managerial accounting tools for business decision making 5th edition jerry j weygandt

1 Managerial Accounting 2 Feature Story: THINK FAST 3 Managerial Accounting Basics 4 Comparing Managerial and Financial Accounting 5 Management Functions 6 Organizational Structure 7 Bus

Jerry J Weygandt PhD, CPA University of Wisconsin—Madison

Madison, Wisconsin

Paul D Kimmel PhD, CPA University of Wisconsin—Milwaukee MiIwaukee, Wisconsin Donald E Kieso PhD, CPA Northern Illinois University DeKalb, Illinois

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Managerial Accounting TOOLS FOR BUSINESS DECISION MAKING

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Jerry J Weygandt PhD, CPA; Paul D Kimmel, PhD, CPA;

and Donald E Kieso, PhD, CPAManagerial Accounting, Edition 5ISBN-13 978- 0-470-47714-4

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Jerry Weygandt

Jerry J Weygandt, PhD, CPA, is Arthur

Andersen Alumni Professor of Accounting

at the University of Wisconsin—Madison

He holds a Ph.D in accounting from the

University of Illinois Articles by Professor

Weygandt have appeared in the Accounting

Review Journal of Accounting Research,

Accounting Horizons, Journal of

Accountancy, and other academic and

professional journals These articles have

examined such financial reporting issues

as accounting for price-level adjustments,

pensions, convertible securities, stock option

contracts, and interim reports Professor

Weygandt is author of other accounting and

financial reporting books and is a member

of the American Accounting Association,

the American Institute of Certified Public

Accountants, and the Wisconsin Society of

Certified Public Accountants He has seved

on numerous committees of the American

Accounting Association and as a member

of the editorial board of the Accounting

Review; he also has served as President

and Secretary-Treasurer of the American

Accounting Association In addition, he has

been actively involved with the American

Institute of Certified Public Accountants

and has been a member of the Accounting

Standards Executive Committee (AcSEC) of

that organization He has served on the FASB

task force that examined the reporting issues

related to accounting for income taxes

and served as a trustee of the Financial

Accounting Foundation Professor Weygandt

has received the Chancellor’s Award for

Excellence in Teaching and the Beta Gamma

Sigma Dean’s Teaching Award He is on the

board of directors of M & I Bank of Southern

Wisconsin He is the recipient of the

Wisconsin Institute of CPA’s Outstanding

Educator’s Award and the Lifetime

Achievement Award In 2001 he received

the American Accounting Association’s

Outstanding Educator Award

Paul D Kimmel, PhD, CPA, received his bachelor’s degree from the University ofMinnesota and his doctorate in accountingfrom the University of Wisconsin He is anAssociate Professor at the University ofWisconsin—Milwaukee, and haspublic accounting experience with Deloitte

& Touche (Minneapolis) He was the recipient

of the UWM School of Business AdvisoryCouncil Teaching Award, the Reggie Taite Excellence in Teaching Award and athree-time winner of the OutstandingTeaching Assistant Award at the University

of Wisconsin He is also a recipient of theElijah Watts Sells Award for Honorary Distinction for his results on the CPA exam

He is a member of the American AccountingAssociation and the Institute of ManagementAccountants and has published articles inAccounting Review, Accounting Horizons,Advances in Management Accounting, Managerial Finance, Issues in Accounting Education, Journal of Accounting Education,

as well as other journals His research interests include accounting for financial instruments and innovation in accountingeducation He has published papers andgiven numerous talks on incorporating critical thinking into accounting education,and helped prepare a catalog of criticalthinking resources for the Federated Schools

of Accountancy

Donald E Kieso, PhD, CPA, received hisbachelor’s degree from Aurora University and his doctorate in accounting from theUniversity of Illinois He has served as chairman of the Department of Accountancyand is currently the KPMG Emeritus Professor

of Accountancy at Northern Illinois University

He has public accounting experience withPrice Waterhouse & Co (San Francisco andChicago) and Arthur Andersen & Co.(Chicago) and research experience with theResearch Division of the American Institute ofCertified Public Accountants (New York) Hehas done post doctorate work as a VisitingScholar at the University of California atBerkeley and is a recipient of NIU’s TeachingExcellence Award and four Golden AppleTeaching Awards Professor Kieso is theauthor of other accounting and businessbooks and is a member of the American Accounting Association, the AmericanInstitute of Certified Public Accountants, andthe Illinois CPA Society He has served as amember of the Board of Directors of theIllinois CPA Society, then AACSB’s AccountingAccreditation Committees, the State of Illinois Comptroller’s Commission, as Secretary- Treasurer of the Federation ofSchools of Accountancy, and asSecretary-Treasurer of the AmericanAccounting Association Professor Kieso iscurrently serving on the Board of Trusteesand Executive Committee of AuroraUniversity, as a member of the Board of Directors of Kishwaukee CommunityHospital, and as Treasurer and Director ofValley West Community Hospital From 1989

to 1993 he served as a charter member ofthe national Accounting Education ChangeCommission He is the recipient of the Outstanding Accounting Educator Awardfrom the Illinois CPA Society, the FSA’sJoseph A Silvoso Award of Merit, the NIUFoundation’s Humanitarian Award for Service

to Higher Education, a Distinguished ServiceAward from the Illinois CPA Society, and

in 2003 an honorary doctorate from Aurora University

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What's new?

With this Fifth Edition of Managerial Accounting: Tools for Business Decision Making, our

goals are straightforward: We want this book to present the fundamental concepts of managerial accounting in an easy-to-understand fashion This revision has maintained the successful features

of previous editions and has improved on them in the following ways:

Do it!, Comprehensive Do it!, and the New Do it! Review

Following the same model of the widely used Do it! mini-demonstration exercises, the new Do it! Review problems are placed in the homework material after the Brief Exercises to provide another

opportunity for students to determine whether they have mastered the content in the chapter.

Comprehensive Do it! problems offer a review of the major concepts discussed in the chapter

before students begin assignment materials.

Enhanced Homework Material

In each chapter we have expanded the number of Self-Study Questions and have added additional

new Exercises At the end of the Problem section, we have updated the Waterways Corporation

continuing problem set This problem applies the topics covered in each chapter and aims to capture student interest in a realistic entrepreneurial situation Finally, the Problem Set B has been updated to provide additional practice opportunities.

Improved Pedagogical Features

New Accounting Across the Organization boxes, to demonstrate the use of accounting

information by people in non-accounting functions (e.g., marketing, finance, management) Important analytical tools have also been updated and are integrated throughout the

book, such as the updated Broadening Your Perspective homework activities Updates to the Decision Toolkit, Decision Toolkit Summary, and Using the Decision Toolkit features have been

made to further engage students in using business information and the decision tools presented

in the chapter to solve problems

New and Updated Real-World Examples

Since students are most often willing to commit time and energy to a topic that they believe

is relevant to their future careers, we believe there is no better way to demonstrate relevance than to reference real-world companies By using high-profile companies like Starbucks , Microsoft , Ben & Jerry’s , Ford Motor Company , Kellogg , Amazon.com , and Time Warner to frame our discussion of accounting issues, we demonstrate the relevance of accounting while exposing students to familiar companies

Due to the economic shift toward service industries, many of the companies used

as examples are service-based This shift is further highlighted with new Service Company Insight boxes, which are intended to generate student interest in the course and consequently

increase the likelihood of student success For additional information on our service company

coverage, see page xvi Other updated Insight boxes focus on management, international, and

ethical issues

This edition was also subject to an overall, comprehensive revision to ensure that it is technically accurate, relevant, and up-to-date A chapter-by-chapter summary of content changes is provided in the chart on the next page.

xiv

Chapter 1 Managerial Accounting

• New Feature Story

• Completely revised “Cost Concepts” section

• New section, “Product Costing for Service Industries”

• New Service Company Insight box

• 3 New Do it! boxes and Review Exercises

• 5 New Self-Study Questions

Chapter 2 Job Order Costing

• 2 New sections, “Job Order costing for Service Companies” and “Advantages and

Disadvantages of Job Order Costing”

• New Service Company Insight box

• 3 New Do it! boxes and Review Exercises

• 7 New Self-Study Questions

Chapter 3 Process Costing

• New Ethics note on equivalent units

• New section, “Product Costing for Service Industries”

• 3 New Do it! boxes and Review Exercises

• 3 New Self-Study Questions

Chapter 4 Activity-Based Costing

• Expanded coverage of “The Origins of ABC”

• New Service Company and International Insight boxes

• 3 New Do it! boxes and Review Exercises

• 4 New Self-Study Questions

Chapter 5 Cost-Volume-Profit

• New Feature Story

• Updated All About You section

• New Management Insight box

• 3 New Do it! boxes and Review Exercises

• 4 New Self-Study Questions

• Updated Problem Set A and Set B

Chapter 6 Cost-Volume-Profit Analysis:

Additional Issues

• 2 New Do it! boxes and Review Exercises

• 4 New Self-Study Questions

• Updated Problem Set A and Set B

Chapter 7 Incremental Analysis

• 4 New Do it! boxes and Review Exercises

• New Service Company Insight box

• 5 New Self-Study Questions

Chapter 8 Pricing

• 2 New Do it! boxes and Review Exercises

• New Service Company and Management Insight boxes

• 5 New Self-Study Questions

Chapter 9 Budgetary Planning

• New Feature Story

• New Service Company Insight box

• 3 New Do it! boxes and Review Exercises

• 5 New Self-Study Questions

Chapter 10 : Budgetary Control and Responsibility Accounting

• 3 New Do it! boxes and Review Exercises

• New Management Insight box

• 5 New Self-Study Questions

Chapter 11 Standard Costs and Balanced Scorecard

• 3 New Do it! boxes and Review Exercises

• 4 New Self-Study Questions

Chapter 12 Planning for Capital Investments

• 4 New Do it! boxes and Review Exercises

• 5 New Self-Study Questions

Chapter 13 Statement of Cash Flows

• 5 New Do it! boxes and Review Exercises

• 2 New Comprehensive Do it!s

• 5 New Self-Study Questions

Chapter 14 Financial Statement Analysis

• New Feature Story

• New Comprehensive Do it!

