Learning Objective 1

Identify the major differences and similarities

between financial and managerial accounting.

Basics

• Managerial accounting concepts are most relevant for manufacturing companies, although it can be applied to merchandising and service companies, as well.

• Reports are prepared mainly for internal use and decision-making

• No required format; in whatever is desired by management

Comparison of Financial and Managerial Accounting

Financial Accounting Managerial Accounting

1. Users External persons who Managers who plan formake financial decisions and control an organization

2. Time focus Historical perspective Future emphasis

3. Verifiability Emphasis on Emphasis on relevance versus relevance verifiability for planning and control

4. Precision versus Emphasis on Emphasis on timeliness precision timeliness

5. Subject Primary focus is on Focuses on segments the whole organization of an organization

6. GAAP Must follow GAAP Need not follow GAAPand prescribed formats or any prescribed format

7. Requirement Mandatory for Notexternal reports Mandatory

Learning Objective 2

Identify and give examples of each of the three basic

manufacturing cost categories.

The Product

DirectMaterials

DirectMaterials

DirectLaborDirectLabor

ManufacturingOverhead

ManufacturingOverhead

Manufacturing Costs

Direct Materials

Raw materials that become an integral part of the product and that can be

conveniently traced directly to it.

Example: A radio installed in an automobileExample: A radio installed in an automobile

Direct Labor

Those labor costs that can be easily traced to individual units of product.

Example: Wages paid to automobile assembly workersExample: Wages paid to automobile assembly workers

Manufacturing costs that cannot be traced directly to specific units produced.

Manufacturing Overhead

Examples: Indirect materials and indirect laborExamples: Indirect materials and indirect labor

Wages paid to employees who are not directly involved in

production work. Examples: maintenance workers,

janitors and security guards.

Materials used to support the production process.

Examples: lubricants and cleaning supplies used in the automobile

assembly plant.

Other cost considerations

1. Product vs period costs2. Differences in the current assets of a merchandising company and a manufacturing company3. Presentation of the income statement under various considerations4. Variable and fixed costs6. Cost classifications for predicting cost behavior7. Direct and indirect costs8. Cost-Volume-Profit analysis8. Variable costing and absorption costing

Product Costs Versus Period Costs

Product costs include direct materials, direct labor, and manufacturing overhead.

Period costs include all selling costs and administrative

costs.

Inventory Cost of Good Sold

BalanceSheet

IncomeStatement

Sale

Expense

IncomeStatement

Quick Check

Which of the following costs would be considered a period rather than a product cost in a manufacturing company?A. Manufacturing equipment depreciation.

B. Property taxes on corporate headquarters.

C. Direct materials costs.

D. Electrical costs to light the production

facility.

E. Sales commissions.

Cost classifications for predicting cost behavior

How a cost will react to changes in the level of activity within the relevant range.

Total variable costs change when activity changes. Total fixed costs remain unchanged when activity changes. Some costs are semi-variable or mixed.

(Relevant range is defined as the range of activity over which a company expects to operate during a year)

Cost Classifications for Predicting Cost Behavior

Behavior of Cost (within the relevant range)

Cost In Total Per Unit

Variable Total variable cost changes Variable cost per unit remainsas activity level changes. the same over wide ranges

of activity.

Fixed Total fixed cost remains Average fixed cost per unit goesthe same even when the down as activity level goes up.

activity level changes.

Mixed Costs

Costs that have both a variable cost element and a fixedcost element

Sometimes calledsemivariable cost

Change in total but not proportionately with changes inactivity level

Illustration 18-5

Mixed or Semi-variable costs

• Methods of breaking the cost down into its fixed and variable components:1. Scattergraph method2. High-low method3. Least-squares regression analysis4. Multiple regression analysis

Quick Check

Which of the following costs would be variable with respect to the number of cones sold at a Baskins & Robbins shop? (There may be more than one correct answer.)

A. The cost of lighting the store.

B. The wages of the store manager.

C. The cost of ice cream.

D. The cost of napkins for customers.

Examples of Variable Costs1. Merchandising companies – cost of goods sold.

2. Manufacturing companies – direct materials, direct labor, and variable overhead.

3. Merchandising and manufacturing companies – commissions, shipping costs, and clerical costs such as invoicing.

4. Service companies – supplies, travel, and clerical.

1. Merchandising companies – cost of goods sold.

2. Manufacturing companies – direct materials, direct labor, and variable overhead.

3. Merchandising and manufacturing companies – commissions, shipping costs, and clerical costs such as invoicing.

4. Service companies – supplies, travel, and clerical.

Quick Check Which of the following statements about

cost behavior are true?a. Fixed costs per unit vary with the level of

activity.

b. Variable costs per unit are constant within the relevant range.

c. Total fixed costs are constant within the relevant range.

d. Total variable costs are constant within the relevant range.

