BUS 3304 – Managerial Accounting

Reading Assignment

During the Basic Accounting (BUS 1102) and Financial Accounting courses we learned that the accounting profession is diverse as to purposes, goals, and tasks that accountants undertake. In this course, we will concentrate on the field of managerial accounting.

Chapter 1, What is Managerial Accounting, will describe managerial accounting and will contrast it with other fields of accounting. The chapter will also review the basics of inventory accounting and the role of Cost of Goods Sold.

In Chapter 2, How is Job Costing Used to Track Production Costs, we begin our learning journey through managerial accounting with a costing model called Job Order Costing. This will be one of a number of ways of how business leaders assign costs to specific business products or ventures.

Chapters 1-2 End-Of-Chapter Questions

Discussion Assignment

Explain how direct materials and direct labor costs are attributed to specifically produced goods or projects (jobs) using Job Order Costing. Please provide at least one example.

You are encouraged to research outside sources and, of course, cite them. Do not, however, quote sources word-for-word, but rather, respond to the Discussion Forum Question in your own words.

Accounting Assignment

Income Statement (with cost of goods sold adjustment). Required: Prepare an income statement for year ended December 31.

Rambler Company had the following activity for the year ended December 31:

Sales revenue $2,050,000Selling expenses $ 575,000General and administrative expenses $ 330,000Cost of goods sold (before adjustment) $ 700,000Under-applied overhead $ 23,000

Learning Journal

The Learning Journal is a space where you should reflect upon what was learned during the week. How it applies to your daily life and will help you with your life (career) goals.

For this week’s reflection, please write three complete and well composed paragraphs where you use, as an example, a company that operates where you live and describe how the job order costing would help the business owners managed their business.

Required Textbook and Materials: UoPeople courses use open educational resources (OER) and other materials specifically donated to the University with free permissions for educational use. Therefore, students are not required to purchase any textbooks or sign up for any websites that have a cost associated with them. The main required textbooks for this course are listed below, and can be readily accessed using the provided links. There may be additional required/recommended readings, supplemental materials, or other resources and websites necessary for lessons; these will be provided for you in the course’s General Information and Forums area, and throughout the term via the weekly course Unit areas and the Learning Guides.

Heisinger, K., & Hoyle, J. B. (2012). Managerial Accounting. Creative Commons by-nc-sa 3.0. https://open.umn.edu/opentextbooks/textbooks/managerial-accounting

