Managerial Accounting: Planning, Cost Concepts, and Financial Reporting for Manufacturing Businesses

Overview of Managerial Accounting

• Purpose of Managerial Accounting:     * The primary objective is to provide information that is useful to the managers of an organization.     * It is designed for internal users within the company.

• Activity Comparisons: Financial Accounting vs. Managerial Accounting:     * Users of Reports: Financial accounting serves external users (e.g., stockholders, creditors, regulators), whereas Managerial accounting serves internal users (Management).     * Types and Frequency of Reports: Financial accounting focuses on financial statements issued annually or quarterly. Managerial accounting produces internal reports as frequently as needed.     * Content of Reports: Financial accounting covers the company as a whole. Managerial accounting focuses on both the company as a whole and various segments or departments.     * Verification: Financial accounting reports are audited by independent external auditors. Managerial accounting has no requirement for independent audits.

• Main Activities of Management Supported by Managerial Accounting:     1. Planning: The process of establishing organizational goals and specifying how to achieve them. A primary example of this activity is the creation of budgets.     2. Directing: This involves coordinating a company's diverse activities and human resources to maintain a smooth-running operation. It includes implementing planned objectives and providing appropriate incentives and motivation.         * Example of Failure in Directing: The scandals involving Wells Fargo are cited as an example where appropriate targets and incentives were not implemented correctly. (Reference: CNN Article on Wells Fargo phony accounts culture).     3. Controlling: The process of gathering feedback to ensure the plan is being followed or modified as circumstances change. This keeps the company on its intended track.

• Relevance to Management:     * Managerial accounting focuses on measurement skills used daily by managers.     * Key questions addressed include:         * How will profits change if the selling price is adjusted?         * How should a financial plan be created for the upcoming year?

• Business Focus:     * While many concepts apply to service companies, the primary focus of this course/material is on manufacturing companies.

Cost Concepts and Classifications

• Managerial Need for Cost Information:     * Effective planning, directing, and controlling require accurate information regarding:         * The costs involved in making a product.         * How costs change when production volume decreases.         * Methods for controlling costs effectively.

• Manufacturing Costs (Product Costs):     * Manufacturing converts raw materials into finished products through various activities and processes. There are three primary types of manufacturing costs:

    1. Direct Materials (DM):         * Definition: Raw materials and parts that can be physically and directly associated with the finished product during the manufacturing process.         * Examples: Flour used in baking bread, syrup used in bottling soft drinks, and steel used in automobile manufacturing.

    2. Direct Labor (DL):         * Definition: Factory labor costs that can be physically and directly traced to the conversion of raw materials into finished goods.         * Examples: Bottlers at Coca-Cola and bakers at Sara Lee.

    3. Manufacturing Overhead (MOH):         * Definition: All manufacturing costs except direct materials and direct labor. These are costs incurred in manufacturing that cannot be easily or conveniently traced to the product.         * Indirect Materials: Raw materials that cannot be easily traced to a finished product or are relatively insignificant (e.g., small quantities of glue or solder).         * Indirect Labor: Labor costs that cannot be easily traced to the product, such as factory maintenance staff or factory supervisors.         * Additional Examples of MOH:             * Maintenance and repairs on production equipment.             * Factory heat and lighting.             * Factory property taxes.             * Factory depreciation.             * Insurance on manufacturing facilities.

• Product Costs Definition and Accounting:     * Product costs are necessary and integral parts of producing the finished product (DM + DL + MOH).     * Accounting Treatment: All product costs are recorded as Inventory on the balance sheet. They do not become expenses until the product is sold, at which point they are reported as Cost of Goods Sold ($COGS$) on the income statement.

Nonmanufacturing Costs (Period Costs)

• Period Costs Definition:     * These are all costs that are not manufacturing costs. They are not reported on the balance sheet as inventory. Instead, they are expensed directly on the income statement during the period in which they are incurred.

• Components of Period Costs:     1. Selling Costs: Costs incurred to secure customer orders and get the finished product to the customer.         * Examples: Advertising, shipping, sales commissions, and sales salaries.     2. Administrative Costs: Costs associated with general management rather than manufacturing or selling.         * Examples: Executive compensation, office salaries, and accounting costs.

• Case Study: KRT Boards Snowboard Factory:     * Property taxes on factory building: Product Cost (Manufacturing Overhead) | $6,000$ per year.     * Advertising costs: Period Cost (Selling) | $60,000$ per year.     * Sales commissions: Period Cost (Selling) | $20$ per board.     * Maintenance salaries (factory facilities): Product Cost (Manufacturing Overhead / Indirect Labor) | $45,000$ per year.     * Salary of plant manager: Product Cost (Manufacturing Overhead / Indirect Labor) | $70,000$ per year.     * Cost of shipping boards: Period Cost (Selling) | $8$ per board.

