts to show a $2,500 credit balance (5% of $50,000) We are also told that its beginning balance is $2,200, which is 5% of the $44,000 accounts receivable on December 31, 2010—see Exhibit 9.10 EXHIBIT 9.10 Allowance for Doubtful Accounts Feb Current year write-offs Dec 31, 2010, bal 2,200 Unadjusted bal Dec 31 adjustment 200 2,300 Dec 31, 2011, bal 2,500 800 July 10 700 Nov 20 500 Point: When using an accounts receivable method for estimating uncollectibles, the allowance account balance is adjusted to equal the estimate of uncollectibles Prior year estimate of allowance for doubtful accounts Allowance for Doubtful Accounts after Bad Debts Adjusting Entry Adjusting entry Current year estimate of allowance for doubtful accounts During 2011, accounts of customers are written off on February 6, July 10, and November 20 Thus, the account has a $200 credit balance before the December 31, 2011, adjustment The adjusting entry to give the allowance account the estimated $2,500 balance is Dec 31 Bad Debts Expense Allowance for Doubtful Accounts To record estimated bad debts 2,300 2,300 Assets Liabilities Equity 22,300 22,300 wiL10874_ch09_358-391.indd Page 368 8/3/10 9:03:25 PM user-f500 368 /Volumes/203/MHBR178/sLa1719X_disk1of1/007731719X/sLa1719X_pagefiles Chapter Accounting for Receivables Decision Insight Decision Insight Aging Pains Experience shows that the longer a receivable is past due, the lower is the likelihood of its collection An aging schedule uses this knowledge to estimate bad debts The chart here is from a survey that reported estimates of bad debts for receivables grouped by how long they were past their due dates Each company sets its own estimates based on its customers and its experiences with those customers’ payment patterns ■ 15% Months past due Bad debts percentage 6% 27% 3–5 43% 6–8 58% 9–11 76% 12–23 >24 89% 0% 100% Estimating Bad Debts—Aging of Receivables Method The aging of accounts receivable method uses both past and current receivables information to estimate the allowance amount Specifically, each receivable is classified by how long it is past its due date Then estimates of uncollectible amounts are made assuming that the longer an amount is past due, the more likely it is to be uncollectible Classifications are often based on 30-day periods After the amounts are classified (or aged), experience is used to estimate the percent of each uncollectible class These percents are applied to the amounts in each class and then totaled to get the estimated balance of the Allowance for Doubtful Accounts This computation is performed by setting up a schedule such as Exhibit 9.11 EXHIBIT 9.11 MUSICLAND Schedule of Accounts Receivable by Age December 31, 2011 Aging of Accounts Receivable Totals Customer Carlie Abbott…………… $ 450 Not Yet Due $ to 30 Days Past Due 31 to 60 Days Past Due 61 to 90 Days Past Due Over 90 Days Past Due $ 100 $ 640 $ 900 450 Jamie Allen…………… 710 Each receivable is grouped by how long it is past its due date Chavez Andres………… 500 $ 710 Balicia Company.……… 740 Each age group is multiplied by its estimated bad debts percent Zamora Services……… 1,000 810 190 Total receivables* … $50,000 $37,000 $6,500 $3,700 $1,900 × 2% × 5% × 10% × 25% × 40% 740 $ 325 $ 370 $ 475 $ 360 300 Percent uncollectible… Estimated bad debts for each group are totaled Estimated uncollectible $ 2,270 $ $ 200 *The “white line break” means that additional customer accounts are not shown in the table but are included in each column’s total Exhibit 9.11 lists each customer’s individual balances assigned to one of five classes based on its days past due The amounts in each class are totaled and multiplied by the estimated percent of uncollectible accounts for each class The percents used are regularly reviewed to reflect changes in the company and economy To explain, Musicland has $3,700 in accounts receivable that are 31 to 60 days past due Its management estimates 10% of the amounts in this age class are uncollectible, or a total of $370 (computed as $3,700 10%) Similar analysis is done for each of the other four classes The final total of $2,270 ($740 $325 370 $475 $360) shown in the first column is the estimated balance for the Allowance for Doubtful Accounts Exhibit 9.12 shows that since the allowance EXHIBIT 9.12 Computation of the Required Adjustment for the Accounts Receivable Method Unadjusted balance Estimated balance Required adjustment $ 200 credit 2,270 credit $2,070 credit wiL10874_ch09_358-391.indd Page 369 8/3/10 10:03:01 PM user-f500 /Volumes/203/MHBR178/sLa1719X_disk1of1/007731719X/sLa1719X_pagefiles Chapter Accounting for Receivables account has an unadjusted credit balance of $200, the required adjustment to the Allowance for Doubtful Accounts is $2,070 (We could also use a T-account for this analysis as shown in the margin.) This yields the following end-of-period adjusting entry 369 Allowance for Doubtful Accounts Unadj bal 200 Req adj 2,070 Estim bal 2,270 Dec 31 Bad Debts Expense Allowance for Doubtful Accounts To record estimated bad debts 2,070 2,070 Alternatively, if the allowance account had an unadjusted debit balance of $500 (instead of the $200 credit balance), its required adjustment would be computed as follows (Again, a T-account can be used for this analysis as shown in the margin.) Assets Liabilities Equity 22,070 22,070 Point: A debit balance implies that write-offs for that period exceed the total allowance Allowance for Doubtful Accounts Unadjusted balance $ 500 debit Estimated balance 2,270 credit Required adjustment $ 2,770 credit Adjusting entry amount Current year estimate of allowance for doubtful accounts Unadj bal 500 Req adj 2,770 Estim bal 2,270 The entry to record the end-of-period adjustment for this alternative case is Dec 31 Bad Debts Expense Allowance for Doubtful Accounts To record estimated bad debts 2,770 2,770 Assets Liabilities Equity 22,770 22,770 The aging of accounts receivable method is an examination of specific accounts and is usually the most reliable of the estimation methods Estimating Bad Debts—Summary of Methods Exhibit 9.13 summarizes the principles guiding all three estimation methods and their focus of analysis Percent of sales, with its income statement focus, does a good job at matching bad debts expense with sales The accounts receivable methods, with their balance sheet focus, a better job at reporting accounts receivable at realizable value EXHIBIT 9.13 Bad Debts Estimation Methods to Estimate Bad Debts or Income Statement Focus Balance Sheet Focus or Percent of Sales [Emphasis on Matching] Sales × Rate = Bad Debts Expense Decision Maker Percent of Receivables Aging of Receivables [Emphasis on Realizable Value] [Emphasis on Realizable Value] Allowance Accounts × Rate = for Doubtful Receivable Accounts Allowance Accounts Rates = for Doubtful Receivable × (by Age) Accounts (by Age) Answer — p 379 Labor Union Chief One week prior to labor contract negotiations, financial statements are released showing no income growth A 10% growth was predicted Your analysis finds that the company increased its allowance for uncollectibles from 1.5% to 4.5% of receivables Without this change, income would show a 9% growth Does this analysis impact negotiations? ■ wiL10874_ch09_358-391.indd Page 370 8/2/10 8:50:46 PM user-f500 370 /Users/user-f500/Desktop Chapter Accounting for Receivables Quick Check Answers — p 379 Why must bad debts expense be estimated if such an estimate is possible? What term describes the balance sheet valuation of Accounts Receivable less the Allowance for Doubtful Accounts? Why is estimated bad debts expense credited to a contra account (Allowance for Doubtful Accounts) rather than to the Accounts Receivable account? SnoBoard Company’s year-end balance in its Allowance for Doubtful Accounts is a credit of $440 By aging accounts receivable, it estimates that $6,142 is uncollectible Prepare SnoBoard’s year-end adjusting entry for bad debts Record entries for these transactions assuming the allowance method is used: Jan 10 The $300 account of customer Cool Jam is determined uncollectible April 12 Cool Jam unexpectedly pays in full the account deemed uncollectible on Jan 10 NOTES RECEIVABLE C2 Describe a note receivable, the computation of its maturity date, and the recording of its existence A promissory note is a written promise to pay a specified amount of money, usually with interest, either on demand or at a definite future date Promissory notes are used in many transactions, including paying for products and services, and lending and borrowing money Sellers sometimes ask for a note to replace an account receivable when a customer requests additional time to pay a past-due account For legal reasons, sellers generally prefer to receive notes when the credit period is long