Accounting for Managers
v. 1.0
This is the book Accounting for Managers (v. 1.0).
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ii
Table of Contents
About the Authors………………………………………………………………………………………………….. 1
Acknowledgments………………………………………………………………………………………………….. 3
Dedication………………………………………………………………………………………………………………. 4
Preface……………………………………………………………………………………………………………………. 5
Chapter 1: What Is Managerial Accounting?…………………………………………………………. 7
Characteristics of Managerial Accounting …………………………………………………………………………………….. 9
Planning and Control Functions Performed by Managers ……………………………………………………………. 14
Key Finance and Accounting Personnel ………………………………………………………………………………………. 19
Ethical Issues Facing the Accounting Industry …………………………………………………………………………….. 24
Computerized Accounting Systems …………………………………………………………………………………………….. 31
Cost Terminology ……………………………………………………………………………………………………………………….. 36
How Product Costs Flow through Accounts …………………………………………………………………………………. 49
Income Statements for Manufacturing Companies………………………………………………………………………. 56
Chapter 2: How Is Job Costing Used to Track Production Costs?………………………… 88
Differentiating Job Costing from Process Costing ………………………………………………………………………… 90
How a Job Costing System Works ………………………………………………………………………………………………… 94
Assigning Manufacturing Overhead Costs to Jobs………………………………………………………………………. 102
Job Costing in Service Organizations …………………………………………………………………………………………. 117
Chapter Wrap-Up: Summary of Cost Flows at Custom Furniture Company…………………………………. 122
Chapter 3: How Does an Organization Use Activity-Based Costing to Allocate
Overhead Costs? …………………………………………………………………………………………………. 154
Why Allocate Overhead Costs? ………………………………………………………………………………………………….. 156
Approaches to Allocating Overhead Costs …………………………………………………………………………………. 158
Using Activity-Based Costing to Allocate Overhead Costs…………………………………………………………… 166
Using Activity-Based Management to Improve Operations ………………………………………………………… 187
Using Activity-Based Costing (ABC) and Activity-Based Management (ABM) in Service
Organizations …………………………………………………………………………………………………………………………… 191
Variations of Activity-Based Costing (ABC) ……………………………………………………………………………….. 201
iii
Chapter 4: How Is Process Costing Used to Track Production Costs?……………….. 240
Comparison of Job Costing with Process Costing ……………………………………………………………………….. 242
Product Cost Flows in a Process Costing System ………………………………………………………………………… 247
Determining Equivalent Units …………………………………………………………………………………………………… 257
The Weighted Average Method …………………………………………………………………………………………………. 262
Preparing a Production Cost Report ………………………………………………………………………………………….. 279
Chapter 5: How Do Organizations Identify Cost Behavior Patterns?………………… 303
Cost Behavior Patterns ……………………………………………………………………………………………………………… 305
Cost Estimation Methods…………………………………………………………………………………………………………… 321
The Contribution Margin Income Statement……………………………………………………………………………… 348
The Relevant Range and Nonlinear Costs…………………………………………………………………………………… 354
Appendix: Performing Regression Analysis with Excel ………………………………………………………………. 358
Chapter 6: How Is Cost-Volume-Profit Analysis Used for Decision Making? ……. 389
Cost-Volume-Profit Analysis for Single-Product Companies ………………………………………………………. 391
Cost-Volume-Profit Analysis for Multiple-Product and Service Companies ………………………………… 408
Using Cost-Volume-Profit Models for Sensitivity Analysis …………………………………………………………. 422
Impact of Cost Structure on Cost-Volume-Profit Analysis ………………………………………………………….. 431
Using a Contribution Margin When Faced with Resource Constraints………………………………………… 434
Income Taxes and Cost-Volume-Profit Analysis ………………………………………………………………………… 437
Using Variable Costing to Make Decisions …………………………………………………………………………………. 444
Chapter 7: How Are Relevant Revenues and Costs Used to Make Decisions? …… 485
Using Differential Analysis to Make Decisions …………………………………………………………………………… 487
Make-or-Buy Decisions……………………………………………………………………………………………………………… 490
Product Line Decisions ……………………………………………………………………………………………………………… 499
Customer Decisions…………………………………………………………………………………………………………………… 513
Review of Cost Terms Used in Differential Analysis …………………………………………………………………… 522
Special Order Decisions …………………………………………………………………………………………………………….. 524
Cost-Plus Pricing and Target Costing ………………………………………………………………………………………… 532
Identifying and Managing Bottlenecks………………………………………………………………………………………. 535
Be Aware of Qualitative Factors ………………………………………………………………………………………………… 541
Appendix: Making Decisions Involving Joint Costs …………………………………………………………………….. 543
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Chapter 8: How Is Capital Budgeting Used to Make Decisions? ………………………… 583
Capital Budgeting and Decision Making…………………………………………………………………………………….. 585
Net Present Value …………………………………………………………………………………………………………………….. 598
The Internal Rate of Return ………………………………………………………………………………………………………. 609
Other Factors Affecting NPV and IRR Analysis …………………………………………………………………………… 616
The Payback Method ………………………………………………………………………………………………………………… 623
Additional Complexities of Estimating Cash Flows …………………………………………………………………….. 632
The Effect of Income Taxes on Capital Budgeting Decisions……………………………………………………….. 637
Appendix: Present Value Tables………………………………………………………………………………………………… 643
Chapter 9: How Are Operating Budgets Created? ……………………………………………… 662
Planning and Controlling Operations ………………………………………………………………………………………… 664
The Budgeting Process ……………………………………………………………………………………………………………… 668
The Master Budget……………………………………………………………………………………………………………………. 671
Budgeting in Nonmanufacturing Organizations ………………………………………………………………………… 704
Ethical Issues in Creating Operating Budgets …………………………………………………………………………….. 711
Chapter 10: How Do Managers Evaluate Performance Using Cost Variance
Analysis? …………………………………………………………………………………………………………….. 743
Flexible Budgets ……………………………………………………………………………………………………………………….. 745
Standard Costs………………………………………………………………………………………………………………………….. 747
Direct Materials Variance Analysis ……………………………………………………………………………………………. 758
Direct Labor Variance Analysis …………………………………………………………………………………………………. 768
Variable Manufacturing Overhead Variance Analysis………………………………………………………………… 779
Determining Which Cost Variances to Investigate …………………………………………………………………….. 787
Using Variance Analysis with Activity-Based Costing ………………………………………………………………… 793
Fixed Manufacturing Overhead Variance Analysis …………………………………………………………………….. 799
Appendix: Recording Standard Costs and Variances ………………………………………………………………….. 806
Chapter 11: How Do Managers Evaluate Performance in Decentralized
Organizations?……………………………………………………………………………………………………. 842
Using Decentralized Organizations to Control Operations …………………………………………………………. 844
Maintaining Control over Decentralized Organizations……………………………………………………………… 852
Comparing Segmented Income for Investment Centers……………………………………………………………… 857
Using Return on Investment (ROI) to Evaluate Performance ……………………………………………………… 862
Using Residual Income (RI) to Evaluate Performance…………………………………………………………………. 881
Using Economic Value Added (EVA) to Evaluate Performance……………………………………………………. 888
Wrap-Up of Game Products, Inc. ……………………………………………………………………………………………….. 898
Appendix: Transfer Prices between Divisions ……………………………………………………………………………. 902
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Chapter 12: How Is the Statement of Cash Flows Prepared and Used? …………….. 938
Purpose of the Statement of Cash Flows ……………………………………………………………………………………. 940
Three Types of Cash Flow Activities ………………………………………………………………………………………….. 943
Four Key Steps to Preparing the Statement of Cash Flows………………………………………………………….. 949
Using the Indirect Method to Prepare the Statement of Cash Flows …………………………………………… 955
Analyzing Cash Flow Information ……………………………………………………………………………………………… 984
Appendix: Using the Direct Method to Prepare the Statement of Cash Flows ……………………………… 993
Chapter 13: How Do Managers Use Financial and Nonfinancial Performance
Measures? …………………………………………………………………………………………………………. 1030
Trend Analysis of Financial Statements …………………………………………………………………………………… 1033
Common-Size Analysis of Financial Statements……………………………………………………………………….. 1044
Ratio Analysis of Financial Information …………………………………………………………………………………… 1053
Wrap-Up of Chapter Example ………………………………………………………………………………………………….. 1095
Nonfinancial Performance Measures: The Balanced Scorecard ………………………………………………… 1098
vi
About the Authors
Kurt Heisinger
Kurt Heisinger (CMA, CPA, MBA) teaches financial and
managerial accounting full time and holds a tenured
position at Sierra College. He recently received the
2011–12 Faculty of the Year award, which was voted on
and presented by the Associated Students of Sierra
College. Kurt has also taught accounting classes at the
University of California—Davis and American River
College.
Kurt began his career in public accounting with Ernst & Young and continued as a
manager of a large local accounting firm in California. He received his MBA at the
University of California—Davis and is currently a certified management accountant
(CMA) and certified public accountant (CPA). The knowledge Kurt gained from his
seven years in industry and more than 15 years in education has enabled him to
write a clear and concise book filled with real world examples.
Joe Ben Hoyle
Joe Hoyle is an associate professor of accounting at the
Robins School of Business at the University of
Richmond. In 2006, he was named by BusinessWeek as
one of 26 favorite undergraduate business professors in
the United States. In 2007, he was selected as the
Virginia Professor of the Year by the Carnegie
Foundation for the Advancement of Teaching and the
Council for the Advancement and Support of Education.
In 2009, he was judged to be one of the 100 most
influential members of the accounting profession by
Accounting Today.
Joe has two market-leading textbooks published with McGraw-Hill—Advanced
Accounting (eleventh edition, 2012) and Essentials of Advanced Accounting (fifth
edition, 2012), both coauthored with Tom Schaefer of the University of Notre Dame
and Tim Doupnik of the University of South Carolina.
1
About the Authors
At the Robins School of Business, Joe teaches fundamentals of financial accounting,
intermediate financial accounting I, intermediate financial accounting II, and
advanced financial accounting. He earned his BA degree in accounting from Duke
University and his MA degree in business and economics, with a minor in education,
from Appalachian State University. He has written numerous articles and continues
to make many presentations around the country on teaching excellence. He
maintains a blog on teaching at http://www.joehoyle-teaching.blogspot.com.
Joe also has three decades of experience operating his own CPA (Certified Public
Accountant) Exam review programs. In 2008, he created CPA Review for Free
(http://www.CPAreviewforFREE.com), which provides thousands of free questions
to help accountants around the world prepare for the CPA Exam.
Joe and his wife, Sarah, have four children and four grandchildren.
2
Acknowledgments
We would like to thank the following reviewers. Their insightful feedback and
suggestions for improving the material helped us make this a better text:
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William Murphy, University of Wisconsin—Stout
Carleton Donchess, Bridgewater State University
Jason Sharp, Ferrum College
Todd Jensen, Sierra College
Robert Walsh, University of Dallas
Michael Brown, Millikin University
Jennifer Robinson, Trident Technical College
James Aitken, Central Michigan University
Delvan Roehling, Ivy Tech Community College
Carol Lawrence, Northern Kentucky University
Curtis Crocker, Central Georgia Technical College
Kathleen Fitzpatrick, University of Toledo
Walt Walczykowski, Sierra College
Annette Fisher, Glendale Community College
Walter Austin, Mercer University
Hubert Glover, Drexel University
Steven LaFave, Augsburg College
Joan Van Hise, Fairfield University
Holly Ratwani, Bridgewater College
Alan Shattuck, Sierra College
Paul Fisher, Rogue Community College
Rick Blumenfeld, Sierra College
Paula Wilson, University of Puget Sound
Jianing Fang, Iona College
Dan Sevall, Lincoln University
Alan Adams, Dean College
John Stancil, Florida Southern College
Christy Land, Catawba Valley Community College
Birendra Mishra, University of California—Riverside
3
Dedication
Kurt Heisinger
To my parents for their continued optimism and support; to my wife and children
for their patience and encouragement; and to Michael Maher, professor of
management at the University of California—Davis, who served as my mentor and
encouraged me to write this book. I could not have done it without him.
4
Preface
Brief, Focused, Essential
Student learning styles continue to evolve as we move into the twenty-first century.
Students want to learn accounting in the most efficient way possible, balancing
coursework with personal schedules. They tend to focus on their studies in short
intense segments between jobs, classes, and family commitments. Meanwhile, the
accounting industry has endured dramatic shifts since the collapse of Enron and
WorldCom, causing a renewed focus on ethical behavior in accounting.
