MANAGERIAL ACCOUNTING

Garrison, Noreen, Brewer (latest edition)

 Accounting
definition
The systematic and comprehensive recording
of financial transactions pertaining to a
business
Or
The systematic recording, reporting,
and analysis of financial transactions of a
business
 Types Of Accounting

• Financial Accounting
• Tax Accounting
• Management Accounting
 Financial Accounting

Financial accounting is the process of

producing information for external use usually
in the form of financial statements. Financial
Statements reflect an entity's past performance
and current position based on a set of
standards and guidelines known as GAAP
(Generally Accepted Accounting Principles).
 Tax Accounting
• Tax Accounting refers to accounting for the
tax related matters. It is governed by the tax
rules prescribed by the tax laws of a
jurisdiction. Often these rules are different
from the rules that govern the preparation of
financial statements for public use (i.e.
GAAP).
 Management Accounting
• Management Accounting produces information primarily for
internal use by the company's management. The information
produced is generally more detailed than that produced for external
use to enable effective organization control and the fulfillment of the
strategic aims and objectives of the entity. Information may be in the
form budgets and forecasts, enabling an enterprise to plan
effectively for its future or may include an assessment based on its
past performance and results. The form and content of any report
produced in the process is purely upon management's discretion.
• Cost Accounting is a branch of management accounting and
involves the application of various techniques to monitor and
control costs. Its application is more suited to manufacturing
concerns.
 Internal users of accounting
information
• Board of directors
• Chief executive officer
• Chief financial office
• Vice-presidents (information systems, human
resources, treasurer, and so forth)
• Business unit managers
• Plant managers
• Store managers
• Line supervisors
 External users of accounting
information
• External users of accounting information are individuals and other
enterprises that have a financial interest in the reporting enterprise,
but are not involved in the day-to-day operations of that enterprise.
• Owners or an investor(he is not an owner-manager)
• Creditors
• Labor unions
• Governmental agencies
• Suppliers
• Customers
• Trade associations
• General public
 CHAPTER 1
MANAGERIAL ACCOUNTING AND THE
BUSINESS ENVIRONMENT
• Every organization-large and small-has managers
• Someone must be responsible for making plans,
organizing resources, directing personnel, and
controlling operations

• Managers everywhere carry out 3 major activities:

1)Planning
2)Directing and motivating
3)Controlling
• Planning involves selecting a course of action and
specifying how the action will be implemented
• Directing and motivating involves mobilizing people
to carry out plans and run routine operations
• Controlling involves ensuring that the plan is actually
carried out and is appropriately modified as
circumstances change
• Management accounting information plays a vital
role in these basic management activities- but most
particularly in the planning and control functions
Comparison of Financial and
Managerial Accounting
 Chapter 2
Cost Terms, Concepts, and Classifications
• To carry out planning and control responsibilities, managers
need information about the organization. This information
often relates to the costs of the organization.
• In managerial accounting, the term cost is used in many
different ways
• The reason is that there are many types of costs, and these
costs are classified differently according to the immediate
needs of management
 ORGANIZATIONS
• Manufacturing
• Merchandising
• Service
 GENERAL COST CLASSIFCATIONS

• Manufacturing costs v/s Non-manufacturing

Costs
• Product Costs v/s Period Costs
 Manufacturing Costs
• Direct Materials
• Direct Labor
• Manufacturing Overhead
 Direct Materials
• Raw materials that become an integral part of
the product and that can be physically and
conveniently traced directly to it.
1)Steel- Automobile
2)Radio-Automobile
3)Cloth-Garment
4)Leather-Shoes
5)Clay-Bricks
 Indirect Materials
Materials used to support the production process.

Examples:
• lubricants and cleaning supplies used in the
automobile assembly plant
• Glue used to assemble a chair
 Direct Labor
• Labor costs that can be physically and
conveniently traced to individual units of
product
1)Assembly-line workers
2)Carpenters
3)Bricklayers
4)Machine operators
 Indirect Labor
• Labor costs that cannot be physically traced to
the creation of products, or that can be traced
only at great costs and inconvenience
1)Labor costs of janitors
2)Supervisors
3)Material handlers
4)Night security guards
 Manufacturing Overhead
• It includes all the costs of manufacturing except direct
materials and direct labors

It includes items such as:

• Indirect materials
• Indirect labor
• Maintenance and repairs on production equipment
• Heat and light (manufacturing facilities)
• Property taxes (manufacturing facilities)
• Depreciation (manufacturing facilities)
• Insurance (manufacturing facilities)
 Manufacturing costs are often
classified as follows:

Direct
Direct Direct
Direct Manufacturing
Manufacturing
Material
Material Labor
Labor Overhead
Overhead

Prime Conversion
Cost Cost
 Non-Manufacturing Costs
• Non-manufacturing costs are sub classified
into 2 categories:

1)Marketing or selling costs

2)Administrative costs
 Marketing or Selling Costs

Costs necessary to secure customer orders and get

the finished products into the hands of the customer
• Advertising
• Shipping
• Sales travel
• Sales commissions
• Sales salaries
• Costs of finished goods warehouses
 Administrative Costs

Costs associated with the general management

of an organization rather than with
manufacturing, marketing or selling.
 Executive compensation
 General accounting
 Secretarial
 Public relations
 Product Costs v/s Period Costs

• Include all the costs that are involved in

acquiring or making a product
• These costs consist of direct materials, direct
labor, and manufacturing overhead.
• Product costs are assigned to an inventory
account on the balance sheet. When the goods
are sold, the costs are released as an expense
(typically called as cost of goods sold) and
matched against sales revenue.
 Period Costs
• Period costs are all the costs that are not included
in product costs
• These costs are expensed on the income statement
in the period in which they are incurred
• Selling and administrative expenses
• Advertising
• Executive salaries
• Sales commissionns
Product Costs Versus Period Costs

Product costs include direct Period costs include all

materials, direct labor, and marketing or selling
manufacturing overhead. costs and administrative
costs.