and when the receivable is for a large amount If a lawsuit is needed to collect from a customer, a note is the buyer’s written acknowledgment of the debt, its amount, and its terms Exhibit 9.14 shows a simple promissory note dated July 10, 2011 For this note, Julia Browne promises to pay TechCom or to its order (according to TechCom’s instructions) a specified amount of money ($1,000), called the principal of a note, at a definite future date (October 8, 2011) As the one who signed the note and promised to pay it at maturity, Browne is the maker of the note As the person to whom the note is payable, TechCom is the payee of the note To Browne, the note is a liability called a note payable To TechCom, the same note is an asset called a note receivable This note bears interest at 12%, as written on the note Interest is the charge for using the money until its due date To a borrower, interest is an expense To a lender, it is revenue EXHIBIT 9.14 Principal Promissory Note Promissory Note July 10, 2011 Date: $1,000 Amount: Date of note Due date Ninety days after date I promise to pay to the order of TechCom Company Los Angeles, CA Payee One thousand and no/100 Dollars 12% for value received with interest at the annual rate of First National Bank of Los Angeles, CA payable at Julia Browne Interest rate Maker Computing Maturity and Interest This section describes key computations for notes including the determination of maturity date, period covered, and interest computation Maturity Date and Period The maturity date of a note is the day the note (principal and interest) must be repaid The period of a note is the time from the note’s (contract) date to wiL10874_ch09_358-391.indd Page 371 8/2/10 8:50:48 PM user-f500 /Users/user-f500/Desktop Chapter Accounting for Receivables 371 its maturity date Many notes mature in less than a full year, and the period they cover is often expressed in days When the time of a note is expressed in days, its maturity date is the specified number of days after the note’s date As an example, a five-day note dated June 15 matures and is due on June 20 A 90-day note dated July 10 matures on October This October due date is computed as shown in Exhibit 9.15 The period of a note is sometimes expressed in months or years When months are used, the note matures and is payable in the month of its maturity on the same day of the month as its original date A nine-month note dated July 10, for instance, is payable on April 10 The same analysis applies when years are used Days in July Minus the date of the note Days remaining in July Add days in August Add days in September Days to equal 90 days, or maturity date of October Period of the note in days EXHIBIT 9.15 31 10 Maturity Date Computation July 11–31 21 31 30 90 Aug 1–31 Sept 1–30 Oct 1–8 Interest Computation Interest is the cost of borrowing money for the borrower or, alter- natively, the profit from lending money for the lender Unless otherwise stated, the rate of interest on a note is the rate charged for the use of the principal for one year The formula for computing interest on a note is shown in Exhibit 9.16 EXHIBIT 9.16 Principal Annual Time expressed 3 Interest of the note interest rate in fraction of year Computation of Interest Formula To simplify interest computations, a year is commonly treated as having 360 days (called the banker’s rule in the business world and widely used in commercial transactions) We treat a year as having 360 days for interest computations in the examples and assignments Using the promissory note in Exhibit 9.14 where we have a 90-day, 12%, $1,000 note, the total interest is computed as follows $1,000 12% 90 $1,000 0.12 0.25 $30 360 Recognizing Notes Receivable Notes receivable are usually recorded in a single Notes Receivable account to simplify recordkeeping The original notes are kept on file, including information on the maker, rate of interest, and due date (When a company holds a large number of notes, it sometimes sets up a controlling account and a subsidiary ledger for notes This is similar to the handling of accounts receivable.) To illustrate the recording for the receipt of a note, we use the $1,000, 90-day, 12% promissory note in Exhibit 9.14 TechCom received this note at the time of a product sale to Julia Browne This transaction is recorded as follows July 10* Notes Receivable Sales Sold goods in exchange for a 90-day, 12% note 1,000 1,000 Assets Liabilities Equity 11,000 11,000 * We omit the entry to Dr Cost of Sales and Cr Merchandise Inventory to focus on sales and receivables When a seller accepts a note from an overdue customer as a way to grant a time extension on a past-due account receivable, it will often collect part of the past-due balance in cash This partial payment forces a concession from the customer, reduces the customer’s debt (and the seller’s risk), and produces a note for a smaller amount To illustrate, assume that TechCom agreed to accept $232 in cash along with a $600, 60-day, 15% note from Jo Cook to Point: Notes receivable often are a major part of a company’s assets Likewise, notes payable often are a large part of a company’s liabilities wiL10874_ch09_358-391.indd Page 372 8/2/10 8:50:49 PM user-f500 372 /Users/user-f500/Desktop Chapter Accounting for Receivables settle her $832 past-due account TechCom made the following entry to record receipt of this cash and note Assets Liabilities Equity 1232 1600 2832 Oct Cash Notes Receivable Accounts Receivable — J Cook Received cash and note to settle account 232 600 832 Valuing and Settling Notes P3 Record the honoring and dishonoring of a note and adjustments for interest Assets Liabilities Equity 1615 115 2600 Recording an Honored Note The principal and interest of a note are due on its matu- rity date The maker of the note usually honors the note and pays it in full To illustrate, when J Cook pays the note above on its due date, TechCom records it as follows Dec Cash Notes Receivable Interest Revenue Collect note with interest of $600 15% 60y360 615 600 15 Interest Revenue, also called Interest Earned, is reported on the income statement Point: When posting a dishonored note to a customer’s account, an explanation is included so as not to misinterpret the debit as a sale on account Assets Liabilities Equity 1816 116 2800 Point: Reporting the details of notes is consistent with the full disclosure principle, which requires financial statements (including footnotes) to report all relevant information Recording a Dishonored Note When a note’s maker is unable or refuses to pay at maturity, the note is dishonored The act of dishonoring a note does not relieve the maker of the obligation to pay The payee should use every legitimate means to collect How companies report this event? The balance of the Notes Receivable account should include only those notes that have not matured Thus, when a note is dishonored, we remove the amount of this note from the Notes Receivable account and charge it back to an account receivable from its maker To illustrate, TechCom holds an $800, 12%, 60-day note of Greg Hart At maturity, Hart dishonors the note TechCom records this dishonoring of the note as follows Oct 14 Accounts Receivable — G Hart Interest Revenue Notes Receivable To charge account of G Hart for a dishonored note and interest of $800 12% 60y360 816 16 800 Charging a dishonored note back to the account of its maker serves two purposes First, it removes the amount of the note from the Notes Receivable account and records the dishonored note in the maker’s account Second, and more important, if the maker of the dishonored note applies for credit in the future, his or her account will reveal all past dealings, including the dishonored note Restoring the account also reminds the company to continue collection efforts from Hart for both principal and interest The entry records the full amount, including interest, to ensure that it is included in collection efforts Recording End-of-Period Interest Adjustment When notes receivable are outstanding at the end of a period, any accrued interest earned is computed and recorded To illustrate, on December 16, TechCom accepts a $3,000, 60-day, 12% note from a customer in granting an extension on a past-due account When TechCom’s accounting period ends on December 31, $15 of interest has accrued on this note ($3,000 12% 15y360) The following adjusting entry records this revenue Assets Liabilities Equity 115 115 Dec 31 Interest Receivable Interest Revenue To record accrued interest earned 15 15 wiL10874_ch09_358-391.indd Page 373 8/2/10 8:50:49 PM user-f500 /Users/user-f500/Desktop Chapter Accounting for Receivables 373 Interest Revenue appears on the income statement, and Interest Receivable appears on the balance sheet as a current asset When