Core Themes
This book is aimed squarely at the new learning styles evident in today’s students
and addresses accounting industry changes as well. Accordingly, three core themes
lie at the foundation of this text:
1. Focused. Students want to be as efficient as possible in their learning.
This book adopts a concise, jargon-free, and easy-to-understand
approach. Key concepts are provided in short segments with bullet
points and step-by-step instructions to simplify concepts. A thoughtful,
stepwise approach helps students avoid distractions and focuses
attention on the big picture.
2. Reinforcement. Review Problems at the end of each major section
offer practical opportunities for students to apply what they have
learned. These Review Problems allow students to immediately
reinforce what they have learned and are provided within the body of
the chapter along with the solutions.
3. Relevance. Students perform better when they can answer the “why”
question. Why is managerial accounting important? Meaningful
references to companies throughout the chapters help students tie the
concepts presented in each chapter to real organizations.
In addition, realistic managerial scenarios present an issue that must be addressed
by the management accountant. These pique student interest and are designed to
show how issues can be resolved using the concepts presented in the chapter.
Finally, Business in Action features in this text link managerial decision making to
real business decisions.
5
Preface
Other Key Features
• A focus on decision making. This book focuses on the essential
managerial accounting concepts used within organizations for
decision-making purposes and covers these concepts in 13
straightforward and concise chapters. Knowing that the majority of
students taking managerial accounting at the introductory level are
general business majors and will not become accountants, this text was
written to help students make informed business decisions using
managerial accounting concepts.
• Thorough end-of-chapter coverage. The Exercises, Problems, and
Cases were developed to give student a wide range of reinforcement at
different levels of complexity and to help build critical thinking skills.
• Ethics coverage. The importance of ethics is evident from the outset
since the book begins with an entire segment on ethical issues facing
the accounting industry. This segment includes the Institute of
Management Accountants’ revised standards of ethical conduct and
describes professional codes of conduct provided by the American
Institute of Certified Public Accountants, Financial Executives
International, and International Federation of Accountants. Ethics
questions and cases are included throughout the text.
• Group projects. The accounting industry and business in general have
made it clear employees must be able to work effectively and
efficiently in groups. In addition, studies show students learn concepts
more effectively when working in groups. To reinforce this idea, we
have included group projects throughout the book.
• Spreadsheet applications. Computer Application features and End-ofChapter Exercises emphasize the importance of using Excel
spreadsheets for analytical purposes.
6
Chapter 1
What Is Managerial Accounting?
© Thinkstock
Dana Matthews is the president of Sportswear Company, a producer of hats and
jerseys for fans of several professional sports teams. Imagine you are the
accountant in charge of all accounting functions at Sportswear. Dana just reviewed
the financial statements for the most recent fiscal year for the first time and has the
following conversation with you:
President
(Dana):
I just reviewed our most recent financial statements, and I noticed we
did not do as well as we had planned. I would like to look more closely
at the profitability of each of our products to determine exactly what
happened, but I don’t have this information in the financial
statements. Is there a reason we don’t include this in the financial
statements?
Yes, the financial statements are prepared following U.S. Generally
Accountant: Accepted Accounting Principles (U.S. GAAP) and are intended for
outside users, such as owners, banks, and suppliers. U.S. GAAP does
7
Chapter 1 What Is Managerial Accounting?
not require us to disclose profitability by product, and we prefer not to
make this information public. Product profitability information stays
in-house and is prepared by our managerial accountant, Dave Hicks.
President:
That makes sense. Can you have Dave pull together product
profitability information for the past year so we can take a close look
at which products are doing well and which are not?
Accountant: You bet. We’ll have the information for you early next week.
8
Chapter 1 What Is Managerial Accounting?
1.1 Characteristics of Managerial Accounting
LEARNING OBJECTIVE
1. Compare characteristics of financial and managerial accounting.
Question: The issue facing the president at Sportswear is a common one. Companies prefer
not to disclose more information than is required by U.S. GAAP, but they would like to have
more detailed information for internal decision-making and performance-evaluation
purposes. This is why it is important to distinguish between financial and managerial
accounting. What is the difference between information prepared by financial accountants
and information prepared by managerial accountants?
Answer: Financial accounting1 focuses on providing historical financial
information to external users. External users are those outside the company,
including owners (e.g., shareholders) and creditors (e.g., banks or bondholders).
Financial accountants reporting to external users are required to follow U.S.
Generally Accepted Accounting Principles (U.S. GAAP)2, a set of accounting rules
that requires consistency in recording and reporting financial information. This
information typically summarizes overall company results and does not provide
detailed information.
1. Provides historical financial
information to external users.
2. A set of accounting rules that
must be followed to provide
consistency in reporting
financial information to
external users.
3. Focuses on internal users,
including executives, product
managers, sales managers, and
any other personnel in the
organization who use
accounting information for
decision making.
Managerial accounting3 focuses on internal users—executives, product managers,
sales managers, and any other personnel within the organization who use
accounting information to make important decisions. Managerial accounting
information need not conform with U.S. GAAP. In fact, conformance with U.S. GAAP
may be a deterrent to getting useful information for internal decision-making
purposes. For example, when establishing an inventory cost for one or more units
of product (each jersey or hat produced at Sportswear Company), U.S. GAAP
requires that production overhead costs, such as factory rent and factory utility
costs, be included. However, for internal decision-making purposes, it might make
more sense to include nonproduction costs that are directly linked to the product,
such as sales commissions or administrative costs.
9
Chapter 1 What Is Managerial Accounting?
Question: It’s clear that financial accounting focuses on reporting to outside users while
managerial accounting focuses on reporting to inside users. What specific characteristics
would we expect to see in managerial accounting information?
Answer: Managerial accounting often focuses on making future projections for
segments of a company. Suppose Sportswear Company is considering introducing a
new line of coffee mugs with team logos on each mug. Management would certainly
need detailed financial projections for sales, costs, and the resulting profits (or
losses). Although historical financial accounting data from other product lines
would be useful, preparing projections for the new line of mugs would be a
managerial accounting function.
Another characteristic of managerial accounting data is its high level of detail. As
noted in the opening dialogue between the president and accountant at Sportswear
Company, the financial information in the annual report provides a general
overview of the company’s financial results but does not provide any detailed
information about each product. Information, such as product profitability, would
come from the managerial accounting function.
Finally, managerial accounting information often takes the form of nonfinancial
measures. For example, Sportswear Company might measure the percentage of
defective products produced or the percentage of on-time deliveries to customers.
This kind of nonfinancial information comes from the managerial accounting
function.
Table 1.1 “Comparison of Financial and Managerial Accounting” summarizes the
characteristics of both managerial and financial accounting.
Table 1.1 Comparison of Financial and Managerial Accounting
Managerial Accounting
Financial Accounting
Users
Inside the organization
Outside the organization
Accounting
rules
None
U.S. Generally Accepted
Accounting Principles (U.S.
GAAP)
Time
horizon
Future projections (sometimes
historical if in detail)
Historical information
1.1 Characteristics of Managerial Accounting
10
Chapter 1 What Is Managerial Accounting?
Level of
detail
Managerial Accounting
Financial Accounting
Often presents segments of an
organization (e.g., products, divisions,
departments)
Presents overall company
information in accordance with
U.S. GAAP
Performance
Financial and nonfinancial
measures
Primarily financial
Follow-Up at Sportswear Company
Question: What did the president at Sportswear Company learn about product profitability
from the information provided by the managerial accountant?
Answer: The president at Sportswear, Dana Matthews, learned that the hats product
line was much more profitable than expected, accounting for 55 percent of the
company’s profits even though initial estimates were that the hat segment would
account for 40 percent of company profits. Conversely, the jerseys product line was
much less profitable than expected, accounting for 45 percent of the company’s
profits.
There are many issues associated with determining product profitability, including
how to allocate costs that are not easily traced to each product and whether the
product revenue and cost information is accurate enough to make important
managerial decisions. These important issues will be addressed throughout the
book.
KEY TAKEAWAY
• Financial accounting provides historical financial information for
external users in accordance with U.S. GAAP. Managerial accounting
provides detailed financial and nonfinancial information for internal
users who use the information for decision making, planning, and
control purposes.
1.1 Characteristics of Managerial Accounting
11
Chapter 1 What Is Managerial Accounting?
REVIEW PROBLEM 1.1
1. Suppose you are the co-owner and manager of a retail store that sells
and repairs mountain bikes. Provide one example of a financial
accounting report that would be useful to you and your co-owner.
Provide two examples of managerial accounting reports that would be
useful to you as the manager.
2. Provide two examples of nonfinancial measures used by a pizza eatery
that serves food in the restaurant and offers delivery services.
3. For each report listed in the following, indicate whether it
relates to financial or managerial accounting. Explain the
reasoning behind your answer for each item.
1. Projected net income for next quarter by division
2. Defective goods produced as a percentage of all goods
produced
3. Income statement for the most current year, prepared in
accordance with U.S. GAAP
4. Monthly sales broken down by geographic region
5. Production department budget for the next quarter
6. Balance sheet at the end of the current year, prepared in
accordance with U.S. GAAP
Solution to Review Problem 1.1
1. Financial accounting reports provided to owners typically include the
income statement, statement of owners’ equity, balance sheet, and
statement of cash flows. All are prepared in accordance with U.S. GAAP.
Managerial accounting reports prepared for managers might include a
quarterly budget for revenues and expenses for each segment of the
business (e.g., bike sales and bike repairs), returns for defective
merchandise as a percent of total monthly sales, income projections to
be used in deciding whether to open a new store, and projected sales for
each bike model. (There are many correct answers to this problem. Use
Table 1.1 “Comparison of Financial and Managerial Accounting” as a
guide in determining the accuracy of your answer.)
2. Examples of nonfinancial measures include percentage of on-time
deliveries, percentage of burned pizzas, average time required to
prepare pizza for restaurant customers (from taking a customer’s order
to providing the pizza at the customer’s table), and results of customer
1.1 Characteristics of Managerial Accounting
12
Chapter 1 What Is Managerial Accounting?
satisfaction surveys. (These are just a few examples. There are many
correct answers to this problem.)
3. The answers appear as follows. Be sure you explained your
answers.
1. Managerial accounting—information is for future projections
