part 2 book “accounting principles ii” has contents: managerial and cost accounting concepts, traditional cost systems, activity-based costing, cost-volume-profit relationships, incremental analysis, capital budgeting, flexible budgets and standard costs, budget.
CHAPTER MANAGERIAL AND COST ACCOUNTING CONCEPTS Financial statements are used by both external users and internal management and provide general information about the entire company For example, the balance sheet reports total inventories and the income statement reports cost of goods sold, but the costs of individual products are not disclosed to the public Internal management needs detailed information to make decisions about its business A comparison of managerial and financial accounting shows the differences between the two sets of information Managerial and Financial Accounting Comparison Managerial Accounting Financial Accounting Users Internal managers Creditors, investors, analysts, and other external users Guidelines for preparation Flexible GAAP—rigid Purpose Decision making and control information General information for credit and investment decisions Frequency of preparation As needed Annually and quarterly Independent opinion None required Auditor’s opinion Type of information Specific to project or management action— may be detailed and include estimates General purpose— very few estimates ACCOUNTING PRINCIPLES II 147 MANAGERIAL AND COST ACCOUNTING CONCEPTS Manufacturing Financial Statements Manufacturing companies have several different accounts compared to service and merchandising companies These include three types of inventory accounts—raw materials, work-in-process, and finished goods—and several long-term fixed asset accounts A manufacturing company uses purchased raw materials and/or parts to produce a product for sale At a point in time, the company’s inventories consist of raw materials, those materials and parts waiting to be used in production; work-in-process, all material, labor, and other manufacturing costs accumulated to date for products not yet completed; and finished goods, the cost of completed products that are ready to be sold The value of each type of inventory is disclosed in a company’s financial statements The amounts may be shown individually on the face of the balance sheet or disclosed in footnotes In the long-term asset section of a manufacturing company’s balance sheet, one would expect to find factory buildings and equipment and possibly a small tools account A manufacturer often has patents for its products or processes The capitalized costs associated with a patent would be included in the intangible asset section of the balance sheet The income statement for a manufacturing company is similar to that prepared for a merchandising company In calculating cost of goods sold, only the finished goods inventory account is used, as shown 148 CLIFFSQUICKREVIEW MANAGERIAL AND COST ACCOUNTING CONCEPTS Manufacturer Merchandiser Cost of goods sold Cost of goods sold Beginning finished $ 14,500 goods inventory Beginning merchandise inventory $10,300 Cost of goods manufactured Cost of goods purchased Goods available for sale Ending finished goods inventory Cost of goods sold 255,000 269,500 (12,600) $256,900 Goods available for sale 129,200 139,500 Ending inventory merchandise (10,600) Cost of goods sold $128,900 Costing Terminology Expenses on an income statement are considered product or period costs Product costs are those costs assigned to an inventory account that eventually become part of cost of goods sold Examples of manufacturing product costs are raw materials used, direct labor, factory supervisor’s salary, and factory utilities In a manufacturing company, product costs are also called manufacturing costs In a service company, product costs are also accumulated as inventory (such as the cost of an audit or of a will) Period costs are those costs recorded as an expense in the period they are incurred Selling expenses such as sales salaries, sales commissions, and delivery expense, and general and administrative expenses such as office salaries, and depreciation on office equipment, are all considered period costs In a manufacturing company, these costs are often referred to as nonmanufacturing costs There are three categories of manufacturing costs: direct materials, direct labor, and