Chapter 16 introduces you to
some of the basic managerial accounting concepts you will use for the remainder
of the course. The introduction to management accounting begins with an overview
of the design requirements of a managerial accounting system. The system must
allocate decision-making authority over a company's resources. Second, it must
furnish the information to support decision-making by managers. Finally, the
system must generate the information needed to evaluate and reward performance.
Managers deal with the operations of the
business, and with information that is internal to the business. We call this
operating information. It involves things like product costing
information, payroll information and other sensitive or confidential
information. For this reason, operating information is not released to the
public, but is used by managers to improve business performance, and ensure the
objectives of the company.
Manufacturing costs are first classified into
direct material, direct labor and manufacturing overhead. With these definitions
established, we introduce the critical distinction between product and period
costs. This discussion in turn lays the foundation for introducing the
manufacturing inventory accounts: raw materials, work-in-process, and finished
goods.
The flow of costs through the inventory accounts is
explained with the help of an extended illustration. The example includes a
detailed analysis of the process of applying overhead using a predetermined
rate. The text explains both the mechanics and the rationale underlying overhead
application at this point, and calls attention to the potential weaknesses of
volume based applications that will be addressed in later chapters.
The chapter closes with the development of
financial statements for a manufacturing company. The schedule of cost of goods
manufactured is introduced as a supplement to the financial statements intended
to assist managers in evaluating the overall costs of manufactured products.
Management Accounting
Management
(or managerial) accounting is intended to fulfill a large number of
requirements. Financial accounting is intended to meet the needs of outside
users of financial information, and follows GAAP. Management accounting is
intended to satisfy the various needs of a large group of decision-makers inside
the business, and does not follow GAAP.
A single set of financial statements satisfies the
requirements of GAAP, but management accounting reports can be tailored for any
situation and user. The form and format can vary widely, depending on the type
of decision being analyzed.
You first need to learn to use a few basic
concepts. After that, those concepts can be modified in an almost infinite
number of ways to analyze business information, and make operating decisions.
A company's audited financial statements look
backwards in to the prior year or years. But managers have to make decisions
today, that affect the present and the future. Financial statements that are a
year or more old are not very useful for the daily decisions managers have to
make. They are more interested in current operating information, and projections
about the future. They are also concerned with setting goals, measuring progress
and achievement, eliminating waste, complying with government regulations, and a
much, much more.
Accounting cycles
An accounting system is often
organized into accounting cycles. These cycles are connected and interrelated.
Costs flow the product costing system as illustrated in your text, and as
described below.
Separating the accounting process lets us
assign different people to different tasks. Many companies have large Accounts
Payable, Accounts Receivable and Payroll departments, not to mention huge
Production departments and many sales people. Separating activities into
accounting cycles helps us understand and apply managerial controls to these
activities.
Accounting Cycles are connected and
interrelated.
Manufacturing Costs
We study
manufacturing environments because they are some of the most complex business
environments. What we learn here can easily be transferred to other, less
complex, situations. Management accounting is really much easier than financial
accounting. We classify all costs as either manufacturing or non-manufacturing.
We separate manufacturing costs into three
categories:
Manufacturing costs relate to making a product.
Direct Materials (DM) - raw materials
and parts, directly traceable to the product. Materials must attach
themselves to, and become part of, the finished product to be considered Direct
Materials.
Direct Labor (DL) - wages and other
payroll costs of the employees that directly work to convert Direct Materials
into finished products. These costs are directly traceable to the
product.
Manufacturing Overhead (OHD) - all the
other costs related to producing products that don't qualify as Direct Materials
or Direct Labor. Picture a manufacturing plant and all the costs of the plant.
Now subtract DM and DL. Everything that's left is Overhead. These costs are
indirectly traceable to the product.
Non-Manufacturing Costs
Some costs
are specifically not manufacturing costs, and therefore not DM, DL or OHD. These
are costs not related to the manufacturing plant or producing the product. The
include the following two categories:
Selling Costs
The costs associated
with selling the product are Selling Costs. These include sales salaries
and commissions, advertising, stores and their related fixtures and equipment.
General and Administrative Costs
The costs associated with the central management and home office of a
company, and general costs of being incorporated, are classified as General and
Administrative (GA) costs. This includes buildings, offices, equipment,
salaries, etc. that are part of the administrative arm of the business, provided
these costs can't be traced directly or indirectly to the manufacturing
function.
Period Costs
Some costs don't have
any future value, and only relate to the current period. These include Selling
costs and GA costs. Other period costs include income taxes and interest
expense.
Inventories
There are three
classifications of inventory.
Materials inventory - raw materials
and parts used in producing goods
Work in process inventory (WIP)- all
partially completed goods, not ready for sale
Finished goods inventory - all
completed goods ready for sale
Cost Flow
We say that costs "flow"
though a company. This means that we collect costs in the books in certain
accounts, and transfer those costs to other accounts, in a way that resembles
how those costs are actually incurred in the manufacturing process.