Financial Statements and Inventory Management

• Differences Between Merchandisers and Manufacturers:     * Income Statement: The difference lies in the Cost of Goods Sold section.     * Balance Sheet: The difference lies in the Current Assets section specifically regarding inventory.

• Comparison of COGS Sections (Income Statement):     * Merchandising Company:         * $\text{Inventory, Jan. 1} + \text{Cost of Goods Purchased} = \text{Cost of Goods Available for Sale}$         * $\text{Cost of Goods Available for Sale} - \text{Inventory, Dec. 31} = \text{Cost of Goods Sold}$     * Manufacturing Company:         * $\text{Finished Goods Inventory, Jan. 1} + \text{Cost of Goods Manufactured (COGM)} = \text{Cost of Goods Available for Sale}$         * $\text{Cost of Goods Available for Sale} - \text{Finished Goods Inventory, Dec. 31} = \text{Cost of Goods Sold}$

• Three Types of Inventory for Manufacturers:     1. Raw Materials: Materials designated to go into the final product.     2. Work in Process (WIP): Partially complete production units requiring further work before they are ready for sale.     3. Finished Goods (FG): Completed units of product that have not yet been sold to customers.

Flow of Product Costs

• Cycle of Costs:     1. Raw Materials Purchases: Recorded in Raw Materials Inventory (Balance Sheet).     2. Production Usage: Direct materials are transferred from Raw Materials to Work in Process Inventory (Balance Sheet). Direct labor and Manufacturing Overhead are also added here.     3. Completion: Completed goods (represented by Cost of Goods Manufactured) move from Work in Process to Finished Goods Inventory (Balance Sheet).     4. Sale: Once sold, costs move from Finished Goods Inventory to Cost of Goods Sold ($COGS$) on the Income Statement.

• Conversion Costs: The combination of Direct Labor ($DL$) and Manufacturing Overhead ($MOH$), representing the costs to convert raw materials into finished products.

Cost of Goods Manufactured (COGM) Schedule

• A separate schedule used to determine the cost of products finished during the period. It summarizes costs transferred from Work in Process into Finished Goods.

• Elements of the Schedule:     * Direct Materials Used: $\text{Beginning Raw Materials Inventory} + \text{Raw Material Purchases} = \text{Total Raw Materials Available for Use}$. Then, $\text{Total Available} - \text{Ending Raw Materials Inventory} = \text{Direct Materials Used}$.     * Total Manufacturing Costs: $\text{Direct Materials Used} + \text{Direct Labor} + \text{Total Manufacturing Overhead}$.     * Cost of Goods Manufactured: $\text{Beginning Work in Process Inventory} + \text{Total Manufacturing Costs} = \text{Total Cost of Work in Process}$. Then, $\text{Total Cost of WIP} - \text{Ending Work in Process Inventory} = \text{Cost of Goods Manufactured}$.

Comprehensive Calculations and Practice Examples

• Example 1: Classification Practice     * Given: DM = $69,000$; DL = $35,000$; MOH = $14,000$; Selling Expenses = $29,000$; Administrative Expenses = $50,000$.     * Product Costs: $69,000 + 35,000 + 14,000 = 118,000$.     * Period Costs: $29,000 + 50,000 = 79,000$.

• Example 2: Cost of Direct Materials Used     * Beginning DM Inventory: $32,000$     * DM Purchases: $276,000$     * Ending DM Inventory: $28,000$     * Calculation: $32,000 + 276,000 - 28,000 = 280,000$.

• Example 3: Total Manufacturing Costs Incurred for the Month     * DM Used: $280,000$     * DL: $375,000$     * MOH: $180,000$     * Calculation: $280,000 + 375,000 + 180,000 = 835,000$.

• Example 4: Cost of Goods Manufactured ($COGM$)     * Beginning WIP: $125,000$     * Mfg costs added in month: $835,000$     * Ending WIP: $200,000$     * Calculation: $125,000 + 835,000 - 200,000 = 760,000$.

• Example 5: Cost of Goods Sold ($COGS$)     * Beginning FG: $130,000$     * COGM: $760,000$     * Ending FG: $150,000$     * Calculation: $\text{Beg. FG } (130,000) + \text{ COGM } (760,000) = \text{ CO Available for Sale } (890,000)$.     * Calculation: $\text{CO Available for Sale } (890,000) - \text{ End. FG } (150,000) = 740,000$.