and involves segments of the company
2. Managerial accounting—nonfinancial detailed measure of
defective products
3. Financial accounting—historical information prepared in
accordance with U.S. GAAP
4. Managerial accounting—detailed information provided
monthly
5. Managerial accounting—information is for future projections
and involves a segment of the company
6. Financial accounting—historical information prepared in
accordance with U.S. GAAP
1.1 Characteristics of Managerial Accounting
13
Chapter 1 What Is Managerial Accounting?
1.2 Planning and Control Functions Performed by Managers
LEARNING OBJECTIVE
1. Describe the planning and control functions performed by managers.
Question: Managers of most organizations continually plan for the future, and after the plan
is implemented, managers assess whether they achieved their goals. What are the two
functions that enable management to go through the process of continually planning and
evaluating?
Answer: The two important functions that enable management to continually plan
for the future and assess implementation are called planning and control.
Planning4 is the process of establishing goals and communicating these goals to
employees of the organization. The control5 function is the process of evaluating
whether the organization’s plans were implemented effectively.
Planning
Question: Continually planning for the future is an important quality of many successful
organizations, such as Southwest Airlines (discussed in Note 1.11 “Business in Action 1.1”).
How do organizations formalize their strategic plans?
4. The process of establishing
goals and communicating these
goals to employees of the
organization.
5. The process of evaluating
whether the organization’s
plans were effectively
implemented.
6. A series of reports used to
quantify an organization’s plan
for the future.
Answer: Organizations formalize their plans by creating a budget6, which is a series
of reports used to quantify an organization’s plans for the future. For example,
Ernst & Young, an international accounting firm, plans for the future by
establishing a budget indicating the labor hours required to perform specific
services for each client. The process of creating a budget for each client enables the
firm to plan for future staffing needs and communicate these needs to employees of
the company. Rather than simply hoping it all works out in the end, Ernst & Young
projects the labor hours required in the future, hires accounting staff based on
these projections, and schedules the staff required for each client.
14
Chapter 1 What Is Managerial Accounting?
A budget can take a variety of forms. A budgeted income statement indicates a
profit plan for the future. A capital budget shows the long-term investments
planned for the future. A cash flow budget outlines cash inflows and outflows for
the future. We provide more information about how budgets can be used for
planning purposes in later chapters.
1.2 Planning and Control Functions Performed by Managers
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Chapter 1 What Is Managerial Accounting?
Business in Action 1.1
Plans for the Future
Review the annual report or 10K for just about any company, and you are likely
to find information regarding plans for the future. Here are some examples:
• Southwest Airlines. A low-fare, short-haul carrier that targets
business commuters as well as leisure travelers states in its annual
report, “We are focused on four big initiatives: the AirTran
integration, the All-New Rapid Rewards program, the addition of
the Boeing 737–800 in 2012, and the replacement of our
reservations system.”
• Sears Holdings Corporation. A multiline retailer that offers a
wide array of merchandise and related services states in its 10K
report, “We will continue to invest in our online properties. By
integrating our vast store network with our online properties, we
believe that Sears Holdings will succeed in the rapidly evolving
retail environment.”
• Nordstrom, Inc. A fashion specialty retailer indicates in its 10K
report that its “strategic growth plan includes opening new
Nordstrom full-line and Nordstrom Rack stores, with 6 announced
Nordstrom full-line and 18 announced Nordstrom Rack store
openings, the majority of which will occur by 2012.”
As these companies go through the process of making decisions about the
future, developing plans based on their decisions, and controlling the
implementation of their plans, managerial accounting information will play a
key role in all phases of the process.
Sources: Southwest Airlines, “Annual Report, 2010,”
http://www.southwest.com; Sears Holdings Corporation, “10K Report, 2010,”
http://www.searsholdings.com; Nordstrom, Inc., “10K Report, 2010,”
http://www.nordstrom.com.
1.2 Planning and Control Functions Performed by Managers
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Chapter 1 What Is Managerial Accounting?
Control
Question: Although planning for the future is important, plans are only effective if
implemented properly. How do organizations assess the implementation of their plans?
Answer: The control function evaluates whether an organization’s plans were
implemented effectively and often leads to recommendations for the future. Many
organizations compare actual results with the initial plan (or budget) to evaluate
performance of employees, departments, or the entire organization.
For example, assume Ernst & Young creates a budget indicating the labor hours
needed to perform tax services for a particular client (this is the planning function).
After the work is performed, actual labor hours used to complete the work are
compared to budgeted labor hours. This analysis is then used to evaluate whether
employees were able to complete the work within the budgeted time and often
results in recommendations for the future. Recommendations might include the
need for adding more labor hours to the budget or obtaining better support
documents from the client.
Planning and controlling operations are critical functions within most
organizations. In today’s business environment, effective planning and control by
managers can be the key to survival.
KEY TAKEAWAY
• Managers continually plan and control operations within organizations.
Planning involves establishing goals and communicating these goals to
employees of the organization. The control function assesses whether
goals were achieved and is often used to evaluate the performance of
employees, departments, and the organization as a whole.
1.2 Planning and Control Functions Performed by Managers
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Chapter 1 What Is Managerial Accounting?
REVIEW PROBLEM 1.2
Assume you are preparing a personal budget of all income and expenses for
next month.
1. Describe the planning and control functions of this process.
2. What benefits might be derived from performing the planning and
control functions for a personal budget?
Solution to Review Problem 1.2
1. The planning function would involve establishing income and
expense goals for next month. Possible sources of income include
wages, scholarships, or student loans. Expenses might include
rent, textbooks, tuition, food, entertainment, and transportation.
The control function occurs after the end of the month and
involves comparing actual income and expenses with budgeted
income and expenses. This allows for the evaluation of whether
income and expense goals were achieved.
2. There are several benefits to using a planning and control
process. The planning function establishes income and expense
goals and helps to identify any deviations from these goals. For
example, planned expenditures are clearly outlined in the budget
and provide guidelines for making expenditure decisions
throughout the month. Without clear guidelines, money might
be spent on items that are not needed.
The control function allows for an evaluation of how well you
met the goals established in the planning process. Perhaps some
goals were achieved (e.g., food expenditures were close to what
was budgeted) while other goals were not (e.g., transportation
expenditures were higher than what was budgeted). The control
function identifies these areas and leads to refined goals in the
future. For example, the decision might be made to carpool next
month to save on transportation costs or to earn more income to
pay for transportation by working additional hours.
1.2 Planning and Control Functions Performed by Managers
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Chapter 1 What Is Managerial Accounting?
1.3 Key Finance and Accounting Personnel
LEARNING OBJECTIVE
1. Describe the functions of key finance and accounting personnel.
Question: From the previous discussion, we know that planning and control functions are
often designed to evaluate the performance of employees and departments of an
organization. This often includes employees overseeing financial information. Thus it is
important to understand how most large companies organize their accounting and finance
personnel. What are the accounting and finance positions within a typical large company,
and what functions do they perform?
Answer: Let’s look at an example to answer this question. Suppose you are the
president of Sportswear Company, mentioned earlier in the chapter, which
produces hats and jerseys for fans of professional sports teams. Assume this is a
large public company. (The term public company7 refers to a company whose
shares of stock are publicly traded—that is, the general investing public can
purchase and sell ownership in the company.) As president of Sportswear, you ask
the following questions:
1.
2.
3.
4.
How much will we owe the government in income taxes for the year?
What was total net income for the last fiscal year?
Should we expand into new geographic markets?
If we do decide to expand into new markets, should we obtain
financing by issuing bonds, obtaining a loan from a bank, or issuing
common stock?
5. How profitable is each segment of our business (hats and jerseys)?
6. How effective are our internal controls over cash?
The challenge is to determine who within Sportswear would be best suited to
answer each of these questions. An organization chart will help in finding a
solution.
7. A company whose shares of
stock are publicly traded.
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Chapter 1 What Is Managerial Accounting?
Organizational Structure
Figure 1.1 “A Typical Organization Chart” is a typical organization chart; it shows
how accounting and finance personnel fit within most companies. The personnel at
the bottom of the chart report to those above them. For example, the managerial
accountant reports to the controller. At the top of the chart are those who control
the company, typically the board of directors (who are elected by the owners or
shareholders). Review Figure 1.1 “A Typical Organization Chart” before moving on
to the detailed discussion of each important finance and accounting position.
Figure 1.1 A Typical Organization Chart
*Represents vice presidents of various departments outside of accounting and finance such as production,
personnel, and research and development.
**In addition to reporting to the chief financial officer, the internal auditor typically reports independently to the
board of directors and/or the audit committee (made up of select members of the board of directors).
Chief Financial Officer
8. The person in charge of all
finance and accounting
functions within the
organization.
The chief financial officer (CFO)8 is in charge of all the organization’s finance and
accounting functions and typically reports to the chief executive officer.
1.3 Key Finance and Accounting Personnel
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Chapter 1 What Is Managerial Accounting?
Controller
The controller9 is responsible for managing the accounting staff that provides
managerial accounting information used for internal decision making, financial
accounting information for external reporting purposes, and tax accounting
information to meet tax filing requirements. The three accountants the controller
manages are as follows:
• Managerial accountant. The managerial accountant10 reports
directly to the controller and assists in preparing information used for
decision making within the organization. Reports prepared by
managerial accountants include operational budgets, cost estimates for
existing products, budgets for new product lines, and profit and loss
reports by division. (Note that some people use the term cost accountant
interchangeably with managerial accountant. Others consider cost
accounting a specific function of managerial accounting that focuses
on measuring costs. In this text, we use the term managerial accountant
and assume that cost accountants focus on measuring costs.)
• Financial accountant. The financial accountant11 reports directly to
the controller and assists in preparing financial information, in
accordance with U.S. GAAP, for those outside the company. Reports
prepared by financial accountants include a quarterly report filed with
the Securities and Exchange Commission (SEC) that is called a 10Q and
an annual report filed with the SEC that is called a 10K.
