Two Chapter Basic Managerial Accounting Concepts
Learning Objectives
1. Explain the meaning of cost and how costs are assigned to products and services. 2. Define the various costs of manufacturing products and providing services as well as the costs of selling and administration. 3. Prepare income statements for manufacturing and service organizations.
OBJECTIVE 1
Explain the meaning of cost and how costs are assigned to products and services.
Cost
Amount of cash or cash equivalent sacrificed for goods and/or services Expected to bring a current or future benefit to the organization
Lets look at an example
Example
A wood furniture manufacturer buys lumber for $10,000
Therefore: Cost of the lumber is the amount given up $10,000
Expenses
As costs are used up in the production of revenues, they are said to expire.
Expired costs are calledExpenses
Cost vs. Price
Be careful! Cost and Price are not the same thing Price Cost
What we pay for something Amount we charge our customers for our products or services
Accumulating Costs
Received telephone bill
Phone Bill $150
Telephone Expense
Recorded in Telephone Expense account
Bal. $800 + $150 $950
Accumulating Costs
This is helpful but managers also need to know which departments used the $950 in Telephone Expense
Telephone Expense
Bal. $800 + $150 $950
In other words, managers want to know how costs are assigned to cost objects.
Cost Objects
Any item for which costs are measured and assigned Examples:
Products Customers Departments Regions
Lets continue with out example
Assigning Costs
Sales Dept.
Lets say the Telephone Expense was incurred by the Sales and the Manufacturing Departments
The Sales and Manufacturing departments are cost objects
Manufacturing Dept.
Assigning Costs
Sales Dept. Telephone Expense
$350
Bal. $800 + $150 $950
Manufacturing Dept.
$600 The accountant assigns the Telephone Expense to the two cost objects.
Assigning Costs
Costs can be assigned in a number of ways Some methods are more accurate, but time consuming While others are quite simple but not as precise
These methods will be discussed in the succeeding chapters.
Direct Costs
Costs that can be easily and accurately traced to a cost object Relationship between the cost and the object can be physically observed
Indirect Costs
Costs that cannot be easily traced to a cost object Relationship between the cost and the object not easily observed Assigned through allocation
Other Categories of Cost
Variable Cost = Increases in total as output increases and decreases in total as output decreases Fixed Cost = Total does not increase as output increases and does not decrease as output decreases
Other Categories of Cost
Opportunity Cost = Benefit given up or sacrificed when one alternative is chosen over another
OBJECTIVE 2
Define the various costs of producing products and services, as well as the costs of selling and administration.
Output
One of the most important cost objects of a company is its output. Two types of output:
Tangible Products Services
Tangible Products
Goods produced by converting raw materials through the use of labor and capital inputs. Produced by manufacturing organizations.
Services
Tasks or activities performed for a customer or an activity performed by a customer using an organizations products or facilities. Produced by services organizations.
Cost Types
Product costs
Associated with the manufacture of goods or the provision of services
Nonproduction costs
All other costs
Nonproduction Costs
Examples:
These are Selling Costs
Distribution Customer Service Marketing
Nonproduction Costs
Examples:
Designing Developing General Administration
These are Administrative Costs
Product Cost Classifications
Only three cost elements can be assigned to products for financial reporting:
Direct Materials Direct Labor Overhead
Direct Materials
Materials that are a part of the final product and can be directly traced to the goods and services being produced.
Direct Labor
Labor that can be directly traced to the goods or services being produced.
Overhead
All product costs other than direct materials or direct labor.
Supplies Indirect Materials Utilities Indirect Labor
Total Product Cost
Total Product Cost
=
Direct + Materials
Direct + Overhead Labor
Even these guys could figure this one out !!!
Product Cost Per Unit
Unit Cost = Total Product Cost Number of Units Produced
Lets work through an example
Example
Information: BlueDenim Company makes blue jeans. Last week:
Direct materials (denim, thread, zippers, and rivets) costing $48,000 were put into production Direct labor of $30,000 (50 workers x 40 hours x $15 per hour) was incurred
By the end of the week, the company had manufactured 30,000 pairs of jeans
Example
Required:
Calculate the total product cost for last week Calculate the cost of one pair of jeans that were produced last week
Now that we know what we have to do, lets get started!