the December 16 note is collected on February 14, TechCom’s entry to record the cash receipt is Feb 14 Cash Interest Revenue Interest Receivable Notes Receivable Received payment of note and its interest 3,060 45 15 3,000 Assets Liabilities Equity 13,060 145 215 23,000 Total interest earned on the 60-day note is $60 The $15 credit to Interest Receivable on February 14 reflects the collection of the interest accrued from the December 31 adjusting entry The $45 interest earned reflects TechCom’s revenue from holding the note from January to February 14 of the current period Quick Check Answers — p 379 Irwin purchases $7,000 of merchandise from Stamford on December 16, 2011 Stamford accepts Irwin’s $7,000, 90-day, 12% note as payment Stamford’s accounting period ends on December 31, and it does not make reversing entries Prepare entries for Stamford on December 16, 2011, and December 31, 2011 Using the information in Quick Check 8, prepare Stamford’s March 16, 2012, entry if Irwin dishonors the note DISPOSAL OF RECEIVABLES Companies can convert receivables to cash before they are due Reasons for this include the need for cash or the desire not to be involved in collection activities Converting receivables is usually done either by (1) selling them or (2) using them as security for a loan A recent survey shows that about 20% of companies obtain cash from either selling receivables or pledging them as security In some industries such as textiles, apparel and furniture, this is common practice C3 Explain how receivables can be converted to cash before maturity Selling Receivables A company can sell all or a portion of its receivables to a finance company or bank The buyer, called a factor, charges the seller a factoring fee and then the buyer takes ownership of the receivables and receives cash when they come due By incurring a factoring fee, the seller receives cash earlier and can pass the risk of bad debts to the factor The seller can also choose to avoid costs of billing and accounting for the receivables To illustrate, if TechCom sells $20,000 of its accounts receivable and is charged a 4% factoring fee, it records this sale as follows Aug 15 Cash Factoring Fee Expense Accounts Receivable Sold accounts receivable for cash, less 4% fee 19,200 800 20,000 The accounting for sales of notes receivable is similar to that for accounts receivable The detailed entries are covered in advanced courses Pledging Receivables A company can raise cash by borrowing money and pledging its receivables as security for the loan Pledging receivables does not transfer the risk of bad debts to the lender because the Global: Firms in export sales increasingly sell their receivables to factors Assets Liabilities Equity 119,200 2800 220,000 wiL10874_ch09_358-391.indd Page 374 8/2/10 8:50:49 PM user-f500 374 /Users/user-f500/Desktop Chapter Accounting for Receivables borrower retains ownership of the receivables If the borrower defaults on the loan, the lender has a right to be paid from the cash receipts of the receivable when collected To illustrate, when TechCom borrows $35,000 and pledges its receivables as security, it records this transaction as follows Aug 20 Assets Liabilities Equity 135,000 135,000 Cash Notes Payable Borrowed money with a note secured by pledging receivables 35,000 35,000 Since pledged receivables are committed as security for a specific loan, the borrower’s financial statements disclose the pledging of them TechCom, for instance, includes the following note with its statements: Accounts receivable of $40,000 are pledged as security for a $35,000 note payable Decision Insight Decision Insight What’s the Proper Allowance? How can we assess whether a company has properly estimated its allowance for uncollectibles? One way is to compute the ratio of the allowance account to the gross accounts receivable When this ratio is analyzed over several consecutive periods, trends often emerge that reflect on the adequacy of the allowance amount ■ GLOBAL VIEW This section discusses similarities and differences between U.S GAAP and IFRS regarding the recognition, measurement, and disposition of receivables Recognition of Receivables Both U.S GAAP and IFRS have similar asset criteria that apply to recognition of receivables Further, receivables that arise from revenue-generating activities are subject to broadly similar criteria for U.S GAAP and IFRS Specifically, both refer to the realization principle and an earnings process The realization principle under U.S GAAP implies an arm’s-length transaction occurs, whereas under IFRS this notion is applied in terms of reliable measurement and likelihood of economic benefits Regarding U.S GAAP’s reference to an earnings process, IFRS instead refers to risk transfer and ownership reward While these criteria are broadly similar, differences exist, and they arise mainly from industry-specific guidance under U.S GAAP, which is very limited under IFRS Valuation of Receivables Both U.S GAAP and IFRS require that receivables be reported net of estimated uncollectibles Further, both systems require that the expense for estimated uncollectibles be recorded in the same period when any revenues from those receivables are recorded This means that for accounts receivable, both U.S GAAP and IFRS require the allowance method for uncollectibles (unless uncollectibles are immaterial) The allowance method using percent of sales, percent of receivables, and aging was explained in this chapter Nokia reports the following for its allowance for uncollectibles: Management specifically analyzes accounts receivables and historical bad debt, customer concentrations, customer creditworthiness, current economic trends and changes in our customer payment terms when evaluating the adequacy of the allowance Disposition of Receivables Both U.S GAAP and IFRS apply broadly similar rules in recording dispositions of receivables Those rules are discussed in this chapter We should be aware of an important difference in terminology Companies reporting under U.S GAAP disclose Bad Debts Expense, which is also referred to as Provision for Bad Debts or the Provision for Uncollectible Accounts For U.S GAAP, provision here refers to expense Under IFRS, the term provision usually refers to a liability whose amount or timing (or both) is uncertain wiL10874_ch18_730-773.indd Page 750 8/9/10 7:40:33 PM user-f500 750 /Volumes/203/MHBR178/sLa1719X_disk1of1/007731719X/sLa1719X_pagefiles Chapter 18 Managerial Accounting Concepts and Principles to shipment Move time is the time spent moving (1) raw materials from storage to production and (2) goods in process from one factory location to another factory location Wait time is the time that an order or job sits with no production applied to it; this can be due to order delays, bottlenecks in production, and poor scheduling Process time is considered value-added time because it is the only activity in cycle time that adds value to the product from the customer’s perspective The other three time activities are considered nonvalue-added time because they add no value to the customer Companies strive to reduce non-value-added time to improve cycle efficiency (CE) Cycle efficiency is the ratio of value-added time to total cycle time—see Exhibit 18.20 EXHIBIT 18.20 Cycle efficiency Cycle Efficiency Value-added time Cycle time To illustrate, assume that Rocky Mountain Bikes receives and produces an order for 500 Tracker® mountain bikes Assume that the following times were measured during production of this order Process time 1.8 days Inspection time 0.5 days Move time 0.7 days Wait time 3.0 days In this case, cycle time is 6.0 days, computed as 1.8 days 0.5 days 0.7 days 3.0 days Also, cycle efficiency is 0.3, or 30%, computed as 1.8 days divided by 6.0 days This means that Rocky Mountain Bikes spends 30% of its time working on the product (value-added time) The other 70% is spent on nonvalue-added activities If a company has a CE of 1, it means that its time is spent entirely on value-added activities If the CE is low, the company should evaluate its production process to see if it can identify ways to reduce nonvalue-added activities The 30% CE for Rocky Mountain Bikes is low and its management should look for ways to reduce non-value-added activities DEMONSTRATION PROBLEM 1: COST BEHAVIOR AND CLASSIFICATION Understanding the classification and assignment of costs is important Consider a company that manufactures computer chips It incurs the following costs in manufacturing chips and in operating the company Plastic board used to mount the chip, $3.50 each Assembly worker pay of $15 per hour to attach chips to plastic board Salary for factory maintenance workers who maintain factory equipment Factory supervisor pay of $55,000 per year to