ACCT Ch18

Comprehensive Notes on Chapter 18: Managerial Accounting Concepts and Principles

1. Introduction to Managerial Accounting

Managerial accounting provides financial and nonfinancial information to assist managers in decision-making, planning, and control. It is distinct from financial accounting, which focuses on external reporting.

Key Functions of Managerial Accounting

1. Planning: Setting goals and devising strategies to achieve them.

2. Control: Monitoring and evaluating activities and employee performance to ensure the organization meets its objectives.

2. Nature of Managerial Accounting

Managerial accounting is relevant across various career paths, including:

• Marketing: Sales and cost data help in product promotion decisions.

• Management: Sales force details aid in performance evaluation.

• Entrepreneurship: Budgeting and financial statements support business growth.

• Non-Profit and For-Profit Organizations: Used to make financial decisions and secure funding.

3. Cost Concepts in Managerial Accounting

3.1 Direct vs. Indirect Costs

• Direct Costs: Can be cost-effectively traced to a cost object (e.g., materials, labor for a specific product).

• Indirect Costs: Cannot be easily traced to a cost object (e.g., factory utilities, factory supervisor salary).

Cost Object Definition

A cost object is a product, process, department, or customer to which costs are assigned.

Examples (Manufacturing a Bike)

• Direct Costs: Tires, seats, frame, pedals, brakes.

• Indirect Costs: Factory rent, maintenance workers’ wages.

Exercise 1 Example (Classifying Costs for a Football)

• Indirect: Electricity used in the plant, salary of the plant manager, depreciation on maintenance equipment.

• Direct: Labor used on the football production line, leather used to make footballs.

4. Manufacturing Costs

Three main categories of manufacturing costs:

1. Direct Materials: Raw materials that are directly incorporated into the final product.

• Example: Leather for footballs, rubber for tennis balls.

2. Direct Labor: Wages and salaries paid to workers who directly manufacture the product.

• Example: Wages of assembly workers.

3. Factory Overhead: All indirect manufacturing costs, including:

• Indirect Labor: Maintenance workers, supervisors.

• Indirect Materials: Screws, glue, staples.

• Other Indirect Costs: Factory utility expenses.

Exercise 2 (Manufacturing a Tennis Ball)

• Direct Materials: Rubber used to form the cores, cans for packaging.

• Direct Labor: Wages paid to assembly workers.

• Factory Overhead: Factory maintenance, glue, depreciation on equipment.

5. Prime Costs and Conversion Costs

Manufacturing costs can also be categorized as:

• Prime Costs: Direct materials + Direct labor.

• Conversion Costs: Direct labor + Factory overhead (costs incurred to convert raw materials into finished goods).

Exercise 3 (Manufacturing a Guitar)

Classify costs as either:

1. Prime Costs

2. Conversion Costs

3. Both

6. Product Costs vs. Period Costs

• Product Costs: Costs directly related to manufacturing a product.

• Period Costs: Costs not tied to production but linked to a time period (e.g., administrative and selling expenses).

Examples:

• Product Costs: Factory insurance, depreciation on factory equipment, indirect labor in making goods.

• Period Costs: Sales commissions, depreciation on office equipment, office manager salary.

Exercise 4 (Classifying Costs)

• Product Cost: Depreciation on factory equipment, rent on factory.

• Period Cost: Tax accountant salary, office manager salary.

7. Cost Concepts for Service Companies

• Similar cost classifications apply to service businesses.

• Costs are categorized as direct materials, direct labor, overhead, selling, or administrative expenses.

8. Reporting Inventory on the Balance Sheet

Three types of inventory for manufacturers:

1. Raw Materials Inventory: Materials awaiting processing.

2. Work-in-Process Inventory: Goods currently in production.

3. Finished Goods Inventory: Completed products ready for sale.

Key difference among manufacturers, merchandisers, and service providers:

• Manufacturers report all three types of inventory.

• Merchandisers only report finished goods inventory.

• Service providers typically do not have inventory.

9. Reporting Costs in the Income Statement

The cost of goods manufactured and sold flows through financial statements:

• Manufacturing Costs → Cost of Goods Manufactured Statement → Cost of Goods Sold (COGS) on the Income Statement.

10. Lean Business Principles

• The goal is to eliminate waste while maximizing customer satisfaction and generating a positive return for the company.

• Continuous improvement challenges employees and managers to refine processes beyond “good enough.”

11. Just-In-Time (JIT) Manufacturing

• Aims to reduce inventory costs by receiving materials only when needed for production.

• Enhances efficiency and reduces waste.

12. Raw Materials Inventory Turnover & Days’ Sales in Raw Materials

• Measures how quickly raw materials are used in production.

• Helps managers assess inventory efficiency.

13. Exercises & Application

Exercise 5 (Direct vs. Indirect Costs)

• Direct: Leather for footballs.

• Indirect: Factory maintenance.

Exercise 6 (Classifying Manufacturing Costs for Tennis Balls)

• Direct Materials: Rubber cores, packaging cans.

• Direct Labor: Assembly worker wages.

• Overhead: Depreciation on equipment, glue costs.

Exercise 7 (Classifying Product and Period Costs)

• Product Costs: Factory insurance, indirect labor in making goods.

• Period Costs: Office manager salary, tax accountant salary.

Summary

• Managerial accounting supports decision-making within an organization.

• Cost classification (direct vs. indirect, product vs. period, prime vs. conversion) is critical for financial reporting.

• Manufacturing costs include direct materials, direct labor, and factory overhead.

• Lean principles & JIT manufacturing enhance operational efficiency.

These notes summarize Chapter 18: Managerial Accounting Concepts and Principles comprehensively, covering fundamental cost concepts, financial reporting, and practical applications.