Essentials of Accounting Chapter05 - University of Phoenixmyresource.phoenix.edu/secure/resource/ACC220R3/acc_220_week5... · Managerial Cost Concepts • Manufacturing costs •

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In January 1998 Compaq Computer had just be-come the largest seller of personal computers, and itwas Forbes magazine’s “company of the year.” Itschief executive, Eckhard Pfeiffer, was riding high.But during the next two years Compaq lost $2 bil-lion. The company was in chaos, and Mr. Pfeifferwas out of a job. What happened?

First, Dell happened. Dell Computer pioneered anew way of making and selling personal computers.Its customers “custom design” their computer overthe Internet or phone. Dell reengineered its “supplychain”: It coordinated its efforts with its suppliersand streamlined its order-taking and productionprocess, and it can ship a computer within two daysof taking an order. Personal computers lose 1 per-cent of their value every week they sit on a shelf.Thus, having virtually no inventory is a great advan-tage to Dell. Compaq tried to adopt Dell’s approach,but with limited success.

The second shock to Compaq came when it ac-quired a company even larger than itself—Digital

F E A T U R E S T O R Y

WHAT A DIFFERENCE A DAY MAKES

C H A P T E R5ManagerialAccounting T H E N A V I G A T O R

■ Scan Study Objectives

■ Read Feature Story

■ Read Preview

■ Read text and answer Before You Go Onp. 217 p. 219 p. 229

■ Work Using the Decision Toolkit

■ Review Summary of Study Objectives

■ Work Demonstration Problem

■ Answer Self-Study Questions

■ Complete Assignments

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S T U D Y O B J E C T I V E S

◆1 Explain the distinguishing features ofmanagerial accounting.

◆2 Identify the three broad functions ofmanagement.

◆3 Define the three classes of manufacturingcosts.

◆4 Distinguish between product and periodcosts.

◆5 Explain the difference between amerchandising and a manufacturingincome statement.

◆6 Indicate how cost of goods manufacturedis determined.

◆7 Explain the differencebetween a merchandisingand a manufacturingbalance sheet.

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After studying this chapter, you shouldbe able to:

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Equipment. Digital was famousas much for its technical serviceas it was for its products. Mr.Pfeiffer believed that the pur-chase of Digital, with its hugeand respected technical salesforce, opened new opportunitiesfor Compaq as a global servicecompany. Now it could sell toand service high-end corporatecustomers. But combining thetwo companies proved to behugely expensive and extremelycomplicated.

Managers are evaluated onthe results of their decisions. In

the long run, it may turn outthat Mr. Pfeiffer had great strate-gic vision and made a good deci-sion. But, in a world that wantsresults at “Internet speed,” Com-paq’s board of directors wasn’twilling to wait and see. Man-agers in today’s rapidly changingglobal environment often mustmake decisions that determinetheir company’s fate, and theirown. This textbook discusses techniques used toassist managers inmaking these deci-sions.

www.compaq.comwww.dell.com

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Essential terms and conceptsare printed in blue where theyfirst appear and are defined inthe end-of-chapter Glossary.

MANAGERIAL ACCOUNTING BASICS

Managerial accounting, also called management accounting, is a field of ac-counting that provides economic and financial information for managers andother internal users. The activities that are part of managerial accounting (andthe chapters in which they are discussed) are as follows.

1. Explaining manufacturing and nonmanufacturing costs and how they arereported in the financial statements (Chapter 5).

2. Computing the cost of providing a service or manufacturing a product.3. Determining the behavior of costs and expenses as activity levels change and

analyzing cost–volume–profit relationships within a company (Chapter 6).4. Assisting management in profit planning and formalizing these plans in the

form of budgets (Chapter 7).5. Providing a basis for controlling costs and expenses by comparing actual re-

sults with planned objectives and standard costs (Chapter 8).6. Accumulating and presenting relevant data for management decision mak-

ing (Chapters 9 and 10).7. Determining prices for external and internal transactions (Chapter 11).

214

This book focuses on issues illustrated in the Feature Story about CompaqComputer. These include determining and controlling the costs of material,labor, and overhead and the relationship between costs and profits. In a pre-

vious financial accounting course, you learned about the form and content of fi-nancial statements for external users of financial information, such as stock-holders and creditors. These financial statements represent the principal productof financial accounting. Managerial accounting focuses primarily on the prepara-tion of reports for internal users of financial information, such as the managersand officers of a company. Managerial accounting provides tools for assisting man-agement in making decisions and for evaluating the effectiveness of those decisions.

The content and organization of this chapter are as follows.

P R E V I E W O F C H A P T E R 5

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Managerial Accounting Basics

• Comparing managerial andfinancial accounting

• Ethical standards• Management functions

Managerial Cost Concepts

• Manufacturing costs• Product vs. period costs

Manufacturing Costs inFinancial Statements

• Income statement• Balance sheet• Cost concepts: A review

ContemporaryDevelopments in Managerial

Accounting

• Service industry trends• Value chain management

MANAGERIAL ACCOUNTING

Managerial Accounting Basics 215

Managerial accounting applies to all types of businesses—service, mer-chandising, and manufacturing. It also applies to all forms of business organi-zations—proprietorships, partnerships, and corporations. Managerial account-ing is needed in not-for-profit entities as well as in profit-oriented enterprises.

Not long ago, the managerial accountant was primarily engaged in cost ac-counting—collecting and reporting manufacturing costs to management. Today,the managerial accountant’s responsibilities extend to strategic cost manage-ment—providing managers with data on the efficient use of company resourcesin both manufacturing and service industries.

COMPARING MANAGERIAL AND FINANCIAL ACCOUNTING

There are both similarities and differences between managerial and financial ac-counting. First, each field of accounting deals with the economic events of abusiness. Thus, their interests overlap. For example, determining the unit costof manufacturing a product is part of managerial accounting. Reporting the to-tal cost of goods manufactured and sold is part of financial accounting. In ad-dition, both managerial and financial accounting require that a company’s eco-nomic events be quantified and communicated to interested parties.

The principal differences between financial accounting and managerial ac-counting are summarized in Illustration 5-1. The diverse needs for economicdata among interested parties are responsible for many of the differences.

Illustration 5-1 Differ-ences between financialand managerial account-ing

External users: stockholders, creditors, and regulators.

Financial statements.Quarterly and annually.

General-purpose.

Pertains to business as a whole. Highly aggregated (condensed).Limited to double-entry accounting and cost data.Generally acceptedaccounting principles.

Audit by CPA.

Primary Usersof Reports

Types and Frequencyof Reports

Purpose of Reports

Content of Reports

Verification Process

Financial Accounting

Internal users: officers and managers.

Internal reports.As frequently as needed.

Special-purpose forspecific decisions.

Pertains to subunits of the business.Very detailed.Extends beyond double-entryaccounting to any relevant data.Standard is relevanceto decisions.

No independent audits.

Managerial Accounting

Production

ReportAnnualReport

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S T U D Y O B J E C T I V E

1

Explain the distinguishingfeatures of managerial accounting.