Inventory Cost of Good Sold Expense

Sale

Balance Income Income

Sheet Statement Statement
 Exercise 2-1
• For each cost, indicate whether it would most likely be classified as direct
materials, direct labor, manufacturing overhead, marketing and selling, or an
administrative cost.
1) The cost of a hard drive installed in a computer
2) The cost of advertising in the newspaper
3) The wages of employees who assemble computers from components
4) Sales commissions paid to the company’s salespeople
5) The wages of the assembly shop’s supervisor
6) The wages of the company’s accountant
7) Depreciation on equipment used to test assembled computers before release to
customers
8) Rent on the facility in the industrial park
 Exercise 2-2
• Classify the following costs as either product costs or period costs in a manufacturing
company:
1) Depreciation on salespersons’ cars
2) Rent on equipment used in the factory
3) Lubricants used for maintenance of machines
4) Salaries of finished goods warehouse personnel
5) Soap and paper towels used by the factory workers at the end of a shift
6) Factory supervisors’ salaries
7) Heat, water, and power consumed in the factory
8) Materials used for boxing products for shipment overseas
9) Advertising costs
10) Workers’ compensation insurance on factory employees’
11) Depreciation on chairs and tables in the factory lunchroom
12) The wages of the receptionist in the administrative offices
13) Lease cost of the corporate jet used by the company’s executives
14) Rent on rooms at a Florida resort for holding of the annual sales conference
15) Attractively designed box for packaging the company’s product-breakfast cereal
Cost Classifications On Financial Statements
 Balance Sheet

• Balance sheet of a manufacturing company is similar to that of

a merchandising company
• However, the inventory accounts differ between the two types
of companies
• A merchandising company has only one class of inventory-
goods purchased from suppliers that are awaiting resale to
customers
• In contrast- manufacturing companies have three classes of
inventories- raw materials, work in process and finished
goods.
• Raw materials are the materials that are used
to make a product
• Work in process consists of units of product
that are only partially complete and will
require further work before they are ready for
sale to a customer
• Finished goods consist of units of product that
have been completed but have not yet been
sold to customers
 Balance Sheet
Merchandiser Manufacturer
Current assets Current assets
Cash Cash
Receivables Receivables
Prepaid Expenses Prepaid Expenses
Merchandise Inventories
Inventory Raw Materials
Work in Process
Finished Goods
 Income Statement
• The income statements of merchandising and
manufacturing companies are very similar
• The only apparent difference is in the labels of
some of the entries in the computation of the
cost of goods sold.
 Income Statement
(COGS in a merchandising company and manufacturing company)
Schedule Of Cost Of Goods Manufactured
EXERCISE 2-10:

The following cost and inventory data are taken from the accounting records of mason company
for the year just completed:

Direct labor cost= $70,000

Purchase of raw materials= $118,000
Indirect labor= $30,000
Maintenance, factory equipment= $6,000
Advertising expense= $90,000
Insurance, factory equipment= $800
Sales salaries= $50,000
Rent, factory facilities= $20,000
Supplies= $4,200
Depreciation, office equipment= $3,000
Depreciation, factory equipment= $19,000

Beginning of the year ($) End of the year ($)

Raw materials 7,000 15,000
Work in process 10,000 5,000
Finished goods 20,000 35,000

REQUIRED:

a) Prepare a schedule of cost of goods manufactured

b) Prepare the cost of goods sold section of mason company’s income statement for the year
• Variable Cost and Fixed Cost

• Direct Cost and Indirect Cost

• Differential Cost and Differential Revenue

• Opportunity Cost and Sunk Cost

 Cost Classification For Predicting Cost Behavior

• Cost behavior refers to how a cost will react to

changes in the level of activity.

• Variable Cost
• Fixed Cost
 Variable Cost
Variable costs is constant if expressed on a per unit
basis
1)Direct materials
2)Lubricants
3)Shipping costs
4)Sales commissions
5)Cost of goods sold
6)Direct Labor is a variable costs. However, in many
situations direct labor may act more like a fixed
cost
 Fixed Cost
• A fixed cost is a cost that remains constant, in total,
regardless of changes in the level of activity
• When we say a cost is fixed, we mean it is fixed within some
relevant range
• Fixed cost per unit increases and decreases inversely with
changes in activity
• Rent
• Straight-line depreciation
• Insurance
• Property taxes
• Supervisory salaries
• advertising
 Cost Classification For Assigning Costs To Cost Objects

• A cost object is anything for which cost data

are desired---including products, product
lines, customers, jobs, and organizational
subunits.

• Direct Cost
• Indirect Cost
• A direct cost is a cost that can be easily and
conveniently traced to the particular cost
object under consideration.

• An indirect cost is a cost that cannot be easily

and conveniently traced to the particular cost
object under consideration.
 COST COST OBJECT

The wages of pediatric nurses The pediatric department

Prescription drugs A particular patient

Heating the hospital The pediatric department

The salary of the head of pediatrics The pediatric department

The salary of the head of pediatrics A particular pediatric patient

Hospital chaplain’s salary A particular patient

Lab tests by outside contractor A particular patient

Lab tests by outside contractor A particular department

 Differential Cost And Revenue
• A difference in costs between any two
alternatives is known as a differential cost
• A difference in revenue between any two
alternatives is known as a differential revenue
• differential cost: incremental cost and
decremental cost
• differential revenue: incremental revenue and
decremental revenue
 Opportunity Cost
• Opportunity cost is the potential benefit that
is given up when one alternative is selected
over another.
Example: If you were not attending college, you
could be earning $15,000 per year. Your
opportunity cost of attending college for one year
is $15,000.
 Sunk Cost
• A sunk cost is a cost that has already been incurred and that
cannot be changed by any decision made now or in future.

• Example: You bought an automobile that cost $10,000 two

years ago. The $10,000 cost is sunk because whether you
drive it, park it, trade it, or sell it, you cannot change the
$10,000 cost.
Classify each costs as being either variable or fixed with respect to the
number of units produced and sold. Also classify each cost as either a selling
and administrative cost or a product cost.