supervise employees Real estate taxes paid on the factory, $14,500 Real estate taxes paid on the company office, $6,000 Depreciation costs on machinery used by workers, $30,000 Salary paid to the chief financial officer, $95,000 Advertising costs of $7,800 paid to promote products 10 Salespersons’ commissions of $0.50 for each assembled chip sold 11 Management has the option to rent the manufacturing plant to six local hospitals to store medical records instead of producing and assembling chips wiL10874_ch18_730-773.indd Page 751 8/9/10 7:40:35 PM user-f500 /Volumes/203/MHBR178/sLa1719X_disk1of1/007731719X/sLa1719X_pagefiles Chapter 18 Managerial Accounting Concepts and Principles 751 Classify each cost in the following table according to the categories listed in the table header A cost can be classified under more than one category For example, the plastic board used to mount chips is classified as a direct material product cost and as a direct unit cost Period Costs Cost Selling and Administrative Unit Cost Classification Product Costs Direct Material (Prime Cost) Direct Labor (Prime and Conversion) Factory Overhead (Conversion Cost) Direct ✔ Plastic board used to mount the chip, $3.50 each Sunk Cost Opportunity Cost Sunk Cost Opportunity Cost Indirect ✔ SOLUTION TO DEMONSTRATION PROBLEM Period Costs Cost* Selling and Administrative Unit Cost Classification Product Costs Direct Material (Prime Cost) Direct Labor (Prime and Conversion) Factory Overhead (Conversion Cost) Direct ✔ ✔ ✔ Indirect ✔ ✔ ✔ ✔ ✔ ✔ ✔ ✔ ✔ ✔ ✔ ✔ 10 ✔ 11 * Costs through 11 refer to the 11 cost items described at the beginning of the problem DEMONSTRATION PROBLEM 2: REPORTING FOR MANUFACTURERS A manufacturing company’s balance sheet and income statement differ from those for a merchandising or service company Required Fill in the [BLANK] descriptors on the partial balance sheets for both the manufacturing company and the merchandising company Explain why a different presentation is required ✔ ✔ wiL10874_ch18_730-773.indd Page 752 8/9/10 7:40:35 PM user-f500 752 /Volumes/203/MHBR178/sLa1719X_disk1of1/007731719X/sLa1719X_pagefiles Chapter 18 Managerial Accounting Concepts and Principles Manufacturing Company Merchandising Company ADIDAS GROUP Partial Balance Sheet December 31, 2011 PAYLESS SHOE OUTLET Partial Balance Sheet December 31, 2011 Current assets Cash [BLANK] [BLANK] [BLANK] Supplies Prepaid insurance Total current assets $10,000 8,000 5,000 7,000 500 500 $31,000 Current assets Cash [BLANK] Supplies Prepaid insurance Total current assets $ 5,000 12,000 500 500 $18,000 Fill in the [BLANK] descriptors on the income statements for the manufacturing company and the merchandising company Explain why a different presentation is required Manufacturing Company Merchandising Company ADIDAS GROUP Partial Income Statement For Year Ended December 31, 2011 PAYLESS SHOE OUTLET Partial Income Statement For Year Ended December 31, 2011 Sales Cost of goods sold Finished goods inventory, Dec 31, 2010 [BLANK] Goods available for sale Finished goods inventory, Dec 31, 2011 Cost of goods sold Gross profit $ 200,000 10,000 120,000 130,000 (7,000) 123,000 $ 77,000 Sales Cost of goods sold Merchandise inventory, Dec 31, 2010 [BLANK] Goods available for sale Merchandise inventory, Dec 31, 2011 Cost of goods sold Gross profit $190,000 8,000 108,000 116,000 (12,000) 104,000 $ 86,000 A manufacturer’s cost of goods manufactured is the sum of (a) _, (b) _, and (c) _ costs incurred in producing the product SOLUTION TO DEMONSTRATION PROBLEM Inventories for a manufacturer and for a merchandiser Manufacturing Company Merchandising Company ADIDAS GROUP Partial Balance Sheet December 31, 2011 PAYLESS SHOE OUTLET Partial Balance Sheet December 31, 2011 Current assets Cash Raw materials inventory Goods in process inventory Finished goods inventory Supplies Prepaid insurance Total current assets $10,000 8,000 5,000 7,000 500 500 $31,000 Current assets Cash Merchandise inventory Supplies Prepaid insurance Total current assets $ 5,000 12,000 500 500 $18,000 Explanation: A manufacturing company must control and measure three types of inventories: raw materials, goods in process, and finished goods In the sequence of making a product, the raw materials move wiL10874_ch18_730-773.indd Page 753 8/9/10 7:40:35 PM user-f500 /Volumes/203/MHBR178/sLa1719X_disk1of1/007731719X/sLa1719X_pagefiles Chapter 18 Managerial Accounting Concepts and Principles 753 into production — called goods in process inventory — and then to finished goods All raw materials and goods in process inventory at the end of each accounting period are considered current assets All unsold finished inventory is considered a current asset at the end of each accounting period The merchandising company must control and measure only one type of inventory, purchased goods Cost of goods sold for a manufacturer and for a merchandiser Merchandising Company Manufacturing Company PAYLESS SHOE OUTLET Partial Income Statement For Year Ended December 31, 2011 ADIDAS GROUP Partial Income Statement For Year Ended December 31, 2011 Sales Cost of goods sold Finished goods inventory, Dec 31, 2010 Cost of goods manufactured Goods available for sale Finished goods inventory, Dec 31, 2011 Cost of goods sold Gross profit $ 200,000 10,000 120,000 130,000 (7,000) 123,000 $ 77,000 Sales Cost of goods sold Merchandise inventory, Dec 31, 2010 Cost of purchases Goods available for sale Merchandise inventory, Dec 31, 2011 Cost of goods sold Gross profit $ 190,000 8,000 108,000 116,000 (12,000) 104,000 $ 86,000 Explanation: Manufacturing and merchandising companies use different reporting terms In particular, the terms finished goods and cost of goods manufactured are used to reflect the production of goods, yet the concepts and techniques of reporting cost of goods sold for a manufacturing company and merchandising company are similar A manufacturer’s cost of goods manufactured is the sum of (a) direct material, (b) direct labor, and (c) factory overhead costs incurred in producing the product DEMONSTRATION PROBLEM 3: MANUFACTURING STATEMENT The following account balances and other information are from SUNN Corporation’s accounting records for year-end December 31, 2011 Use this information to prepare (1) a table listing factory overhead costs, (2) a manufacturing statement (show only the total factory overhead cost), and (3) an income statement Advertising expense Amortization expense — Factory Patents Bad debts expense Depreciation expense — Office equipment Depreciation expense — Factory building Depreciation expense — Factory equipment Direct labor Factory insurance expired Factory supervision Factory supplies used Factory utilities Finished goods inventory, Dec 31, 2010 Finished goods inventory, Dec 31, 2011 $ 85,000 16,000 28,000 37,000 133,000 78,000 250,000 62,000 74,000 21,000 115,000 15,000 12,500 Goods in process inventory, Dec 31, 2010 Goods in process inventory, Dec 31, 2011 Income taxes Indirect labor Interest expense Miscellaneous expense Property taxes on factory equipment Raw materials inventory, Dec 31, 2010 Raw materials inventory, Dec 31, 2011 Raw materials purchases Repairs expense — Factory equipment Salaries expense Sales PLANNING THE SOLUTION ● ● ● Analyze the account balances and select those that are part of factory overhead costs Arrange these costs in a table that lists factory overhead costs for the year Analyze the remaining costs and select those related to production activity for the year; selected costs should include the materials and goods in process inventories and direct labor $ 8,000 9,000 53,400 26,000 25,000 55,000 14,000 60,000 78,000 313,000 31,000 150,000 1,630,000 wiL10874_ch18_730-773.indd Page 754 8/9/10 7:40:35 PM user-f500 754 /Volumes/203/MHBR178/sLa1719X_disk1of1/007731719X/sLa1719X_pagefiles Chapter 18 Managerial Accounting Concepts and Principles ● ● Prepare a manufacturing statement for the year showing the calculation of the cost of materials used in production, the cost of direct labor, and the total factory overhead cost When presenting overhead cost on this statement, report only total overhead cost from the table of overhead costs for the year Show the costs of beginning and ending goods in process inventory to determine cost of goods manufactured Organize the remaining revenue and expense items into the income statement for the year Combine cost of goods manufactured from the manufacturing statement with the finished goods inventory amounts to compute cost of goods sold for the year SOLUTION TO DEMONSTRATION PROBLEM SUNN CORPORATION Factory Overhead Costs For Year Ended December 31, 2011 Amortization expense — Factory patents Depreciation expense — Factory building Depreciation expense — Factory equipment Factory insurance expired