ETHICAL STANDARDS FOR MANAGERIALACCOUNTANTS

Managerial accountants have an ethical obligation to their companies and thepublic. To provide guidance for managerial accountants, the Institute of Man-agement Accountants (IMA) has developed a code of ethical standards, entitledStandards of Ethical Conduct for Practitioners of Management Accounting and Fi-nancial Management. This code divides the managerial accountants’ responsi-bilities into four areas: (1) competence, (2) confidentiality, (3) integrity, and (4)objectivity. The code states that management accountants should not commitacts in violation of these standards. Nor should they condone such acts by oth-ers within their organizations.

Helpful Hints clarify conceptsbeing discussed.

Helpful Hint The IMA code ofethical standards is provided inAppendix D.

Business Insight examplesillustrate interesting situationsin real companies and showhow they make decisionsusing accounting information.Examples labeled as e-Business Insights describehow e-business technology isbeing used in accountingapplications.

MANAGEMENT FUNCTIONS

Management’s activities and responsibilities can be classified into three broadfunctions. They are:

1. Planning.2. Directing and motivating.3. Controlling.

In performing these functions, managers make decisions that have a significantimpact on the organization.

Planning requires management to look ahead and to establish objectives.These objectives are often diverse: maximizing short-term profits and marketshare, maintaining a commitment to environmental protection, and contribut-ing to social programs. A key objective of management is to add value to thebusiness under its control. Value is usually measured by the trading price of thecompany’s stock and by the potential selling price of the company.

Directing and motivating involves coordinating a company’s diverse activ-ities and human resources to produce a smooth-running operation. This func-tion relates to implementing planned objectives and providing necessary incen-tives. For example, manufacturers such as Campbell Soup Company, GeneralMotors, and Compaq Computer must coordinate purchasing, manufacturing,warehousing, and selling. Service corporations such as American Airlines, Fed-eral Express, and AT&T must coordinate scheduling, sales, and acquisitions ofequipment and supplies. Directing also involves selecting executives, appointingmanagers and supervisors, and hiring and training employees. Most companiesprepare organization charts to show the interrelationship of activities and thedelegation of authority and responsibility within the company.

The third management function, controlling, is the process of keeping thecompany’s activities on track. In controlling operations, managers determinewhether planned goals are being met. When there are deviations from targetedobjectives, they must decide what changes are needed to get back on track.

How do managers achieve control? A smart manager in a small operationshould make personal observations, ask good questions, and know how to eval-uate the answers. But such a system in a large organization would be chaotic.Imagine the president of Compaq Computer attempting to determine whetherplanned objectives are being met without some record of what has happened

216 CHAPTER 5 Managerial Accounting

– B U S I N E S S I N S I G H TThe trend toward more automated and computerized factories haschanged the way managers and employees interact. For one thing,

managers have fewer direct labor employees to supervise because fewer areneeded on the line. Instead of standing in one spot all day, employees and man-agers have become more mobile, monitoring the computers that control pro-duction, and involving themselves in a variety of jobs.

Recently, two technology giants, General Electric and Cisco Systems, joinedforces to build computerized infrastructures for manufacturers. Their goal is toimprove productivity by making better use of data generated by factory-au-tomation equipment. Ultimately their systems should provide a closer link be-tween the factory and corporate offices. They believe the market for such sys-tems will be $3 billion by 2003.

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2Identify the three broadfunctions of management.

e

Managerial Cost Concepts 217

Manufacturing Costs

ManufacturingOverhead

Direct LaborDirect Materials

Illustration 5-2 Classifi-cations of manufacturingcosts

Illustrations like this one convey information in pictorial form tohelp you visualize and apply the ideas as you study.

and what is expected to occur. Thus, a formal system of evaluation is typicallyused in large businesses. It would include such items as budgets, responsibilitycenters, and performance evaluation reports.

Decision making is not a separate management function. Rather, it is theoutcome of the exercise of good judgment in planning, directing, motivating,and controlling.

You are now ready to study specific applications of managerial accounting.As you study the managerial chapters, you will encounter many new terms, con-cepts, and reports. At the same time, you will find some new uses and inter-pretations of a number of familiar financial accounting terms.

B E F O R E Y O U G O O N . . .

◆ Review It

1. Compare financial accounting and managerial accounting, identifying the principal differences.

2. Identify and discuss the three broad functions of management.

MANAGERIAL COST CONCEPTS

To perform the three management functions effectively, management needs in-formation. One very important type of information is related to costs. For ex-ample, questions such as the following should be asked.

1. What costs are involved in making a product or providing a service?2. If production volume is decreased, will costs decrease?3. What impact will automation have on total costs?4. How can costs best be controlled?

To answer these questions, management needs reliable and relevant cost infor-mation. We now explain and illustrate the costs that management uses.

MANUFACTURING COSTS

Manufacturing consists of activities and processes that convert raw materialsinto finished goods. Contrast this type of operation with merchandising, whichsells merchandise in the form in which it is purchased. Manufacturing costs aretypically classified as shown in Illustration 5-2.

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♦S T U D Y O B J E C T I V E

3

Define the three classes ofmanufacturing costs.

Helpful Hint A manufactureruses masking tape to protectcertain sections of its productwhile other sections are painted.The tape is removed and thrownaway when the paint is dry. Isthe tape a direct or an indirectmaterial? Answer: Indirect.

Direct Materials

To obtain the materials that will be converted into the finished product, the man-ufacturer purchases raw materials. Raw materials are the basic materials andparts used in the manufacturing process. For example, auto manufacturers suchas General Motors, Ford, and DaimlerChrysler use steel, plastics, and tires asraw materials in making cars.

Raw materials that can be physically and directly associated with the fin-ished product during the manufacturing process are called direct materials. Ex-amples include flour in the baking of bread, syrup in the bottling of soft drinks,and steel in the making of automobiles. In the Feature Story, direct materialsfor Compaq Computer and Dell Computer include plastic, glass, hard drives,and processing chips.

But some raw materials cannot be easily associated with the finished prod-uct. These are considered indirect materials. Indirect materials (1) do not phys-ically become part of the finished product, such as lubricants and polishing com-pounds, or (2) cannot be traced because their physical association with thefinished product is too small in terms of cost, such as cotter pins and lock wash-ers. Indirect materials are accounted for as part of manufacturing overhead.

Direct Labor

The work of factory employees that can be physically and directly associatedwith converting raw materials into finished goods is considered direct labor.Bottlers at Coca-Cola, bakers at Sara Lee, and typesetters at TechBooks areemployees whose activities are usually classified as direct labor. In contrast, thewages of maintenance people, time-keepers, and supervisors are usually identi-fied as indirect labor. Their efforts have no physical association with the fin-ished product, or it is impractical to trace the costs to the goods produced. Likeindirect materials, indirect labor is classified as manufacturing overhead.