• Tax accountant. The tax accountant12 reports directly to the
controller and assists in preparing tax reports for governmental
agencies, including the Internal Revenue Service.
9. The person responsible for
managing the accounting staff
that provides managerial
accounting information used
for internal decision making,
financial accounting
information for external
reporting purposes, and tax
accounting information to
meet tax filing requirements.
10. The person who assists in
preparing information used for
decision making within the
organization.
11. The person who assists in
preparing financial
information in accordance with
U.S. GAAP for external users.
12. The person who assists in
preparing tax reports for
governmental agencies.
13. The person responsible for
obtaining financing, projecting
cash flow needs, and managing
cash and short-term
investments for the
organization.
14. The person responsible for
confirming that controls
within the company are
effective in ensuring accurate
financial data.
Treasurer
The treasurer13 reports directly to the CFO. A treasurer’s primary duties include
obtaining sources of financing for the organization (e.g., from banks and
shareholders), projecting cash flow needs, and managing cash and short-term
investments.
Internal Auditor
An internal auditor14 reports to the CFO and is responsible for confirming that the
company has controls that ensure accurate financial data. The internal auditor
often verifies the financial information provided by the managerial, financial, and
tax accountants (all of whom report to the controller and ultimately to the CFO). If
conflicts arise with the CFO, an internal auditor can report directly to the board of
directors or to the audit committee, which consists of select board members.
1.3 Key Finance and Accounting Personnel
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Chapter 1 What Is Managerial Accounting?
Not All Organizations Are Alike!
Question: The organization chart in Figure 1.1 “A Typical Organization Chart” is intended to
serve as a guide. However, all organizations are not the same, particularly smaller
organizations. How might the organizational structure differ for a small organization?
Answer: Smaller organizations tend to have only one or two key finance and
accounting personnel who perform the functions described previously. For
example, one accountant might perform the financial and managerial accounting
duties while another takes care of the tax work (or the tax work might be
contracted out to a tax firm). Instead of employing its own internal auditor, an
organization might hire one from an outside consulting firm. Some organizations
may not have a CFO, or they may have a CFO but not a controller. An organization’s
structure depends on many different factors, including its size and reporting
requirements, as indicated in the Note 1.23 “Business in Action 1.2”.
Business in Action 1.2
The Organizational Structure of a Not-for-Profit Symphony
Financial limitations prevent a small not-for-profit symphony in California
from hiring full-time finance and accounting employees. In spite of having
annual revenues approaching $200,000, all financial transactions are processed
and recorded by a part-time bookkeeper hired by the symphony. The
bookkeeper also inputs budget information and provides monthly financial
reports to the treasurer. The treasurer, a volunteer member of the board of
directors, is responsible for establishing the annual budget and providing
monthly financial reports to the board of directors. An outside firm prepares
and processes all tax filings, assembles annual financial statements, and
performs a review of the accounting operations at the end of each fiscal year.
Notice how the symphony does not have any of the formal positions identified
in Figure 1.1 “A Typical Organization Chart”, with the exception of the
treasurer. This illustrates how financial constraints and reporting requirements
may require an organization to be creative in establishing its organizational
structure.
1.3 Key Finance and Accounting Personnel
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Chapter 1 What Is Managerial Accounting?
KEY TAKEAWAY
• It is important to understand the key accounting and finance positions
within a typical company and how each position fits into the
organizational structure. The chief financial officer (CFO) oversees all
accounting and finance personnel, including the controller, treasurer,
and internal auditor. The controller is responsible for the managerial,
financial, and tax accounting staff.
REVIEW PROBLEM 1.3
For each of the six questions listed at the beginning of this section for
Sportswear Company, determine who within the company would be
responsible for providing the appropriate information. Assume Sportswear
has the same organizational structure as the one shown in Figure 1.1 “A
Typical Organization Chart”.
Solution to Review Problem 1.3
1. The tax accountant is responsible for determining the income taxes to
be paid to various government agencies.
2. The financial accountant prepares the annual report, which includes the
income statement where net income can be found.
3. Although several personnel would likely be involved, the managerial
accountant is responsible for providing financial projections. However,
the financial accountant might provide historical information for
existing geographic segments, which would form the basis for the
managerial accountant’s estimates.
4. The treasurer handles financing decisions.
5. Detailed financial information that goes beyond what is required by U.S.
GAAP may be provided by the managerial accountants.
6. The internal auditors are responsible for evaluating the effectiveness of
internal controls.
1.3 Key Finance and Accounting Personnel
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Chapter 1 What Is Managerial Accounting?
1.4 Ethical Issues Facing the Accounting Industry
LEARNING OBJECTIVE
1. Use standards of ethical conduct to resolve ethical conflicts facing
accountants.
Imagine you are the accountant for Drive Write, a company that produces computer disk
drives, and you are in charge of all accounting functions within the company. The president
has informed you that if the company’s profits grow by 20 percent this year, you will receive
a $20,000 bonus, and she will receive a $50,000 bonus. No bonuses will be awarded if profit
growth is less than 20 percent. Because the company’s profits have grown 20 percent
annually for the last 10 years, investors have come to expect significant growth from one
year to the next. Near the end of this fiscal year, the president and you have the following
conversation:
President:
We are awfully close to hitting our numbers and getting to the 20
percent target. With two weeks remaining, projections show we will
come in at 18 percent for the year. What can we do on the accounting
side to increase current year profits?
Well, I’m not sure there is anything we can do. Our accounting is
Accountant: squeaky clean, as confirmed by our independent auditors. Perhaps our
sales will improve next year.
President:
There has to be something we can do—I could sure use the bonus
money, and our investors would appreciate an increase in their
investment! I know we have a large customer order to be filled the first
week of next year. Why not include that sale in this year’s numbers?
Accountant: I’m not comfortable recording sales in the wrong fiscal year.
President:
We’re only talking about moving sales by a few days! I would like you
to consider this carefully. If you can’t do this, I may have to find an
accountant who can! Let’s talk about our options later this week.
Question: The situation at Drive Write creates a serious ethical dilemma. (The Drive Write
example is based on a real company called MiniScribe Corporation, subsequently purchased
by a competitor.) Companies are constantly under pressure to meet sales and profit goals.
Employees who succeed in meeting these goals often reap huge monetary rewards; those who
fail may be penalized with lower pay or may even lose their jobs. What would you do if asked
to record information in a way that distorts the company’s financial results?
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Chapter 1 What Is Managerial Accounting?
Answer: As the accountant for Drive Write, your response to the president’s request
would likely affect your reputation as a professional and your future as an
accountant. The unethical behavior at corporations like Xerox, Enron, and
WorldCom in recent years makes it imperative that we know both how to act
ethically and how to resolve ethical conflicts.
To help guide accounting professionals through ethical dilemmas like the one at
Drive Write, the Institute of Management Accountants (IMA) has established a
Statement of Ethical Professional Practice, which appears in Figure 1.2 “IMA Statement
of Ethical Professional Practice”. The standards outlined in this statement are
guidelines that can help accountants choose an ethically acceptable course of
action. As you review Figure 1.2 “IMA Statement of Ethical Professional Practice”,
notice that the IMA specifies four core responsibilities (competence, confidentiality,
integrity, and credibility) as well as guidelines on how to resolve ethical conflicts.
The “Resolution of Ethical Conflict” section provides specific guidance on how to
resolve the conflict at Drive Write.
Figure 1.2 IMA Statement of Ethical Professional Practice
1.4 Ethical Issues Facing the Accounting Industry
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Chapter 1 What Is Managerial Accounting?
Source: Adapted from the Institute of Management Accountants, http://www.imanet.org.
Question: The IMA is just one of many professional accounting organizations. Do other
professional accounting organizations also provide guidance regarding ethics in accounting?
Answer: Yes, other professional organizations do provide ethical guidance. Several
are listed as follows:
• The American Institute for Certified Public Accountants (AICPA) has a
Code of Professional Conduct (see http://www.aicpa.org).
• Financial Executives International provides a Model Code of Ethical
Conduct for Financial Managers (see http://www.financialexecutives.org).
• The International Federation of Accountants has a Code of Ethics and
Statement of Policy Implementation & Enforcement of Ethical Requirements
(see http://www.ifac.org).
• The Securities and Exchange Commission (SEC), in compliance with the
Sarbanes-Oxley Act of 2002, requires a company to disclose whether it
has adopted a code of ethics (see http://www.sec.gov).
• The Institute of Management Accountants even provides an ethics help
line to give financial professionals a resource to provide guidance in
making the right decisions (see http://www.imanet.org).
Because of alleged wrongdoing, such as that reported in the Note 1.27 “Business in
Action 1.3”, improving ethics is a top priority for most businesses as shown in the
Note 1.28 “Business in Action 1.4”. As a result, professional organizations like those
we have cited have become instrumental in providing ethical guidelines.
1.4 Ethical Issues Facing the Accounting Industry
26
Chapter 1 What Is Managerial Accounting?
Business in Action 1.3
Production Firm Employees Charged with Fraud
The Securities and Exchange Commission (SEC) filed three actions against
Diebold, Inc., a manufacturer and seller of automated teller machines, for
improperly inflating earnings over a five-year period. Three former
employees—the CFO, controller, and director of accounting—were accused of
improperly inflating revenue on factory orders, improperly recognizing
revenue on a lease transaction, manipulating reserves and accruals, improperly
capitalizing expenses, and improperly increasing the value of inventory. These
actions allegedly resulted in over 40 misstated annual, quarterly, and other
reports filed with the SEC, along with numerous inaccurate press releases.
The company agreed to pay a $25,000,000 civil penalty, and the three former
employees remain in litigation. Although the CEO was not accused of
wrongdoing, he settled with the SEC and agreed to pay back cash bonuses,
stock, and stock options received during the periods when the financial fraud
was committed.
Source: Securities and Exchange Commission, “SEC Charges Diebold and Former
Executives with Accounting Fraud,” news release, June 2, 2010.
1.4 Ethical Issues Facing the Accounting Industry
27
Chapter 1 What Is Managerial Accounting?
Business in Action 1.4
The Code of Ethics at Home Depot and Hewlett-Packard
Ethics policies are becoming increasingly important to organizations. Home
Depot, Inc., has an ethics code that “provides the basic principles for associates
to make business decisions consistent with how Home Depot operates” and
“forms the groundwork for our ethical behavior.”
Hewlett-Packard Company has established “business ethics guided by
enduring values.” The company states it is committed to the following
principles: honesty, excellence, responsibility, compassion, citizenship,
fairness, and respect.
Sources: Home Depot, “Home Page,” http://www.homedepot.com; HewlettPackard, “Home Page,” http://www.hp.com.
KEY TAKEAWAY