overhead ACCOUNTING PRINCIPLES II 149 MANAGERIAL AND COST ACCOUNTING CONCEPTS Direct materials are those materials (including purchased parts) that are used to make a product and can be directly associated with the product Some materials used in making a product have a minimal cost, such as screws, nails, and glue, or not become part of the final product, such as lubricants for machines and tape used when painting Such materials are called indirect materials and are accounted for as manufacturing overhead Direct labor is the cost of the workers who make the product The cost of supervisory personnel, management, and factory maintenance workers, although they are needed to operate the factory, are classified as indirect labor because these workers not use the direct materials to build the product Manufacturing overhead costs include indirect materials, indirect labor, and all other manufacturing costs Depreciation on factory equipment, factory rent, factory insurance, factory property taxes, and factory utilities are all examples of manufacturing overhead costs Together, the direct materials, direct labor, and manufacturing overhead are referred to as manufacturing costs The costs of selling the product are operating expenses (period cost) and not part of manufacturing overhead costs because they are not incurred to make a product The Cost of Goods Manufactured Schedule The cost of goods manufactured schedule is used to calculate the cost of producing products for a period of time The cost of goods manufactured amount is transferred to the finished goods inventory account during the period and is used in calculating cost of goods sold on the income statement The cost of goods manufactured schedule reports the total manufacturing costs for the period that were added to work-in-process, and adjusts these costs for the change in the work-in-process inventory account to calculate the cost of goods manufactured 150 CLIFFSQUICKREVIEW MANAGERIAL AND COST ACCOUNTING CONCEPTS Red Car, Inc Cost of Goods Manufactured Schedule For the Year Ended December 31, 20X0 Direct materials used Beginning raw materials inventory $ 6,200 Add: Cost of raw materials purchased 49,400 Total raw materials available 55,600 Less: Ending raw materials inventory (5,800) Total raw materials used $ 49,800 Direct labor 125,600 Manufacturing overhead Indirect materials Indirect labor 4,100 43,700 Depreciation—factory building 9,500 Depreciation—factory equipment 5,400 Insurance—factory Property taxes—factory Total manufacturing overhead Total manufacturing costs Add: Beginning work-in-process inventory 12,000 4,500 79,200 254,600 10,200 264,800 Less: Ending work-in-process inventory Cost of goods manufactured (9,800) $255,000 The cost of goods manufactured for the period is added to the finished goods inventory To calculate the cost of goods sold, the change in finished goods inventory is added to/subtracted from the cost of goods manufactured ACCOUNTING PRINCIPLES II 151 Sales $427,000 Cost of goods sold $ 14,500 Beginning finished goods inventory Cost of goods manufactured 255,000 Total goods available for sale 269,500 Ending finished goods inventory (12,600) Cost of goods sold 256,900 Gross profit 170,100 Operating expenses Selling expenses CLIFFSQUICKREVIEW Sales salaries Depreciation—sales equipment Total selling expenses $65,300 21,000 86,300 MANAGERIAL AND COST ACCOUNTING CONCEPTS 152 Red Car, Inc Income Statement For the Year Ended December 31, 20X0 ACCOUNTING PRINCIPLES II Administrative expenses Office salaries 35,000 Depreciation—office equipment 12,000 Insurance expense 9,000 Office supplies expense 2,400 Total administrative expenses Total operating expenses Income from operations Interest revenue 58,400 144,700 25,400 5,100 Income before taxes 30,500 Income taxes 10,675 Net income $ 19,825 MANAGERIAL AND COST ACCOUNTING CONCEPTS 153 MANAGERIAL AND COST ACCOUNTING CONCEPTS Accounting by Manufacturing Companies The accounting cycle is the same in a manufacturing company, merchandising company, and a service company Journal entries are used to record transactions, adjusting journal entries are used to recognize costs and revenues in the appropriate period, financial statements are prepared, and closing entries are recorded Raw material purchases are recorded in the raw material inventory account if the perpetual inventory