1) Hamburger buns in a Wendy’s outlet

2) Advertising by a dental office
3) Apples processed and canned by Del Monte.
4) Shipping canned apples from a Del Monte plant to customers
5) Insurance on a factory producing contact lenses
6) Insurance on IBM’s corporate headquarters
7) Salary of supervisors overseeing production of printers
8) Commissions paid to encyclopedia Britannica sales persons
9) Depreciation of factory lunchroom facilities at a general electric plant
10) Steering wheels installed in BMWs
PROBLEM 2-28:

Visic Corporation, a manufacturing company, produces a single product. The following

information has been taken from the company’s production, sales, and cost records for the just
completed year.

Production in units= 29,000

Sales in units=?
Ending finished goods inventory in units=?
Sales in dollars=$1,300,000

COSTS:
Advertising= $105,000
Entertainment and travel=$40,000
Direct labor= $90,000
Indirect labor= $85,000
Raw materials purchased= $480,000
Building rent (production uses 80% of the space; administrative and sales offices use the rest)=
$40,000
Utilities, factory= $108,000
Royalty paid for use of production patent, $1.50 per unit produced=?
Maintenance, factory= $9,000
Rent for special production equipment, $7,000 per year plus $0.30 per unit produced=?
Selling and administrative salaries=$210,000
Other factory overhead costs=$6,800
Other selling and administrative expenses=$17,000

Beginning of the year ($) End of the year ($)

Raw materials 20,000 30,000
Work in process 50,000 40,000
Finished goods 0 ?

The finished goods inventory is being carried at the average unit production cost for the year.
The selling price of the product is $50 per unit.

REQUIRED:

a) Prepare a schedule of cost of goods manufactured for the year

Compute the following:
1) The number of units in the finished goods inventory at the end of the year
2) The cost of the units in the finished goods inventory at the end of the year

b) Prepare an income statement for the year

PROBLEM 2-24:

Finished goods inventory, beginning= $20,000

Finished goods inventory, ending= $40,000
Depreciation, factory= $27,000
Administrative expenses= $110,000
Utilities, factory= $8,000
Maintenance, factory= $40,000
Supplies, factory= $11,000
Insurance, factory= $4,000
Purchases of raw materials= $125,000
Raw materials inventory, beginning= $9,000
Raw materials inventory, ending= $6,000
Direct labor= $70,000
Indirect labor= $15,000
Work in process inventory, beginning= $17,000
Work in process inventory, ending= $30,000
Sales= $500,000
Selling expenses= $80,000

1) Prepare a schedule of cost of goods manufactured

2) Prepare an income statement
3) Assume that the company produced the equivalent of 10,000units of product during the
year just completed. What is the average cost per unit for direct materials? What was the
average cost per unit for factory depreciation?
4) Assume that the company expects to produce 15,000 units of product during the coming
year. What average cost per unit and what total cost would you expect the company to
incur for direct materials at this level of activity? For factory depreciation? (in preparing
your answer, assume that direct materials is a variable cost and that depreciation is a
fixed cost; also assume that depreciation is computed on a straight-line basis)
 Chapter #3
Systems Design: Job-Order Costing
• Product costing is the process of assigning costs to
the products and services provided by a company
• The essential purpose of any managerial costing
system should be to provide cost data to help
managers plan, control, direct and make decisions.
 PROCESS AND JOB-ORDER COSTING

• In computing the cost of a product or a service, managers

are faced with a difficult problem
• Many costs (such as rent) do not change much from month
to month, whereas production may change frequently, with
production going up in one month and then down in another
• In practice, assigning costs to products and services involves
averaging across time and across products
• The way in which this averaging is carried out depends
heavily on the type of production process
• Two costing systems are commonly used in manufacturing
and in many service companies; these two systems are
known as process costing and job-order costing.
 Process Costing

• A process costing system is used in situations where

the company produces many units of a single product
for long periods.
• The industries are characterized by essentially
homogeneous product that flows through the process
on a continuous basis.
• Example: Mixing and bottling beverages at Coca-Cola
• One unit of product is indistinguishable from any other
unit of product
• Each unit is assigned the same average cost as any
other unit produced during the period
Formula For Process Costing

Unit Product Cost= Total Manufacturing Cost / Total Units Produced

 Job-Order Costing
• A job-order costing system is used in situations where many
different products are produced each period

• Industries are characterized by diverse outputs

• Job-order costing is also used extensively in service
industries
• For example: an attorney in a large criminal law
practice would ordinarily keep separate records of the
costs of advising and defending each client
• The record-keeping and cost assignment problems are
more complex when a company sells many different
products and services than when it has only a single
product
• A job-order costing system requires more effort than a
process-costing system
 EXAMPLE

LEVI STRAUSS
• Clothing factory would make many different types of
jeans for both men and women during a month
• A particular order might consist of 1000 stonewashed
men’s blue denim jeans, style number A312.
• This order of 1000 jeans is called a batch or a job
• In a job-order costing system, costs are traced and
allocated to jobs and then the costs of the job are
divided by the number of units in the job to arrive at an
average cost per unit
 Comparing Process and Job-Order Costing

Job-Order Process
Number of jobs worked Many
Individual Single Product
Cost accumulated by Job Department
Average cost computed by Job Department
 Exercise 3-1
Which method of determining product costs, job-order costing or process
costing, would be more appropriate in each of the following situations?