• 4 New Do it! boxes and Review Exercises

• 5 New Self-Study Questions

• Updated Problem Set B and Financial Reporting Problem

xv

Company

Coverage in the

Fifth Edition

The U.S economy is increasingly comprised

of service companies As we note in the text,

even large, well-known manufacturers such as

General Electric and Hewlett Packard believe

that a significant portion of their future

growth will involve providing services rather

than manufacturing goods As a consequence,

many students will eventually work in a

service environment In light of this, we

have expanded our emphasis on service

companies in this edition, in an effort to

demonstrate that managerial accounting is

equally relevant to both service companies

and manufacturers

We have done this in a number of ways,

integrated throughout the textbook and its

features In some instances, we have added

sections that specifically address the

similarities and differences of applying

managerial accounting techniques in a

service company environment rather than a

manufacturing environment We have also

expanded our use of service company

examples, where the use of a service

company is just as instructionally valid as a

manufacturer In previous editions, we had

already added many end-of-chapter exercises

that were based on service companies In

this Fifth Edition, we built on that by adding

additional service company end-of-chapter

materials Throughout the text, an icon

highlights our coverage of service company examples and problems

In addition, we have provided a listing

by chapter here:

Chapter 1: section on Product Costing for

Service Industries; Service Company Insight box; E1-6, E1-7, and E1-13

Chapter 2: section on Job Order Costing for

Service Companies; Service Company Insight box; E2-11, E2-12, and E2-13

Chapter 3: section on Process Costing for

Service Companies; E3-14, E3-15, and E3-16

Chapter 4: section on Activity-Based Costing

in Service Companies; 3 Service Company Insight boxes; BE4-1, BE4-9, BE4-10, Do it! Review 4-3, E4-5, E4-7, E4-16, P4-5A, P4-5B, and BYP4-1 (Decision Making Across the Organization)

Chapter 5: Feature Story, service company

examples in Cost Behavior Analysis and Mixed Costs sections; 2 Service Company Insight boxes; E5-8 through E5-11; and P5-1A and P5-1B

Chapter 6: 2 Service Company Insight boxes;

Using the Decision Toolkit; E6-1, E6-2, E6-4, E6-7, E6-8, and E6-15; P6-4A and P6-4B; BYP6-4 (Exploring the Web); and BYP6-7 (All About You activity)

Chapter 7: Service Company Insight box;

E7-13; and P7-4A and P7-4B

Chapter 8: Service Company Insight box; E8-6,

E8-8, E8-9, E8-10, and E8-15; P8-3A, P8-4A, P8-3B, and P8-4B; BYP8-2 (Managerial Analysis); BYP8-5 (Communication Activity); and BYP8-6 (Ethics Case)

Chapter 9: section on Budgeting in

Non-manufacturing Companies; Service Company Insight box; Self-Study Question 15; E9-3, E9-

18, E9-19, and E9-20; and BYP9-5 (Communication Activity)

Chapter 10: Service Company Insight box;

E10-8, E10-11, E10-18, and E10-19; and BYP10-1 (Decision Making Across the Organization)

Chapter 11: Service Company Insight box;

All About You; E11-4, E11-14, and E11-22; P11-5A and P11-5B; BYP11-1 (Decision Making Across the Organization); and BYP11-4 (Exploring the Web)

Chapter 12: E12-8 and E12-9; and P12-2A,

P12-3A, P12-4A, P12-5A, P12-2B, P12-3B, P12-4B, and P12-5B

xvi

10 Budgetary Control and Responsibility Accounting 434

11 Standard Costs and Balanced Scorecard 492

12 Planning for Capital Investments 542

Performance Evaluation Concepts

13 Statement of Cash Flows 582

14 Financial Statement Analysis 644

APPENDICES

A Time Value of Money A-1

B Standards of Ethical Conduct for Management Accountants B-1

Cases for Managerial Decision Making CA-1

(The full text of these Cases is available online at

www.wiley.com/college/weygandt.)

COMPANY INDEX I-1 SUBJECT INDEX I-3

xviii

1 Managerial Accounting 2

Feature Story: THINK FAST 3

Managerial Accounting Basics 4

Comparing Managerial and Financial Accounting 5 Management Functions 6

Organizational Structure 7 Business Ethics 8

Managerial Cost Concepts 10

Manufacturing Costs 10 Product versus Period Costs 12

Manufacturing Costs in Financial Statements 13

Income Statement 13 Balance Sheet 16 Cost Concepts—A Review 17 Product Costing for Service Industries 19

Managerial Accounting Today 20

The Value Chain 20 Technological Change 21 Just-in-Time Inventory Methods 21 Quality 22

Activity-Based Costing 22 Theory of Constraints 22 Balanced Scorecard 23

All About You: OUTSOURCING AND JOBS 24

APPENDIX: Accounting Cycle for a Manufacturing Company 27

Worksheet 28 Closing Entries 29

2 Job Order Costing 54

Feature Story: “ AND WE’D LIKE IT IN RED” 55

Cost Accounting Systems 56

Job Order Cost System 56 Process Cost System 57

Job Order Cost Flow 58

Accumulating Manufacturing Costs 59

Assigning Manufacturing Costs to Work

in Process 61 Assigning Costs to Finished Goods 67 Assigning Costs to Cost of Goods Sold 68 Job Order Costing for Service Companies 68

Summary of Job Order Cost Flows 70

Advantages and Disadvantages of Job Order

Costing 71

Reporting Job Cost Data 72

Under- or Overapplied Manufacturing

Overhead 73

All About You: MINDING YOUR OWN BUSINESS 75

3 Process Costing 98

Feature Story : BEN & JERRY’S TRACKS ITS MIX-UPS 99

The Nature of Process Cost Systems 100

Uses of Process Cost Systems 100 Process Costing for Service Industries 101

Similarities and Differences Between Job Order

Cost and Process Cost Systems 101 Process Cost Flow 103

Assigning Manufacturing Costs—Journal

Comprehensive Example of Process Costing 110

Compute the Physical Unit Flow (Step 1) 110

Compute Equivalent Units of Production

(Step 2) 111 Compute Unit Production Costs (Step 3) 112

Prepare a Cost Reconciliation Schedule

(Step 4) 113 Preparing the Production Cost Report 113 Costing Systems—Final Comments 115

APPENDIX: FIFO Method 119

Equivalent Units Under FIFO 119 Comprehensive Example 120 FIFO and Weighted-Average 124

Example of Traditional Costing versus ABC 155

Identify and Classify Activities and

Allocate Overhead to Cost Pools (Step 1) 156 Identify Cost Drivers (Step 2) 156

Compute Overhead Rates (Step 3) 157 Assign Overhead Costs to Products (Step 4) 157 Comparing Units Costs 158

Activity-Based Costing: A Closer Look 161

Benefits of ABC 161 Limitations of ABC 161 When to Use ABC 162

xix

Value-Added versus Non–Value-Added

Activities 163 Classification of Activity Levels 165

Activity-Based Costing in Service Industries 167

Traditional Costing Example 167 Activity-Based Costing Example 168

All About You: WHERE DOES THE TIME GO? 171

APPENDIX: Just-in-Time Processing 174

Objective of JIT Processing 174 Elements of JIT Processing 174 Benefits of JIT Processing 175

5 Cost-Volume-Profit 202

Feature Story : UNDERSTANDING MEDICAL COSTS

MIGHT LEAD TO BETTER HEALTH CARE 203

Cost Behavior Analysis 204

Variable Costs 204 Fixed Costs 205 Relevant Range 206 Mixed Costs 208

Importance of Identifying Variable and

Fixed Costs 211

Cost-Volume-Profit Analysis 211

Basic Components 212 CVP Income Statement 212 Break-Even Analysis 215 Target Net Income 218 Margin of Safety 220