Total Product Cost
Direct Materials + Direct Labor + Overhead Direct Materials Direct Labor Overhead
$48,000 30,000 72,000
Total Product Cost $150,000
Per Unit Cost
Total Product Cost Number of Units Produced
$150,000 30,000
= $5 per pair of jeans
Example
Information:
BlueDenim Company makes blue jeans. Last week:
Direct materials (denim, thread, zippers, and rivets) costing $48,000 were put into production Direct labor of $30,000 (50 workers x 40 hours x $15 per hour) was incurred
By the end of the week, the company had manufactured 30,000 pairs of jeans
Example
Now that we know what we have to do, lets get started!
Required: Calculate the total prime cost for last week Calculate the per-unit prime cost Calculate the total conversion cost for last week Calculate the per-unit conversion cost
Prime Costs
Direct Materials
$48,000 Prime Costs per unit
+ +
Direct Labor
$30,000
=
$78,000 30,000
Units produced
=
$2.60
Conversion Costs
Direct Labor + Overhead
It is the cost of converting raw materials into a final product
Conversion Costs
Direct Labor
$30,000 Conversion Costs per unit
+ + =
Overhead
$72,000
$102,000 30,000
Units produced
=
$3.40
Period Costs
Unlike product costs which are carried in inventory; period costs are expensed in the period in which they are incurred.
Two categories of period costs: Selling Costs and Administrative Costs
Selling Costs
Costs necessary to market, distribute, and service a product or service. Examples:
Salaries and commissions of sales people Advertising Warehousing Customer Service Shipping
Administrative Costs
All associated costs with research, development, and general administration of the organization that cannot reasonably be assigned to either selling or production. Examples:
General Accounting Top Executive Salaries Legal Fees Expenses of printing the annual report
OBJECTIVE 3
Prepare income statements for manufacturing and service organizations.
Cost of Goods Manufactured
Total product cost of goods completed during the current period Direct Materials + Direct Labor + Overhead
Sounds simple enough. But theres more to it than meets the eye.
Direct Materials Used
Lets go through an example.
Only the amount used on products produced during the current period Consider beginning and ending inventory levels Key point: Purchases do not equal materials used
Example
Information: BlueDenim Company makes blue jeans. On May 1, BlueDenim had $68,000 of materials in inventory During the month of May, the company purchased $210,000 of materials. On May 31, materials inventory equaled $22,000.
Example Required:
Calculate the direct materials used in production for the month of May.
Direct Materials
Beginning Ending Materials + Purchases - Materials Inventory Inventory $68,000 Materials = Used in Production
+ $210,000 - $22,000 = $256,000
Second type of inventory Cost of partially completed goods that are still on the factory floor at the end of the period Units are started, but not finished Included direct materials, direct labor, and overhead costs
Work in Process
Example
Information: BlueDenim Company makes blue jeans. During the month of May, the company purchased $210,000 of materials On May 31, materials inventory equaled $22,000 During the month of May, BlueDenim Company incurred:
Direct labor cost of $135,000 Overhead of $150,000
Example
Information continued: Inventory information is as follows: May 1 $68,000 50,000 May 31 $22,000 16,000
Materials Work in Process
Example
Required:
Calculate the cost of goods manufactured for the month of May. Calculate the cost of one pair of jeans assuming that 115,000 pairs of jeans were completed during May.
BlueDenim Company Cost of Goods Manufactured For the Month of May
Direct materials Direct labor Overhead Total Manufacturing Cost Work in Process, May 1 Cost of Goods Manufactured Per unit Cost of Goods Manufactured $575,000 115,000 units $256,000 135,000 150,000 $541,000 50,000 $575,000 = $5
Example
Information:
On May 1 BlueDenim Company had 10,000 units in finished goods inventory costing $50,000 On May 31 the company had 26,000 units in finished goods inventory costing $130,000
Example
Required:
Calculate the cost of goods sold for the month of May. Calculate the number of pairs of jeans that were sold during May.
