Chapter 1: Introduction to Managerial Accounting

Differences Between Managerial and Financial Accounting

Managerial accounting and financial accounting serve distinct purposes within an organization. Understanding their differences is fundamental for business decision-making.

• Primary Users: Managerial accounting is used by internal stakeholders (managers, employees), while financial accounting is for external users (investors, creditors, regulators).

• Primary Functions: Managerial accounting focuses on planning, controlling, and decision-making. Financial accounting emphasizes reporting financial results and compliance.

• Reporting Frequency: Managerial reports are generated as needed (often daily or weekly), whereas financial reports are periodic (quarterly, annually).

• Other Characteristics: Managerial accounting is future-oriented and may use estimates; financial accounting is historical and must follow GAAP.

Example: A manager uses cost data to decide whether to launch a new product, while an investor reviews audited financial statements to assess company performance.

Types of Business Organizations

Businesses are classified based on their operations and the nature of their products or services.

• Manufacturing Companies: Produce goods from raw materials (e.g., car manufacturers).

• Merchandising Companies: Buy and sell finished goods (e.g., retailers like Walmart).

• Service Companies: Provide intangible services (e.g., consulting firms, hospitals).

• Retailers: A subset of merchandising companies that sell goods directly to the public.

Example: A bakery (manufacturing), a bookstore (merchandising), and a law firm (service).

Sustainability Accounting and Ethics

Sustainability accounting considers the impact of business decisions on people, profit, and planet, addressing the needs of multiple stakeholders.

• Triple Bottom Line: Focuses on social (people), economic (profit), and environmental (planet) performance.

• Ethics: Standards for judging fairness, honesty, and right versus wrong in business conduct.

• Sarbanes-Oxley Act: U.S. legislation aimed at improving corporate governance and accountability, including provisions for internal controls and ethical standards.

Example: A company implements recycling programs and fair labor practices to meet sustainability goals.

Cost Concepts

Understanding cost terminology is essential for analyzing and managing expenses.

• Out-of-Pocket Costs: Actual cash payments made for resources.

• Opportunity Cost: The value of the next best alternative foregone.

• Direct Costs: Costs that can be traced directly to a cost object (e.g., direct materials).

• Indirect Costs: Costs not directly traceable (e.g., factory rent).

• Variable Costs: Change with production volume (e.g., raw materials).

• Fixed Costs: Remain constant regardless of activity (e.g., salaries).

• Relevant Costs: Affect future decisions; Irrelevant Costs: do not.

• Prime Costs: Direct materials + direct labor.

• Conversion Costs: Direct labor + manufacturing overhead.

• Manufacturing Costs: Direct labor, direct materials, manufacturing overhead.

• Non-manufacturing Costs: Selling and administrative expenses.

• Product Costs: Capitalized as inventory; Period Costs: expensed in the period incurred.

Example: Factory supervisor salary is an indirect, fixed, manufacturing overhead cost.

Chapter 2: Job Order Costing

Job-Order Costing vs. Process Costing

Costing systems are chosen based on the nature of production.

• Job-Order Costing: Used for customized, unique products (e.g., construction, custom furniture).

• Process Costing: Used for homogeneous, mass-produced items (e.g., chemicals, food processing).

Example: A law firm uses job-order costing; a paint manufacturer uses process costing.

Documents in Job-Order Costing

Several documents track costs in a job-order system.

• Materials Requisition Form: Records materials drawn for a job.

• Labor Time Ticket: Tracks labor hours spent on a job.

• Job Cost Sheet: Summarizes all costs for a specific job.

Formula for Total Manufacturing Cost:

Predetermined Overhead Rate and Overhead Application

Overhead is applied to jobs using a predetermined rate based on estimated activity.

• Predetermined Overhead Rate Formula:

• Overhead Applied Formula:

• Over/Under Applied Overhead: Occurs when applied overhead differs from actual overhead.

• Effects on Cost of Goods Sold:

  • Applied > Actual = Overapplied = Reduce Cost of Goods Sold

  • Actual > Applied = Underapplied = Increase Cost of Goods Sold

Example: If $10,000 overhead is applied but only $9,000 is incurred, $1,000 is overapplied.

Inventory Accounts in Manufacturing

Manufacturing companies use three main inventory accounts.

• Raw Materials: Materials purchased but not yet used.

• Work-in-Process (WIP): Goods partially completed.

• Finished Goods: Completed products ready for sale.

Example: Steel in a car factory is raw material; assembled cars not yet sold are finished goods.

Cost Flow in Job-Order Costing

Costs move through accounts as production progresses.

• Cost of Goods Manufactured: Amount transferred from WIP to Finished Goods.

• Components:

  • Direct Materials Used (actual)

  • Direct Labor (actual)

  • Applied Manufacturing Overhead (not actual)

Formula:

Service Firms and Indirect Costs

Service firms assign indirect costs based on billable hours.

• Billable Hours: Used as the activity base for allocating indirect costs.

Example: A consulting firm allocates overhead to client projects based on hours worked.

Chapter 3: Process Costing

Characteristics of Process Costing

Process costing is used for standardized, continuous production of homogeneous products.

• Homogeneous Products: All units are identical.

• Standardized Processes: Production steps are consistent.

• Cost Tracing: Costs are traced to processes, not individual products.

• Work-in-Process Accounts: Separate WIP accounts for each major process.

Example: A soft drink manufacturer uses process costing for bottling, mixing, and packaging.

Weighted Average Method and Equivalent Units

The weighted average method is used to calculate equivalent units and allocate costs in process costing.

• Physical Units vs. Equivalent Units: Physical units must be greater than or equal to equivalent units.

• Cost Separation: Costs are separated into direct materials and conversion costs (direct labor + overhead).

Formula for Equivalent Units (Weighted Average):

Formula for Cost per Equivalent Unit:

Production Report Preparation

Production reports summarize the flow of units and costs through a process.

• Reconciliation of Physical Units: Beginning inventory + units started = units completed + ending inventory.

• Steps:

  1. Account for physical units.

  2. Calculate equivalent units.

  3. Determine cost per equivalent unit.

  4. Allocate costs to completed and ending WIP.

Example: If 100 units are started, 80 completed, and 20 are 50% complete, equivalent units = 80 + (20 x 0.5) = 90.

Sample Production Report Table

The production report helps allocate costs between completed and in-process units.

Additional info: In practice, production reports may include more detailed columns for beginning inventory, units started, units completed, and ending inventory, as well as cost reconciliation steps.