method is used, or the raw materials purchases account if the periodic inventory method is used For example, using the periodic inventory method, the purchase of $750 of raw materials on account is recorded as an increase (debit) to raw materials purchases and an increase (credit) to accounts payable Date General Journal Account Title and Description Ref Debit Credit 20X0 May 27 Raw Materials Purchases 750 Accounts Payable—TLM Co 750 Purchase materials from TLM The entry to record payroll would include an increase (debit) to direct labor instead of wages expense and an increase (credit) to the withholding liability account and wages payable To record $1,000 wages for T Kaschalk, the entry would be: Date General Journal Account Title and Description Ref Debit Credit 20X0 May 31 Direct Labor Federal Income Taxes Payable FICA Taxes Payable 154 1,000 150.00 76.50 CLIFFSQUICKREVIEW MANAGERIAL AND COST ACCOUNTING CONCEPTS Date Account Title and Description Ref Debit Credit Credit Union Payable 50.00 Wages Payable 723.50 Record TK wages The factory building depreciation of $9,500 is classified as a manufacturing cost It is recorded with an increase (debit) to factory depreciation and an increase (credit) to accumulated depreciation—building Date General Journal Account Title and Description Ref Debit Credit 20X0 May 31 Factory Depreciation Expense Accumulated Depreciation— Building 9,500 9,500 Record factory building depreciation Some companies use one account, factory overhead, to record all costs classified as factory overhead If one overhead account is used, factory overhead would be debited in the previous entry instead of factory depreciation At the end of the cycle, the closing entries are prepared For a manufacturing company that uses the periodic inventory method, closing entries update retained earnings for net income or loss and adjust each inventory account to its period end balance A special account called manufacturing summary is used to close all the accounts whose amounts are used to calculate cost of goods manufactured The manufacturing summary account is closed to income summary Income summary is eventually closed to retained earnings The manufacturing accounts are closed first The closing entries that follow are based on the accounts included in the cost of goods manufactured schedule and income statement for Red Car, Inc ACCOUNTING PRINCIPLES II 155 MANAGERIAL AND COST ACCOUNTING CONCEPTS Date C1 General Journal Account Title and Description Ref Debit Raw Materials Inventory (Ending) 5,800 Work-in-Process Inventory (Ending) 9,800 Manufacturing Summary Credit 15,600 Adjust inventory balances C2 Manufacturing Summary Raw Materials Inventory (Beginning) 270,600 6,200 Work-in-Process Inventory (Beginning) 10,200 Raw Materials Purchases 49,400 Direct Labor Indirect Materials Indirect Labor 125,600 4,100 43,700 Depreciation— Factory Building 9,500 Depreciation— Factory Equipment 5,400 Insurance—Factory 12,000 Property Taxes—Factory 4,500 Close manufacturing accounts and adjust inventory balances 156 CLIFFSQUICKREVIEW CAPITAL BUDGETING When net cash flows are not all the same, the Present Value of an Annuity of table cannot be used Instead, a separate present value calculation must be made for each period’s cash flow A financial calculator or a spreadsheet can be used to calculate the present value Assume the same project information for the Cottage Gang’s investment except for net cash flows, which are summarized with their present value calculations below Period Estimated Annual Net Cash Flow (1) $ 44,000 8929 $ 39,288 55,000 7972 43,846 60,000 7118 42,708 57,000 6355 36,224 51,000 5674 28,937 44,000 5066 22,290 39,000 4523 17,640 Totals $350,000 12% Discount Factor * (2) Present Value (1) × (2) $230,933 *Taken from Appendix A 282 CLIFFSQUICKREVIEW CAPITAL BUDGETING The NPV of the project is $83,195, calculated as follows: Present Value of Cash Flows Annual Net Cash Flows Salvage Value ($5,000 × 4523)* Total Present Value of Net Cash Inflows $230,933 2,262 233,195 Less: Investment Cost (150,000) Net Present Value $ 83,195 * Taken from Appendix A The difference between the NPV under the equal cash flows example ($50,000 per year for seven years or $350,000) and the unequal cash flows ($350,000 spread unevenly over seven years) is the timing of the cash flows Most companies’ required