Factory supervision Factory supplies used Factory utilities Indirect labor Property taxes on factory equipment Repairs expense — Factory equipment Total factory overhead SUNN CORPORATION Manufacturing Statement For Year Ended December 31, 2011 $ 16,000 133,000 78,000 62,000 74,000 21,000 115,000 26,000 14,000 31,000 $570,000 Direct materials Raw materials inventory, Dec 31, 2010 Raw materials purchase Raw materials available for use Less raw materials inventory, Dec 31, 2011 Direct materials used Direct labor Factory overhead Total manufacturing costs Goods in process inventory, Dec 31, 2010 Total cost of goods in process Less goods in process inventory, Dec 31, 2011 Cost of goods manufactured SUNN CORPORATION Income Statement For Year Ended December 31, 2011 Sales Cost of goods sold Finished goods inventory, Dec 31, 2010 Cost of goods manufactured Goods available for sale Less finished goods inventory, Dec 31, 2011 Cost of goods sold Gross profit Operating expenses Advertising expense Bad debts expense Depreciation expense—Office equipment Interest expense Miscellaneous expense Salaries expense Total operating expenses Income before income taxes Income taxes Net income $1,630,000 $ 15,000 1,114,000 1,129,000 12,500 1,116,500 513,500 85,000 28,000 37,000 25,000 55,000 150,000 380,000 133,500 53,400 $ 80,100 $ 60,000 313,000 373,000 78,000 295,000 250,000 570,000 1,115,000 8,000 1,123,000 9,000 $1,114,000 wiL10874_ch18_730-773.indd Page 755 8/9/10 7:40:36 PM user-f500 /Volumes/203/MHBR178/sLa1719X_disk1of1/007731719X/sLa1719X_pagefiles Chapter 18 Managerial Accounting Concepts and Principles 755 Summary Explain the purpose and nature of, and the role of ethics in, managerial accounting The purpose of managerial accounting is to provide useful information to management and other internal decision makers It does this by collecting, managing, and reporting both monetary and nonmonetary information in a manner useful to internal users Major characteristics of managerial accounting include (1) focus on internal decision makers, (2) emphasis on planning and control, (3) flexibility, (4) timeliness, (5) reliance on forecasts and estimates, (6) focus on segments and projects, and (7) reporting both monetary and nonmonetary information Ethics are beliefs that distinguish right from wrong Ethics can be important in reducing fraud in business operations C1 Describe accounting concepts useful in classifying costs We can classify costs on the basis of their (1) behavior—fixed vs variable, (2) traceability—direct vs indirect, (3) controllability— controllable vs uncontrollable, (4) relevance—sunk vs out of pocket, and (5) function—product vs period A cost can be classified in more than one way, depending on the purpose for which the cost is being determined These classifications help us understand cost patterns, analyze performance, and plan operations C2 Define product and period costs and explain how they impact financial statements Costs that are capitalized because they are expected to have future value are called product costs; costs that are expensed are called period costs This classification is important because it affects the amount of costs expensed in the income statement and the amount of costs assigned to inventory on the balance sheet Product costs are commonly made up of direct materials, direct labor, and overhead Period costs include selling and administrative expenses C3 Explain how balance sheets and income statements for manufacturing and merchandising companies differ The main difference is that manufacturers usually carry three inventories on their balance sheets — raw materials, goods in process, and finished goods — instead of one inventory that merchandisers carry The main difference between income statements of manufacturers and merchandisers is the items making up cost of goods sold A merchandiser adds beginning merchandise inventory to cost of goods purchased and then subtracts ending merchandise inventory to get cost of goods sold A manufacturer adds beginning finished goods inventory to cost of goods C4 manufactured and then subtracts ending finished goods inventory to get cost of goods sold Explain manufacturing activities and the flow of manufacturing costs Manufacturing activities consist of materials, production, and sales activities The materials activity consists of the purchase and issuance of materials to production The production activity consists of converting materials into finished goods At this stage in the process, the materials, labor, and overhead costs have been incurred and the manufacturing statement is prepared The sales activity consists of selling some or all of finished goods available for sale At this stage, the cost of goods sold is determined C5 Describe trends in managerial accounting Important trends in managerial accounting include an increased focus on satisfying customers, the impact of a global economy, and the growing presence of e-commerce and service-based businesses The lean business model, designed to eliminate waste and satisfy customers, can be useful in responding to recent trends Concepts such as total quality management, just-in-time production, and the value chain often aid in application of the lean business model C6 Compute cycle time and cycle efficiency, and explain their importance to production management It is important for companies to reduce the time to produce their products and to improve manufacturing efficiency One measure of that time is cycle time (CT), defined as Process time Inspection time Move time Wait time Process time is value-added time; the others are nonvalue-added time Cycle efficiency (CE) is the ratio of value-added time to total cycle time If CE is low, management should evaluate its production process to see if it can reduce non-value-added activities A1 Compute cost of goods sold for a manufacturer A manufacturer adds beginning finished goods inventory to cost of goods manufactured and then subtracts ending finished goods inventory to get cost of goods sold P1 Prepare a manufacturing statement and explain its purpose and links to financial statements The manufacturing statement reports computation of cost of goods manufactured for the period It begins by showing the period’s costs for direct materials, direct labor, and overhead and then adjusts these numbers for the beginning and ending inventories of the goods in process to yield cost of goods manufactured P2 Guidance Answers to Decision Maker and Decision Ethics Production Manager It appears that all three friends want to pay the bill with someone else’s money David is using money belonging to the tax authorities, Denise is taking money from her company, and Derek is defrauding the client To prevent such practices, companies have internal audit mechanisms Many companies also adopt ethical codes of conduct to help guide employees We must recognize that some entertainment expenses are justifiable and even encouraged For example, the tax law allows certain deductions for entertainment that have a business purpose Corporate policies also sometimes allow and encourage reimbursable spending for social activities, and contracts can include entertainment as allowable costs Nevertheless, without further details, payment for this bill should be made from personal accounts Entrepreneur Tracing all costs directly to cost objects is always desirable, but you need to be able to so in an economically feasible manner In this case, you are able to trace 90% of the assembly department’s direct costs It may not be economical to spend more money on a new software to trace the final 10% of costs You need to make a cost–benefit trade-off If the software offers benefits beyond tracing the remaining 10% of the assembly department’s costs, your decision should consider this wiL10874_ch18_730-773.indd Page 756 8/9/10 7:40:36 PM user-f500 756 /Volumes/203/MHBR178/sLa1719X_disk1of1/007731719X/sLa1719X_pagefiles Chapter 18 Managerial Accounting Concepts and Principles Purchase Manager Opportunity costs relate to the potential quality and delivery benefits given up by not choosing supplier (A) Selecting supplier (B) might involve future costs of poor-quality seats (inspection, repairs, and returns) Also, potential delivery delays could interrupt work and increase manufacturing costs Your company could also incur sales losses if the product quality of supplier (B) is low As purchase manager, you are responsible for these costs and must consider them in making your decision Guidance Answers to Quick Checks d Financial accounting information is intended for users external to an organization such as investors, creditors, and government authorities Managerial accounting focuses on providing information to managers, officers, and other decision makers