• Should you encounter ethical conflicts during your career, use the
resources provided by internal company policies, by professional
organizations such as the IMA and AICPA, and by governmental
organizations such as the SEC as a guide to ethical behavior and the
resolution of ethical conflicts.
1.4 Ethical Issues Facing the Accounting Industry
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Chapter 1 What Is Managerial Accounting?
REVIEW PROBLEM 1.4
1. Describe the four key standards of ethical conduct for IMA members
outlined in Figure 1.2 “IMA Statement of Ethical Professional Practice”.
2. What steps does the IMA recommend for resolving ethical conflicts?
3. Using Figure 1.2 “IMA Statement of Ethical Professional Practice” as a
guide, discuss your options as the accountant at Drive Write.
Solution to Review Problem 1.4
1. The four key standards shown in Figure 1.2 “IMA Statement of
Ethical Professional Practice” are outlined as follows:
1. Competence. Members of the IMA must maintain an
adequate level of skill to perform duties in an accurate and
professional manner.
2. Confidentiality. Members of the IMA must not disclose
confidential information for any reason unless legally
obligated to do so.
3. Integrity. Members of the IMA must avoid any actual or
apparent conflict of interest, including receiving gifts or
favors, and must not engage in any activity that would
discredit the profession.
4. Credibility. Members of the IMA must disclose all relevant
information fairly and objectively.
2. Several options exist for resolving ethical conflicts. The IMA
suggests the following courses of action:
1. Follow the policies of the organization involving the
resolution of ethical conflicts.
2. If following the organization’s policies does not effectively
resolve the conflict, discuss the problem with your
immediate supervisor unless the supervisor is involved.
3. If the immediate superior cannot reach a satisfactory
resolution, the problem should be presented to the next
higher managerial level.
4. If all higher levels of management do not reach a satisfactory
resolution, an acceptable reviewing authority may be a
group, such as the audit committee, executive committee,
board of directors, board of trustees, or owners.
1.4 Ethical Issues Facing the Accounting Industry
29
Chapter 1 What Is Managerial Accounting?
5. Another option includes consulting an objective advisor (e.g.,
IMA ethics counseling service or an attorney).
3. Several options are available. The IMA suggests first following the
organization’s policies with regard to resolving ethical conflicts. If Drive
Write does not have policies in place or if following the organization’s
policies does not resolve the conflict, the next step is to discuss the
conflict with the immediate supervisor. However, the president of Drive
Write (the immediate supervisor) is involved in the conflict, so
approaching the president’s superiors would be best. This could be the
audit committee, executive committee, board of directors, or owners. If
after pursuing these different courses of action the ethical conflict still
exists, it may be appropriate to consult an objective advisor (e.g., the
IMA helpline) and perhaps consult an attorney as to legal obligations
and rights concerning the ethical conflict. (Many would argue that
regardless of the outcome, one would not want to work for a company
where this type of unethical behavior occurs at the top, or anywhere
within the organization, and that resigning is the best course of action.)
1.4 Ethical Issues Facing the Accounting Industry
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Chapter 1 What Is Managerial Accounting?
1.5 Computerized Accounting Systems
LEARNING OBJECTIVE
1. Understand how accounting systems can help organizations.
Question: Many companies today are growing out of their accounting systems. In the old
days, accounting systems were designed primarily to track daily transactions and provide
reports to external users on a monthly, quarterly, or annual basis. But times have changed,
and companies now need more information internally to make good decisions. Accounting
systems are currently used for both external reporting (financial accounting) and internal
reporting (managerial accounting). Even relatively small accounting packages, such as
QuickBooks and Peachtree, provide features that are important for managerial accounting.
However, most agree that no single accounting system will meet the needs of every
organization and that two important factors must be considered when choosing a system.
What are the two factors that must be considered when deciding on an accounting system?
Answer: The two factors are (1) the size of the organization and (2) the information
needs of the organization. Each factor is discussed next.
How Big Is Your Company?
Accounting software is designed to serve different-sized companies. The size of a
company is commonly measured in sales revenue. Experts express varying opinions
on what constitutes a small, midsized, or large company. Some believe that small
companies have sales up to $10,000,000, midsized companies have sales up to
$100,000,000, and large companies have sales greater than $100,000,000. Others
prefer different amounts. Regardless of the number used, the goal is to find an
accounting system that best meets the needs of the organization, and the size of the
organization plays a big part in finding the best-fitting system.
What Information Is Needed?
Before selecting an accounting system, an organization must determine its
accounting needs. Some organizations simply need the equivalent of a check
register, which provides easy tracking of expense codes as checks are issued and
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Chapter 1 What Is Managerial Accounting?
makes bank reconciliations a snap. Other organizations require more than a check
register; they may demand a system that can create invoices, process payroll, and
track inventory. More complex organizations will want the ability to perform more
advanced functions. Such organizations might need to customize reports (e.g.,
create an income statement by division or customer), modify input screens, send
financial reports via e-mail, export reports to spreadsheet software such as Excel,
and create reports with graphics (e.g., tables, pie charts, and line charts).
Enterprise Resource Planning System
Question: Clearly the size and information needs of a company will drive the selection of an
accounting system for the company. As the need for accounting data has become more
complex, accounting systems have been developed that perform a wide variety of tasks.
These systems are called enterprise resource planning systems. What is an enterprise
resource planning system, and how does this system help companies utilize accounting data?
Answer: Enterprise resource planning (ERP)15 systems are designed to record and
share information across functional areas (e.g., accounting, marketing, human
resources, and shipping) and across geographical areas (e.g., from a sales office in
California to headquarters in Hong Kong). ERP systems continually update
information to provide real-time data to all users, and the data can be organized in
different formats to meet the needs of internal and external users. For example, in
his book Onward, Howard Schultz describes how as CEO of Starbucks he reviews
comparative financial data for Starbucks stores daily. This information comes from
the ERP system at Starbucks.
The idea behind ERP software, and a central theme in managerial accounting, is
that accurate and up-to-date financial information will help organizations make
better decisions. Better decisions typically lead to improvements in profitability,
efficiency, and customer satisfaction.
15. A system designed to record
and share information across
functional and geographical
areas to meet the needs of
internal and external users.
ERP systems are expensive. Annual costs for large organizations can easily exceed
$10,000,000. However, smaller systems for midsized companies are available at a
much lower cost. Most ERP software is offered in modules for functional accounting
areas, such as accounts receivable, accounts payable, payroll, inventory, and job
costing. The more modules included, the higher the cost will be. Popular makers of
ERP systems include Microsoft, Oracle, and SAP Corporation.
1.5 Computerized Accounting Systems
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Chapter 1 What Is Managerial Accounting?
In deciding whether to upgrade to an ERP system, organizations must be sure that
the benefits of using the data from a new system outweigh the costs of
implementing the system. If management does not intend to use the information to
improve planning and decision making, then going with a less sophisticated
accounting system may be the better approach.
Using Spreadsheet Software
Question: ERP systems commonly provide a means to download data to spreadsheets for
further analysis. How can spreadsheet software help us to analyze financial information?
Answer: Since managers make extensive use of spreadsheets to organize and
analyze data, most computerized accounting systems are designed to export data to
spreadsheet software programs such as Excel. For example, Figure 1.3 “Excel
Spreadsheet for Southwest Airlines” shows how a spreadsheet was used to import
data directly from Southwest Airlines’ 2010 annual report. This allows the user to
analyze the data more easily. Notice that in Figure 1.3 “Excel Spreadsheet for
Southwest Airlines” the total operating revenue increased over the three years
shown. We could use Excel to quickly determine the exact percentage increase from
2008 to 2009 and from 2009 to 2010.
1.5 Computerized Accounting Systems
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Chapter 1 What Is Managerial Accounting?
Figure 1.3 Excel Spreadsheet for Southwest Airlines
Question: Let’s assume you are asked to prepare an income statement showing revenue and
expense projections for next year. How might you use Excel to prepare your projections?
Answer: You could start by exporting this year’s results from the accounting system
to an Excel spreadsheet. Then you could set up a new column to show estimates for
next year. You would likely discuss different aspects of the income statement with
various personnel in the organization—making changes as you go—before finalizing
your projections.
Imagine the work involved if you did not use a computer but instead had to write
the information down by hand. If there were any changes to the information, you
would have to make time-consuming calculations, and once the data were finalized,
you would be faced with the manual preparation of formal reports. With the
relatively recent advances in business technology, the days of preparing
1.5 Computerized Accounting Systems
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Chapter 1 What Is Managerial Accounting?
information manually are over. Most organizations require their accounting and
finance personnel to have advanced computer spreadsheet skills. Our goal is to
provide you with an opportunity to use spreadsheets in a way that mirrors the real
world.
KEY TAKEAWAY
• Throughout this text, you will learn about different methods of
recording, sorting, analyzing, and reporting financial information for
internal users. Before deciding to implement one of these methods, ask
yourself the following question: Will the benefits derived from a new
system, such as an ERP system, exceed the costs of putting the system in
place? If the answer is “yes,” then go for it! If the answer is “no,”
consider other alternatives.
REVIEW PROBLEM 1.5
Assume you are the CFO for an electronics consulting firm with annual
revenues of $30,000,000 and annual profit of $5,000,000. The current
accounting system is used for basic functions, such as issuing checks,
creating invoices, and processing payroll. The company is considering
upgrading its accounting system by purchasing an ERP system. Describe the
factors to be considered by the company in making this decision.
Solutions to Review Problem 1.5
This company is a midsized company with $30,000,000 in revenues, although
some would argue that this is a small company. Going to an ERP system is
probably not appropriate if management is simply looking for a few reports
beyond what most financial accounting systems can provide.
If management has a need for more detailed and complex financial
information—other than processing checks, invoices, and payroll—then a
low-end ERP system might be appropriate. However, the benefits derived
from such a system must outweigh the costs.
1.5 Computerized Accounting Systems
35
Chapter 1 What Is Managerial Accounting?
1.6 Cost Terminology
LEARNING OBJECTIVE
1. Understand the terms used for costing purposes.
Question: Much of what we discuss in this book relates to companies that manufacture
products, such as Nike and Apple, and terminology is a key component of accounting for
manufacturing companies. The challenge is in classifying costs correctly for items such as
production materials, production labor, marketing department labor, rent for production