1) An Elmer's glue factory

2) A textbook publisher
3) An Exxon oil refinery
4) A facility that makes minute maid frozen orange juice
5) A Scott paper mill
6) A custom home builder
7) A shop that customizes vans
8) A manufacturer of specialty chemicals
9) An auto repair shop
10)A law office
11)An advertising agency
 Exercise 3-1
1) An Elmer's glue factory- Process costing
2) A textbook publisher- Job-order costing
3) An Exxon oil refinery- Process costing
4) A facility that makes minute maid frozen orange juice- Process
costing
5) A Scott paper mill- Process costing
6) A custom home builder- Job-order costing
7) A shop that customizes vans- Job-order costing
8) A manufacturer of specialty chemicals- Job-order costing/ Process
costing
9) An auto repair shop- Job-order costing
10) A law office- Job-order costing
11) An advertising agency - Job-order costing
 Manufacturing Costs
• Direct materials
• Direct labor
• Manufacturing overhead

To study the operation of a job-order costing

system, we will see how each of these three
types of costs is recorded and accumulated
Measuring Direct Materials Cost
• Bill of materials for the product
• A bill of materials is a document that lists the type
and quantity of each item of materials needed to
complete a unit a product
• Materials requisition form
• The materials requisition form is a detailed source
document that (1) specifies the type and quantity
of materials to be drawn (2) identifies the job to
which the costs of the materials are to be charged
Materials Requisition Form

Will E. Delite
• After being notified that the production order
has been issued, the accounting department
prepares a job cost sheet
• A job cost sheet is a form prepared for each
separate job that records the materials, labor
and over-head costs charged to the job
• After direct materials are issued, the
accounting department records their costs
directly on the job cost sheet
 Measuring Direct Labor Cost
• Direct labor consist of labor charges that are
easily traced to a particular job
• Workers use time tickets to record the time they
spend on each job and task
• It is an hour-by-hour summary of the employee’s
activities throughout the year
• At the end of the day, the time tickets are gathered
and the accounting department enters the direct
labor hours and costs on individual job cost sheets
Employee Time Ticket
• Manual method for recording and posting
labor costs
• Computerized systems (bar codes are used to
enter the basic data into the computer)
• Each employee and each job has a unique bar
code
 Exercise 3-2
Cycle Gear Corporation has incurred the following costs on job number W456, an order for 20
special sprockets to be delivered at the end of next month.
Direct materials
• On April 10, requisition number 15673 was issued for 20 titanium blanks to be used in the
special order. The blanks cost $15 each.
• On April 11, requisition number 15678 was issued for 480 hardened nibs to be used in the
special order. The nibs cost $ 1.25 each.
Direct labor:
• On April 12, Jamie Unser worked from 11:00 a.m. until 2:45 p.m. on Job W456. he is paid
$9.60 per hour.
• On April 18, Melissa Chan worked from 8:15 a.m. until 11:30 a.m. on Job W456. She is paid
$12.20 per hour.

Required:
• How much cost should have been recorded on each of the documents (materials requisition
form; time ticket; job cost sheet) for Job W456?
 Application Of Manufacturing Overhead

• Assigning manufacturing overhead to units of product can be a

difficult task
• The only way to assign overhead costs to products is to use an
allocation process
We use an allocation base because:
1. It is impossible or difficult to trace overhead costs to particular jobs.
2. Manufacturing overhead consists of many different items ranging
from the grease used in machines to production manager’s salary.
3. Many types of manufacturing overhead costs are fixed even though
output fluctuates during the period.
• This allocation of overhead costs is accomplished
by selecting an allocation base that is common to
all of the company’s products and services
• An allocation base is a measure such as direct-
labor hours or machine hours that is used to
assign overhead costs to products and services
• The most widely used allocation bases are direct-
labor hours and direct labor cost, with machine-
hours and even units of product (where a
company has only a single product) also used to
some extent.
Calculating The Predetermined Overhead Rate
(POHR)

Estimated total manufacturing

overhead cost for the coming period
POHR =
Estimated allocation base
for the coming period

Ideally,
Ideally, the
the allocation
allocation base
base isis aa
cost
cost driver
driver that
that causes
causes
overhead.
overhead.
 The formula for determining the amount of
overhead cost to apply to a particular job

• Overhead applied to a particular job=

(predetermined overhead rate * amount of
allocation base incurred by the job)
 The need for a predetermined overhead rate
(POHR)
• Using a predetermined rate makes it possible to estimate total
job costs sooner.
• Actual overhead for the period is not known until the end of
the period.
• The difference between manufacturing overhead cost applied
to work in process and manufacturing overhead cost actually
incurred during a period is termed as either over or under-
applied manufacturing overhead.
 Exercise 3-5
Luthan company uses a POHR of $23.40 per direct labor hour.
This POHR was based on 11,000 estimated direct labor-hours
and $257,400 of estimated total manufacturing overhead. The
company incurred actual total manufacturing overhead costs
of $249,900 and 10,800 total direct labor hours during the
period.
Required:
• Determine the amount of manufacturing overhead that would
have been applied to units of product during the period.
 Quick Check 
Job
Job WR53
WR53 at at NW
NW Fab,
Fab, Inc.
Inc. required
required $200
$200 ofof
direct
direct materials
materials and
and 10
10 direct
direct labor
labor hours
hours atat
$15
$15 per
per hour.
hour. Estimated
Estimated total
total overhead
overhead for
for the
the
year
year was
was $760,000
$760,000 andand estimated
estimated direct
direct labor
labor
hours
hours were
were 20,000.
20,000. What
What would
would bebe recorded
recorded
as
as the
the cost
cost of
of job
job WR53?
WR53?
a.a. $200.
$200.
b.
b. $350.
$350.
c.c. $380.
$380.
d.
d. $730.
$730.
 Quick Check 
Job
Job WR53
WR53 at at NW
NW Fab,
Fab, Inc.
Inc. required
required $200
$200 ofof
direct
direct materials
materials and
and 10
10 direct
direct labor
labor hours
hours atat
$15
$15 per
per hour.
hour. Estimated
Estimated total
total overhead
overhead for
for the
the
year
year was
was $760,000
$760,000 andand estimated
estimated direct
direct labor
labor
hours
hours were
were 20,000.
20,000. What
What would
would bebe recorded
recorded
as
as the
the cost
cost of
of job
job WR53?
WR53?
a.a. $200.
$200.
b.
b. $350.
$350.
c.c. $380.
$380.
d.
d. $730.
$730.
EXERCISE 3-9:

White Company has two departments, cutting and finishing. The company uses a job-order cos
system and computes a POHR in each department. The cutting department bases its rate on
machine-hours and the finishing department bases its rate on direct labor cost. At the beginning
of the year, the company made the following estimates:

Department #1 Department #2
Cutting Finishing
Direct labor hours 6,000 30,000
Machine hours 48,000 5,000
Manufacturing overhead cost $360,000 $486,000
Direct labor cost $50,000 $270,000

Required:

 Compute the POHR to be used in each department

 Assume the overhead rates that you compute in (1) above are in effect. The job cost sheet
for Job 203, which was started and completed during the year, showed the following:

Department #1 Department #2
Cutting Finishing
Direct labor hours 6 20
Machine hours 80 4
Materials requisitioned $500 $310
Direct labor cost $70 $150

Compute the total overhead cost applied to Job 203.