Direct Materials

Direct Labor

Manufacturing Overhead

Manufacturing overhead consists of costs that are indirectly associated with themanufacture of the finished product. These costs may also be manufacturing coststhat cannot be classified as direct materials or direct labor. Manufacturing over-head includes indirect materials, indirect labor, depreciation on factory buildingsand machines, and insurance, taxes, and maintenance on factory facilities.

One study found the following magnitudes of the three different productcosts as a percentage of the total product cost: direct materials 54.4 percent, di-rect labor 12.9 percent, and manufacturing overhead 32.6 percent. Note that thedirect labor component is the smallest. This component of product cost is drop-

ManufacturingOverhead

B U S I N E S S I N S I G H T

Management PerspectiveRecently a closely watched study of productivity reported that aU.S. manufacturer, Ford, outperformed the North American plants

of many of its Japanese rivals. It also reported that productivity at General Mo-tors had improved the most of all auto makers. On a per car basis, GM spends$1,979 on labor and benefits. Ford spends $1,667, and Nissan, the most efficientof all North American operators, spends just $1,055. If GM were as efficient asNissan it would reduce labor spending by $5.3 billion.Source: Karen Lundegaard, “Ford Plant, GM Receive High Marks in Study of Auto Makers’ Pro-ductivity.” Wall Street Journal, June 16, 2000.

Managerial Cost Concepts 219

ping substantially because of automation. In some companies, direct labor hasbecome as little as 5 percent of the total cost.

Allocating materials and labor costs to specific products is fairly straight-forward. But dealing with overhead presents problems. How much of the pur-chasing agent’s salary is attributable to the hundreds of products made in thesame plant? What about the grease that keeps the machines humming, or thecomputers that make sure paychecks come out on time? Boiled down to its sim-plest form, the question becomes: Which products cause which costs? In sub-sequent chapters we show various methods of allocating overhead to products.

PRODUCT VERSUS PERIOD COSTS

Each of the manufacturing cost components (direct materials, direct labor, andmanufacturing overhead) are product costs. As the term suggests, product costsare costs that are a necessary and integral part of producing the finished prod-uct. Product costs are recorded as inventory when incurred. Under the match-ing principle, these costs do not become expenses until the finished goods in-ventory is sold. The expense is cost of goods sold.

Period costs are costs that are matched with the revenue of a specific timeperiod rather than included as part of the cost of a salable product. These arenonmanufacturing costs. Period costs include selling and administrative ex-penses. They are deducted from revenues in the period in which they are in-curred.

The foregoing relationships and cost terms are summarized in Illustration5-3. Our main concern in this chapter is with product costs.

Alternative TerminologyTerms such as factoryoverhead, indirectmanufacturing costs, andburden are sometimes usedinstead of manufacturingoverhead.

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4

Distinguish between product and period costs.

Direct Materials

Direct Labor

Manufacturing Overhead

Manufacturing Costs

All Costs

Product Costs Period Costs

SellingExpenses

AdministrativeExpenses

Nonmanufacturing Costs

Illustration 5-3 Productversus period costs


◆ Review It

1. What are the major cost classifications involved in manufacturing a product?2. What are product and period costs, and what is their relationship to the man-

ufacturing process?

Helpful Hint An unethicalmanager may choose to inflatethe company’s earnings by absorbing period costs (such as selling and administrativeexpenses not pertaining to production) in the ending in-ventory balances.

Alternative TerminologyProduct costs are also calledinventoriable costs.

Alternative Terminology notespresent synonymous termsused in practice.

◆ Do It

A bicycle company has these costs: tires, salaries of employees who put tires onthe wheels, factory building depreciation, wheel nuts, spokes, salary of factorymanager, handle bars, and salaries of factory maintenance employees. Classifyeach cost as direct materials, direct labor, or overhead.

Action Plan• Classify as direct materials any raw materials that can be physically and di-

rectly associated with the finished product.• Classify as direct labor the work of factory employees that can be physically

and directly associated with the finished product.• Classify as manufacturing overhead any costs that are indirectly associated

with the finished product.

Solution: Tires, spokes, and handle bars are direct materials. Salaries of employees who put tires on the wheels are direct labor. All of the other costs are manufacturing overhead.

Related exercise material: BE5-4, BE5-5, BE5-7, E5-1, and E5-2.

MANUFACTURING COSTS IN FINANCIAL

STATEMENTS

The financial statements of a manufacturer are very similar to those of a mer-chandiser. The principal differences pertain to the cost of goods sold section inthe income statement and the current assets section in the balance sheet.

INCOME STATEMENT

Under a periodic inventory system, the income statements of a merchandiserand a manufacturer differ in the cost of goods sold section. For a merchandiser,cost of goods sold is computed by adding the beginning merchandise inventoryand the cost of goods purchased and subtracting the ending merchandise in-ventory. For a manufacturer, cost of goods sold is computed by adding the be-ginning finished goods inventory and cost of goods manufactured and sub-tracting the ending finished goods inventory. (See Illustration 5-4.)


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BeginningMerchandise

Inventory

EndingFinished Goods

Inventory

–

+ –

Cost ofGoods

Purchased+ =

=

Cost ofGoods Sold

BeginningFinished Goods

Inventory

Cost ofGoods

Manufactured

EndingMerchandise

Inventory

Manufacturer

MerchandiserIllustration 5-4 Cost ofgoods sold components

Helpful Hint A periodic inventory system is assumedhere.

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5

Explain the difference be-tween a merchandising anda manufacturing incomestatement.

Manufacturing Costs in Financial Statements 221

A number of accounts are involved in determining the cost of goods manu-factured. To eliminate excessive detail, it is customary to show in the incomestatement only the total cost of goods manufactured. The details are presentedin a Cost of Goods Manufactured Schedule. The form and content of this sched-ule are shown in Illustration 5-7 (page 222).

Determining the Cost of Goods Manufactured

An example may help show how the cost of goods manufactured is determined.Assume that Compaq Computer has a number of computers in various stages ofproduction on January 1. In total, these partially completed units are called be-ginning work in process inventory. The costs assigned to beginning work inprocess inventory are based on the manufacturing costs incurred in the priorperiod.

The manufacturing costs incurred in the current year are used first to com-plete the work in process on January 1. They then are used to start the produc-tion of other computers. The sum of the direct materials costs, direct labor costs,and manufacturing overhead incurred in the current year is the total manu-facturing costs for the current period.

We now have two cost amounts: (1) the cost of the beginning work in processand (2) the total manufacturing costs for the current period. The sum of thesecosts is the total cost of work in process for the year.

At the end of the year, some computers may be only partially completed. Thecosts of these units become the cost of the ending work in process inventory.To find the cost of goods manufactured, we subtract this cost from the totalcost of work in process. The determination of the cost of goods manufacturedis shown graphically in Illustration 5-6 on the next page.

Helpful Hint Does the amountof “total manufacturing costsfor the current year” includethe amount of “beginning work in process inventory?”Answer: No.

Illustration 5-5 Cost ofgoods sold sections ofmerchandising andmanufacturing incomestatements

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6

Indicate how cost of goodsmanufactured is determined.