All About You: A HYBRID DILEMMA 222

6 Cost-Volume-Profit Analysis:

Additional Issues 242

Feature Story: WHAT GOES UP (FAST),

MUST COME DOWN (FAST) 243

Cost-Volume-Profit (CVP) Review 244

Basic Concepts 244 Basic Computations 246 CVP and Changes in the Business Environment 247

Cost Structure and Operating Leverage 256

Effect on Contribution Margin Ratio 257 Effect on Break-even Point 257

Effect on Margin of Safety Ratio 258 Operating Leverage 258

All About You: BIG DECISIONS FOR

YOUR ENERGY FUTURE 260

APPENDIX: Absorption Costing versus Variable Costing 263

Example Comparing Absorption Costing with

Variable Costing 263

An Extended Example 266 Decision-Making Concerns 270 Potential Advantages of Variable Costing 271

7 Incremental Analysis 296

Feature Story: MAKE IT OR BUY IT? 297

Management’s Decision-Making Process 298

Incremental Analysis Approach 299 How Incremental Analysis Works 299

Types of Incremental Analysis 301

Accept an Order at a Special Price 301 Make or Buy 302

Sell or Process Further 305 Retain or Replace Equipment 308 Eliminate an Unprofitable Segment 308

Other Considerations in Decision Making 310

Feature Story: “I’LL CALL YOUR BLUFF,

AND RAISE YOU 46%” 337

SECTION 1 External Sales 338 Target Costing 339

Cost-Plus Pricing 341

Limitations of Cost-Plus Pricing 342

Variable-Cost Pricing 343 Time-and-Material Pricing 345

SECTION 2 Internal Sales 348 Negotiated Transfer Prices 349

No Excess Capacity 350 Excess Capacity 350 Variable Costs 351 Summary of Negotiated Transfer Pricing 352

Cost-Based Transfer Prices 352 Market-Based Transfer Prices 354 Effect of Outsourcing on Transfer Pricing 354 Transfers Between Divisions in Different Countries 354

APPENDIX: Other Cost Approaches to Pricing 359

Absorption-Cost Pricing 359 Variable-Cost Pricing 361

Length of the Budget Period 389 The Budgeting Process 390 Budgeting and Human Behavior 390 Budgeting and Long-Range Planning 392 The Master Budget 392

Preparing the Operating Budgets 394

Sales Budget 394 Production Budget 395 Direct Materials Budget 396 Direct Labor Budget 398 Manufacturing Overhead Budget 399 Selling and Administrative Expense Budget 400 Budgeted Income Statement 400

Preparing the Financial Budgets 402

Cash Budget 402 Budgeted Balance Sheet 405

Budgeting in Nonmanufacturing Companies 407

Merchandisers 407 Service Enterprises 408 Not-for-Profit Organizations 408

All About You: AVOIDING PERSONAL

Flexible Budgets 439

Why Flexible Budgets? 439 Developing the Flexible Budget 441 Flexible Budget—A Case Study 442 Flexible Budget Reports 444 Management by Exception 446

The Concept of Responsibility Accounting 447

Controllable versus Noncontrollable Revenues

and Costs 449 Responsibility Reporting System 449

Types of Responsibility Centers 452

Responsibility Accounting for Cost Centers 452

Responsibility Accounting for Profit

Centers 453

Responsibility Accounting for Investment

Centers 455 Principles of Performance Evaluation 458

APPENDIX: Residual Income—Another Performance Measurement 464

Residual Income Compared to ROI 464 Residual Income Weakness 465

Scorecard 492

Feature Story: HIGHLIGHTING PERFORMANCE

EFFICIENCY 493

The Need for Standards 494

Distinguishing between Standards and

Budgets 494 Why Standard Costs? 495

Setting Standard Costs—A Difficult Task 495

Ideal versus Normal Standards 496

Statement Presentation of Variances 508

APPENDIX 11B: A Closer Look at Overhead Variances 519

Overhead Controllable Variance 519 Overhead Volume Variance 520

12 Planning for Capital

Investments 542

Feature Story: SOUP IS GOOD FOOD 543

The Capital Budgeting Evaluation Process 544

Cash Flow Information 545 Illustrative Data 546

Cash Payback 547 Net Present Value Method 548

Equal Annual Cash Flows 549 Unequal Annual Cash Flows 550 Choosing a Discount Rate 551 Simplifying Assumptions 551 Comprehensive Example 552

Additional Considerations 553

Intangible Benefits 553

Profitability Index for Mutually Exclusive

Projects 555 Risk Analysis 557 Post-Audit of Investment Projects 557

Other Capital Budgeting Techniques 558

Internal Rate of Return Method 558 Comparing Discounted Cash Flow Methods 561 Annual Rate of Return Method 561

xxi

13 Statement of Cash Flows 582

Feature Story: “GOT CASH?” 583

The Statement of Cash Flows: Usefulness and Format 584

Usefulness of the Statement of Cash Flows 584 Classification of Cash Flows 585

Significant Noncash Activities 586 Format of the Statement of Cash Flows 587 Preparing the Statement of Cash Flows 588 Indirect and Direct Methods 589

Preparing the Statement of Cash Flows—Indirect Method 590

Step 1: Operating Activities 591

Summary of Conversion to Net Cash Provided by

Operating Activities—Indirect Method 595 Step 2: Investing and Financing Activities 597 Step 3: Net Change in Cash 598

Using Cash Flows to Evaluate a Company 600

Free Cash Flow 600

APPENDIX 13A: Using a Worksheet to Prepare the Statement of Cash Flows—Indirect Method 605

Preparing the Worksheet 606

APPENDIX 13B: Statement of Cash Flows—

Direct Method 611

Step 1: Operating Activities 612 Step 2: Investing and Financing Activities 616 Step 3: Net Change in Cash 617

Preparing the Statement of Cash Flows—

Direct Method 588

14 Financial Statement Analysis 644

Feature Story: IT PAYS TO BE PATIENT 645

Basics of Financial Statement Analysis 646

Need for Comparative Analysis 646 Tools of Analysis 647

Horizontal Analysis 647

Balance Sheet 648 Income Statement 649 Retained Earnings Statement 650

Vertical Analysis 651

Balance Sheet 651 Income Statement 652

Ratio Analysis 654

Liquidity Ratios 655 Profitability Ratios 658 Solvency Ratios 663 Summary of Ratios 664

Earning Power and Irregular Items 667

Discontinued Operations 667 Extraordinary Items 668 Changes in Accounting Principle 670 Comprehensive Income 670

Simple Interest A-1 Compound Interest A-2

SECTION 1: Future Value Concepts A-2 Future Value of a Single Amount A-2 Future Value of an Annuity A-4

SECTION 2: Present Value Concepts A-7 Present Value Variables A-7

Present Value of a Single Amount A-7 Present Value of an Annuity A-9 Time Periods and Discounting A-11 Computing the Present Values in a Capital Budgeting Decision A-11

SECTION 3: Using Financial Calculators A-13 Present Value of a Single Sum A-13

Plus and Minus A-14 Compounding Periods A-14 Rounding A-14

Present Value of an Annuity A-15 Useful Applications of the Financial Calculator A-15

Auto Loan A-15 Mortgage Loan Amount A-15

APPENDIX B: Standards of Ethical Conduct for Management Accountants B-1

IMA Statement of Ethical Professional Practice B-1 Principles B-1

Standards B-1 Resolution of Ethical Conflict B-2

Cases for Management Decision Making CA-1(The full text of these Cases is available online at

www.wiley.com/college/weygandt.)

Photo Credits PC-1 Company Index I-1 Subject Index I-3

xxii

study objectives

After studying this chapter, you should be able to:

1Explain the distinguishing features of managerial accounting

2Identify the three broad functions of management

3Define the three classes of manufacturing costs

4Distinguish between product and period costs

5Explain the difference between a merchandising and amanufacturing income statement

6Indicate how cost of goods manufactured is determined

7Explain the difference between a merchandisingand a manufacturing balance sheet

8Identify trends in managerial accounting

Managerial Accounting

2

● the navigator

● ScanStudy Objectives

● ReadFeature Story

● ReadPreview

● Read Text and answer

p 9 p 13 p 15 p 23

● WorkUsing the Decision Toolkit

● Review Summary of Study Objectives

The Navigator is a learning system designed to

prompt you to use the learning aids in the chapter

and to help you set priorities as you study.

The business world changes rapidly.

To survive you must make informed, quick decisions Considerthis In January of 1998, Compaq

personal computers and Forbes

magazine’s “company of the year.”

