CHAPTER

20

MANAGEMENT ACCOUNTING: The Manufacturing Business

MANAGEMENT ACCOUNTING

The Basics

Management Accounting

Financial Accounting

External users (Public)

Classified Financial Statements

To provide general all-purpose info for all users

Issued Annually

Past orientation: historical cost data

Pertains to entity as a whole and is very condensed

Reporting standards are GAAPs

Annual independent audit required

Internal users (officers, management, Dept. Heads, etc.)

Internal reports

To provide specific information for internal management/decision makers

Issued as frequently as needed

Future orientation: budgets & projections as well as historical cost

Pertains to departments and divisions and may be very detailed

Reporting standard is relevance to the decision to be made

No independent audits

  • The notes for this chapter are broken down into the four functions that Management Accountants perform. They:

    • Determine which costs are involved in manufacturing, and report them in the financial statements.
    • Establish the cost of manufactured items (for controlling, reporting, and for setting selling price-levels)
    • Provide information on where and why costs are changing (for decision making purposes).
    • Evaluate cost behaviour in a company as production levels change (i.e. Economies of Scale).

MANAGEMENT ACCOUNTING

The Functions of Management Accountants

MANAGEMENT ACCOUNTING

  • Determine which costs are involved in manufacturing, and report them in the Financial Statements.

MANAGEMENT ACCOUNTING

  • Determine which costs are involved in manufacturing

The Product’s Cost (Steel)

Direct Materials

Direct Labour

Overhead

MANAGEMENT ACCOUNTING

  • Determine which costs are involved in manufacturing

Direct Materials

Direct Labour

Overhead

Administrative Expenses

Selling Expenses

Operating Costs

Manufacturing Costs

Period Costs

Product Costs

MANAGEMENT ACCOUNTING

  • Determine which costs are involved in manufacturing
  • Direct Materials: Raw materials that can be physically and conveniently associated with the finished product during the manufacturing process.
    • Those that cannot be easily associated become part of overhead.

MANAGEMENT ACCOUNTING

  • Determine which costs are involved in manufacturing
  • Direct Labour: The work of factory employees that can be physically and conveniently associated with converting raw materials into finished goods.
    • Labour that cannot be easily associated with the production process becomes part of overhead

  • Overhead: Consists of costs that are indirectly associated with the manufacture of the finished product.

  • Manufacturing overhead includes
      • Indirect materials;
      • Indirect labour;
      • Amortization on factory buildings and machinery; and
      • Insurance, taxes, and maintenance on factory facilities.

MANAGEMENT ACCOUNTING

  • Determine which costs are involved in manufacturing

MANAGEMENT ACCOUNTING

  • Determine which costs are involved in manufacturing

Cost Flow in a Manufacturing Business

  • So now we know what is involved in the cost of manufactured products. (DM, DL, OH)
  • The next thing we have to look at is how these Manufacturing Costs flow from the Balance Sheet (as inventory items) to the Income Statement (as Cost of Goods Sold).
  • We’ll then look at how this “Flow” is shown on the financial statements.

Recall the COGS for a Merchandise Business:

  • The cost of buying (and having shipped in) the items that were sold to customers.

MANAGEMENT ACCOUNTING

  • Determine which costs are involved in manufacturing

What is the Cost of Goods Sold?

Cost of Goods Available for Sale

Beginning Inventory

Net Purchases

Ending Inventory

COST OF GOODS SOLD

MANAGEMENT ACCOUNTING

  • Determine which costs are involved in manufacturing

What is the Cost of Goods Sold?

The COGS for a Manufacturing Business:

  • COGS is still the cost of the items sold to customers. However, since WE make the products, COGS must include all Manufacturing Costs.
  • The first thing you must realise, is that manufacturing businesses have three inventories
  • Goods (and costs) move from one inventory to the other during the manufacturing process.
      • (Incidentally, each of the three is valued according to FIFO, LIFO, or Average Cost too)!

Raw Materials Inventory (DM)

Work in Process Inventory

Finished Goods Inventory

Direct Labour (DL) and Overhead (OH) are added here. (Also known as conversion costs)

MANAGEMENT ACCOUNTING

  • Determine which costs are involved in manufacturing

What is Cost of Goods Sold?

Beginning Raw Materials Inventory

Ending Work in Process Inventory

Ending Raw Materials Inventory

Raw Materials Purchased

Overhead

Direct Materials Used

Direct Labour

Manufacturing Costs

Beginning Work in Process Inventory

Beginning Finished Goods Inventory

COST OF GOODS SOLD

Ending Finished Goods Inventory

Cost of Goods Manufactured

Finished Goods Inventory

Work in Process Inventory

Raw Materials Inventory

Manufacturing Costs Are Added to the Value of Inventory

MANAGEMENT ACCOUNTING

  • Determine which costs are involved in manufacturing

What is Cost of Goods Sold?