The cost of goods sold sections for merchandising and manufacturing com-panies in Illustration 5-5 show the different presentations. The other sections ofan income statement are similar for merchandisers and manufacturers.

MERCHANDISING COMPANY MANUFACTURING COMPANYIncome Statement (partial) Income Statement (partial)

For the Year Ended December 31, 2002 For the Year Ended December 31, 2002

Cost of goods sold Cost of goods soldMerchandise inventory, January 1 $ 70,000 Finished goods inventory, January 1 $ 90,000Cost of goods purchased 650,000 Cost of goods manufactured

(see Illustration 5-7) 370,000

Cost of goods available for sale 720,000 Cost of goods available for sale 460,000Merchandise inventory, December 31 400,000 Finished goods inventory, December 31 80,000

Cost of goods sold $320,000 Cost of goods sold $380,000

Cost of Goods Manufactured Schedule

An internal report shows each of the cost elements shown in Illustration 5-6.This report is called the cost of goods manufactured schedule. The schedulefor Olsen Manufacturing Company (using assumed data) is shown in Illustra-tion 5-7. Note that the schedule presents detailed data for direct materials andfor manufacturing overhead.

Review Illustration 5-6 and then examine the cost of goods manufacturedschedule in Illustration 5-7. You should be able to distinguish between “totalmanufacturing costs” and “cost of goods manufactured.” The difference is theeffect of the change in work in process during the period.


BeginningWork in Process

Inventory

Cost of GoodsManufactured

=

– =

Total CurrentManufacturing

Costs

Total Cost ofWork in Process

Total Cost ofWork in Process

EndingWork in Process

Inventory

+

Illustration 5-6 Cost ofgoods manufacturedformula

Illustration 5-7 Cost ofgoods manufacturedschedule

Often, numbers or categoriesin the financial statements arehighlighted in red type todraw your attention to keyinformation.

OLSEN MANUFACTURING COMPANYCost of Goods Manufactured ScheduleFor the Year Ended December 31, 2002

Work in process, January 1 $ 18,400Direct materials

Raw materials inventory, January 1 $ 16,700Raw materials purchases 152,500

Total raw materials available for use 169,200Less: Raw materials inventory, December 31 22,800

Direct materials used $146,400Direct labor 175,600Manufacturing overhead

Indirect labor 14,300Factory repairs 12,600Factory utilities 10,100Factory depreciation 9,440Factory insurance 8,360

Total manufacturing overhead 54,800

Total manufacturing costs 376,800

Total cost of work in process 395,200Less: Work in process, December 31 25,200

Cost of goods manufactured $370,000

Manufacturing Costs in Financial Statements 223

BALANCE SHEET

The balance sheet for a merchandising company shows just one category of in-ventory. In contrast, the balance sheet for a manufacturer may have three in-ventory accounts. They are:

Is the company maintainingcontrol over the costs of pro-duction?

Cost of material, labor, and over-head

Cost of goods manufacturedschedule

Compare the cost of goodsmanufactured to revenue ex-pected from product sales.

DECISION TOOLKIT

Decision Checkpoints Info Needed for Decision Tool to Use for Decision How to Evaluate Results

Finished GoodsInventory

Work in ProcessInventory

Raw MaterialsInventory

Shows the cost of completed goods on hand. Shows the cost applicable to

units that have been started into production but are onlypartially completed.

Shows the cost of raw materials on hand.

Illustration 5-8Inventory accounts fora manufacturer

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7

Explain the difference be-tween a merchandising anda manufacturing balancesheet.

Finished Goods Inventory is to a manufacturer what Merchandise Inventory isto a merchandiser. It represents the goods that are available for sale.

The current assets sections presented in Illustration 5-9 contrast the pre-sentations of inventories for merchandising and manufacturing companies. Man-ufacturing inventories are generally listed in the order of their liquidity—the or-der in which they are expected to be realized in cash. Thus, finished goodsinventory is listed first. The remainder of the balance sheet is similar for the twotypes of companies. Illustration 5-9 Current

assets sections of mer-chandising and manufac-turing balance sheets

MERCHANDISING COMPANY MANUFACTURING COMPANYBalance Sheet Balance Sheet

December 31, 2002 December 31, 2002

Current assets Current assetsCash $100,000 Cash $180,000Receivables (net) 210,000 Receivables (net) 210,000Merchandise inventory 400,000 InventoriesPrepaid expenses 22,000 Finished goods $80,000

Total current assets $732,000 Work in process 25,200Raw materials 22,800 128,000

Prepaid expenses 18,000

Total current assets $536,000

Each step in the accounting cycle for a merchandiser applies to a manu-facturer. For example, prior to preparing financial statements, adjusting en-tries are required. The adjusting entries are essentially the same as those ofa merchandiser. The closing entries are also similar for manufacturers andmerchandisers. (For more detail, see Appendix 1A at the end of the chapter.)


What is the composition of amanufacturing company’sinventory?

Amount of raw materials, work inprocess, and finished goodsinventory

Balance sheet Determine whether there issufficient finished goodsinventory, raw materials, andwork in process to meetforecasted demand.

DECISION TOOLKIT


COST CONCEPTS—A REVIEW

You have learned a number of cost concepts in this chapter. Because many ofthese concepts are new, we believe an extended example will help illustrate howthey are used. Assume that Northridge Company manufactures and sells pre-hung metal doors. Recently, it also has decided to start selling pre-hung wooddoors.

An old warehouse that the company owns will be used to manufacture thenew product. Northridge identifies the following costs associated with manu-facturing and selling the pre-hung wood doors.

1. The material cost (wood) for each door is $10.2. Labor costs required to construct a wood door are $8 per door.3. Depreciation on the new equipment used to make the wood doors using the

straight-line method is $25,000 per year.4. Property taxes on the warehouse used to make the wood doors are $6,000

per year.5. Advertising costs for the pre-hung wood doors total $2,500 per month or

$30,000 per year.6. Sales commissions related to pre-hung wood doors sold are $4 per door.7. Salaries for employees who maintain the warehouse are $28,000.8. The salary of the plant manager in charge of pre-hung wood doors is $70,000.9. The cost of shipping pre-hung wood doors is $12 per door sold.

These manufacturing and selling costs can be assigned to the various categoriesshown in Illustration 5-10 on page 225.

Remember that total manufacturing costs are the sum of the product costs—direct materials, direct labor, and manufacturing overhead. If Northridge Com-pany produces 10,000 pre-hung wood doors the first year, the total manufac-turing costs would be $309,000 as shown in Illustration 5-11 on page 225.

Knowing the total manufacturing costs, Northridge can compute the manu-facturing cost per unit, assuming 10,000 units: The cost to produce one pre-hungwood door is $30.90 ($309,000 � 10,000 units).

The cost concepts discussed in this chapter will be used extensively in sub-sequent chapters. Study Illustration 5-10 carefully. If you do not understand anyof these classifications, go back and reread the appropriate section in this chap-ter.