During the next two years, it lost $2billion and its CEO was out of a job

Compaq fell victim to Dell

of making and selling computers Itreengineered its supply chain so that

it could produce computers with theexact features that customers ordered,ship them within 24 hours of takingthe order, and invest almost no money

in inventory Compaq was not able torespond quickly enough Ultimately, itmerged with Hewlett-Packard (HP).After the merger of HP andCompaq, HP lost significant market

share in the PC market to Dellbecause its cost structure made ithard to compete with Dell on price

To make matters worse for HP, Dellthen began selling computer printers,

a business that HP had alwaysdominated Many people predictedthat Dell would soon reign supremeover the printer business as well

Just when it appeared that Dellcould not be beat, HP regained itsfooting and Dell stumbled By June

2008, HP had accomplished aremarkable three-year turnaround Withmore than $100 billion in sales, HPhad become the biggest technologycompany in the world How did it doit? HP adopted “lean” manufacturingpractices so it could compete withDell on price In addition, it developedexciting design innovations that itmarketed successfully in retail stores,

as compared to Dell’s online salesapproach

Perhaps most importantly, HPhas expanded its consulting and datastorage services You can only sell apiece of equipment once Butconsulting services provide ongoing,high-margin revenue that frequentlyresults in additional hardware sales

To further expand its service revenueopportunities, in 2008 HP acquiredElectronic Data Services (EDS) for

$13.9 billion Although many industryanalysts questioned the decision, HPsays the move was based on a sound strategy Now managementmust prove that it was the correctdecision for the

All About You: Outsourcing and Jobs (p 24)

“Inside Chapter” lists boxes in the chapter that should be of special interest

to you.

The Feature Story helps you picture how

the chapter topic relates to the real world

of business and accounting You will find references to the story throughout the chapter.

Managerial Accounting Basics

ac-counting that provides economic and financial information for managers and other internal users The activities that are part of managerial accounting (and the chapters in which they are discussed in this textbook) are as follows.

1 Explaining manufacturing and nonmanufacturing costs and how they are reported in the financial statements (Chapter 1).

2 Computing the cost of providing a service or manufacturing a product (Chapters 2, 3, and 4).

3 Determining the behavior of costs and expenses as activity levels change and analyzing cost–volume–profit relationships within a company (Chapters 5 and 6).

4 Accumulating and presenting data for management decision making (Chapter 7).

5 Determining prices for external and internal transactions (Chapter 8).

6 Assisting management in profit planning and formalizing these plans in the form of budgets (Chapter 9).

7 Providing a basis for controlling costs and expenses by comparing actual sults with planned objectives and standard costs (Chapters 10 and 11).

re-8 Accumulating and presenting data for capital expenditure decisions (Chapter 12).

This chapter focuses on issues illustrated in the Feature Story about Compaq Computer , Hewlett-Packard , and

Dell These include determining and controlling the costs of material, labor, and overhead and the relationship between costs and profits In a financial accounting course, you learned about the form and content of finan- cial statements for external users of financial information, such as stockholders and creditors These finan-

cial statements represent the principal product of financial accounting Managerial accounting focuses ily on the preparation of reports for internal users of financial information, such as the managers and officers

primar-of a company In today’s rapidly changing global environment, managers primar-often make decisions that determine their company’s fate—and their own Managers are evaluated on the results of their decisions Managerial accounting provides tools for assisting management in making decisions and for evaluating the effectiveness of those decisions.

The content and organization of this chapter are as follows.

• Comparing managerial and

• Product vs period costs

Managerial Cost Concepts

• Income statement

• Cost of goods manufactured

• Balance sheet

• Cost concepts—A review

• Product costing for service industries

Manufacturing Costs in Financial Statements

Managerial Accounting

4

Essential terms and

concepts are printed in blue

where they first appear

and are defined in the

end-of-chapter Glossary.

The Preview describes the purpose

of the chapter and outlines the major topics and subtopics you will find in it.

Managerial accounting applies to all types of businesses—service, dising, and manufacturing It also applies to all forms of business organizations—

merchan-proprietorships, partnerships, and corporations Not-for-profit entities as well as profit-oriented enterprises need managerial accounting.

In the past, managerial accountants were primarily engaged in cost accounting—

collecting and reporting costs to management Recently that role has changed significantly First, as the business environment has become more automated, methods to determine the amount and type of cost in a product have changed.

Second, managerial accountants are now held responsible for strategic cost agement; that is, they assist in evaluating how well the company is employing its resources As a result, managerial accountants now serve as team members alongside personnel from production, marketing, and engineering when the com- pany makes critical strategic decisions.

man-Opportunities for managerial accountants to advance within the company are considerable Financial executives must have a background that includes an understanding of managerial accounting concepts Whatever your position in the company—marketing, sales, or production, knowledge of managerial ac- counting greatly improves your opportunities for advancement As the CEO of

Microsoft noted: “If you’re supposed to be making money in business and posed to be satisfying customers and building market share, there are numbers that characterize those things And if somebody can’t sort of speak to me quan- titatively about it, then I’m nervous.”

sup-COMPARING MANAGERIAL AND FINANCIAL ACCOUNTING

There are both similarities and differences between managerial and financial counting First, each field of accounting deals with the economic events of a

ac-business Thus, their interests overlap For example, determining the unit cost of manufacturing a product is part of managerial accounting Reporting the total

cost of goods manufactured and sold is part of financial accounting In tion, both managerial and financial accounting require that a company’s eco- nomic events be quantified and communicated to interested parties.

addi-Illustration 1-1 summarizes the principal differences between financial counting and managerial accounting The need for various types of economic data is responsible for many of the differences.

ac-Managerial Accounting Basics 5

External users: stockholders, creditors, and regulators

Financial statements

Quarterly and annually

General-purpose

Pertains to business as a whole

Highly aggregated (condensed)

Limited to double-entry accounting and cost data

Generally acceptedaccounting principles

Audit by CPA

Primary Users

of Reports Types and Frequency

of Reports Purpose of Reports Content of Reports

Pertains to subunits of the business

Production Repor t

Manager

Illustration 1-1

Differences betweenfinancial and managerialaccounting

Explain the distinguishing features of managerial accounting.

1study objective

Dell A key objective of management is to add value to the business under its

control Value is usually measured by the trading price of the company’s stock and by the potential selling price of the company.

Directing involves coordinating a company’s diverse activities and human resources to produce a smooth-running operation This function relates to imple- menting planned objectives and providing necessary incentives to motivate em- ployees For example, manufacturers such as Campbell Soup Company , General Motors , and Dell must coordinate purchasing, manufacturing, warehousing, and selling Service corporations such as American Airlines , Federal Express , and

AT&T must coordinate scheduling, sales, service, and acquisitions of equipment and supplies Directing also involves selecting executives, appointing managers and supervisors, and hiring and training employees.

The third management function, controlling, is the process of keeping the

company’s activities on track In controlling operations, managers determine

Identify the three broad

functions of management

2study objective

Even the Best Have to Get Better

Louis Vuitton is a French manufacturer of high-end handbags, wallets, and suitcases Its reputation for quality and style allows it to charge extremely high prices— for example, $700 for a tote bag But often in the past, when demand was hot, supply was nonexistent—shelves were empty, and would-be buyers left empty-handed.

Luxury-goods manufacturers used to consider stock-outs to be a good thing, but recently Louis Vuitton changed its attitude The company adopted “lean” processes used

by car manufacturers and electronics companies to speed up production of “hot” ucts Work is done by flexible teams, with jobs organized based on how long a task takes By reducing wasted time and eliminating bottlenecks, what used to take 20 to

prod-30 workers eight days to do now takes 6 to 12 workers one day Also, production ployees who used to specialize on a single task on a single product are now multiskilled This allows them to quickly switch products to meet demand.

em-To make sure that the factory is making the right products, within a week of a uct launch, Louis Vuitton stores around the world feed sales information to the head- quarters in France, and production is adjusted accordingly Finally, the new production processes have also improved quality Returns of some products are down by two-thirds, which makes quite a difference to the bottom line when the products are pricey.

prod-Source: Christina Passariello, “Louis Vuitton Tries Modern Methods on Factory Lines,” Wall Street Journal,

Insight boxes illustrate

interesting situations in real

companies and show how

managers make decisions

using accounting

information Guideline

answers to the critical

thinking questions appear on

the last page of the chapter.

whether planned goals are being met When there are deviations from targeted objectives, managers must decide what changes are needed to get back on track.

Recent scandals at companies like Enron , Lucent , and Xerox attest to the fact that companies must have adequate controls to ensure that the company devel- ops and distributes accurate information.

How do managers achieve control? A smart manager in a small operation can make personal observations, ask good questions, and know how to evaluate the answers But using this approach in a large organization would result in chaos Imagine the president of Dell attempting to determine whether the com- pany is meeting its planned objectives, without some record of what has happened and what is expected to occur Thus, large businesses typically use a formal sys- tem of evaluation These systems include such features as budgets, responsibility centers, and performance evaluation reports—all of which are features of man- agerial accounting.