Contribution format income statementThe contribution margin format emphasizes cost behavior. All items in the income statement are re-classified as to fixed and variable costs.

Starting item (Sales) and the bottom line (Net Income) are the same in both the traditional income statement and a contribution format income statement. The difference is how the costs in between these two items contribute to the analysis.

In the latter, after all costs have been re-classified, variable costs are subtracted from total sales to arrive at the contribution margin. This margin covers fixed costs and a certain level of profit, thus the term contribution margin. (Note that some operating expenses may be variable.)

As you will see, this is a very powerful analysis tool and answers “what if?” questions.

Uses of the Contribution Format

The contribution income statement format is used as an internal planning and decision-making tool. This

approach will be used for:

1.Cost-volume-profit analysis 2.Budgeting3.Segmented reporting of profit data4.Special decisions such as pricing and make-or-buy analysis.

Here, we will only look at #1 above.

The contribution income statement format is used as an internal planning and decision-making tool. This

approach will be used for:

1.Cost-volume-profit analysis 2.Budgeting3.Segmented reporting of profit data4.Special decisions such as pricing and make-or-buy analysis.

Here, we will only look at #1 above.

The Contribution FormatTotal Unit

Sales Revenue 100,000$ 50$

Less: Variable costs 60,000 30

Contribution margin 40,000$ 20$

Less: Fixed costs 30,000

Net operating income 10,000$

The contribution margin format emphasizes cost behavior. Contribution margin covers fixed costs and

provides for income.

The contribution margin format emphasizes cost behavior. Contribution margin covers fixed costs and

provides for income.

The Contribution FormatComparison of the Contribution Income Statement

with the Traditional Income Statement

Traditional Approach Contribution Approach (costs organized by function ) (costs organized by behavior )

Sales 100,000$ Sales 100,000$ Less cost of goods sold 70,000 Less variable expenses 60,000 Gross margin 30,000$ Contribution margin 40,000$ Less operating expenses 20,000 Less fixed expenses 30,000 Net operating income 10,000$ Net operating income 10,000$

Used primarily forexternal reporting.

Used primarily bymanagement.

Basics of Cost-Volume-Profit Analysis

Contribution Margin (CM) is the amount remaining from sales revenue after variable expenses have been deducted.

Sales (500 bicycles) 250,000$ Less: Variable expenses 150,000 Contribution margin 100,000 Less: Fixed expenses 80,000 Net operating income 20,000$

Racing Bicycle CompanyContribution Income Statement

For the Month of June

The contribution income statement is helpful to managers in judging the impact on profits of changes in selling price, cost, or volume. The

emphasis is on cost behavior.

Basics of Cost-Volume-Profit Analysis

The contribution income statement is helpful to managers in judging the impact on profits of changes in selling price, cost, or volume The emphasis is on cost behavior. Example:

Racing Bicycle Company Contribution Income Statement For the Month of June 2011

Sales (500 bicycles) 250,000 Less: Variable expenses 150,000 Contribution margin 100,000 Less: Fixed expenses 80,000 Net Income 20,000

Basics of Cost-Volume-Profit Analysis

Suppose there is a 10% increase in sales, how would it affect net income?

Racing Bicycle Company Contribution Income Statement For the Month of June 2011

550 bicyclesSales (500 bicycles) 250,000 $275,000Less: Variable expenses 150,000 165,000 Contribution margin 100,000 110,000Less: Fixed expenses 80,000 80,000 Net Income 20,000 30,000

Basics of Cost-Volume-Profit Analysis

Suppose the company believes that by increasing advertising by $10,000 next month, sales would increase by 25 bicycles. Should the company spend for the additional advertising?

Racing Bicycle Company Contribution Income Statement For the Month of June 2011

Sales (500 bicycles) 250,000 Less: Variable expenses 150,000 Contribution margin 100,000 Less: Fixed expenses 80,000 Net Income 20,000

CVP/Profit Graph

Prepare and interpret a cost-volume-profit (CVP) graph

and a profit graph.

CVP/Profit/Breakeven Graph

Use the contribution margin ratio (CM ratio) to compute changes in

contributionmargin and net operating income

resulting fromchanges in sales volume.