Job-order Costing–The Flow Of Costs

JOURNAL ENTRIES
 EXERCISE: 3-10:
The Polaris Company uses a job-order costing system. The following data
relate to October, the first month of the company’s fiscal year.
• Raw materials purchased on account, $210,000
• Raw material issued to production, $190,000 ($ 178,000 direct materials
and $12,000 indirect materials)
• Direct labor cost incurred, $90,000; indirect labor cost incurred, $110,000
• Depreciation recorded on factory equipment, $40,000
• Other manufacturing overhead costs incurred during October, $70,000
(credit accounts payable)
• The company applies manufacturing overhead costs to production on the
basis of $8 per machine-hour. There were 30,000 machine-hours recorded
for October.
(Recording manufacturing overhead is a two-step process. First, when
actual overhead costs are incurred, they are added to the Manufacturing
Overhead account. Second, when overhead is applied to jobs, the
Manufacturing Overhead account is reduced, and Work in Process
Inventory is increased)
• Production orders costing $520,000 according to their job cost sheets were
completed during October and transferred to finished goods.
• Production orders that had cost $480,000 to complete according to their
job cost sheets were shipped to customers during the month. These goods
were sold on account at 25% above cost.
• Prepare T-accounts for manufacturing overhead and work in process.
Compute the ending balance in each account, assuming that work in
process has a beginning balance of $42,000.
• Actual manufacturing overhead costs are debited to the accounts as they are
incurred day by day through the year
• When a job is completed, overhead cost is applied to the job by means of the
predetermined overhead rate, and work in process is debited and manufacturing
overhead is credited
• The predetermined overhead rate is based on estimates of what overhead costs are
expected to be, and it is established before the year begins.
• As a result, the overhead cost applied during a year will almost certainly turn out to
be more or less than the overhead cost that is actually incurred.
• The debit balance in manufacturing overhead account is called under-applied
overhead. Any credit balance in manufacturing overhead account is called over-
applied overhead.
• Once you have determined if overhead is under-
applied or over-applied, Calculate the difference
between applied overhead and actual overhead. This
is the amount that you must adjust cost of goods sold
to bring it to the actual cost.
• If overhead is over-applied, meaning you have too
much overhead in cost of goods sold, subtract the
amount that is over-applied.
• If overhead is under-applied, meaning you have too
little overheard in cost of goods sold, add the amount
that is under-applied.
 Practice For Students
• Exercise 3.4 (Larned Corporation-----)
• Problem 3.18 :Comprehensive Problem (Gold
Nest Company----)
Cost-Volume-Profit
Relationships
• CVP analysis helps managers understand the
interrelationships among cost, volume, and
profit.
• It is a vital tool in my business decisions
• These decisions include what products and
services to offer, what pricing policy to follow,
what marketing strategy to employ, and what
basic cost structure to use.
 Contribution Income Statement
(FORMAT)
• Contribution income statement emphasizes the behavior of costs
• Contribution income statement is prepared for management’s use inside the
company
DATA:
sale price/ unit= $250
sale= 400 units
variable cost/unit= $150
fixed expenses= $35,000
 ACTIVITY FOR STUDENTS
• Prepare contribution income statement if:
1)units sold=400
2)units sold=425
3)Break-even level of sales
• Once the break-even point has been reached,
net operating income will increase by the
amount of unit contribution margin for each
additional unit sold.
Alternative Method For Estimating Profits
 ACTIVITY FOR STUDENTS
• Per unit selling price=$500
• Per unit variable cost=$300
• Fixed costs= $80,000

Use this information to prepare CVP graph (break-even chart)

 Contribution Margin Ratio
• FORMULA
• INTERPRETATION
DATA:
Unit contribution margin= $100
Unit selling price=$250
 Break-Even Computations
The Equation Method
• Break-Even Quantity
• Break-Even Sales

The Contribution Margin Method/Formula Method

• Break-Even Quantity
• Break-Even Sales
 Target Profit Analysis
Calculating unit sales and dollar sales using The
Equation Method and The Contribution Margin
Method
 The Margin Of Safety
• The margin of safety is the excess of budgeted (or
actual) sales dollars over the break-even volume of
sales dollars.
• It states the amount by which sales can drop
before losses are incurred.
• The higher the margin of safety, the lower the risk
of not breaking even.
FORMULA:
• Margin Of Safety ($/Rs)
• Margin Of Safety (%)
 Exercise 6-3

Last month when Holiday Creations, Inc., sold 50,000 units,

total sales were $200,000, total variables expenses were
$120,000, and total fixed expenses were $65,000.

Required:
• What is the company’s contribution margin ratio?
• Estimate the change in company’s net income it were to
increase its total sales by $1000.
 Exercise 6-4
Data for Hermann Corporation are shown below:
Per unit Percentage
Selling price 90 100%
Less: variables expenses (63) (70%)
Contribution margin 27 30%

Fixed expenses are $30,000 per month and the company is selling 2,000 units
per month.

The marketing manager argues that a $5000 increase in the monthly advertising
budget would increase monthly sales by $9000. Should the advertising budget
be increased?