facilities, and rent for the administrative services facilities. These costs must be classified
accurately so that they appear correctly in company financial reports. The starting point for
learning how to classify costs correctly is in understanding two broad categories of costs.
What are the two broad terms used to categorize cost information in a manufacturing
setting?
Answer: The two broad categories of costs are manufacturing costs and
nonmanufacturing costs. Each category is described in detail as follows.
Manufacturing Costs
All costs related to the production of goods are called manufacturing costs16; they
are also referred to as product costs17. A manufacturer purchases materials,
employs workers who use the materials to assemble the goods, provides a building
where the materials are stored and goods are assembled, and sells the goods. We
classify the costs associated with these activities into three categories: direct
materials, direct labor, and manufacturing overhead.
16. All costs related to the
production of goods; also called
product costs.
17. All costs related to the
production of goods; also called
manufacturing costs.
To help clarify which costs are included in these three categories, let’s look at a
furniture company that specializes in building custom wood tables called Custom
Furniture Company. Each table is unique and built to customer specifications for
use in homes (coffee tables and dining room tables) and offices (boardroom and
meeting room tables). The sales price of each table varies significantly, from $1,000
to more than $30,000. Figure 1.4 “Direct Materials, Direct Labor, and Manufacturing
Overhead at Custom Furniture Company” shows examples of production activities
at Custom Furniture Company for each of the three categories (we continue using
36
Chapter 1 What Is Managerial Accounting?
this company as an example in Chapter 2 “How Is Job Costing Used to Track
Production Costs?”).
Figure 1.4 Direct Materials, Direct Labor, and Manufacturing Overhead at Custom Furniture Company
© Thinkstock
Direct Materials
Question: Raw materials used in the production process that are easily traced to the product
are called direct materials18. What materials used in the production process at Custom
Furniture would be classified as direct materials?
Answer: The wood used to build tables and the hardware used to attach table legs
would be considered direct materials. Small, inexpensive items like glue, nails, and
masking tape are typically not included in direct materials because the cost of
tracing these items to the product outweighs the benefit of having accurate cost
data. These minor types of materials, often called supplies or indirect materials, are
included in manufacturing overhead, which we define later.
18. Raw materials used in the
production process that are
easily traced to the product.
19. Labor performed by workers
who convert materials into a
finished product and whose
time is easily traced to the
product.
1.6 Cost Terminology
Direct Labor
Question: Workers who convert materials into a finished product and whose time is easily
traced to the product are called direct labor19. Who represents direct labor at Custom
Furniture?
37
Chapter 1 What Is Managerial Accounting?
Answer: Direct labor would include the workers who use the wood, hardware, glue,
lacquer, and other materials to build tables.
Manufacturing Overhead
Question: All costs associated with the production process other than direct material costs
and direct labor costs are called manufacturing overhead20. Terms synonymous with
manufacturing overhead include factory overhead, factory burden, and overhead. What
items are included in manufacturing overhead?
Answer: Manufacturing overhead consists of the following:
• Indirect material costs21. The cost of materials necessary to
manufacture a product that are not easily traced to the product or not
worth tracing to the product.
• Indirect labor costs22. The cost of workers who are involved in the
production process but whose time cannot easily be traced to the
product. For example, supervisors in the production process who
oversee several different products and are responsible for hiring
employees, scheduling employees, and ordering materials are
considered indirect labor.
• Other manufacturing costs. These are all other costs for items
associated with the factory, including equipment maintenance,
insurance, utilities, and depreciation.
Table 1.2 “Manufacturing Costs at Custom Furniture Company” provides several
examples of manufacturing costs at Custom Furniture Company by category.
20. All costs associated with the
production process other than
direct material costs and direct
labor costs.
21. The costs of materials
necessary to manufacture a
product that are not easily
traced to the product or that
are not worth tracing to the
product.
22. The costs of workers who are
involved in the production
process but whose time cannot
easily be traced to the product.
1.6 Cost Terminology
Table 1.2 Manufacturing Costs at Custom Furniture Company
Direct Materials
• Wood: cherry, maple, oak, and mahogany
• Hardware: drawer handles
Direct Labor
38
Chapter 1 What Is Managerial Accounting?
• Workers who cut, plane, and glue wood
• Workers who fill and sand tables
• Workers who stain and finish tables
Manufacturing Overhead
• Indirect materials: glue, screws, nails, sandpaper, stain, and lacquer
• Indirect labor: factory supervisors
• Other manufacturing costs: equipment maintenance, equipment
depreciation, factory utilities, factory insurance, factory building
depreciation, and factory property taxes
Note 1.43 “Business in Action 1.5” details the materials, labor, and manufacturing
overhead at a company that has been producing boats since 1968.
1.6 Cost Terminology
39
Chapter 1 What Is Managerial Accounting?
Business in Action 1.5
Photo courtesy of Brian Miller, http://www.flickr.com/photos/13233728@N00/5155012186/
Manufacturing Costs at MasterCraft
MasterCraft produces boats for water skiers and wake boarders. Each boat
produced incurs significant manufacturing costs. MasterCraft records these
manufacturing costs as inventory on the balance sheet until the boats are sold,
at which time the costs are transferred to cost of goods sold on the income
statement.
Examples of direct materials for each boat include the hull, engine,
transmission, carpet, gauges, seats, windshield, and swim platform. Examples of
indirect materials (part of manufacturing overhead) include glue, paint, and
screws. Direct labor includes the production workers who assemble the boats
and test them before they are shipped out. Indirect labor (part of
manufacturing overhead) includes the production supervisors who oversee
production for several different boats and product lines.
Manufacturing overhead includes the indirect materials and indirect labor
mentioned previously. Other manufacturing overhead items are factory
building rent, maintenance and depreciation for production equipment, factory
utilities, and quality control testing.
1.6 Cost Terminology
40
Chapter 1 What Is Managerial Accounting?
Source: MasterCraft, “Home Page,” http://www.mastercraft.com.
Nonmanufacturing Costs
Costs that are not related to the production of goods are called nonmanufacturing
costs23; they are also referred to as period costs24. These costs have two
components—selling costs and general and administrative costs—which are described
next. Examples of nonmanufacturing costs appear in Figure 1.5 “Examples of
Nonmanufacturing Costs at Custom Furniture Company”.
Selling Costs
Question: Costs incurred to obtain customer orders and provide customers with a finished
product are called selling costs25. (They are also often called marketing costs or selling and
advertising costs.) What activities would be classified as selling costs at Custom Furniture?
Answer: Examples of selling costs include advertising, sales commissions, salaries
for marketing and advertising personnel, office space for marketing and advertising
personnel, finished goods storage costs, and shipping costs paid by the seller for
products shipped to customers.
General and Administrative Costs
23. Costs that are not related to
the production of goods; also
called period costs.
24. Costs that are not related to
the production of goods; also
called nonmanufacturing costs.
25. Costs incurred to obtain
customer orders and provide
customers with a finished
product.
26. Costs related to the overall
management of an
organization.
1.6 Cost Terminology
Question: Costs related to the overall management of an organization are called general
and administrative costs26. What activities would be classified as general and
administrative costs at Custom Furniture?
Answer: Examples include personnel and support staff in the following areas:
accounting, human resources, legal, executive, and information technology.
Depreciation of office equipment and buildings associated with these areas would
also be included as general and administrative costs. General and administrative
costs are often simply called administrative costs.
41
Chapter 1 What Is Managerial Accounting?
Figure 1.5 Examples of Nonmanufacturing Costs at Custom Furniture Company
Although selling costs and general and administrative costs are considered
nonmanufacturing costs, managers often want to assign some of these costs to
products for decision-making purposes. For example, sales commissions and
shipping costs for a specific product could be assigned to the product. This does not
comply with U.S. GAAP because, under U.S. GAAP, only product costs can be
assigned to products. However, as we noted earlier, managerial accounting
information is tailored to meet the needs of the users and need not follow U.S.
GAAP.
Distinguishing between manufacturing and nonmanufacturing costs is not always
simple. For example, if legal staff works on an issue associated with production
personnel and if human resources staff hires assembly line workers, are the costs
involved manufacturing or nonmanufacturing costs? It is up to each organization to
determine how to handle such costs for product costing purposes. The advantage of
managerial accounting over financial accounting is that costs can be organized in
any manner that helps managers make decisions. However, in this chapter, to avoid
ambiguity, we follow the definitions provided by U.S. GAAP.
Presentation of Manufacturing and Nonmanufacturing Costs in
Financial Statements
Question: At this point, you should be able to distinguish between manufacturing costs and
nonmanufacturing costs. Why is it important to make this distinction?
1.6 Cost Terminology
42
Chapter 1 What Is Managerial Accounting?
Answer: Distinguishing between the two categories is critical because the category
determines where a cost will appear in the financial statements. All manufacturing
costs (direct materials, direct labor, and manufacturing overhead) are attached to
inventory as an asset on the balance sheet until the goods are sold, at which point
the costs are transferred to cost of goods sold on the income statement as an
expense. As we indicated earlier, nonmanufacturing costs are also called period
costs; that is because they are expensed on the income statement in the time period
in which they are incurred.
Table 1.3 “Manufacturing Versus Nonmanufacturing Costs” clarifies the
relationship between manufacturing and nonmanufacturing costs. It also describes
the point at which these costs are recorded as expenses on the income statement.
(Remember that the terms manufacturing cost and product cost are interchangeable,
as are the terms nonmanufacturing cost and period cost.)
Table 1.3 Manufacturing Versus Nonmanufacturing Costs
Manufacturing Costs (Also Called
Product Costs)
• Direct materials
• Direct labor
• Manufacturing
overhead
Timing of expense: Costs are expensed
when goods are sold.
Nonmanufacturing Costs (Also Called Period
Costs)
• Selling
• General and administrative
Timing of expense: Costs are expensed during
the time period incurred.
Note 1.48 “Business in Action 1.6” provides examples of nonmanufacturing costs at
PepsiCo, Inc.
1.6 Cost Terminology
43
Chapter 1 What Is Managerial Accounting?
Business in Action 1.6
Source: Photo courtesy of JeffBedord, http://www.flickr.com/photos/jeffbedford/6218820224/in/photostream/.
Nonmanufacturing Costs at PepsiCo
PepsiCo, Inc., produces more than 500 products under several different brand
names, including Frito-Lay, Pepsi-Cola, Gatorade, Tropicana, and Quaker. Net
sales for 2010 totaled $57,800,000,000, resulting in operating profits of
$6,300,000,000. Cost of sales represented the highest cost on the income
statement at $26,600,000,000. The second highest cost on the income
statement—selling and general and administrative expenses—totaled
$22,800,000,000. These expenses are period costs, meaning they must be
expensed in the period in which they are incurred.
Examples of selling costs for PepsiCo include television advertising (probably
the biggest piece of the $22,800,000,000), promotional coupons, costs of
shipping products to customers, and salaries of marketing and advertising
personnel.
Examples of general and administrative costs include salaries and bonuses of
top executives and the costs of administrative departments, including