within the organization No, GAAP not control the practice of managerial accounting Unlike external users, the internal users need managerial accounting information for planning and controlling business activities rather than for external comparison Different types of information are required, depending on the activity Therefore it is difficult to standardize managerial accounting Variable costs increase when volume of activity increases By being able to trace costs to cost objects (say, to products and departments), managers better understand the total costs associated with a cost object This is useful when managers 10 consider making changes to the cost object (such as when dropping the product or expanding the department) Raw materials inventory, goods in process inventory, and finished goods inventory The cost of goods sold for merchandising companies includes all costs of acquiring the merchandise; the cost of goods sold for manufacturing companies includes the three costs of manufacturing: direct materials, direct labor, and overhead a No; companies rarely report a manufacturing statement Beginning goods in process inventory is added to total manufacturing costs to yield total goods in process Ending goods in process inventory is subtracted from total goods in process to yield cost of goods manufactured for the period Key Terms Continuous improvement (p 748) Control (p 733) Controllable or not controllable cost (p 737) Conversion costs (p 743) Cost object (p 737) Customer orientation (p 747) Cycle efficiency (CE) (p 750) Cycle time (CT) (p 749) Direct costs (p 737) Direct labor (p 742) Direct labor costs (p 742) Direct material (p 742) Direct material costs (p 742) Ethics (p 736) mhhe.com/wildFAP20e Factory overhead (p 742) Factory overhead costs (p 742) Finished goods inventory (p 741) Fixed cost (p 736) Goods in process inventory (p 741) Indirect costs (p 737) Indirect labor (p 742) Indirect labor costs (p 742) Indirect material (p 740) Institute of Management Accountants (IMA) (p 736) Internal control system (p 736) Just-in-time (JIT) manufacturing (p 748) Lean business model (p 747) Managerial accounting (p 732) Multiple Choice Quiz Answers on p 773 Manufacturing statement (p 745) Non-value-added time (p 750) Opportunity cost (p 738) Out-of-pocket cost (p 738) Period costs (p 738) Planning (p 732) Prime costs (p 743) Product costs (p 738) Raw materials inventory (p 740) Sunk cost (p 738) Total quality management (TQM) (p 748) Value-added time (p 750) Value chain (p 748) Variable cost (p 736) mhhe.com/wildFAP20e Additional Quiz Questions are available at the book’s Website Continuous improvement a Is used to reduce inventory levels b Is applicable only in service businesses c Rejects the notion of “good enough.” d Is used to reduce ordering costs e Is applicable only in manufacturing businesses wiL10874_ch18_730-773.indd Page 757 8/9/10 7:40:36 PM user-f500 /Volumes/203/MHBR178/sLa1719X_disk1of1/007731719X/sLa1719X_pagefiles Chapter 18 Managerial Accounting Concepts and Principles A direct cost is one that is a Variable with respect to the cost object b Traceable to the cost object c Fixed with respect to the cost object d Allocated to the cost object e A period cost Costs that are incurred as part of the manufacturing process, but 757 c Indirect labor, indirect materials, and fixed expenses d Variable costs, fixed costs, and period costs e Opportunity costs, sunk costs, and direct costs A company reports the following for the current year Finished goods inventory, beginning year Finished goods inventory, ending year Cost of goods sold are not clearly traceable to the specific unit of product or batches of product, are called a Period costs b Factory overhead c Sunk costs d Opportunity costs e Fixed costs The three major cost components of manufacturing a product are a Direct materials, direct labor, and factory overhead b Period costs, product costs, and sunk costs $6,000 3,200 7,500 Its cost of goods manufactured for the current year is a $1,500 b $1,700 c $7,500 d $2,800 e $4,700 Icon denotes assignments that involve decision making Discussion Questions Describe the managerial accountant’s role in business plan- 15 Besides inventories, what other assets often appear on manu- ning, control, and decision making Distinguish between managerial and financial accounting on a Users and decision makers b Purpose of information c Flexibility of practice d Time dimension e Focus of information f Nature of information Identify the usual changes that a company must make when it adopts a customer orientation Distinguish between direct material and indirect material Distinguish between direct labor and indirect labor Distinguish between (a) factory overhead and (b) selling and administrative overhead What product cost is listed as both a prime cost and a conversion cost? Assume that you tour Apple’s factory where it Apple makes its products List three direct costs and three indirect costs that you are likely to see Should we evaluate a manager’s performance on the basis of controllable or noncontrollable costs? Why? Explain why knowledge of cost behavior is useful in product performance evaluation Explain why product costs are capitalized but period costs are expensed in the current accounting period Explain how business activities and inventories for a manufacturing company, a merchandising company, and a service company differ Why does managerial accounting often involve working with numerous predictions and estimates? How an income statement and a balance sheet for a manufacturing company and a merchandising company differ? facturers’ balance sheets but not on merchandisers’ balance sheets? Why does a manufacturing company require three different inventory categories? Manufacturing activities of a company are described in the _ This statement summarizes the types and amounts of costs incurred in its manufacturing _ What are the three categories of manufacturing costs? List several examples of factory overhead List the four components of a manufacturing stateApple ment and provide specific examples of each for Apple Prepare a proper title for the annual “manufacPalm turing statement” of Palm Does the date match the balance sheet or income statement? Why? Describe the relations among the income statement, the manufacturing statement, and a detailed listing of factory overhead costs Define and describe cycle time and identify the components of cycle time Explain the difference between value-added time and nonvalue-added time Define and describe cycle efficiency Can management of a company such as Research In Motion use cycle time and cycle efficiency as useful measures of performance? Explain Access Dell’s annual report (10-K) for the fiscal year ended January 29, 2010, at the SEC’s EDGAR database (SEC.gov) or its Website (Dell.com) From its financial statement notes, identify the titles and amounts of its inventory components 10 11 12 13 14 16 17 18 19 20 21 22 23 24 25 26 27 RIM wiL10874_ch18_730-773.indd Page 758 8/9/10 7:40:36 PM user-f500 /Volumes/203/MHBR178/sLa1719X_disk1of1/007731719X/sLa1719X_pagefiles 758 Chapter 18 Managerial Accounting Concepts and Principles QUICK STUDY Identify whether each description most likely applies to managerial or financial accounting _ Its primary focus is on the organization as a whole _ Its principles and practices are very flexible _ It is directed at external users in making investment, credit, and other decisions _ Its primary users are company managers _ Its information is often available only after an audit is complete QS 18-1 Managerial accounting versus financial accounting C1 QS 18-2 Managerial accounting defined C1 QS 18-3 Fixed and variable costs C2 QS 18-4 Direct and indirect costs C2 QS 18-5 Product and period costs C3 QS 18-6 Inventory reporting for manufacturers C4 QS 18-7 Cost of goods sold P1 QS 18-8 Manufacturing flows identified C5 Managerial accounting (choose one) Must follow generally accepted accounting principles Provides information to aid management in planning and controlling business activities Is directed at reporting aggregate data on the company as a whole Provides information that is widely available to all interested parties Which of these statements is true regarding fixed and variable costs? Fixed costs increase and variable costs decrease in total as activity volume decreases Fixed costs stay the same and variable costs increase in total as activity volume increases Both fixed and variable costs increase as activity volume increases Both fixed and variable costs stay the same in total as activity volume increases Kasey Anthony Company produces sporting equipment, including basketballs Identify each of the following costs as direct or indirect if the cost object is a basketball