Refer to the original data. Management is considering using higher-quality

components that would increase the variable cost by $2 per unit. The marketing
manager believes the higher quality product would increase sales by 10% per
month. Should the higher quality components be used?
 Exercise 6-15
• Menlo Company manufactures and sells a single product. The company’s sales and
expenses for last quarter follow:
Total Per Unit
Sales 450,000 30

Less: Variables Expenses (180,000) (12)

Contribution Margin 270,000 18

Less: Fixed Expenses (216,000)

Net Operating Income 54,000

Required:
• What is the quarterly break-even point in units sold and in sales dollars?
• Without resorting to computations, what is the total contribution margin at the break-even point?
• How many units would have to be sold each quarter to earn a target profit of $90,000? Use the contribution
margin method. Verify your answer by preparing a contribution format income statement at the target sales
level.
• Refer the original data. Compute the company’s margin of safety in both dollar and percentage terms.
• What is the company’s CM ratio? If sales increase by $50,000 per quarter and there is no change in fixed
expenses, by how much would you expect quarterly net operating income to increase?
 CLASS ACTIVITY FOR STUDENTS
• Exercise 6-1
• Exercise 6-2
• Exercise 6-5
• Exercise 6-6
• Exercise 6-7
• Exercise 6-9
• Exercise 6-10
• Problem 6-19
 VARIABLE COSTING
A TOOL FOR MANAGEMENT
• Two general approaches are used in manufacturing
companies for costing products for the purposes of valuing
inventories and cost of goods sold.

• One approach, called ABSORPTION COSTING--generally used

for external financial reports.

• The other approach, called VARIABLE COSTING, is preferred

by some managers for internal decision making and must be
used when an income statement is prepared in the
contribution format.
 CONCEPTS---CHAPTER #2
• PRODUCT COSTS

• PERIOD COSTS
 ABSORPTION COSTING
(FULL COST METHOD)
• It treats all manufacturing costs as product costs,
regardless of whether they are variable or fixed.
• The costs of a unit of product under the
absorption costing method consists of direct
materials, direct labor, and both variable and
fixed manufacturing overhead.
• It allocates a portion of fixed manufacturing
overhead cost to each unit of product, along
with the variable manufacturing costs.
 VARIABLE COSTING
(DIRECT COSTING OR MARGINAL COSTING)
• Under variable costing, only those manufacturing costs that vary with
output are treated as product costs.
• It consists of direct materials, direct labor, and the variable portion of
manufacturing overhead.
• Fixed manufacturing overhead is not treated as a product cost under this
method.
• Fixed manufacturing overhead is treated as a period cost.
• The cost of a unit of product in inventory or in cost of goods sold under
the variable costing method does not contain any fixed manufacturing
overhead cost.
 UNIT COST COMPUTATIONS
• Number of units produced each year= 6000
Variable costs per unit:
Direct materials = $2
Direct labor =$4
Variable manufacturing overhead =$1
Variable selling and administrative expenses= $3
Fixed costs per year:
Fixed manufacturing overhead = $30,000
Fixed selling and administrative expenses =$10,000

REQUIREMENT:
Compute the unit product cost under Absorption Costing and Variable
Costing.
INCOME COMPARISON OF ABSORPTION COSTING AND VARIABLE COSTING
FORMAT
 DATA
• Units in beginning inventory= 0
• Units produced= 6,000
• Units sold= 5,000
• Units in ending inventory= 1,000
• Selling price per unit= $20

Variable costs per unit:

Direct materials = $2
Direct labor =$4
Variable manufacturing overhead =$1
Variable selling and administrative expenses= $3

Fixed costs per year:

Fixed manufacturing overhead = $30,000
Fixed selling and administrative expenses =$10,000
• Calculate unit product cost under Absorption
Costing and Variable Costing

• Prepare income statements under Absorption

Costing and Variable Costing
• Under absorption costing method, if inventories increase then
some of the fixed manufacturing costs of the current period
will not appear on the income statement as part of cost of
goods sold. Instead, these costs are deferred to a future
period and are carried on the balance sheet as part of the
inventory account. Such a deferral of costs is known as fixed
manufacturing overhead cost deferred in inventory.

• Any units of product not sold under absorption costing result

in fixed manufacturing costs being inventories and carried
forward on the balance sheet as assets to the next period.
EXERCISE 7-5:

Lynch Company manufactures and sells a single product. The following costs were incurred
during the company’s first year of operations:

Variable costs per unit:

Direct materials = $6
Direct labor =$9
Variable manufacturing overhead =$3
Variable selling and administrative expenses= $4

Fixed costs per year:

Fixed manufacturing overhead = $300,000
Fixed selling and administrative expenses =$190,000

During the year, the company produced 25,000 units and sold 20,000 units. The selling price of
the company’s product is $50 per unit.

REQUIRED:

1) Calculate unit product cost under Absorption Costing and Variable Costing
2) Prepare income statements under Absorption Costing and Variable Costing
EXTENDED COMPARISON OF INCOME DATA
BASIC DATA:

Selling price per unit sold =$20

Variable manufacturing cost per unit produced= $7
Fixed manufacturing overhead costs per year= $150,000
Variable selling and administrative expenses per unit sold= $1
Fixed selling and administrative expenses per year= $90,000

YEAR 1 YEAR 2 YEAR 3

Units in beginning 0 0 5,000
inventory
Units produced 25,000 25,000 25,000
Units sold 25,000 20,000 30,000

Units in ending 0 5,000 0

inventory

REQUIREMENT:

1) Compute the unit product cost under Absorption Costing and Variable Costing
2) Prepare income statements under Absorption Costing and Variable Costing for Year 1,
Year 2 and Year 3
EXERCISE 7-7:
Sierra Company incurs the following costs to produce and sell a single product.
 
Variable costs per unit:
Direct materials ............................................................ $9
Direct labor .................................................................. $10
Manufacturing overhead............................................... $5
Selling and administrative expenses ………………… ……….$3
Fixed costs per year:
Fixed manufacturing overhead ………………………………….$150,000
Fixed selling and administrative expenses …………………$400,000
 
During the last year, 25,000 units were produced and 22,000 units were sold. The Finished Goods
inventory account at the end of the year shows a balance of $72,000 for the 3,000 unsold units.
 
• Is the company using absorption costing or variable costing to cost units in the Finished Goods inventory
account? Show computations to support your answer.
 
Assume the company wishes to prepare financial statements for the year to issue to its stockholders

• Is the $72,000 figure for finished goods inventory the correct amount to use on these statements for
external reporting purposes? Explain.
 