$25,000

$35,000

$30,000

$100,000

$70,000

$95,000

$15,000

$180,000

$15,000

$20,000

$170,000

$10,000

$160,000

Finished Goods Inventory

Work in Process Inventory

Raw Materials Inventory

Manufacturing Costs Are Added to the Value of Inventory

MANAGEMENT ACCOUNTING

  • … and Report Them in the Financial Statements

Cost of Goods Sold

Work in Process, Jan. 1st

Direct Labour

Raw Materials Inventory, Jan. 1st

Total Raw Materials Available

Add: Raw Materials Purchased

Direct Materials Used

Less: Raw Materials Inventory, Dec. 31st

Direct Materials

Indirect Labour

Overhead

Factory Utilities

Factory Repairs

Total Manufacturing Costs

Factory Amortization

Total Overhead

Less: Work in Process, Dec. 31st

Cost of Goods Manufactured

Finished Goods Inventory, Jan. 1st

Less: Finished Goods Inventory, Dec. 31st

Cost of Goods Sold

$20,000

$15,000

$25,000

$100,000

$125,000

$(30,000)

$95,000

$15,000

$15,000

$30,000

$5,000

$20,000

$70,000

$180,000

$160,000

$(35,000)

$(10,000)

$170,000

Manufacturing Costs

Finished Goods Inventory

Work in Process Inventory

Raw Materials Inventory

MANAGEMENT ACCOUNTING

  • … and Report Them in the Financial Statements

Do Problems:

BE20-9, 10

E20-2, -4, -6, -8

P20-4

MANAGEMENT ACCOUNTING

  • Establish the Cost of manufactured items (for controlling, reporting, and for setting selling price-levels)

Financial Accounting

Management Accounting

MANAGEMENT ACCOUNTING

  • Establish the Costs of Manufactured Items

Balance Sheet

Income Statement

Cash Flow Statement

Journalizing Transactions

Product Costing

Budgeting and Forecasting

Monitoring Variance from Budgets to Control Costs

External Users via Annual Reports

Management and Internal Users via Multiple Reports and Data

COGS

COGM

  • One of the most important jobs of management accounting is determining the cost of a product.
  • Think about it: if you don’t know how much it costs, you can’t do any of the following:
      • Determine a selling price that will cover all costs
      • Decide how low a sales price or volume discount you can offer
      • Determine how to control costs (ex: finding which materials are driving cost the most, etc.)
      • The list goes on and on…

MANAGEMENT ACCOUNTING

  • Establish the Costs of Manufactured Items
  • A popular method for determining cost is ABC Costing.
  • The hardest part of finding the cost of a product is assigning overhead costs in a reliable and meaningful way.
  • ABC Costing applies overhead based on those things that actually drive costs (called cost drivers)
    • For example, if a product requires a lot of machining, “machine hours” will drive costs.
    • So you find $overhead/machine hour, and apply costs based on how many machine hours a product uses.

MANAGEMENT ACCOUNTING

  • Establish the Costs of Manufactured Items

Activity Based Costing

The steps are as follows:

      • Find all costs (DM, DL, OH)
      • Determine the Overhead Cost/Driver
        • To do this, first find the quantity of each “driver” (i.e. number of machine hours used in the period)
        • Then find the all the costs of running the factory & machines during the period (including Amortization)
        • Then divide to find the Overhead Cost/Driver
      • Apply the Overhead Cost/Driver rate to each product, for each driver.

MANAGEMENT ACCOUNTING

  • Establish the Costs of Manufactured Items

Activity Based Costing

An example: Your company manufactures two models of Widgets: Generic, and Deluxe

Total Overhead

Machining

Finishing

Shipping

$200,000

$320,000

$150,000

MANAGEMENT ACCOUNTING

  • Establish the Costs of Manufactured Items

Activity Based Costing

Step 1: Find All Costs

Deluxe

Generic

Direct Materials ($40/kg)

Direct Labour ($10/hour)

Overhead (Indirect)

0.5 kg

0.6 kg

3.0 hrs

6.0 hrs

$670,000

$20

$24

$30

$60

$670,000

Machining

Finishing

Shipping

Units to be Made

Deluxe

Generic

Driver

Total Drivers

MANAGEMENT ACCOUNTING

  • Establish the Costs of Manufactured Items

Activity Based Costing

Step 2: Determine the Overhead Cost/Driver

  • Find the quantity of each “driver”

$200,000

$320,000

$150,000

$670,000

10,000

5,000

Hrs/Widget

Hrs/Widget

# of Shipments

1

2

100

150

2

4

Total Overhead

20,000 hrs

40,000 hrs

250 Shpmts

Cost per Driver

$10/Hr

$8/Hr

$6/$18 per W

  • Find the costs of running the factory and machines
  • Divide to find the Overhead Cost/Driver

(10,000W x 1hr) + (5,000W x 2hrs)