Contemporary Developments in Managerial Accounting 225

Illustration 5-10Assignment of costs tocost categories

CONTEMPORARY DEVELOPMENTS IN

MANAGERIAL ACCOUNTING

Since the 1970s, the competitive environment for U.S. businesses has changedsignificantly. For example, the airline, financial services, and telecommunica-tions industries have been deregulated. Global competition has intensified, par-ticularly in the automotive and electronics industries. Today, business managersdemand from managerial accountants different and better information than theyneeded just a few years ago. Factors such as those discussed below will con-tribute to the expanding role of managerial accounting in the twenty-first century.

SERVICE INDUSTRY TRENDS

The Feature Story notes that at the peak of its success as a personal computermanufacturer, Compaq purchased Digital Equipment. Its management believesthat the future of computing lies in providing computer services, rather than inmanufacturing hardware. In fact, during the most recent decade, the U.S.economy in general shifted toward an emphasis on providing services, ratherthan goods. Today over 50 percent of U.S. workers are employed by service

Product Costs

Direct Direct Manufacturing PeriodCost Item Materials Labor Overhead Costs

1. Material cost ($10)per door X

2. Labor costs ($8)per door X

3. Depreciation onnew equipment($25,000 per year) X

4. Property taxes($6,000 per year) X

5. Advertising costs($30,000 per year) X

6. Sales commissions($4 per door) X

7. Maintenance salaries($28,000 per year) X

8. Salary of plantmanager ($70,000) X

9. Cost of shippingpre-hung doors($12 per door) X

Cost Number and Item Manufacturing Cost

1. Material cost ($10 � 10,000) $100,0002. Labor cost ($8 � 10,000) 80,0003. Depreciation on new equipment 25,0004. Property taxes 6,0007. Maintenance salaries 28,0008. Salary of plant manager 70,000

Total manufacturing costs $309,000

Illustration 5-11 Com-putation of total manufac-turing costs

companies, and that percentage is projected to increase in coming years. Muchof this chapter focused on manufacturers. But most of the techniques that youwill learn in this course are equally applicable to service entities.

In some respects, the challenges for managerial accounting are greater in ser-vice companies than in manufacturing companies. Further complicating mattersin recent years, many service industries have been deregulated (for example: truck-ing, airlines, telecommunications, and banking). In a deregulated environment theinformation provided by managerial accounting is even more important. Illustra-tion 5-12 presents examples of questions faced by service-company managers.

Managers of service companies look to managerial accounting to answerthese questions. In some instances the managerial accountant may need to de-velop new systems for measuring the cost of serving individual customers. Inothers, he or she may need new operating controls to improve the quality andefficiency of specific services. Many of the examples we present in subsequentchapters will be based on service companies.


Transportation(American Airlines,Amtrak)

Package deliveryservices(FedEx, UPS)

Telecommunications(AT&T,AOL Time Warner)

Professional services(attorneys, accountants,physicians)

Financial institutions(Wells Fargo,Merrill Lynch)

Health care(Blue Cross-BlueShield, HMOs)

Questions Faced by Service-Company ManagersIndustry/Company

What fee structure to use?What mode of transportation to use?

What fee structure to use?Whether to service a new community?How many households will it take to break even?Whether to invest in a new satellite or lay new cable?

How much to charge for particular services?How much office overhead to allocate toparticular jobs?How efficient and productive are individualstaff members?

Which services to charge for, and which toprovide for free?Whether to build a new branch office or toinstall a new ATM?Should fees vary depending on the size ofthe customers’ accounts?

Whether to invest in new equipment?How much to charge for various services?How to measure the quality of services provided?

Whether to buy new or used planes?Whether to service a new route?

UPS

Illustration 5-12 Serviceindustries and companiesand the managerialaccounting questions theyface

Contemporary Developments in Managerial Accounting 227

VALUE CHAIN MANAGEMENT

The value chain is the term that describes all activities associated with provid-ing a product or service. The value chain includes activities such as research anddevelopment, ordering raw materials, manufacturing, marketing, delivery, andcustomer relations. Each of these activities should be designed and operated sothat they add value to the product or service. A critical component of the valuechain is the supply chain. The supply chain is all of the activities from receiptof an order to delivery of a product or service. A number of factors affect effortsto manage the value chain and supply chain.

Technological Change

Many companies now employ enterprise resource planning (ERP) softwaresystems to manage their value chain. ERP systems provide a comprehensive,centralized, integrated source of information used to manage all major businessprocesses, from purchasing to manufacturing to recording human resources. Inlarge companies, an ERP system might replace as many as 200 individual soft-ware packages. For example, an ERP system can eliminate the need for indi-vidual software packages for personnel, inventory management, receivables, andpayroll. Because the value chain extends beyond the walls of the company, ERPsystems both collect and provide information from and to the company’s majorsuppliers, customers, and business partners.

– B U S I N E S S I N S I G H TThrough computer-integrated manufacturing (CIM), many com-panies can now manufacture products that are untouched by

human hands. An example is the use of robotic equipment in the steel and au-tomobile industries. Automation significantly reduces direct labor costs in manycases. The worker simply monitors the manufacturing process by watching in-strument panels.

Also, the widespread use of computers has greatly reduced the cost of ac-cumulating, storing, and reporting managerial accounting information. Com-puters now make it possible to do more detailed costing of products, processes,and services than was possible under manual processing.

e


Service Company PerspectiveAt South Central Bell (Telephone), management accountantshave shed their scorekeeping image. A corporate reorganization

plan challenged the accountants to “show their stuff.” They took on the roles ofinterpreter, advisor, and partner. To do so, they had to understand what the ac-counting numbers mean, relate the numbers to business activity, and recom-mend alternative courses of action. In addition, they must evaluate these alter-natives and make decisions to maximize business efficiency.

Technology is also affecting the value chain through business-to-businesse-commerce on the Internet. The Internet has dramatically changed the way corporations do business with one another. It enables customers and suppliersto share information nearly instantaneously. In addition, it has changed the marketplace, often having the effect of cutting out the “middle man.” Industriessuch as the automobile, airline, hotel, and electronics have made commitments

to purchase some or all of their supplies and raw materials in the huge busi-ness-to-business electronic marketplaces. For example, Hilton Hotels recentlycommitted to purchase as much as $1.5 billion of bed sheets, pest control ser-vices, and other items from an Internet supplier, PurchasePro.com.

Just-in-Time Inventory Methods

Many companies have significantly lowered inventory levels and costs using just-in-time (JIT) inventory methods. Under a just-in-time method, goods are manu-factured or purchased just in time for use. As noted in the Feature Story, Dell Com-puter is famous for having developed a system for making computers in responseto individual customer requests. Even though each computer is custom-made tomeet each customer’s particular specifications, it takes Dell less than 48 hours toassemble the computer and put it on a truck. By integrating its information sys-tems with those of its suppliers, Dell reduced its inventories to nearly zero. This isa huge advantage in an industry where products become obsolete nearly overnight.