Decision making is not a separate management function Rather, it is the come of the exercise of good judgment in planning, directing, and controlling.

out-ORGANIZATIONAL STRUCTURE

In order to assist in carrying out management functions, most companies

pre-pare organization charts to show the interrelationships of activities and the

del-egation of authority and responsibility within the company Illustration 1-2 shows

a typical organization chart, which outlines the delegation of responsibility.

Stockholders own the corporation, but they manage it indirectly through a

directors The board formulates the operating policies for the company or organization The board also selects officers, such as a president and one or more vice presidents, to execute policy and to perform daily management functions.

business Obviously, even in a small business, in order to accomplish organizational

Managerial Accounting Basics 7

Illustration 1-2

Corporation’s organizationchart

Vice PresidentHumanResources

Vice PresidentOperations

Vice PresidentFinance/ChiefFinancial Officer

Vice PresidentMarketing

GeneralCounsel/andSecretary

Treasurer Controller

Board ofDirectorsStockholders

Chief ExecutiveOfficer andPresident

objectives, the company relies on delegation of responsibilities As the tion chart on page 7 shows, the CEO delegates responsibilities to other officers Each member of the organization has a clearly defined role to play.

organiza-Responsibilities within the company are frequently classified as either line

or staff positions Employees with line positions are directly involved in the company’s primary revenue-generating operating activities Examples of line po- sitions include the vice president of operations, vice president of marketing, plant managers, supervisors, and production personnel Employees with staff posi-

a firm like General Electric or ExxonMobil , employees in finance, legal, and man resources have staff positions While activities of staff employees are vital

hu-to the company, these employees are nonetheless there hu-to serve the line ees who engage in the company’s primary operations.

and finance issues the company faces The CFO is supported by the controller

and the treasurer The controller’s responsibilities include (1) maintaining the accounting records, (2) maintaining an adequate system of internal control, and (3) preparing financial statements, tax returns, and internal reports The treas- urer has custody of the corporation’s funds and is responsible for maintaining the company’s cash position.

Also serving the CFO is the internal audit staff The staff’s responsibilities clude reviewing the reliability and integrity of financial information provided by the controller and treasurer Staff members also ensure that internal control systems are functioning properly to safeguard corporate assets In addition, they investigate compliance with policies and regulations, and in many companies they determine whether resources are being used in the most economical and efficient fashion The vice president of operations oversees employees with line positions For example, the company might have multiple plant managers, each of whom would report to the vice president of operations Each plant would also have depart- ment managers, such as fabricating, painting, and shipping, each of whom would report to the plant manager.

in-BUSINESS ETHICS

All employees within an organization are expected to act ethically in their ness activities Given the importance of ethical behavior to corporations and their owners (stockholders), an increasing number of organizations provide codes of business ethics for their employees.

busi-Despite these efforts, recent business scandals resulted in massive ment losses and numerous employee layoffs A recent survey of fraud by interna- tional accounting firm KPMG reported a 13% increase in instances of corporate fraud compared to five years earlier It noted that while employee fraud (such things as expense-account abuse, payroll fraud, and theft of assets) represented 60% of all instances of fraud, financial reporting fraud (the intentional misstate- ment of financial reports) was the most costly to companies That should not be surprising given the long list of companies such as Enron , Global Crossing ,

invest-WorldCom , and others that engaged in massive financial frauds, which led to huge financial losses and thousands of lost jobs.

Creating Proper Incentives

Companies like Motorola , IBM , and Nike use complex systems to control and uate the actions of managers They dedicate substantial resources to monitor and effectively evaluate the actions of employees Unfortunately, these systems and con- trols sometimes unwittingly create incentives for managers to take unethical actions For example, companies prepare budgets to provide direction Because the budget

eval-is also used as an evaluation tool, some managers try to “game’’ the budgeting process

before you go on

by underestimating their division’s predicted performance so that it will be easier to meet their performance targets On the other hand, if the budget is set at unattain- able levels, managers sometimes take unethical actions to meet the targets in order

to receive higher compensation or, in some cases, to keep their jobs.

For example, in recent years, airline manufacturer Boeing was plagued by a ries of scandals including charges of over-billing, corporate espionage, and illegal conflicts of interest Some long-time employees of Boeing blame the decline in ethics on a change in the corporate culture that took place after Boeing merged with McDonnell Douglas They suggest that evaluation systems implemented after the merger to monitor results and evaluate employee performance made employ- ees believe they needed to succeed no matter what actions were required to do so.

se-As another example, manufacturing companies need to establish production goals for their processes Again, if controls are not effective and realistic, problems develop To illustrate, Schering-Plough , a pharmaceutical manufacturer, found that employees were so concerned with meeting production standards that they failed

to monitor the quality of the product, and as a result the dosages were often wrong.

Code of Ethical Standards

In response to corporate scandals in 2000 and 2001, the U.S Congress enacted legislation to help prevent lapses in internal control This legislation, referred to

as the Sarbanes-Oxley Act of 2002 (SOX) has important implications for the financial community One result of SOX was to clarify top management’s respon- sibility for the company’s financial statements CEOs and CFOs must now certify that financial statements give a fair presentation of the company’s operating re- sults and its financial condition In addition, top managers must certify that the company maintains an adequate system of internal controls to safeguard the company’s assets and ensure accurate financial reports.

Another result of SOX is that companies now pay more attention to the position of the board of directors In particular, the audit committee of the board

com-of directors must be comprised entirely com-of independent members (that is, employees) and must contain at least one financial expert.

non-Finally, to increase the likelihood of compliance with the rules that are part

of the new legislation, the law substantially increases the penalties for misconduct.

To provide guidance for managerial accountants, the Institute of

Manage-ment Accountants (IMA) has developed a code of ethical standards, entitled IMA

Statement of Ethical Professional Practice Management accountants should not

commit acts in violation of these standards Nor should they condone such acts

by others within their organizations We include the IMA code of ethical dards in Appendix B at the end of the book Throughout the book, we will address various ethical issues managers face.

stan-Managerial Accounting Basics 9

Do it! Indicate whether the following statements are true or false.

1 Managerial accountants have a single role within an organization, collecting and porting costs to management

re-2 Financial accounting reports are general-purpose and intended for external users

3 Managerial accounting reports are special-purpose and issued as frequently as needed

4 Managers’ activities and responsibilities can be classified into three broad functions:

cost accounting, budgeting, and internal control

5 As a result of the Sarbanes-Oxley Act of 2002, managerial accounting reports mustnow comply with generally accepted accounting principles (GAAP)

6 Top managers must certify that a company maintains an adequate system of internalcontrols

Managerial Accounting Concepts

The Do it! exercises ask you

to put newly acquired knowledge to work They outline the Action Plan necessary to complete the exercise, and they show a Solution.

Managerial Cost Concepts

In order for managers at companies like Dell or Hewlett-Packard to plan, direct, and control operations effectively, they need good information One very impor- tant type of information is related to costs Managers should ask questions such

as the following.

1 What costs are involved in making a product or providing a service?

2 If we decrease production volume, will costs decrease?

3 What impact will automation have on total costs?

4 How can we best control costs?

To answer these questions, managers need reliable and relevant cost information.

We now explain and illustrate the various cost categories that companies use.

MANUFACTURING COSTS

Manufacturing consists of activities and processes that convert raw materials into finished goods Contrast this type of operation with merchandising, which sells merchandise in the form in which it is purchased Manufacturing costs are typically classified as shown in Illustration 1-3.

Solution Action Plan

• Understand that managerial

accounting is a field of

accounting that provides

economic and financial

information for managers and

other internal users.

• Understand that financial

accounting provides information

for external users.

• Analyze which users require

which different types of

information.

1 False Managerial accountants determine product costs In addition, managerial countants are now held responsible for evaluating how well the company is employ-ing its resources As a result, when the company makes critical strategic decisions,managerial accountants serve as team members alongside personnel from production,marketing, and engineering

ac-2 True

3 True

4 False Managers’ activities are classified into three broad functions: planning, ing, and controlling Planning requires managers to look ahead to establish objectives.Directing involves coordinating a company’s diverse activities and human resources toproduce a smooth-running operation Controlling is keeping the company’s activities

direct-on track

5 False SOX clarifies top management’s responsibility for the company’s financial ments In addition, top managers must certify that the company maintains an adequatesystem of internal control to safeguard the company’s assets and ensure accuratefinancial reports

state-6 True

Related exercise material: BE1-1, BE1-2, BE1-3, E1-1, and Do it! 1-1.

Define the three classes of

manufacturing costs.

3study objective

Manufacturing Costs

ManufacturingOverheadDirect Labor

Direct Materials

Illustration 1-3

Classifications of

manufacturing costs

Direct Materials

To obtain the materials that will be converted into the finished product, the

man-ufacturer purchases raw materials Raw materials are the basic materials and

parts used in the manufacturing process For example, auto manufacturers such

as General Motors , Ford , and Toyota use steel, plastic, and tires as raw als in making cars.

materi-Raw materials that can be physically and directly associated with the finished product during the manufacturing process are direct materials Examples include flour in the baking of bread, syrup in the bottling of soft drinks, and steel in the making of automobiles Direct materials for Hewlett-Packard and Dell Computer

(in the Feature Story) include plastic, glass, hard drives, and processing chips.