rate of return is their cost of capital Cost of capital is the rate at which the company could obtain capital (funds) from its creditors and investors If there is risk involved when cash flows are estimated into the future, some companies add a risk factor to their cost of capital to compensate for uncertainty in the project and, therefore, in the cash flows Most companies have more project proposals than they funds available for projects They also have projects requiring different amounts of capital and with different NPVs In comparing projects for possible authorization, companies use a profitability index The index divides the present value of the cash flows by the required investment For the Cottage Gang, the profitability index of the project with equal cash flows is 1.54, and the profitability index for the project with unequal cash flows is 1.56 ACCOUNTING PRINCIPLES II 283 CAPITAL BUDGETING Profitability Index = Present Value of Cash Flows Required Investment Equal Cash Flows 1.54 = $230,452 $150,000 Unequal Cash Flows 1.56 = $233,195 $150,000 Internal rate of return The internal rate of return also uses the present value concepts The internal rate of return (IRR) determines the interest yield of the proposed capital project at which the net present value equals zero, which is where the present value of the net cash inflows equals the investment If the IRR is greater than the company’s required rate of return, the project may be accepted To determine the internal rate of return requires two steps First, the internal rate of return factor is calculated by dividing the proposed capital investment amount by the net annual cash inflow Then, the factor is found in the Present Value of an Annuity of table using the service life of the project for the number of periods The discount rate that the factor is the closest to is the internal rate of return A project for Knightsbridge, Inc., has equal net cash inflows of $50,000 over its seven-year life and a project cost of $200,000 By dividing the cash flows into the project investment cost, the factor of 4.00 ($200,000 ÷ $50,000) is found The 4.00 is looked up in the Present Value of an Annuity of table on the seven-period line (it has a seven-year life), and the internal rate of return of 16% is determined (see Appendix B) 284 CLIFFSQUICKREVIEW CAPITAL BUDGETING Annual rate of return method The three previous capital budgeting methods were based on cash flows The annual rate of return uses accrual-based net income to calculate a project’s expected profitability The annual rate of return is compared to the company’s required rate of return If the annual rate of return is greater than the required rate of return, the project may be accepted The higher the rate of return, the higher the project would be ranked The annual rate of return is a percentage calculated by dividing the expected annual net income by the average investment Average investment is usually calculated by adding the beginning and ending project book values and dividing by two Annual Rate of Return = Estimated Annual Net Income Average Investment Assume the Cottage Gang has expected annual net income of $5,572 with an investment of $150,000 and a salvage value of $5,000 This proposed project has a 7.2% annual rate of return ($5,572 net income ÷ $77,500 average investment) Annual Rate of Return = Estimated Annual Net Income / Average Investment 7.2% = $5,572 / $77,500 (1) (2) ACCOUNTING PRINCIPLES II 285 CAPITAL BUDGETING (1) Accrual Basis Income Statement Revenues Operating Expenses $310,000 280,000 Depreciation Expense (A) 20,714 Income before Taxes 9,286 Income Taxes (40%) 3,714 Net Income (A) $ 5,572 Straight-line with cost of $150,000, salvage value of $5,000, and a service life of seven years $150, 000 - $5, 000 (2) Calculation of Average Investment Beginning Investment $150,000 Ending Investment (Salvage Value) 5,000 155,000 Divide for Average Average Investment ÷ $ 77,500 The annual rate of return should not be used alone in making capital budgeting decisions, as its results may be misleading It uses accrual basis of accounting and not actual cash flows or time value of money 286 CLIFFSQUICKREVIEW 4% 5% 6% 14% 16% 18% 20% 22% 287 0.9804 0.9615 0.9524 0.9434 0.9259 0.9091 0.8929 0.8772 0.8621 0.8475 0.8333 0.8197 0.9612 0.9246 0.9070 0.8900 0.8573 0.8264 0.7972 0.7695 0.7432 