Quality

JIT inventory systems require an increased emphasis on product quality. If prod-ucts are produced only as they are needed, it is very costly for the company tohave to stop production because of defects or machine breakdowns. Many com-panies have installed total quality management (TQM) systems to reduce de-fects in finished products. The goal is to achieve zero defects. These systems re-quire timely data on defective products, rework costs, and the cost of honoringwarranty contracts. Often this information is used to help redesign the productin a way that makes it less prone to defect. Or it may be used to reengineer theproduction process to reduce setup time and decrease the potential for error. TQMsystems also provide information on nonfinancial measures such as customer sat-isfaction, number of service calls, and time to generate reports. Attention to thesemeasures, which employees can control, leads to increased profitability.



Management PerspectiveWhen it comes to total quality management, few companies can com-pare with Chiquita Brands International. Grocery store customers

are very picky about bananas—bad bananas are consistently the number one gro-cery store complaint. Because bananas often account for up to 3 percent of a gro-cery store’s sales, Chiquita goes to great lengths to protect the popular fruit. Whilebananas are in transit from Central America, “black box” recording devices attachedto shipping crates ensure that they are kept in an environment of 90 percent hu-midity and an unvarying 55-degree temperature. Upon arrival in the U.S., bananasare ripened in airtight warehouses that use carefully monitored levels of ethylenegas. Regular checks are made of each warehouse using ultrasonic detectors thatcan detect leaks the size of a pinhole. Says one grocery store executive, “No otheritem in the store has this type of attention and resources devoted to it.”Source: Devon Spurgeon, “When Grocers in U.S. Go Bananas Over Bad Fruit, They Call Lauben-thal,” Wall Street Journal, August 14, 2000, p. A1.

Focus on Activities

As discussed earlier, overhead costs have become an increasingly large compo-nent of product and service costs. By definition, overhead costs cannot be directlytraced to individual products. But to determine each product’s cost, overhead mustbe allocated to the various products. In order to obtain more accurate productcosts, many companies now allocate overhead using activity-based costing

Using the Decision Toolkit 229

(ABC). Under ABC, overhead is allocated based on each product’s use of activi-ties in making the product. For example, the company can keep track of the costof setting up machines for each batch of a production process. Then a particu-lar product can be allocated part of the total set-up cost based on the number ofset-ups that product required. Activity-based costing is beneficial because it re-sults in more accurate product costing and in more careful scrutiny of all activ-ities in the supply chain. For example, if a product’s cost is high because it re-quires a high number of set-ups, management will be motivated to determinehow to produce the product using the optimal number of machine set-ups.


◆ Review It

1. How does the content of an income statement for a merchandiser differ fromthat for a manufacturer?

2. How are the work in process inventories reported in the cost of goods man-ufactured schedule?

3. How does the content of the balance sheet for a merchandiserdiffer from that for a manufacturer?

4. Identify a number of factors that affect the management of a company’s value chain.

Giant Manufacturing Co. Ltd. specializes in manufacturing many different modelsof bicycles. Assume that a new model, the Jaguar, has been well accepted. As a re-sult, the company has established a separate manufacturing facility to produce thesebicycles. The company produces 1,000 bicycles per month. Giant’s monthly manu-facturing cost and other expenses data related to these bicycles are as follows.

USING THE DECISION TOOLKIT

1. Rent on manufacturingequipment (lease cost) $2,000/month

2. Insurance onmanufacturing building $750/month

3. Raw materials (frames,tires, etc.) $80/bicycle

4. Utility costs formanufacturing facility $1,000/month

5. Supplies for generaloffice $800/month

6. Wages for assemblyline workers inmanufacturing facility $30/bicycle

7. Depreciation on officeequipment $650/month

8. Miscellaneousmaterials (lubricants,solders, etc.) $1.20/bicycle

9. Property taxes onmanufacturingbuilding $2,400/year

10. Manufacturingsupervisor’s salary $3,000/month

11. Advertising forbicycles $30,000/year

12. Sales commissions $10/bicycle13. Depreciation on

manufacturingbuilding $1,500/month

Instructions

(a) Prepare an answer sheet with the following column headings.

Product Costs

Cost Direct Direct Manufacturing PeriodItem Materials Labor Overhead Costs

Enter each cost item on your answer sheet, placing an “X” mark under the ap-propriate headings.

(b) Compute total manufacturing costs for the month.

THE

NAVIGATOR

✔


Solution

(a) Product Costs

Cost Direct Direct Manufacturing PeriodItem Materials Labor Overhead Costs

1. Rent on equipment ($2,000/month) X

2. Insurance on manufacturingbuilding($750/month) X

3. Raw materials ($80/bicycle) X

4. Manufacturing utilities($1,000/month) X

5. Office supplies ($800/month) X

6. Wages for workers ($30/bicycle) X

7. Depreciation on office equipment ($650/month) X

8. Miscellaneous materials($1.20/bicycle) X

9. Property taxes onbuilding ($2,400/year) X

10. Manufacturing supervisor’s salary ($3,000/month) X

11. Advertising cost ($30,000/year) X

12. Sales commissions($10/bicycle) X

13. Depreciation on manufacturingbuilding ($1,500/month) X

(b) Cost Item Manufacturing Cost

Rent on equipment $ 2,000Insurance 750Raw materials ($80 � 1,000) 80,000Manufacturing utilities 1,000Labor ($30 � 1,000) 30,000Miscellaneous materials ($1.20 � 1,000) 1,200Property taxes ($2,400 � 12) 200Manufacturing supervisor’s salary 3,000Depreciation on building 1,500

Total manufacturing costs $119,650

THE

NAVIGATOR

✔

Explain the distinguishing features of manager-ial accounting. The distinguishing features of manager-ial accounting are:

Primary users of reports—internal users, who areofficers, department heads, managers, and supervi-sors in the company.

Type and frequency of reports—internal reportsthat are issued as frequently as the need arises.

Purpose of reports—to provide special-purpose in-formation for a particular user for a specific deci-sion.

Content of reports—pertains to subunits of the busi-ness and may be very detailed; may extend beyonddouble-entry accounting system; the reporting stan-dard is relevance to the decision being made.

Verification of reports—no independent audits.

Identify the three broad functions of manage-ment. The three functions are planning, directing andmotivating, and controlling. Planning requires manage-ment to look ahead and to establish objectives. Directingand motivating involves coordinating the diverse activi-ties and human resources of a company to produce asmooth-running operation. Controlling is the process ofkeeping the activities on track.

Define the three classes of manufacturing costs.Manufacturing costs are typically classified as either (1)direct materials, (2) direct labor, or (3) manufacturingoverhead. Raw materials that can be physically and di-rectly associated with the finished product during themanufacturing process are called direct materials. Thework of factory employees that can be physically and di-rectly associated with converting raw materials into fin-ished goods is considered direct labor. Manufacturing

overhead consists of costs that are indirectly associatedwith the manufacture of the finished product.