produced by Kasey Anthony Materials used to produce basketballs Electricity used in the production plant Labor used on the basketball production line Salary of manager who supervises the entire plant Depreciation on equipment used to produce basketballs Which of these statements is true regarding product and period costs? Sales commission is a product cost and factory rent is a period cost Factory wages are a product cost and direct material is a period cost Factory maintenance is a product cost and sales commission is a period cost Sales commission is a product cost and depreciation on factory equipment is a product cost Three inventory categories are reported on a manufacturing company’s balance sheet: (i) raw materials, (ii) goods in process, and (iii) finished goods Identify the usual order in which these inventory items are reported on the balance sheet (i)(ii)(iii) (ii)(i)(iii) (ii)(iii)(i) (iii)(ii)(i) A company has year-end cost of goods manufactured of $5,000, beginning finished goods inventory of $700, and ending finished goods inventory of $850 Its cost of goods sold is $4,250 $4,000 $4,850 $6,550 Identify the usual sequence of manufacturing activities by filling in the blank (with i, ii or iii) corresponding to its order: _ Production activities; _ sales activities; _ materials activities wiL10874_ch18_730-773.indd Page 759 8/9/10 7:40:37 PM user-f500 /Volumes/203/MHBR178/sLa1719X_disk1of1/007731719X/sLa1719X_pagefiles Chapter 18 Managerial Accounting Concepts and Principles 759 Match each lean business concept with its best description by entering its letter in the blank _ Customer orientation A Inventory is acquired or produced only as needed _ Total quality management B Flexible product designs can be modified to accommodate customer choices _ Just-in-time manufacturing C Every manager and employee constantly looks for ways to improve company operations _ Continuous improvements D Focuses on quality throughout the production process QS 18-9 Compute cost of goods sold for year 2011 using the following information QS 18-10 Lean business concepts C6 Cost of goods sold Finished goods inventory, Dec 31, 2010 Goods in process inventory, Dec 31, 2010 Goods in process inventory, Dec 31, 2011 Cost of goods manufactured, year 2011 Finished goods inventory, Dec 31, 2011 P1 $321,500 74,550 81,200 972,345 297,200 Prepare the 2011 manufacturing statement for Carmichael Company using the following information QS 18-11 Cost of goods manufactured Direct materials Direct labor Factory overhead costs Goods in process, Dec 31, 2010 Goods in process, Dec 31, 2011 P2 $192,500 65,150 26,000 159,600 144,750 Compute and interpret (a) manufacturing cycle time and (b) manufacturing cycle efficiency using the following information from a manufacturing company Process time Inspection time Move time Wait time QS 18-12 Manufacturing cycle time and efficiency A1 15 minutes minutes 6.4 minutes 36.6 minutes Nestlé reports beginning raw materials inventory of 3,590 and ending raw materials inventory of 3,708 (both numbers in millions of Swiss francs) If Nestlé purchased 12,000 (in millions of Swiss francs) of raw materials during the year, what is the amount of raw materials it used during the year? QS 18‐13 Both managerial accounting and financial accounting provide useful information to decision makers Indicate in the following chart the most likely source of information for each business decision (a decision can require major input from both sources, in which case both can be marked) EXERCISES Primary Information Source Business Decision Plan the budget for next quarter Measure profitability of all individual stores Prepare financial reports according to GAAP Determine location and size for a new plant Determine amount of dividends to pay stockholders Evaluate a purchasing department’s performance Report financial performance to board of directors Estimate product cost for a new line of shoes Managerial Financial Direct materials used C5 Exercise 18-1 Sources of accounting information C1 wiL10874_ch18_730-773.indd Page 760 8/9/10 7:40:37 PM user-f500 /Volumes/203/MHBR178/sLa1719X_disk1of1/007731719X/sLa1719X_pagefiles 760 Chapter 18 Managerial Accounting Concepts and Principles Exercise 18-2 In the following chart, compare financial accounting and managerial accounting by describing how each differs for the items listed Be specific in your responses Characteristics of financial accounting and managerial accounting Financial Accounting C1 Exercise 18-3 Planning and control descriptions C1 Exercise 18-4 Cost analysis and identification C3 Managerial Accounting Nature of information Flexibility of practice Focus of information Time dimension Users and decision makers Timeliness of information Purpose of information Complete the following statements by filling in the blanks _ is the process of setting goals and making plans to achieve them _ _ usually covers a period of to 10 years _ _ usually covers a period of one year _ is the process of monitoring planning decisions and evaluating an organization’s activities and employees Georgia Pacific, a manufacturer, incurs the following costs (1) Classify each cost as either a product or a period cost If a product cost, identify it as a prime and/or conversion cost (2) Classify each product cost as either a direct cost or an indirect cost using the product as the cost object Product Cost Cost 10 11 12 Exercise 18-5 Cost classifications C2 Exercise 18-6 Cost analysis and classification C2 Office supplies used Bad debts expense Small tools used Factory utilities Advertising Amortization of patents on factory machine Payroll taxes for production supervisor Accident insurance on factory workers Depreciation — Factory building State and federal income taxes Wages to assembly workers Direct materials used Period Direct Indirect Prime Conversion Cost Cost Cost (1) Identify each of the five cost classifications discussed in the chapter (2) List two purposes of identifying these separate cost classifications Listed here are product costs for the production of soccer balls (1) Classify each cost (a) as either fixed or variable and (b) as either direct or indirect (2) What pattern you see regarding the relation between costs classified by behavior and costs classified by traceability? Cost by Behavior Product Cost Taxes on factory Machinery depreciation Coolants for machinery Wages of assembly workers Lace to hold leather together Leather covers for soccer balls Annual flat fee paid for office security Cost by Traceability Variable Fixed Direct Indirect wiL10874_ch18_730-773.indd Page 761 8/9/10 7:40:37 PM user-f500 /Volumes/203/MHBR178/sLa1719X_disk1of1/007731719X/sLa1719X_pagefiles Chapter 18 Managerial Accounting Concepts and Principles Current assets for two different companies at calendar year-end 2011 are listed here One is a manufacturer, Roller Blades Mfg., and the other, Sunny Foods, is a grocery distribution company (1) Identify which set of numbers relates to the manufacturer and which to the merchandiser (2) Prepare the current asset section for each company from this information Discuss why the current asset section for these two companies is different Account Company Company Cash Raw materials inventory Merchandise inventory Goods in process inventory Finished goods inventory Accounts receivable, net Prepaid expenses $ 9,000 — 47,000 — — 64,000 3,500 $ 7,000 44,000 — 32,000 52,000 77,000 700 Compute cost of goods sold for each of these two companies for the year ended December 31, 2011 761 Exercise 18-7 Balance sheet identification and preparation C4 Exercise 18-8 Cost of goods sold computation File Edit View Insert Format Tools Data Window P1 Help 254% 55 Helvetica Roman 12 Century Merchandising Beginning inventory Merchandise Finished goods Cost of purchases Cost of goods manufactured Ending inventory Merchandise Finished goods New Homes Manufacturing $250,000 $500,000 460,000 886,000 150,000 144,000 Using the following data, compute (1) the cost of goods manufactured and (2) the cost of goods sold for both Canyon Company and Rossings Company Beginning finished goods inventory Beginning goods in process inventory Beginning raw materials inventory Rental cost on factory equipment Direct labor Ending finished goods inventory Ending goods in process inventory Ending raw materials inventory Factory utilities Factory supplies used General and administrative expenses Indirect labor Repairs—Factory equipment Raw materials purchases Sales salaries Canyon Company Rossings Company $14,000 16,500 9,250 29,000 21,000 19,650 24,000 7,300 11,000 10,200 23,000 3,250 6,780 35,000 52,000 $18,450 21,950 11,000 24,750 37,000 15,300 18,000 9,200 14,000 5,200 45,000 9,660 3,500 54,000 48,000 Check Century Merchandising COGS, $560,000 Exercise 18-9 Cost