Some raw materials cannot be easily associated with the finished product.

These are called indirect materials Indirect materials have one of two teristics: (1) They do not physically become part of the finished product (such

charac-as lubricants and polishing compounds) Or, (2) they cannot be traced because their physical association with the finished product is too small in terms of cost (such as cotter pins and lock washers) Companies account for indirect materi-

als as part of manufacturing overhead.

Direct Labor

The work of factory employees that can be physically and directly associated with converting raw materials into finished goods is direct labor Bottlers at Coca- Cola , bakers at Sara Lee , and typesetters at Aptara Corp are employees whose activities are usually classified as direct labor Indirect labor refers to the work

of employees that has no physical association with the finished product, or for which it is impractical to trace costs to the goods produced Examples include wages of maintenance people, time-keepers, and supervisors Like indirect mate-

rials, companies classify indirect labor as manufacturing overhead.

Managerial Cost Concepts 11

Direct Materials

Direct Labor

How Many Labor Hours to Build a Car?

Nissan and Toyota were number 1 and 2 in a recent annual study of labor ductivity in the auto industry But U.S auto manufacturers showed improvements Labor represents about 15% of the total cost to make a vehicle Since Nissan required only 28.46 labor hours per vehicle, it saves about $300 to $450 in labor costs to build a car relative

pro-to Ford , the least-efficient manufacturer General Motors (GM) has shown steady ment over the years In 1998 it needed almost 17 more hours of labor than Toyota to build

improve-a cimprove-ar; it now needs only 4 more hours thimprove-an Toyotimprove-a Chrysler says that much of its ment in labor productivity has come from designing cars that are easier to build.

improve-Source: Rick Popely, “Japanese Automakers Lead Big Three in Productivity Review,” Knight Ridder Tribune News Service, June 1, 2006, p 1.

Management Insight

Why might Nissan production require significantly fewer labor hours?

?

Manufacturing Overhead

manufacture of the finished product These costs may also be manufacturing costs that cannot be classified as direct materials or direct labor Manufacturing over- head includes indirect materials, indirect labor, depreciation on factory buildings and machines, and insurance, taxes, and maintenance on factory facilities.

One study found the following magnitudes of the three different product costs as a percentage of the total product cost: direct materials 54%, direct labor

ManufacturingOverhead

13%, and manufacturing overhead 33% Note that the direct labor component

is the smallest This component of product cost is dropping substantially cause of automation Companies are working hard to increase productivity by decreasing labor A Nissan Motor plant in Tennessee produces Altima automo- biles using only 15.74 labor hours per vehicle, compared to 26 to 28 hours per vehicle at Ford and Daimler plants, for example In some companies, direct labor has become as little as 5% of the total cost.

be-Allocating materials and labor costs to specific products is fairly ward Good record keeping can tell a company how much plastic it used in mak- ing each type of gear, or how many hours of factory labor it took to assemble a part But allocating overhead costs to specific products presents problems How much of the purchasing agent’s salary is attributable to the hundreds of differ- ent products made in the same plant? What about the grease that keeps the ma- chines humming, or the computers that make sure paychecks come out on time? Boiled down to its simplest form, the question becomes: Which products cause the incurrence of which costs? In subsequent chapters we show various meth- ods of allocating overhead to products.

straightfor-PRODUCT VERSUS PERIOD COSTS

Each of the manufacturing cost components—direct materials, direct labor, and manufacturing overhead—are product costs As the term suggests, product costs

are costs that are a necessary and integral part of producing the finished uct Companies record product costs, when incurred, as inventory Under the matching principle, these costs do not become expenses until the company sells the finished goods inventory At that point, the company records the expense as cost of goods sold.

period rather than included as part of the cost of a salable product These are nonmanufacturing costs Period costs include selling and administrative expenses.

In order to determine net income, companies deduct these costs from revenues

in the period in which they are incurred.

Illustration 1-4 summarizes these relationships and cost terms Our main concern in this chapter is with product costs.

Alternative Terminology Some

companies use terms such as

factory overhead, indirect

manufacturing costs, and burden

Alternative Terminology Product

costs are also called inventoriable

AdministrativeExpenses

Nonmanufacturing Costs

Alternative Terminology

notes present synonymous

terms used in practice.

before you go on

Manufacturing Costs in Financial Statements

The financial statements of a manufacturer are very similar to those of a chandiser For example, you will find many of the same sections and same accounts in the financial statements of Procter & Gamble that you find in the financial statements of Dick’s Sporting Goods The principal differences between their financial statements occur in two places: the cost of goods sold section in the income statement and the current assets section in the balance sheet.

mer-INCOME STATEMENT

Under a periodic inventory system, the income statements of a merchandiser and a manufacturer differ in the cost of goods sold section Merchandisers com- pute cost of goods sold by adding the beginning merchandise inventory to the

cost of goods purchased and subtracting the ending merchandise inventory.

Manufacturers compute cost of goods sold by adding the beginning finished

goods inventory to the cost of goods manufactured and subtracting the

end-ing finished goods inventory Illustration 1-5 shows these different methods.

Manufacturing Costs in Financial Statements 13

Do it! A bicycle company has these costs: tires, salaries of employees who put

tires on the wheels, factory building depreciation, lubricants, spokes, salary of factorymanager, handlebars, and salaries of factory maintenance employees Classify each cost

as direct materials, direct labor, or overhead

Managerial Cost Concepts Action Plan

• Classify as direct materials any raw materials that can be physically and directly associated with the finished product.

• Classify as direct labor the work

of factory employees that can be physically and directly associated with the finished product.

• Classify as manufacturing head any costs that are indirectly associated with the finished product.

over-Tires, spokes, and handlebars are direct materials Salaries of employees who put tires

on the wheels are direct labor All of the other costs are manufacturing overhead

Related exercise material: BE1-4, BE1-5, BE1-6, BE1-7, E1-2, E1-3, E1-4, E1-5, E1-6, E1-7, and

1-2.

Do it!

Explain the difference between a merchandising and a manufacturing income statement.

5study objective

BeginningMerchandiseInventory

EndingFinished GoodsInventory

–

Cost ofGoods

Purchased

=

Cost ofGoods Sold

BeginningFinished GoodsInventory

Cost ofGoods

Manufactured

EndingMerchandiseInventory

Manufacturer

Merchandiser Illustration 1-5goods sold componentsCost of

Helpful Hint We assume a periodic inventory system in this illustration.

Solution

Helpful Hints clarify concepts being discussed.

Cost of goods sold Cost of goods sold

—————————

—————————

Cost of goods available for sale 720,000 Cost of goods available for sale 460,000

manu-Illustration 1-6 shows the different presentations of the cost of goods sold sections for merchandising and manufacturing companies The other sections

of an income statement are similar for merchandisers and manufacturers.

Income Statement (partial) Income Statement (partial) For the Year Ended December 31, 2011 For the Year Ended December 31, 2011

Cost of Goods Manufactured

An example may help show how companies determine the cost of goods factured Assume that on January 1 HP has a number of computers in various

manu-stages of production In total, these partially completed units are called

begin-ning work in process inventory The costs the company assigns to beginning

work in process inventory are based on the manufacturing costs incurred in

the prior period

HP first uses the manufacturing costs incurred in the current year to plete the work that was in process on January 1 It then incurs manufacturing costs for production of new orders The sum of the direct materials costs, direct labor costs, and manufacturing overhead incurred in the current year is the

We now have two cost amounts: (1) the cost of the beginning work in process and (2) the total manufacturing costs for the current period The sum of these costs is the total cost of work in process for the year.

At the end of the year, HP may have some computers that are only partially

completed The costs of these units become the cost of the ending work in

process inventory To find the cost of goods manufactured , we subtract this cost from the total cost of work in process Illustration 1-7 shows the formula for determining the cost of goods manufactured.

Indicate how cost of

goods manufactured is

determined.

6study objective

Beginning Total

Total Cost of Work in Process ⴙ Manufacturing ⴝ Work in Process Inventory Costs

Total Cost of Ending Cost of Goods

Work in Process ⴚ Work in Process ⴝ Manufactured

Inventory

of goods manufactured

formula

Do it! The following information is available for Keystone Manufacturing

Company

Raw material inventory $12,000 $10,000Work in process inventory 2,500 4,000Materials purchased in March $ 90,000

Direct labor in March 75,000Manufacturing overhead in March 220,000Prepare the cost of goods manufactured schedule for the month of March

Cost of Goods Manufactured

before you go on

Cost of Goods Manufactured Schedule

The cost of goods manufactured schedule reports cost elements used in

calculating cost of goods manufactured Illustration 1-8 shows the schedule for Olsen Manufacturing Company (using assumed data) The schedule presents detailed data for direct materials and for manufacturing overhead.