Distinguish between product and period costs.Product costs are costs that are a necessary and integralpart of producing the finished product. Product costs arealso called inventoriable costs. Under the matching prin-ciple, these costs do not become expenses until the in-ventory to which they attach is sold. Period costs are coststhat are identified with a specific time period rather thanwith a salable product. These costs relate to nonmanu-facturing costs and therefore are not inventoriable costs.

Explain the difference between a merchandisingand a manufacturing income statement. The differencebetween a merchandising and a manufacturing incomestatement is in the cost of goods sold section. A manu-facturing cost of goods sold section shows beginning andending finished goods inventories and the cost of goodsmanufactured.

Indicate how cost of goods manufactured is de-termined. The cost of the beginning work in process isadded to the total manufacturing costs for the currentyear to arrive at the total cost of work in process for theyear. The ending work in process is then subtracted fromthe total cost of work in process to arrive at the cost ofgoods manufactured.

Explain the difference between a merchandisingand a manufacturing balance sheet. The difference be-tween a merchandising and a manufacturing balancesheet is in the current assets section. In the current as-sets section of a manufacturing com-pany’s balance sheet, three inventory ac-counts are presented: finished goodsinventory, work in process inventory, andraw materials inventory.

SUMMARY OF STUDY OBJECTIVES

THE

NAVIGATOR

✔

Is the company maintainingcontrol over the costs ofproduction?

What is the composition of amanufacturing company’sinventory?

Cost of material, labor, andoverhead

Amount of raw materials, work in process, and finished goodsinventory

Cost of goods manufacturedschedule

Balance sheet

Compare the cost of goodsmanufactured to revenueexpected from product sales.

Determine whether there is sufficient finished goodsinventory, raw materials, andwork in process to meetforecasted demand.

DECISION TOOLKIT—A SUMMARY


Summary of Study Objectives 231

♦1

♦2

♦3

♦4

♦5

♦6♦7

A P P E N D I X 5 A

ACCOUNTING CYCLE FOR A

MANUFACTURING COMPANY

The accounting cycle for a manufacturing company is the same as for a mer-chandising company when a periodic inventory system is used. The journaliz-ing and posting of transactions is the same, except for the additional manufac-turing inventories and manufacturing cost accounts. Similarly, the preparationof a trial balance and the journalizing and posting of adjusting entries are thesame. Some changes, however, occur in the use of a work sheet and in prepar-ing closing entries.

To illustrate the changes in the work sheet, we will use the cost of goodsmanufactured schedule for Olsen Manufacturing presented in Illustration 5-7,along with other assumed data. For convenience, the cost of goods manufac-tured schedule is reproduced in Illustration 5A-1.

WORK SHEET

When a work sheet is used in preparing financial statements, two additionalcolumns are needed for the cost of goods manufactured schedule. As illustratedin the work sheet in Illustration 5A-2, debit and credit columns for this sched-ule are inserted before the income statement columns.

In the cost of goods manufactured columns, the beginning inventories ofraw materials and work in process are entered as debits. In addition, all the man-ufacturing costs are entered as debits. The reason is that each of these amounts

Illustration 5A-1 Costof goods manufacturedschedule


♦


8

Prepare a work sheet andclosing entries for a manu-facturing company.

OLSEN MANUFACTURING COMPANYCost of Goods Manufactured ScheduleFor the Year Ended December 31, 2002

Work in process, January 1 $ 18,400Direct materials

Raw materials inventory, January 1 $ 16,700Raw materials purchases 152,500

Total raw materials available for use 169,200Less: Raw materials inventory, December 31 22,800

Direct materials used $146,400Direct labor 175,600Manufacturing overhead

Indirect labor 14,300Factory repairs 12,600Factory utilities 10,100Factory depreciation 9,440Factory insurance 8,360



Total cost of work in process 395,200Less: Work in process, December 31 25,200


Work Sheet 233

increases cost of goods manufactured. Ending inventories for raw materials andwork in process are entered as credits in the cost of goods manufactured columnsbecause they have the opposite effect—they decrease cost of goods manufac-tured. The balancing amount for these columns is the cost of goods manufac-tured. Note that the amount ($370,000) agrees with the amount reported for costof goods manufactured in Illustration 5A-1. This amount is also entered in theincome statement debit column.

The income statement and balance sheet columns for a manufacturing com-pany are basically the same as for a merchandising company. For example, thetreatment of the finished goods inventories is identical with the treatment ofmerchandise inventory. That is, the beginning inventory is entered in the debitcolumn, and the ending finished goods inventory is entered in the income state-ment credit column and in the balance sheet debit column.

Illustration 5A-2 Partialwork sheet

OLSEN MANUFACTURING COMPANYWork Sheet (partial)

For the Year Ended December 31, 2002

Adjusted Trial Cost of GoodsBalance Manufactured Income Statement Balance Sheet

Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr.

Cash 42,500 42,500Accounts

Receivable (Net) 71,900 71,900Finished Goods Inv. 24,600 24,600 19,500 19,500Work in Process Inv. 18,400 18,400 25,200 25,200Raw Materials Inv. 16,700 16,700 22,800 22,800Plant Assets 724,000 724,000Accumulated Depr. 278,400 278,400Notes Payable 100,000 100,000Accounts Payable 40,000 40,000Income Taxes Payable 5,000 5,000Common Stock 200,000 200,000Retained Earnings 205,100 205,100Sales 680,000 680,000Raw Materials

Purchases 152,500 152,500Direct Labor 175,600 175,600Indirect Labor 14,300 14,300Factory Repairs 12,600 12,600Factory Utilities 10,100 10,100Factory Depreciation 9,440 9,440Factory Insurance 8,360 8,360Selling Expenses 114,900 114,900Administrative Exp. 92,600 92,600Income Tax Exp. 20,000 20,000

Totals 1,508,500 1,508,500 418,000 48,000

Cost of GoodsManufactured 370,000 370,000

Totals 418,000 418,000 622,100 699,500 905,900 828,500

Net Income 77,400 77,400

Totals 699,500 699,500 905,900 905,900

Dec. 31 Work in Process Inventory (Dec. 31) 25,200Raw Materials Inventory (Dec. 31) 22,800

Manufacturing Summary 48,000(To record ending raw materials and workin process inventories)

31 Manufacturing Summary 418,000Work in Process Inventory (Jan. 1) 18,400Raw Materials Inventory (Jan. 1) 16,700Raw Materials Purchases 152,500Direct Labor 175,600Indirect Labor 14,300Factory Repairs 12,600Factory Utilities 10,100Factory Depreciation 9,440Factory Insurance 8,360

(To close beginning raw materials andwork in process inventories andmanufacturing cost accounts)

31 Finished Goods Inventory (Dec. 31) 19,500Sales 680,000

Income Summary 699,500(To record ending finished goods inventoryand close sales account)

31 Income Summary 622,100Finished Goods Inventory (Jan. 1) 24,600Manufacturing Summary 370,000Selling Expenses 114,900Administrative Expenses 92,600Income Tax Expense 20,000

(To close beginning finished goodsinventory, manufacturing summary, andexpense accounts)

31 Income Summary 77,400Retained Earnings 77,400

(To close net income to retained earnings)

As in the case of a merchandising company, financial statements can be pre-pared from the statement columns of the work sheet. In addition, the cost ofgoods manufactured schedule can also be prepared directly from the work sheet.