of goods manufactured and cost of goods sold computation P1 P2 Check Canyon COGS, $105,030 wiL10874_ch18_730-773.indd Page 762 8/9/10 7:40:40 PM user-f500 /Volumes/203/MHBR178/sLa1719X_disk1of1/007731719X/sLa1719X_pagefiles 762 Chapter 18 Managerial Accounting Concepts and Principles Exercise 18-10 For each of the following accounts for a manufacturing company, place a ✔ in the appropriate column indicating that it appears on the balance sheet, the income statement, the manufacturing statement, and/or a detailed listing of factory overhead costs Assume that the income statement shows the calculation of cost of goods sold and the manufacturing statement shows only the total amount of factory overhead (An account can appear on more than one report.) Components of accounting reports P2 File Edit View Insert Format Tools Data Window Help 159% 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 Exercise 18-11 Manufacturing statement preparation Account Balance Sheet 55 Helvetica Roman 12 Income Statement Manufacturing Statement Overhead Report Accounts receivable Computer supplies used in office Beginning finished goods inventory Beginning goods in process inventory Beginning raw materials inventory Cash Depreciation expense—Factory building Depreciation expense—Factory equipment Depreciation expense—Office building Depreciation expense—Office equipment Direct labor Ending finished goods inventory Ending goods in process inventory Ending raw materials inventory Factory maintenance wages Computer supplies used in factory Income taxes Insurance on factory building Rent cost on office building Office supplies used Property taxes on factory building Raw materials purchases Sales Given the following selected account balances of Randa Company, prepare its manufacturing statement for the year ended on December 31, 2011 Include a listing of the individual overhead account balances in this statement P2 Check Cost of goods manufactured, $546,390 Exercise 18-12 Income statement preparation P2 Sales Raw materials inventory, Dec 31, 2010 Goods in process inventory, Dec 31, 2010 Finished goods inventory, Dec 31, 2010 Raw materials purchases Direct labor Factory computer supplies used Indirect labor Repairs—Factory equipment Rent cost of factory building Advertising expense General and administrative expenses Raw materials inventory, Dec 31, 2011 Goods in process inventory, Dec 31, 2011 Finished goods inventory, Dec 31, 2011 $1,252,000 39,000 55,900 64,750 177,600 227,000 19,840 49,000 7,250 59,000 96,000 131,300 44,700 43,500 69,300 Use the information in Exercise 18-11 to prepare an income statement for Randa Company (a manufacturer) Assume that its cost of goods manufactured is $546,390 wiL10874_ch18_730-773.indd Page 763 8/9/10 7:40:42 PM user-f500 /Volumes/203/MHBR178/sLa1719X_disk1of1/007731719X/sLa1719X_pagefiles Chapter 18 Managerial Accounting Concepts and Principles The following chart shows how costs flow through a business as a product is manufactured Some boxes in the flowchart show cost amounts Compute the cost amounts for the boxes that contain question marks 763 Exercise 18-13 Cost flows in manufacturing C5 Materials Activity Raw materials purchases $37,500 Raw materials available for use in production $ ? Beginning raw materials inventory $7,500 Ending raw materials inventory $5,000 Direct materials used in production $ ? Production Activity Direct labor used in production $78,000 Beginning goods in process inventory $22,500 Factory overhead used in production $132,000 Total goods in process $ ? Ending goods in process inventory $ ? Finished goods manufactured $245,500 Sales Activity Beginning finished goods inventory $ ? Finished goods available for sale $286,000 Ending finished goods inventory $30,000 Finished goods sold $ ? Customer orientation means that a company’s managers and employees respond to customers’ changing wants and needs A manufacturer of metal parts has created a customer satisfaction survey that it asks each of its customers to complete The survey asks about the following factors: (A) product performance; (B) price; (C) lead time; (D) delivery Each factor is to be rated as unsatisfactory, marginal, average, satisfactory, or very satisfied a Match the competitive forces through to the factors on the survey A factor can be matched to more than one competitive force Survey Factor A Product performance B Price C Lead time D Delivery Exercise 18-14 Customer orientation in practice C6 Competitive Force _ Cost _ Time _ Quality _ Flexibility of service b How can managers of this company use the information from this customer satisfaction survey to bet- ter meet competitive forces and satisfy their customers? Following are three separate events affecting the managerial accounting systems for different companies Match the management concept(s) that the company is likely to adopt for the event identified There is some overlap in the meaning of customer orientation and total quality management and, therefore, some responses can include more than one concept Exercise 18-15 Management concepts C6 wiL10874_ch18_730-773.indd Page 764 8/9/10 7:40:44 PM user-f500 764 /Volumes/203/MHBR178/sLa1719X_disk1of1/007731719X/sLa1719X_pagefiles Chapter 18 Managerial Accounting Concepts and Principles Event _ The company starts measuring inventory turnover and discontinues elaborate inventory records Its new focus is to pull inventory through the system _ The company starts reporting measures on customer complaints and product returns from customers _ The company starts reporting measures such as the percent of defective products and the number of units scrapped PROBLEM SET A Problem 18-1A Managerial accounting role C1 Management Concept a Total quality management (TQM) b Just-in-time (JIT) system c Continuous improvement (CI) d Customer orientation (CO) This chapter explained the purpose of managerial accounting in the context of the current business environment Review the automobile section of your local newspaper; the Sunday paper is often best Review advertisements of sport-utility vehicles and identify the manufacturers that offer these products and the factors on which they compete Required Discuss the potential contributions and responsibilities of the managerial accounting professional in helping an automobile manufacturer succeed (Hint: Think about information and estimates that a managerial accountant might provide new entrants into the sport-utility market.) Problem 18-2A Cost computation, classification, and analysis Listed here are the total costs associated with the 2011 production of 1,000 drum sets manufactured by NeatBeat The drum sets sell for $300 each C2 C3 Costs Plastic for casing—$12,000 Wages of assembly workers—$60,000 Property taxes on factory—$6,000 Accounting staff salaries — $45,000 Drum stands (1,000 stands outsourced)—$25,000 Rent cost of equipment for sales staff—$7,000 Upper management salaries—$100,000 Annual flat fee for maintenance service—$9,000 Sales commissions—$10 per unit 10 Machinery depreciation—$10,000 Cost by Behavior Cost by Function Variable Product $12,000 Fixed Period $12,000 Required Check (1) Total variable manufacturing cost, $97,000 Classify each cost and its amount as (a) either fixed or variable and (b) either product or period (The first cost is completed as an example.) Compute the manufacturing cost per drum set Analysis Component Assume that 1,200 drum sets are produced in the next year What you predict will be the total cost of plastic for the casings and the per unit cost of the plastic for the casings? Explain Assume that 1,200 drum sets are produced in the next year What you predict will be the total cost of property taxes and the per unit cost of the property taxes? Explain Problem 18-3A Cost classification and explanation C2 C3 Assume that you must make a presentation to the marketing staff explaining the difference between product and period costs Your supervisor tells you the marketing staff would also like clarification regarding prime and conversion costs and an explanation of how these terms fit with product and period cost You are told that many on the staff are unable to classify costs in their merchandising activities ... Apple 20 08 20 07 20 06 $61,101 $ 5,346 11.4 $ 32, 479 $ 2, 030 16.0 $61,133 $ 5 ,29 2 11.6 $24 ,006 $ 1,445 16.6 $57, 420 $ 4,3 52 13 .2 $19,315 $ 1,074 18.0 20 05 $55,788 $ 3, 826 14.6 $13,931... Allowance for Doubtful Accounts Unadjusted balance $ 500 debit Estimated balance 2, 270 credit Required adjustment $ 2, 770 credit Adjusting entry amount Current year estimate... Exercise 9-16 Accounting for bad debts following IFRS P2 PROBLEM SET A Problem 9-1A Sales on account and credit card sales C1 20 11 20 10 20 09 $305,000 22 ,900 $23 6,000 20 ,700 $28 8,000 17,400 Hitachi,