Review Illustration 1-7 and then examine the cost of goods manufactured schedule in Illustration 1-8 You should be able to distinguish between “Total manufacturing costs” and “Cost of goods manufactured.” The difference is the effect of the change in work in process during the period.

Manufacturing Costs in Financial Statements 15

OLSEN MANUFACTURING COMPANY

Cost of Goods Manufactured ScheduleFor the Year Ended December 31, 2011

of goods manufacturedschedule

Direct materials

Raw materials inventory, January 1 $ 16,700Raw materials purchases 152,500Total raw materials available for use 169,200Less: Raw materials inventory, December 31 22,800Direct materials used $146,400

Manufacturing overhead

Indirect labor 14,300Factory repairs 12,600Factory utilities 10,100Factory depreciation 9,440Factory insurance 8,360Total manufacturing overhead 54,800

Total cost of work in process 395,200

DECISION CHECKPOINTS TOOL TO USE FOR DECISION HOW TO EVALUATE RESULTS

Is the company maintaining control over the costs of production?

Cost of material, labor, and overhead

Cost of goods manufactured schedule

Compare the cost of goods manufactured to revenue expected from product sales.

INFO NEEDED FOR DECISION

DECISION TOOLKIT

Each chapter presents useful information about how decision makers analyze and solve business problems.

Decision Toolkits

summarize the key features

of a decision tool and review why and how to use it.

Often, numbers or categories

in the financial statements

are highlighted in red type to

draw your attention to key information.

BALANCE SHEET

The balance sheet for a merchandising company shows just one category of ventory In contrast, the balance sheet for a manufacturer may have three inven- tory accounts, as shown in Illustration 1-9.

in-Solution Action Plan

• Start with beginning work in

process as the first item in the

cost of goods manufactured

schedule.

• Sum direct materials used,

direct labor, and total

manufacturing overhead to

determine total manufacturing

costs.

• Sum beginning work in process

and total manufacturing costs

to determine total cost of work

in process.

• Cost of goods manufactured is

the total cost of work in

process less ending work in

process.

KEYSTONE MANUFACTURING COMPANYCost of Goods Manufactured ScheduleFor the Month Ended March 31Work in process, March 1 $ 2,500Direct materials

Raw materials, March 1 $ 12,000Raw material purchases 90,000Total raw materials available for use 102,000Less: Raw materials, March 31 10,000Direct materials used $ 92,000Direct labor 75,000Manufacturing overhead 220,000Total manufacturing costs 387,000Total cost of work in process 389,500Less: Work in process, March 31 4,000Cost of goods manufactured $385,500

Related exercise material: BE1-8, BE1-10, BE1-11, E1-8, E1-9, E1-10, E1-11, E1-12, E1-13, E1-14,

E1-15, E1-16, E1-17,andDo it!1-3.

Finished Goods Inventory

Work in Process Inventory

Raw Materials Inventory

Shows the cost of completed goods on hand

Shows the cost applicable tounits that have been started into production but are onlypartially completed

Shows the cost of raw materials on hand

Finished Goods Inventory is to a manufacturer what Merchandise Inventory is

to a merchandiser Each of these classifications represents the goods that the company has available for sale.

The current assets sections presented in Illustration 1-10 (next page) contrast the presentations of inventories for merchandising and manufacturing compa- nies Manufacturing companies generally list their inventories in the order of their liquidity—the order in which they are expected to be realized in cash Thus, fin- ished goods inventory comes first The remainder of the balance sheet is simi- lar for the two types of companies.

Each step in the accounting cycle for a merchandiser applies to a turer For example, prior to preparing financial statements, manufacturers make adjusting entries The adjusting entries are essentially the same as those of a merchandiser The closing entries are also similar for manufacturers and mer- chandisers.

manufac-Manufacturing Costs in Financial Statements 17

Illustration 1-10

Current assets sections

of merchandising andmanufacturing balancesheets

Balance Sheet Balance SheetDecember 31, 2011 December 31, 2011Current assets Current assets

Cash $100,000 Cash $180,000Receivables (net) 210,000 Receivables (net) 210,000

Prepaid expenses 22,000 Finished goods $80,000

Total current assets $732,000 Work in process 25,200

Prepaid expenses 18,000Total current assets $536,000

For expanded coverage, see the appendix at the end of the chapter.

DECISION CHECKPOINTS TOOL TO USE FOR DECISION HOW TO EVALUATE RESULTS

What is the composition of a manufacturing company’s inventory?

Amount of raw materials, work in process, and finished goods inventories

Balance sheet Determine whether there are

sufficient finished goods, raw materials, and work in process inventories to meet forecasted demand.

INFO NEEDED FOR DECISION

DECISION TOOLKIT

COST CONCEPTS—A REVIEW

You have learned a number of cost concepts in this chapter Because many of these concepts are new, we provide here an extended example for review Sup- pose you started your own snowboard factory, Terrain Park Boards Think that’s impossible? Burton Snowboards was started by Jake Burton Carpenter, when he was only 23 years old Jake initially experimented with 100 different prototype designs before settling on a final design Then Jake, along with two relatives and

a friend, started making 50 boards per day in Londonderry, Vermont nately, while they made a lot of boards in their first year, they were only able to sell 300 of them To get by during those early years, Jake taught tennis and tended bar to pay the bills.

Unfortu-Here are some of the costs that your snowboard factory would incur.

1 The materials cost of each snowboard (wood cores, fiberglass, resins, metal screw holes, metal edges, and ink) is $30.

2 The labor costs (for example, to trim and shape each board using jig saws and band saws) are $40.

3 Depreciation on the factory building and equipment (for example, presses, grinding machines, and lacquer machines) used to make the snowboards is

$25,000 per year.

4 Property taxes on the factory building (where the snowboards are made) are

$6,000 per year.

5 Advertising costs (mostly online and catalogue) are $60,000 per year.

6 Sales commissions related to snowboard sales are $20 per snowboard.

7 Salaries for maintenance employees are $45,000 per year.

8 The salary of the plant manager is $70,000.

9 The cost of shipping is $8 per snowboard.

Illustration 1-11 shows how Terrain Park Boards would assign these turing and selling costs to the various categories.

manufac-Product Costs

1 Material cost ($30) per board X

2 Labor costs ($40) per board X

3 Depreciation on factory equipment ($25,000 per year) X

4 Property taxes on factory building ($6,000 per year) X

5 Advertising costs ($60,000 per year) X

6 Sales commissions

7 Maintenance salaries (factory facilities) ($45,000 per year) X

8 Salary of plant manager ($70,000) X

9 Cost of shipping boards ($18 per board) X

Illustration 1-11

Assignment of costs to

cost categories

Remember that total manufacturing costs are the sum of the product costs—

direct materials, direct labor, and manufacturing overhead If Terrain Park Boards produces 10,000 snowboards the first year, the total manufacturing costs would be $846,000 as shown in Illustration 1-12.

3 Depreciation on factory equipment 25,000

4 Property taxes on factory building 6,000

7 Maintenance salaries (factory facilities) 45,000

8 Salary of plant manager 70,000

Knowing the total manufacturing costs, Terrain Park Boards can compute the manufacturing cost per unit Assuming 10,000 units, the cost to produce one snowboard is $84.60 ($846,000 ⫼ 10,000 units).

In subsequent chapters, we will use extensively the cost concepts discussed

in this chapter Study Illustration 1-11 carefully If you do not understand any of these classifications, go back and reread the appropriate section in this chapter.

PRODUCT COSTING FOR SERVICE INDUSTRIES

The Feature Story notes HP’s belief that its greatest opportunities for growth are

in technology services, not hardware In fact, much of the U.S economy has shifted toward an emphasis on services Today, more than 50% of U.S workers are employed by service companies Airlines, marketing agencies, cable compa- nies, and governmental agencies are just a few examples of service companies.

How do service companies differ from manufacturing companies? One good way

to differentiate these two different types of companies is by how quickly the product is used or consumed by the customer—services are consumed immedi- ately For example, when a restaurant produces a meal, that meal is not put in inventory, but it is instead consumed immediately An airline uses special equip- ment to provide its product, but again, the output of that equipment is consumed immediately by the customer in the form of a flight And a marketing agency per- forms services for its clients that are immediately consumed by the customer in the form of a marketing plan For a manufacturing company, like Boeing , it of- ten has a long lead time before its airplane is used or consumed by the customer.