Short problems

• Gayne Corporation's contribution margin ratio is 12% and its fixed monthly expenses are $84,000. If the company's sales for a month are $738,000, what is the best estimate of the company's net operating income? Assume that the fixed monthly expenses do not change.

• A) $565,440• B) $654,000• C) $88,560• D) $4,560

Short problems• Data concerning Kardas Corporation's single product appear below:•• Per Unit Percent of Sales•Selling price $140 100%•Variable expenses 28 20%•Contribution margin $112 80%

• The company is currently selling 8,000 units per month. Fixed expenses are $719,000 per month. The marketing manager believes that a $20,000 increase in the monthly advertising budget would result in a 180 unit increase in monthly sales. What should be the overall effect on the company's monthly net operating income of this change? (show shortcut).

• A) decrease of $160• B) increase of $20,160• C) decrease of $20,000• D) increase of $160

Variable Costing

• What are variable costing and absorption costing?

• Absorption costing is what we learned in cost accounting, i.e., consider all costs in determining unit cost ; therefore, fixed overhead manufacturing costs are product costs.

• Variable costing considers only variable costs; therefore, all fixed expenses are considered as period costs.

• (The difference is in the computation of unit product cost.)

Overview of Absorption and Variable Costing

Direct Materials

Direct Labor

Variable Manufacturing Overhead

Fixed Manufacturing Overhead

Variable Selling and Administrative Expenses

Fixed Selling and Administrative Expenses

VariableCosting

AbsorptionCosting

ProductCosts

PeriodCosts

ProductCosts

PeriodCosts

Harvey Company produces a single productwith the following information available:

Number of units produced annually 25,000 Variable costs per unit:

Direct materials, direct labor, and variable mfg. overhead 10$ Selling & administrative expenses 3$

Fixed costs per year:Manufacturing overhead 150,000$ Selling & administrative expenses 100,000$

Unit Cost Computations

Unit product cost is determined as follows:

Under absorption costing, all production costs, variable and fixed, are included when determining unit product cost. Under

variable costing, only the variable production costs are included in product costs.

Absorption Costing

Variable Costing

Direct materials, direct labor, and variable mfg. overhead 10$ 10$ Fixed mfg. overhead ($150,000 ÷ 25,000 units) 6 - Unit product cost 16$ 10$

Unit Cost Computations

Income Comparison ofAbsorption and Variable CostingLet’s assume the following additional information for Harvey Company.– 20,000 units were sold during the year at a price

of $30 each.– There is no beginning inventory.

Now, let’s compute net operatingincome using both absorptionand variable costing.

Absorption CostingSales (20,000 × $30) 600,000$ Less cost of goods sold: Beginning inventory -$ Add COGM (25,000 × $16) 400,000 Goods available for sale 400,000 Ending inventory (5,000 × $16) 80,000 320,000 Gross margin 280,000 Less selling & admin. exp. Variable (20,000 × $3) 60,000$ Fixed 100,000 160,000 Net operating income 120,000$

Absorption Costing

Fixed manufacturing overhead deferred in inventory is 5,000 units × $6 = $30,000.

Variable CostingSales (20,000 × $30) 600,000$ Less variable expenses: Beginning inventory -$ Add COGM (25,000 × $10) 250,000 Goods available for sale 250,000 Less ending inventory (5,000 × $10) 50,000 Variable cost of goods sold 200,000 Variable selling & administrative expenses (20,000 × $3) 60,000 260,000 Contribution margin 340,000 Less fixed expenses: Manufacturing overhead 150,000$ Selling & administrative expenses 100,000 250,000 Net operating income 90,000$

Variablemanufacturing

costs only.

All fixedmanufacturing

overhead isexpensed.

Variable Costing

Variable Costing• What is the difference between variable costing and absorption costing?

The difference is only in the treatment of fixed manufacturing overhead in inventory.

• Why is absorption costing not appropriate in decision making? Absorption costing does not dovetail with CVP analysis, nor does it support decision making. It treats fixed manufacturing overhead as a variable cost. It assigns per unit fixed manufacturing overhead costs to production.

• (Explain: “fixed manufacturing overhead deferred in inventory”, and “fixed manufacturing overhead released from inventory”.)

• When do the net operating incomes under both approaches equal?

Quick Check

Which method will produce the highest values for work in process and finished goods inventories? a. Absorption costing.

b. Variable costing.

c. They produce the same values for these inventories.

d. It depends. . .