0.7182 0.6944 0.6719 0.9423 0.8890 0.8638 0.8396 0.7938 0.7513 0.7118 0.6750 0.6407 0.6086 0.5787 0.5507 0.9238 0.8548 0.8227 0.7921 0.7350 0.6830 0.6355 0.5921 0.5523 0.5158 0.4823 0.4514 0.9057 0.8219 0.7835 0.7473 0.6806 0.6209 0.5674 0.5194 0.4761 0.4371 0.4019 0.3700 0.8880 0.7903 0.7462 0.7050 0.6302 0.5645 0.5066 0.4556 0.4104 0.3704 0.3349 0.3033 0.8706 0.7599 0.7107 0.6651 0.5835 0.5132 0.4523 0.3996 0.3538 0.3139 0.2791 0.2486 0.8535 0.7307 0.6768 0.6274 0.5403 0.4665 0.4039 0.3506 0.3050 0.2660 0.2326 0.2038 0.8368 0.7026 0.6446 0.5919 0.5002 0.4241 0.3606 0.3075 0.2630 0.2255 0.1938 0.1670 10 0.8203 0.6756 0.6139 0.5584 0.4632 0.3855 0.3220 0.2697 0.2267 0.1911 0.1615 0.1369 11 0.8043 0.6496 0.5847 0.5268 0.4289 0.3505 0.2875 0.2366 0.1954 0.1619 0.1346 0.1122 12 0.7885 0.6246 0.5568 0.4970 0.3971 0.3186 0.2567 0.2076 0.1685 0.1372 0.1122 0.0920 13 0.7730 0.6006 0.5303 0.4688 0.3677 0.2897 0.2292 0.1821 0.1452 0.1163 0.0935 0.0754 14 0.7579 0.5775 0.5051 0.4423 0.3405 0.2633 0.2046 0.1597 0.1252 0.0985 0.0779 0.0618 APPENDIX A ACCOUNTING PRINCIPLES II Period 2% Present Value of 8% 10% 12% 2% 4% 5% 6% 16% 18% 20% 22% 15 0.7430 0.5553 0.4810 0.4173 0.3152 0.2394 0.1827 0.1401 0.1079 0.0835 0.0649 0.0507 16 0.7284 0.5339 0.4581 0.3936 0.2919 0.2176 0.1631 0.1229 0.0930 0.0708 0.0541 0.0415 17 0.7142 0.5134 0.4363 0.3714 0.2703 0.1978 0.1456 0.1078 0.0802 0.0600 0.0451 0.0340 18 0.7002 0.4936 0.4155 0.3503 0.2502 0.1799 0.1300 0.0946 0.0691 0.0508 0.0376 0.0279 19 0.6864 0.4746 0.3957 0.3305 0.2317 0.1635 0.1161 0.0829 0.0596 0.0431 0.0313 0.0229 20 0.6730 0.4564 0.3769 0.3118 0.2145 0.1486 0.1037 0.0728 0.0514 0.0365 0.0261 0.0187 APPENDIX A 288 Period Present Value of 8% 10% 12% 14% CLIFFSQUICKREVIEW 4% 5% 16% 18% 20% 22% 0.9804 0.9615 0.9524 0.9434 0.9259 0.9091 0.8929 0.8772 0.8621 0.8475 0.8333 0.8197 1.9416 1.8861 1.8594 1.8334 1.7833 1.7355 1.6901 1.6467 1.6052 1.5656 1.5278 1.4915 2.8839 2.7751 2.7232 2.6730 2.5771 2.4869 2.4018 2.3216 2.2459 2.1743 2.1065 2.0422 3.8077 3.6299 3.5460 3.4651 3.3121 3.1699 3.0373 2.9137 2.7982 2.6901 2.5887 2.4936 4.7135 4.4518 4.3295 4.2124 3.9927 3.7908 3.6048 3.4331 3.2743 3.1272 2.9906 2.8636 5.6014 5.2421 5.0757 4.9173 4.6229 4.3553 4.1114 3.8887 3.6847 3.4976 3.3255 3.1669 6.4720 6.0021 5.7864 5.5824 5.2064 4.8684 4.5638 4.2883 4.0386 3.8115 3.6046 3.4155 7.3255 6.7327 6.4632 6.2098 5.7466 5.3349 4.9676 4.6389 4.3436 4.0776 3.8372 3.6193 8.1622 7.4353 7.1078 6.8017 6.2469 5.7590 5.3282 4.9464 4.6065 4.3030 4.0310 3.7863 289 10 8.9826 8.1109 11 9.7868 8.7605 8.3064 7.8869 7.1390 6.4951 5.9377 5.4527 5.0286 4.6560 4.3271 4.0354 12 10.5753 9.3851 8.8633 8.3838 7.5361 6.8137 6.1944 5.6603 5.1971 4.7932 4.4392 4.1274 13 11.3484 9.9856 9.3936 8.8527 7.9038 7.1034 6.4235 5.8424 5.3423 4.9095 4.5327 4.2028 14 12.1062 10.5631 9.8986 9.2950 8.2442 7.3667 6.6282 6.0021 5.4675 5.0081 4.6106 4.2646 7.7217 7.3601 6.7101 6.1446 5.6502 5.2161 4.8332 4.4941 4.1925 3.9232 APPENDIX B ACCOUNTING PRINCIPLES II Period 2% Present Value of an Annuity of 6% 8% 10% 12% 14% 4% 5% 16% 18% 20% 22% 15 12.8493 11.1184 10.3797 9.7122 8.5595 7.6061 6.8109 6.1422 5.5755 5.0916 4.6755 4.3152 16 13.5777 11.6523 10.8378 10.1059 8.8514 7.8237 6.9740 6.2651 5.6685 5.1624 4.7296 4.3567 17 14.2919 12.1657 11.2741 10.4773 9.1216 8.0216 7.1196 6.3729 5.7487 5.2223 4.7746 4.3908 18 14.9920 12.6593 11.6896 10.8276 9.3719 8.2014 7.2497 6.4674 5.8178 5.2732 4.8122 4.4187 19 15.6785 13.1339 12.0853 11.1581 9.6036 8.3649 7.3658 6.5504 5.8775 5.3162 4.8435 4.4415 20 16.3514 13.5903 12.4622 11.4699 9.8181 8.5136 7.4694 6.6231 5.9288 5.3527 4.8696 4.4603 APPENDIX B 290 Period 2% Present Value of an Annuity of 6% 8% 10% 12% 14% CLIFFSQUICKREVIEW Notes Notes Notes Notes Notes Notes ... Stop 120 0 1700 120 0 1700 120 0 1700 Total Hours 4 4 4 Hourly Rate 25 25 25 25 25 25 Total Approved by: MJM Supervisor Total Cost 100 100 100 100 100 100 600 Costed by: MJM Accounting Department... Requisition # Cost R-1396 11,000 Date 6 /22 6 /22 6 /29 6 /29 7/6 7/6 7/13 7/13 Total 11,000 Total Time Ticket L-1034 L-1035 L -29 55 L -29 56 L-3179 L-3180 L -21 93 L -21 94 Manufacturing Overhead Cost 1,000... Summary C2 27 0,600 15,600 C1 25 5,000 25 5,000 C3 158 CLIFFSQUICKREVIEW MANAGERIAL AND COST ACCOUNTING CONCEPTS Income Summary C3 C5 25 5,000 169,875 444,700 C4 424 ,875 444,700 19, 825 C6 19, 825 Retained