In general here is the way costs flow
through an accounting system:
Direct Materials >
Direct Labor ==>
Mfg Overhead => |
Work in Process => |
Finished Goods=> |
Cost of Goods
Sold |
These are the actual accounts that will be
debited and credited in a way that approximates the way costs are actually
incurred in the production process. These accounts are all debited to increase
the account, and credited to decrease the account.
To move costs along we debit the account the
cost is moving into, and credit the account the cost is moving from.
Total cost increases as it moves along, just like a snowball gets bigger as you
roll it around in the snow. As goods move through the manufacturing process they
pick up all the related costs along the way. Materials and labor are added as
the goods are worked on, and overhead is added along the way.
Let's look at how one unit of product picks up
costs in its journey through the production process. Amalgamated Widget, Inc.
produces a variety of widgets for home and commercial use. The production
manager requisitions raw materials, from the Materials inventory. Materials
inventory account is credited and the costs are transferred to the Work in
Process inventory account.
Work is started in the shaping and forming
department. Labor is added at this point by crediting Direct Labor and debiting
Work in Process inventory. After the widgets are formed, they go to the
finishing department. The appropriate finish is applied and the finished widget
is sent to the packing department, where it is prepared for shipment. Additional
Materials and Direct Labor costs are added to Work in Process in the finishing
and packing departments.
Overhead is added to the product cost at each stage
of the operation by debiting Work in Process inventory and crediting the
Overhead account. We will discuss Overhead allocation more in a moment.
At this point the product is complete and ready for
sale. The final cost is transferred to the Finished Goods inventory account.
When the item is sold the cost will then be transferred to the Cost of Goods
Sold account.
The total cost of producing a widget accumulates as
the widget moves along though the production process.
Unit Product Costs
The word "unit"
comes from the Latin unus, meaning one. The Spanish word uno comes
from the same Latin root, and also means one. A Unit Cost is the cost of
producing one unit of product. We might break that down into its component parts
- labor, materials & overhead - perhaps in great detail.
Manufacturing companies usually make a large
quantity of products at a time. Each batch of product may be thousands of units.
In some cases production is done on an assembly line, and there is little
distinction between departments, aside from those arbitrarily determined by
management.
Ultimately the company must set a selling price for
its goods. Since goods are sold one at a time, the company must determine the
total cost of producing a single unit of goods. Unit costs are tracked
throughout the production cycle in some accounting systems. In other cases, unit
costs are determined at the end of production, after all costs of production
have been accumulated and the finished units have been counted.
It is important that you clearly distinguish
between unit costs and total costs, in your mind, at all times in this class.
Applying Overhead
Overhead
consists of a large number of separate costs related to the manufacturing
process. They are collected in a single account and allocated to the product
cost using what is called an overhead application rate.
The overhead application rate is simply a way to
divide the total overhead costs for a year, across all the units of goods
produced that year. Here's the formula:
Total Annual Overhead Costs
Overhead Cost Driver
The overhead cost driver, is something related to
production that can be used to help spread the total cost evenly to individual
units of product. Sometimes that is simply the number of units of products
produced in a given year. At other times that's not the best measure to use. For
instance, hot dogs are produced by the tens-of-thousands per day, packed into
boxes and sold by the palette load. The overhead cost applied to one hot dog
would be a very small amount, and not very relevant to managers. They will apply
overhead costs in a way relevant to the decisions they need to make.
Allocating overhead using labor hours
Labor hours are often used as a cost driver, to apply overhead. Total
overhead costs are divided by total estimated labor hours to come up with a
dollar rate per labor hour. Each time labor is recorded, a corresponding amount
of overhead can also be allocated and recorded (transferred to WIP).
Advantages of using labor hours:
Tends to be a
predictable & steady amount
Different pay rates among employees is
irrelevant
Labor hours are closely related to production, so should be an
accurate measure
Let's look at an example. The company estimates it
will have 100,000 labor hours and spend $200,000 in overhead costs. The company
records 8,300 labor hours this month. Their overhead allocation is:
$200,000 / 100,000 hours = $2 per labor hour x
8,300 hours = $16,600
The company would transfer $16,600 from the
Overhead account to Work in Process for the month's production.
Allocating overhead using labor
dollars
Some very large companies allocate overhead using labor dollars,
because they have a large work force, and their total labor dollars tends to be
a predictable amount. They may be operating under a labor contract. They may
have a large and wide-spread work force.
Overhead costs are allocated in much the same
manner as above, except that labor dollars would be used, instead of labor
hours.
Other Overhead Allocation Methods
Some companies use other allocation methods for overhead. Whatever method is
used should be a reliable and predictable method, where a cost driver or
reasonable cause and effect relationship can be found between costs and
production.
Overhead costs are allocated using journal entries,
which means that these managerial accounting entries will also affect the
audited financial statements released to outsiders. The allocation method will
come under the scrutiny of the company's auditors, so it should be a reasonable
method that complies with GAAP.
from :http://www.middlecity.com/
Big assumption! The company is efficiently run and has just the ideal amount of assets and liabilities for the existing situation. This assumption will have to be faced later. Keep it in mind for now.
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