BASIC DATA: [PRACTICE SESSION]

Selling price per unit sold =$25

Variable manufacturing cost per unit produced= $10
Fixed manufacturing overhead costs per year= $300,000
Variable selling and administrative expenses per unit sold= $1
Fixed selling and administrative expenses per year= $200,000

YEAR 1 YEAR 2
Units in beginning inventory 0 10,000

Units produced 50,000 30,000

Units sold 40,000 40,000

Units in ending inventory 10,000 0

REQUIREMENT:

1) Compute the unit product cost under Absorption Costing and Variable Costing
2) Prepare income statements under Absorption Costing and Variable Costing for Year 1
and Year 2
 Self Reading: Class Activity
• Role of Management Accountants in a
Complex and Competitive Business
Environment

• Management Accountant-A Key Player in

Decision Making
 Chapter #9
Profit Planning
• Profit planning is accomplished through the
preparation of a number of budgets, which
when brought together, form an integrated
business plan known as the MASTER BUDGET.
• The master budget is an essential management
tool that communicates management’s plans
throughout the organization, allocates
resources, and coordinates activities.
• A budget is a detailed plan for acquiring and
using financial and other resources over a
specified time period.
 The Master Budget: An Overview
Sales
Budget
Ending
Finished Goods
Budget Selling and
Production
Administrative
Budget
Budget

Direct Direct Manufacturing

Materials Labor Overhead
Budget Budget Budget

Cash
Budget

Budgeted Financial Statements

 THE SALES BUDGET
• A sales budget is a detailed schedule showing the expected
sales for the budget period: typically, it is expressed in both
dollars and units.
• The sales budget helps determine how many units need to be
produced.
• Sales budget is the starting point in preparing the master
budget.
• It has 2 sections:
Section 1: Shows the budgeted/projected sales
Section 2: Schedule of cash receipts for the projected sales. This
schedule is used later to prepare cash budget.
 ABC INC.
Sales Budget
For the year ended December 31, 2006
1st Quarter 2nd Quarter 3rd Quarter 4th Quarter YEAR
Budgeted 10,000 30,000 40,000 20,000 100,000
sales in units
Selling price 20 20 20 20 20
per unit
($20)
Total sales 200,000 600,000 800,000 400,000 2,000,000
($)
 Prepare a schedule of expected cash collections

70% of the sales are collected in the quarter in which sale is made and the remaining
30% are collected in the following quarter

Account receivable, beginning balance= $90,000

 EXERCISE 9-1

Silver Company makes a product that is very popular as a mother’s day gift. Thus, peak sales
occur in may of each year. These peak sales are shown in the company’s sales budget for the
second quarter given below (all sales are on account):

BUDGETED SALES:

April= $300,000
May= $500,000
June= $200,000
Total= $1,000,000

From past experience, the company has learned that 20% of a month’s sales are collected in
the month of sale, another 70% are collected in the month following sale, and the remaining
10% are collected in the second month following sale. Bad debts are negligible and can be
ignored. February sales totaled $230,000, and March sales totaled $260,000.

REQUIRED:
Prepare a schedule of expected cash collections from sales, by month and in total, for the
second quarter.
 The Production Budget
• The production budget is prepared after the sales budget
• Production requirements are influenced by the desired level
of ending inventory
• The ending inventory is intended to provide some cushion in
case problems develop in production or sales increases
unexpectedly
FORMAT:
• The management would like ending inventory in each month
to be equal to 20% of the following month’s sales
• On March 31, 4,000 units were on hand
The Production Budget

Assumed ending inventory.

 THE DIRECT MATERIALS BUDGET

• The direct materials budget details the raw

materials that must be purchased to fulfill the
production budget and to provide for adequate
inventories
Direct materials budget has 2 sections:
Section 1: Raw materials to be purchased and the
its related cost
Section 2: Cash disbursements for raw materials
EXERCISE 9-3: DIRECT MATERIALS BUDGET

Three grams of musk oil are required for each bottle of mink caress, a very popular perfume
made by a small company in western Siberia. The cost of the musk oil is 150 roubles per
kilogram. Budgeted production of mink caress is given below by quarters for year 2 and for the
first quarter of year 3.

Budgeted Production, In Bottles: Year 2 (Quarters)

1st: 60,000
2nd: 90,000
3rd: 150,000
4th: 100,000

YEAR 3 (QUARTER)

1st: 70,000

The oil has become so popular as a perfume ingredient that it has become necessary to carry
large inventories as a precaution against stock-outs. For this reason, the inventory of musk oil at
the end of a quarter must be equal to 20% of the following quarter’s production needs. Some
36,000 grams of musk oil will be on hand to start the first quarter of year 2.

REQUIRED:

Prepare a direct materials budget for musk oil, by quarter and in total, for year 2. At the bottom
of your budget, show the amount of purchases in roubles for each quarter and for the year in
total.
 1st Q 2nd Q 3rd Q 4th Q TOTAL 1st Q

Budgeted 60,000 90,000 150,000 100,000 70,000

production(in
bottles)
Raw materials
needed per
bottle
Production
needs (in
grams)
Add desired
ending
inventory of
raw materials
Total needs

Less
beginning
inventory of
raw materials

Raw materials
to be
purchased
Cost of raw 150 roubles 150 roubles 150 roubles 150 roubles
materials per per per per per
kilogram kilogram kilogram kilogram kilogram

Cost of raw
materials to
be purchased
 The Direct Labor Budget
• The direct labor budget is also developed from the production budget
• Direct labor requirements must be completed so that the company will know whether sufficient labor
time is available to meet production needs

FORMAT
Required production (in units)
Direct labor hours per unit
Total direct labor hours needed
Direct labor cost per hour
Total direct labor cost
EXERCISE 9-4:

The production department of Rordan Corporation has submitted the following forecast of units to be produced by quarter
for the upcoming fiscal year:
Each unit requires 0.35 direct-labors, and direct laborers are paid $12 per hour.