($200,000 / 20,000 Hours)

($320,000 / 40,000 Hours)

(10,000W x 2hrs) + (5,000W x 4hrs)

$150,000 / 250 Shipments = $600 / Shipment

($600 x 100S)/10,000 Generic = $6/Widget

($600 x 150S)/5,000 Deluxe = $18/Widget

Deluxe

Generic

MANAGEMENT ACCOUNTING

  • Establish the Costs of Manufactured Items

Activity Based Costing

Step 3: Apply the Overhead Cost/Driver rate

Machining

Finishing

Shipping

Direct Labour

Direct Materials

Overhead (Indirect)

$20

$24

$30

$60

Recall from Step 2:

1hr

2hrs

$6

$18

2hrs

4hrs

$10/Hr

$8/Hr

Per Widget

Deluxe

Generic

Cost per Driver

Drivers

$10

$16

$6

$20

$32

$18

Total Product Cost

$82

$154

Recall from Step 1:

Generic

Deluxe

Drivers

Cost per Driver

$40/Kg

$10/Hr

0.5kg

6.0hrs

3.0hrs

0.6kg

Deluxe

Generic

Machining

Finishing

Shipping

Direct Labour

Direct Materials

Overhead (Indirect)

$20

$24

$30

$60

$10

$16

$6

$20

$32

$18

Total Product Cost

$82

$154

MANAGEMENT ACCOUNTING

  • Establish the Costs of Manufactured Items

How do you use this information?

  • Pricing products
      • Can’t set appropriate price without knowing product cost

Break Even Point = Operating Expenses / Contribution Margin per Item

  • Set Budgets and Monitor for variance
      • Once you know cost info, you can predict sales, costs and then monitor regularly for variance. This allows you to identify and control problems in a business.

  • Break-even Analysis
      • Knowing the contribution margin per product sold will allow you to calculate how many units you need to sell to cover non-product costs (i.e. operating costs) and break even.

BEP is when

Operating Expenses = (X)[%a(Ma) + %b(Mb) + %c(Mc)]

Where %a is total of all units sold that are product A, Ma is the contribution margin per unit of product A, and X is the total number of units sold of ALL types.

  • Determining Contribution Margin
      • Once you know cost, you can determine the Contribution Margin each product will make to gross profit

Do Problems:

See the handout

MANAGEMENT ACCOUNTING

  • Provide information on where and why costs are changing (for decision making purposes)

MANAGEMENT ACCOUNTING

  • Provide Information on Where and Why Costs are Changing

Balance Sheet

Income Statement

Cash Flow Statement

Journalizing Transactions

Product Costing

Budgeting and Forecasting

Monitoring Variance from Budgets to Control Costs

Financial Accounting

Management Accounting

External Users via Annual Reports

Management and Internal Users via Multiple Reports and Data

Cost per Driver

COGS

COGM

MANAGEMENT ACCOUNTING

  • Provide Information on Where and Why Costs are Changing

Budget Variance Analysis

  • Once you've determined products costs and set budgets, the management accountant’s role is to analyze why actual costs differ from budgeted costs (and they always do).
  • This is important information for managers to have
  • They need it in order to determine why costs are rising or falling
  • This enables them to isolate any problems, and deal with them if possible.
  • This is the purpose of completing a Budget Variance Analysis: to find problems.
  • Consider the cost data from the previous ABC Costing example (just for Deluxe Widgets).
  • Our budgets predicted the following:

Budgeted

Actual

MANAGEMENT ACCOUNTING

  • Provide Information on Where and Why Costs are Changing

Deluxe Widgets to be made

5,000

Direct Materials ($24 per Widget)

$120,000

$105,000

If actual costs turned out to be $105,000 what would that tell you?

How about now?

3,000

Budget Variance Analysis

  • The fact is you have absolutely no idea what the number “$105,000 tells you.
  • That isn’t enough to isolate what caused the variance and solve the problem (if there even is one).
  • To do this, you require the following info:
        • Production volume
        • Efficiency – Units of input per unit of output (i.e. how much material per widget made)
        • Cost of a unit of input

MANAGEMENT ACCOUNTING

  • Provide Information on Where and Why Costs are Changing

Budget Variance Analysis

MANAGEMENT ACCOUNTING

  • Provide Information on Where and Why Costs are Changing

Budget Variance Analysis

$40/kg

0.6kg

5,000

$40/kg

0.6kg

3,000

$40/kg

0.7kg

3,000

$50/kg

0.7kg

3,000

$120,000

$72,000

$84,000

$105,000

($48,000)

$12,000

$21,000

Lower Production

Wastage

Price Increases

Cause:

Material Cost

Material Usage

Production Volume

TOTALS

This variance is due to the fact that the actual volume of widgets produced was less than what was planned.

This variance results from using more material for the actual production volume than what the budget allows for.

This variance is due to a change in the budgeted price paid for the actual quantities used.

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