Cost of Goods Sold
Represent the total cost of units sold during a period Includes only product cost Includes direct materials, direct labor, and overhead Reported as an expense on the income statement
Sold is the key word. Lets continue with our example
BlueDenim Company Cost of Goods Sold For the Month of May
Cost of goods manufactured Finished goods, May 1 Finished goods, May 31 Cost of Goods Sold
$575,000 50,000 (130,000) $495,000
Reported as an expense on the Income Statement
BlueDenim Company Cost of Goods Sold For the Year Ended December 31, 2010
Cost of goods manufactured Finished goods, May 1 Finished goods, May 31 Cost of Goods Sold
Reported as an asset on the Balance Sheet
$575,000 50,000 (130,000) $495,000
Units Sold
Number of units sold: Finished goods inventory, May 1 Units finished during May Finished goods inventory, May 31 Units sold during May 10,000 115,000 (26,000) 99,000
Example
Required: Prepare an income statement for BlueDenim for the month of May.
Example
Information: BlueDenim Company sold 99,000 pairs of jeans during the month of May at a total cost of $495,000 Each pair sold at a price of $8 BlueDenim also incurred two types of selling costs:
Commissions equal to 10% of the sales price Other selling expense of $120,000
Administrative expense totaled $85,000
BlueDenim Income Statement For the Month of May Sales revenue $792,000
99,000 rockers x $8
BlueDenim Company Income Statement For the Month of May Sales revenue Cost of goods sold Gross margin
Gross Margin is the difference between sales revenue and cost of goods sold.
$792,000 495,000 $297,000
BlueDenim Income Statement For the Month of May Sales revenue Cost of goods sold Gross margin Less: Selling expense: Commissions $ 79,200 120,000 Fixed selling expense Administrative expense Operating income
$792,000 x 10%
$792,000 495,000 $297,000
199,200 85,000 $ 12,800
BlueDenim Company Income Statement For the Month of May
Sales revenue Cost of goods sold Gross margin Less: Selling expense: Commissions $ 79,200 Fixed selling expense 120,000 Administrative expense Operating income $792,000 495,000 $297,000
% 100.0
199,200 85,000 $ 12,800
Each item is divided by Sales revenue. For example, $792,000/$792,000 = 100%
BlueDenim Income Statement For the Month of May
Sales revenue Cost of goods sold Gross margin Less: Selling expense: Commissions $ 79,200 Fixed selling expense 120,000 Administrative expense Operating income $792,000 495,000 $297,000
% 100.0 62.5 $495,000/ $792,000 = 62.5%
199,200 85,000 $ 12,800
BlueDenim Income Statement For the Month of May
Sales revenue Cost of goods sold Gross margin Less: Selling expense: Commissions $ 79,200 Fixed selling expense 120,000 Administrative expense Operating income $792,000 495,000 $297,000
% 100.0 62.5 37.5
199,200 85,000 $ 12,800
25.2 10.7 1.6
How would an Income Statement for a service business be different that this Income Statement?
Example
Required: Prepare an income statement for Komala Information Systems for the past for the month.
Example
Information: Komala Information Systems designs and installs software for small companies. Last month, Komala had costs of:
Materials, $5,000 Direct labor, $35,000 Overhead, $55,000 Selling expenses, $5,000 Administrative expenses, $7,000
Sales totaled $130,000
Income Statement Service Organization
Materials Labor Overhead
Cost of services sold is typically made up of:
No beginning or ending finished goods inventories. Cost of Services Sold will always equal Cost of Services Manufactured.
Komala Information Systems Income Statement For the Past Month Sales Cost of services sold Direct materials Direct labor Overhead Gross margin Less: Selling expense Administrative expense Operating income $130,000 $ 5,000 35,000 55,000
95,000 $35,000 5,000 7,000 $23,000
The End