Units To Be Produced:
1st Quarter: 8000
2nd Quarter : 6500
3rd Quarter : 7000
4th Quarter : 7500

REQUIRED:
• Construct the company’s direct labor budget for the upcoming fiscal year, assuming that the direct labor work force is
adjusted each quarter to match the number of hours required to produce the forecasted number of units produced.
• Construct the company’s direct labor budget for the upcoming fiscal year, assuming that the direct labor work force is NOT
adjusted each quarter. Instead , assume that the company’s direct labor work force consists of permanent employees who are
guaranteed to be paid for at least 2600 hours of work each quarter. If the number of required direct labor-hours is less than
this number, the workers are paid for 2600 hours anyway. Any hours worked in excess of 2600 hours in a quarter are paid at
the rate of 1.5 times the normal hourly rate for direct labor.
 Manufacturing Overhead Budget
• The manufacturing overhead budget provides a
schedule of all costs of production other than
direct materials and direct labor.
• Manufacturing overhead is separated into fixed
and variable components.
• Because the variable component of the
manufacturing overhead depends on direct labor,
the first line in the manufacturing overhead
budget consists of the budgeted direct-labor
hours from the direct labor budget.
 FORMAT

Budgeted direct labor-hours

Multiply: Variable overhead rate

Variable manufacturing overhead

Fixed manufacturing overhead

Total manufacturing overhead

Less: depreciation

Cash disbursements for manufacturing overhead

 EXERCISE 9-5
The direct labor budget of Yuvwell Corporation for the upcoming fiscal year contains the
following details concerning budgeted direct labor-hours.
Budgeted Direct Labor-hours:
1st Quarter: 8000
2nd Quarter : 8200
3rd Quarter : 8500
4th Quarter : 7800
The company’s variable manufacturing overhead rate is $3.25 per direct labor-hour and the
company’s manufacturing overhead is $48,000 per quarter. The only noncash item included in
the fixed manufacturing overhead is depreciation, which is $16,000 per quarter.

REQUIRED:
1) Construct the company’s manufacturing overhead budget for the upcoming fiscal year.
2) Construct the company’s manufacturing overhead rate for the upcoming fiscal year.
 Selling And Administrative Expense Budget
• Selling and administrative expense budget lists
the budgeted expenses for areas other than
manufacturing.
• Selling and administrative expense budget is
divided into variable and fixed cost
components
 EXERCISE 9-6

The budgeted unit sales of Weller Company for the upcoming fiscal year are provided
below:

BUDGETED UNIT SALES:

1st Quarter: 15,000

2nd Quarter : 16,000
3rd Quarter : 14,000
4th Quarter : 13,000
The company’s variable selling and administrative expense pr unit is $2.50. fixed selling
and administrative expenses include advertising expense of $8000 per quarter, executive
salaries of $35,000 per quarter, and depreciation of $20,000 per quarter. In addition the
company will make insurance payments of $5000 in the first quarter and $5000 in the
third quarter . Finally property taxes of $8000 will be paid in the second quarter.
REQUIRED:
Prepare the company’s selling and administrative expense budget for the upcoming fiscal
year.
 CASH BUDGET
The cash budget is composed of 4 major sections:
1) The receipts section
2) The disbursements section
3) The cash excess or deficiency section
4) The financing section

• The receipts section consists of a listing of all the cash inflows, except for financing, expected
during the budget period. Generally, the major source of receipts will be from sales
• The disbursements section consists of all cash payments that are planned for the budget
period. These payments will include raw materials purchases, direct labor payments,
manufacturing overhead costs, and so on, as contained in their respective budgets. In addition,
other cash disbursements such as equipment purchases and dividends are listed.
• If a cash deficiency exists during any budget period, the company will need to borrow funds.
If there is a cash excess during an budget period, funds borrowed in previous periods can be
repaid or the excess funds can be invested.
• The financing section details the borrowings and repayments projected to take place during
the budget period. It also lists interest payments that will be due on money borrowed.
FORMAT
PROBLEM 9-14:

You have been asked to prepare a December cash budge for Ashton Company, a distributor of
exercise equipment. The following information is available about the company’s operations:

 The cash balance on December 1 is $40,000

 Actual sales for October and November and expected sales for December are as follows:

October November December

Cash sales $65,000 $70,000 $83,000
Sales on account $400,000 $525,000 $600,000

Sales on account are collected over a 3-month period as follows: 20% collected in the month of
sale, 60% collected in the month following sale, and 18% collected in the second month
following sale. The remaining 2% is uncollectible.

 Purchases of inventory will total $280,000 for December. 30% of a month’s inventory
purchases are paid during the month of purchase. The accounts payable remaining from
November’s inventory purchases total $161,000, all of which will be paid in December.
 Selling and administrative expenses are budgeted at $430,000 for December. Of this
amount, $50,000 is for depreciation.
 A new web server for the marketing department costing $76,000 will be purchased for
cash during December, and dividends totaling $9000 will be paid during the month.
 The company maintains a minimum cash balance of $20,000. An open line of credit is
available from the company’s bank to bolster the cash position as needed.

REQUIRED:

1) Prepare a schedule of expected cash collections for December

2) Prepare a schedule of expected cash disbursements for merchandise purchases for
December
3) Prepare a cash budget for December. Indicate in the financing section any borrowing that
will be needed during the month.
 Chapter #9
• All Exercises
• Problem 9-9 (Herbal Care Corp----)
• Problem 9-11 (Pearl Products Limited-----)
• Problem 9-12 (The Production Department of Zan Corporation----)
• Problem 9-13 (The Production Department of Hruska Corporation----)
• Problem 9-14 (Ashton Company)
• Problem 9-15 (Minden Company----)
• Problem 9-16 (Garden Sales-------)
• Problem 9-17 (Milo Company-----)
• Problem 9-18 (Westex Products-----)
 Self Reading: Class Activity
(10% Weightage In Mid-term Exam)

• KRAFT FOODS (Budgeting and Strategy)

• Management accounting leads to smart

decision making-from organizational
performance perspective (March and April,
2015)
• Just-in-time (JIT) production and inventory control system
• Total quality management (TQM)
• Process reengineering
• Lean production
• Six sigma
• Theory of constraints (TOC)
• E-Commerce