In presenting our initial examples, we used manufacturing companies cause accounting for the manufacturing environment requires the use of the broadest range of accounts That is, the accounts used by service companies rep- resent a subset of those used by manufacturers because service companies are not producing inventory Neither the restaurant, the airline, or the marketing agency discussed above produces an inventoriable product However, just like a manufacturer, each needs to keep track of the costs of its services in order to know whether it is generating a profit A successful restaurateur needs to know the cost of each offering on the menu, an airline needs to know the cost of flight service to each destination, and a marketing agency needs to know the cost to develop a marketing plan Thus, the techniques shown in this chapter, to accu- mulate manufacturing costs to determine manufacturing inventory, are equally useful for determining the costs of providing services.

be-For example, let’s consider the costs that HP might incur on a consulting engagement A significant portion of its costs would be salaries of consulting personnel It might also incur travel costs, materials, software costs, and depreciation charges on equipment used by the employees to provide the con- sulting service In the same way that it needs to keep track of the cost of man- ufacturing its computers and printers, HP needs to know what its costs are on each consulting job It could prepare a cost of services provided schedule sim- ilar to the cost of goods manufactured schedule in Illustration 1-8 The struc- ture would be essentially the same as the cost of goods manufactured schedule, but section headings would be reflective of the costs of the particular service organization.

Managers of service companies look to managerial accounting to answer many questions In some instances, the managerial accountant may need to de- velop new systems for measuring the cost of serving individual customers In others, companies may need new operating controls to improve the quality and efficiency of specific services Many of the examples we present in subsequent chapters will be based on service companies To highlight the relevance of the techniques used in this course for service companies, we have placed a service

Manufacturing Costs in Financial Statements 19

Ethics Note Do telecommunications companies have an obligation to provide service to remote or low-user areas for a fee that may be less than the cost of the service?

Ethics Notes help sensitize you to some of the ethical issues in accounting.

company icon next to those items in the text and end-of-chapter materials that relate to nonmanufacturing companies.

Low Fares but Decent Profits

During 2008, when other airlines were cutting flight service due to the recession, Allegiant Airlines increased capacity by 21% Sounds crazy, doesn’t it? But

it must know something, because while the other airlines were losing money, it was erating profits Consider also that its average one-way fare is only $83 So how does it make money? As a low-budget airline, it focuses on controlling costs It purchases used planes for $4 million each rather than new planes for $40 million It flies out of small towns, so wages are low and competition is nonexistent It only flies a route if its 150- passenger planes are nearly full (it averages about 90% of capacity) If a route isn’t fill- ing up, it quits flying it as often or cancels it altogether It adjusts its prices weekly The bottom line is that it knows its costs to the penny Knowing what your costs are might not be glamorous, but it sure beats losing money.

gen-Source: Susan Carey, “For Allegiant, Getaways Mean Profits,” Wall Street Journal Online, February 18, 2009.

Service Company Insight

What are some of the line items that would appear in the cost of services vided schedule of an airline?

pro-?

Managerial Accounting Today

In recent years, the competitive environment for U.S business has changed nificantly For example, the airline, financial services, and telecommunications industries have been deregulated Global competition has intensified The world economy now has the European Union, NAFTA, and ASEAN Countries like China and India are becoming economic powerhouses As indicated earlier, man- agerial accountants must be forward-looking, acting as advisors and informa- tion providers to different members of the organization Some of the issues they face are discussed below.

sig-THE VALUE CHAIN

serv-ice For a manufacturer these include research and development, product design, acquisition of raw materials, production, sales and marketing, delivery, customer relations, and subsequent service Illustration 1-13 depicts the value chain for a manufacturer In recent years, companies have made huge strides in analyzing all stages of the value chain in an effort to improve productivity and eliminate waste Japanese automobile manufacturer Toyota pioneered many of these innovations.

Identify trends in

managerial accounting

8study objective

manufacturer’s value chain

Speedy Delivery

Production Research &

Unlimited Warranty

In the 1980s many companies purchased giant machines to replace humans

in the manufacturing process These machines were designed to produce large batches of products In recent years these large-batch manufacturing processes have been recognized as very wasteful They require vast amounts of inventory storage capacity and considerable movement of materials Consequently, many companies have reengineered their manufacturing processes As one example, the manufacturing company Pratt and Whitney replaced many large machines with smaller, more flexible ones and reorganized its plants for more efficient flow of goods Pratt and Whitney reduced the time that its turbine engine blades spend in the grinding section of its factory from 10 days down to 2 hours It cut the total amount of time spent making a blade from 22 days to 7 days Analysis

of the value chain has made companies far more responsive to customer needs and has improved profitability.

TECHNOLOGICAL CHANGE

Technology has played a large role in the value chain Computerization and automation have permitted companies to be more effective in streamlining pro- duction and thus enhancing the value chain For example, many companies now employ enterprise resource planning (ERP) software systems to manage their value chain ERP systems provide a comprehensive, centralized, integrated source of information that companies can use to manage all major business processes, from purchasing to manufacturing to human resources.

In large companies, an ERP system might replace as many as 200 ual software packages For example, an ERP system can eliminate the need for individual software packages for personnel, inventory management, receivables, and payroll Because the value chain extends beyond the walls of the company, ERP systems enable a two-way flow of information between a company and its major suppliers, customers, and business partners Such systems both collect and disperse information throughout the value chain The largest ERP provider, German corporation SAP AG , has more than 36,000 customers worldwide.

individ-Another example of technological change is computer-integrated

manufac-turing (CIM) Using CIM, many companies can now manufacture products that are untouched by human hands An example is the use of robotic equipment in the steel and automobile industries Workers monitor the manufacturing process

by watching instrument panels Automation significantly reduces direct labor costs in many cases.

Also, the widespread use of computers has greatly reduced the cost of mulating, storing, and reporting managerial accounting information Computers now make it possible to do more detailed costing of products, processes, and services than was possible under manual processing.

accu-Technology is also affecting the value chain through business-to-business (B2B) e-commerce on the Internet The Internet has dramatically changed the way cor- porations do business with one another Interorganizational information systems connected over the Internet enable suppliers to share information nearly instan- taneously The Internet has also changed the marketplace, often cutting out intermediaries Industries such as the automobile, airline, hotel, and electronics industries have made commitments to purchase some or all of their supplies and raw materials in the huge B2B electronic marketplaces For example, Hilton Hotels

recently agreed to purchase as much as $1.5 billion of bed sheets, pest control services, and other items from an online supplier, PurchasePro.com

JUST-IN-TIME INVENTORY METHODS

Many companies have significantly lowered inventory levels and costs using

man-ufactured or purchased just in time for sale As noted in the Feature Story, Dell

Managerial Accounting Today 21

is famous for having developed a system for making computers in response to individual customer requests Even though each computer is custom-made to meet each customer’s particular specifications, it takes Dell less than 48 hours

to assemble the computer and put it on a truck By integrating its information systems with those of its suppliers, Dell reduced its inventories to nearly zero This is a huge advantage in an industry where products become obsolete nearly overnight.

QUALITY

JIT inventory systems require an increased emphasis on product quality If ucts are produced only as they are needed, it is very costly for the company to stop production because of defects or machine breakdowns Many companies have installed total quality management (TQM) systems to reduce defects in finished products The goal is to achieve zero defects These systems require timely data on defective products, rework costs, and the cost of honoring warranty contracts Often, companies use this information to help redesign the product

prod-in a way that makes it less prone to defects Or they may use the prod-information

to reengineer the production process to reduce setup time and decrease the potential for error TQM systems also provide information on nonfinancial meas- ures such as customer satisfaction, number of service calls, and time to gener- ate reports Attention to these measures, which employees can control, leads to increased profitability.

ACTIVITY-BASED COSTING

As discussed earlier, overhead costs have become an increasingly large nent of product and service costs By definition, overhead costs cannot be directly traced to individual products But to determine each product’s cost, over-

compo-head must be allocated to the various products In order to obtain more

accu-rate product costs, many companies now allocate overhead using activity-based

use of activities in making the product For example, companies can keep track

of their cost of setting up machines for each batch of a production process Then companies can allocate part of the total set-up cost to a particular product based

on the number of set-ups that product required.

Activity-based costing is beneficial because it results in more accurate uct costing and in more careful scrutiny of all activities in the value chain For example, if a product’s cost is high because it requires a high number of set-ups, management will be motivated to determine how to produce the product using the optimal number of machine set-ups Both manufacturing and service com- panies now widely use ABC Allied Signal and Coca-Cola have both enjoyed improved results from ABC Fidelity Investments uses ABC to identify which cus- tomers cost the most to serve.

prod-THEORY OF CONSTRAINTS

All companies have certain aspects of their business that create “bottlenecks’’— constraints that limit the company’s potential profitability An important aspect

of managing the value chain is identifying these constraints The theory of

to achieve the company’s goals Automobile manufacturer General Motors has implemented the theory of constraints in all of its North American plants GM has found that it is most profitable when it focuses on fixing bottlenecks, rather than worrying about whether all aspects of the company are functioning at full capacity It has greatly improved the company’s ability to effectively use over- time labor while meeting customer demand Chapter 6 discusses an application

of the theory of constraints.

Ethics Note Does just-in-time

inventory justify “just-in-time”

employees obtained through

temporary employment services?