personnel, accounting, legal, and information technology.
Source: PepsiCo, “PepsiCo 2010 Annual Report,” http://www.pepsico.com.
1.6 Cost Terminology
44
Chapter 1 What Is Managerial Accounting?
KEY TAKEAWAY
• All manufacturing costs that are easily traceable to a product are
classified as either direct materials or direct labor. All other
manufacturing costs are classified as manufacturing overhead. All
nonmanufacturing costs are not related to production and are classified
as either selling costs or general and administrative costs.
1.6 Cost Terminology
45
Chapter 1 What Is Managerial Accounting?
REVIEW PROBLEM 1.6
1. The following manufacturing items are for a construction
company working on several custom homes. Identify whether
each item should be categorized as direct materials, direct labor,
or manufacturing overhead.
1.
2.
3.
4.
5.
6.
7.
8.
Nails
Lumber
Drywall
Workers building the house frame
Supervisor responsible for three homes
Light bulbs
Cabinets
Depreciation of construction equipment
2. Identify whether each item in the following should be
categorized as a product (manufacturing) cost or as period
(nonmanufacturing) cost. Also indicate whether the cost should
be recorded as an expense when the cost is incurred or as an
expense when the goods are sold.
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
11.
12.
13.
14.
15.
16.
Advertising
Shipping costs for raw materials coming from a supplier
Shipping costs for goods shipped to a customer
Chief executive officer’s salary
Production supervisor’s salary
Depreciation on production equipment
Raw materials used in production
Paper used by the accounting staff
Commissions paid to salespeople
Janitorial services provided for production facility
Supplies used by human resources personnel
Utility costs for retail store
Insurance costs for production facility
Assembly line workers
Clerical support for chief executive officer
Maintenance of production equipment
3. Identify whether each item listed in item 2 should be categorized as
direct materials, direct labor, manufacturing overhead, selling cost, or
general and administrative cost.
1.6 Cost Terminology
46
Chapter 1 What Is Managerial Accounting?
Solution to Review Problem 1.6
1.
1.
2.
3.
4.
5.
6.
Manufacturing overhead
Direct materials
Direct materials
Direct labor
Manufacturing overhead
Manufacturing overhead (You might call this a direct
material, but the benefit of tracking this item as a direct
material probably does not outweigh the cost.)
7. Direct materials
8. Manufacturing overhead
2.
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
11.
12.
13.
14.
15.
16.
Period cost, expensed when incurred
Product cost, expensed when goods are sold
Period cost, expensed when incurred
Period cost, expensed when incurred
Product cost, expensed when goods are sold
Product cost, expensed when goods are sold
Product cost, expensed when goods are sold
Period cost, expensed when incurred
Period cost, expensed when incurred
Product cost, expensed when goods are sold
Period cost, expensed when incurred
Period cost, expensed when incurred
Product cost, expensed when goods are sold
Product cost, expensed when goods are sold
Period cost, expensed when incurred
Product cost, expensed when goods are sold
3.
1. Selling
2. Direct materials or manufacturing overhead, depending on if
the materials are easily traced to the product (direct) or not
(indirect manufacturing overhead)
3. Selling
1.6 Cost Terminology
47
Chapter 1 What Is Managerial Accounting?
4.
5.
6.
7.
8.
9.
10.
11.
12.
13.
14.
15.
16.
1.6 Cost Terminology
General and administrative
Manufacturing overhead
Manufacturing overhead
Direct materials or manufacturing overhead, depending on if
the materials are easily traced to the product (direct) or not
(indirect manufacturing overhead)
General and administrative
Selling
Manufacturing overhead
General and administrative
Selling
Manufacturing overhead
Direct labor
General and administrative
Manufacturing overhead
48
Chapter 1 What Is Managerial Accounting?
1.7 How Product Costs Flow through Accounts
LEARNING OBJECTIVE
1. Identify how costs flow through the three inventory accounts and cost
of goods sold account.
Question: Custom Furniture Company’s direct materials include items such as wood and
hardware. Direct labor involves the employees who build the custom tables. Manufacturing
overhead includes items such as indirect materials (glue, screws, nails, sandpaper, and
stain), indirect labor (production supervisor), and other manufacturing costs, such as
factory equipment maintenance and factory utilities. What accounts are used to record the
costs associated with these items, and where do these accounts appear in the financial
statements?
Answer: All the costs mentioned previously for Custom Furniture are product costs
(also called manufacturing costs). Product costs are recorded as an asset on the
balance sheet until the products are sold, at which point the costs are recorded as
an expense on the income statement. To record product costs as an asset,
accountants use one of three inventory accounts: raw materials inventory, work-inprocess inventory, or finished goods inventory. The account they use depends on
the product’s level of completion. They use one expense account—cost of goods
sold—to record the product costs when the goods are sold.
Table 1.4 “Accounts Used to Record Product Costs” summarizes the accounts used
to track product costs. Figure 1.6 “Flow of Product Costs through Balance Sheet and
Income Statement Accounts” shows how product costs flow through the balance
sheet and income statement. Lastly, Note 1.57 “Business in Action 1.7” provides an
example of how the accounts shown in Table 1.4 “Accounts Used to Record Product
Costs” and Figure 1.6 “Flow of Product Costs through Balance Sheet and Income
Statement Accounts” appear in financial statements. Take time to review these
items carefully. Your understanding of them will help clarify how product costs
flow through the accounts and where product costs appear in the financial
statements. The following discussion provides further clarification.
49
Chapter 1 What Is Managerial Accounting?
Product Costs on the Balance Sheet
Question: What is the difference between raw materials inventory, work-in-process
inventory, and finished goods inventory?
Answer: Each of these accounts is used to record product costs depending on where
the product is in the production process, and each account is an asset account on
the balance sheet.
Raw Materials
The raw materials inventory27 account records the cost of materials not yet put
into production. For Custom Furniture Company, this account includes items such
as wood, brackets, screws, nails, glue, lacquer, and sandpaper.
Work in Process
The work-in-process (WIP) inventory28 account records the costs of products that
have not yet been completed. Suppose Custom Furniture Company has eight tables
that are still in production at the end of the year. All manufacturing costs
associated with these incomplete eight tables—direct materials, direct labor, and
manufacturing overhead—are included in the WIP inventory account.
27. An account used to record the
cost of materials not yet put
into production.
28. An account used to record
costs associated with products
in the production process that
are not yet complete.
29. The cost of completed goods
transferred from work-inprocess inventory into finished
goods inventory.
30. An account used to record the
manufacturing costs associated
with products that are
completed and ready to sell.
Once goods in WIP inventory are completed, they are transferred into finished
goods inventory. The cost of completed goods that are transferred out of WIP
inventory into finished goods inventory is called the cost of goods
manufactured29.
Finished Goods
The finished goods inventory30 account records the manufacturing costs of
products that are completed and ready to sell. Suppose Custom Furniture Company
has five completed tables at the end of the year (in addition to the eight partially
completed tables in work-in-process inventory). The manufacturing costs of these
five tables—direct materials, direct labor, and manufacturing overhead—are
included in the finished goods inventory account until the tables are sold. (For the
purposes of this example, assume the tables are “sold” when delivered to the
customer.)
1.7 How Product Costs Flow through Accounts
50
Chapter 1 What Is Managerial Accounting?
Product Costs on the Income Statement
Question: The costs of materials not yet put into production are included in raw materials
inventory. The costs associated with products that are not yet complete are included in WIP
inventory. And the costs associated with products that are completed and ready to sell are
included in finished goods inventory. What happens to the product costs in finished goods
inventory when the products are sold?
Answer: When completed goods are sold, their costs are transferred out of finished
goods inventory into the cost of goods sold31 account. Cost of goods sold is an
expense account on the income statement that represents the product costs of all
goods sold during the period.
For example, suppose Custom Furniture Company sells one table that cost $3,000 to
produce (i.e., direct materials, direct labor, and manufacturing overhead costs
incurred to produce the table total $3,000). The $3,000 cost is in finished goods
inventory until the entry is made to record the sale, at which time finished goods
inventory is reduced by $3,000 (the table is no longer in inventory) and cost of
goods sold is increased by $3,000.
Table 1.4 Accounts Used to Record Product Costs
Account Name
Description
Financial Statement
Raw materials inventory Cost of unused production materials Balance sheet (asset)
Work-in-process
inventory
Cost of incomplete products
Balance sheet (asset)
Finished goods
inventory
Cost of completed products not yet
sold
Balance sheet (asset)
Cost of goods sold
Cost of products sold
Income statement
(expense)
31. An expense account on the
income statement that
represents the product costs
for all goods sold during the
period.
1.7 How Product Costs Flow through Accounts
51
Chapter 1 What Is Managerial Accounting?
Figure 1.6 Flow of Product Costs through Balance Sheet and Income Statement Accounts
1.7 How Product Costs Flow through Accounts
52
Chapter 1 What Is Managerial Accounting?
Business in Action 1.7
Source: Photo courtesy of Matthew Rutledge, http://www.flickr.com/photos/rutlo/4252743250//.
Presentation of Product Costs at Advanced Micro Devices
Advanced Micro Devices (AMD), a producer of microprocessors and flash
memory devices for personal and networked computers, has annual revenues
of $6,500,000,000. A summarized version of AMD’s balance sheet appears as
follows (all amounts are in millions). Notice that three inventory accounts,
totaling $632,000,000, support the total inventory amount that appears in the
asset section of the balance sheet. The raw materials inventory account
($28,000,000) is used to record the cost of materials not yet put into production.
The work-in-process inventory account ($441,000,000) is used to record costs
associated with microprocessors and flash memory devices in the production
process that are not yet complete. The finished goods inventory account
($163,000,000) is used to record the product costs associated with AMD’s
products that are completed and ready to sell.
1.7 How Product Costs Flow through Accounts
53
Chapter 1 What Is Managerial Accounting?
When AMD sells finished goods, the cost of these goods is transferred out of
finished goods inventory into the cost of goods sold account, which this
company calls cost of sales, as many companies do. The operating portion of
AMD’s income statement follows—again, all amounts are in millions. Notice
that cost of sales appears below net sales and above all other operating
expenses.
Source: Advanced Micro Devices, “Advanced Micro Devices 2010 Annual
Report,” http://www.amd.com.
1.7 How Product Costs Flow through Accounts
54
Chapter 1 What Is Managerial Accounting?
KEY TAKEAWAY
• The raw materials inventory account is used to record the cost of
materials not yet put into production. The work-in-process inventory
account is used to record the cost of products that are in production but
that are not yet complete. The finished goods inventory account is used
to record the costs of products that are complete and ready to sell.
These three inventory accounts are assets accounts that appear on the
balance sheet. The costs of completed goods that are sold are recorded
in the cost of goods sold account. This account appears on the income
statement as an expense.
REVIEW PROBLEM 1.7
Match each of the following accounts with the appropriate description that
follows.
•
•
•
•
_____ Raw materials inventory
_____ Work-in-process inventory
_____ Finished goods inventory
_____ Cost of goods sold
1. Used to record product costs of goods that are completed and ready to
sell
2. Used to record product costs of goods that have been sold
3. Used to record product costs of goods that are still in production
4. Used to record the cost of materials not yet put into production…

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