CLOSING ENTRIES

The closing entries for a manufacturing company are different than for a mer-chandising company. A Manufacturing Summary account is used to close allaccounts that appear in the cost of goods manufactured schedule. The bal-ance of the Manufacturing Summary account is the Cost of Goods Manufac-tured for the period. Manufacturing Summary is then closed to Income Sum-mary. The closing entries can be prepared from the work sheet. As illustratedbelow, the closing entries for the manufacturing accounts are prepared first. Theclosing entries for Olsen Manufacturing are as follows.


Glossary 235

After posting, the summary accounts will show the following.

Illustration 5A-3 Sum-mary accounts for a man-ufacturing company, afterposting

Manufacturing Summary

Dec. 31 Close 418,000 Dec. 31 Close 48,00031 Close 370,000

Income Summary

Dec. 31 Close 622,100 Dec. 31 Close 699,50031 Close 77,400

These data precisely track the closing entries. It also would be possible to posteach account balance to the Manufacturing Summary account.

SUMMARY OF STUDY OBJECTIVE FOR APPENDIX 5APrepare a work sheet and closing entries for a

manufacturing company. Two additional columns areneeded in the work sheet for the cost of goods manu-factured. In these columns, the beginning inventories ofraw materials and work in process are entered as deb-

its, and the ending inventories are entered as credits. Allmanufacturing costs are entered as debits. To close allof the accounts that appear in the cost of goods manu-factured schedule, a Manufacturing Summary accountis used.

♦8

GLOSSARY

Activity-based costing (ABC) A method of allocatingoverhead based on each product’s use of activities in mak-ing the product. (p. 229)

Cost of goods manufactured Total cost of work inprocess less the cost of the ending work in process in-ventory. (p. 221)

Direct labor The work of factory employees that canbe physically and directly associated with converting rawmaterials into finished goods. (p. 218)

Direct materials Raw materials that can be physicallyand directly associated with manufacturing the finishedproduct. (p. 218)

Enterprise resource planning (ERP) system Soft-ware that provides a comprehensive, centralized, inte-grated source of information used to manage all majorbusiness processes. (p. 227)

Indirect labor Work of factory employees that has nophysical association with the finished product, or forwhich it is impractical to trace the costs to the goods pro-duced. (p. 218)

Indirect materials Raw materials that do not physi-cally become part of the finished product or cannot betraced because their physical association with the fin-ished product is too small. (p. 218)

Just-in-time (JIT) inventory Inventory system inwhich goods are manufactured or purchased just in timefor use. (p. 228)

Managerial accounting A field of accounting that pro-vides economic and financial information for managersand other internal users. (p. 214)

Manufacturing overhead Manufacturing costs thatare indirectly associated with the manufacture of the finished product. (p. 218)

Period costs Costs that are matched with the revenueof a specific time period and charged to expense as incurred. (p. 219)

Product costs Costs that are a necessary and integralpart of producing the finished product. (p. 219)

Supply chain All activities from receipt of an order to delivery of a product or service. (p. 227)

Total cost of work in process Cost of the beginningwork in process plus total manufacturing costs for the current period. (p. 221)

Total manufacturing costs The sum of direct materi-als, direct labor, and manufacturing overhead incurredin the current period. (p. 221)


DEMONSTRATION PROBLEM

Superior Manufacturing Company has the following cost and expense data for the yearending December 31, 2002.

Raw materials, 1/1/02 $ 30,000 Insurance, factory $ 14,000Raw materials, 12/31/02 20,000 Property taxes, factory building 6,000Raw materials purchased 205,000 Sales (net) 1,500,000Indirect materials 15,000 Delivery expenses 100,000Work in process, 1/1/02 80,000 Sales commissions 150,000Work in process, 12/31/02 50,000 Indirect labor 90,000Finished goods, 1/1/02 110,000 Factory machinery rent 40,000Finished goods, 12/31/02 120,000 Factory utilities 65,000Direct labor 350,000 Depreciation, factory building 24,000Factory manager’s salary 35,000 Administrative expenses 300,000

Instructions(a) Prepare a cost of goods manufactured schedule for Superior Company for 2002.(b) Prepare an income statement for Superior Company for 2002.(c) Assume that Superior Company’s ledgers show the balances of the following cur-

rent asset accounts: Cash $17,000, Accounts Receivable (net) $120,000, PrepaidExpenses $13,000, and Short-term Investments $26,000. Prepare the currentassets section of the balance sheet for Superior Company as of December 31,2002.

Solution to Demonstration Problem

(a) SUPERIOR MANUFACTURING COMPANYCost of Goods Manufactured ScheduleFor the Year Ended December 31, 2002

Work in process, 1/1 $ 80,000Direct materials

Raw materials inventory, 1/1 $ 30,000Raw materials purchased 205,000

Total raw materials available for use 235,000Less: Raw materials inventory, 12/31 20,000Direct materials used $215,000

Direct labor 350,000Manufacturing overhead

Indirect labor 90,000Factory utilities 65,000Factory machinery rent 40,000Factory manager’s salary 35,000Depreciation on building 24,000Indirect materials 15,000Factory insurance 14,000Property taxes 6,000



Total cost of work in process 934,000Less: Work in process, 12/31 50,000


Action Plan• Start with beginning work in

process as the first item inthe cost of goods manufac-tured schedule.

• Sum direct materials used,direct labor, and total manu-facturing overhead to deter-mine total current manufac-turing costs.

• Sum beginning work inprocess and total currentmanufacturing costs to de-termine total cost of work inprocess.

• Cost of goods manufacturedis the total cost of work inprocess less ending work inprocess.

• In the cost of goods sold sec-tion of the income statement,show beginning and endingfinished goods inventory andcost of goods manufactured.

• In the balance sheet, listmanufacturing inventories inthe order of their expectedrealization in cash, with fin-ished goods first.

Total quality management (TQM) Systems imple-mented to reduce defects in finished products with thegoal of achieving zero defects. (p. 228)

Value chain All activities associated with providing aproduct or service. (p. 227)

Self-Study Questions 237

(b) SUPERIOR MANUFACTURING COMPANYIncome Statement

For the Year Ended December 31, 2002

Sales (net) $1,500,000Cost of goods sold

Finished goods inventory, January 1 $110,000Cost of goods manufactured 884,000

Cost of goods available for sale 994,000Less: Finished goods inventory, December 31 120,000

Cost of goods sold 874,000

Gross profit 626,000Operating expenses

Administrative expenses 300,000Sales commissions 150,000Delivery expenses 100,000

Total operating expenses 550,000

Net income $ 76,000

(c) SUPERIOR MANUFACTURING COMPANYBalance Sheet (partial)

December 31, 2002

Current assetsCash $ 17,000Short-term investments 26,000Accounts receivable (net) 120,000Inventories

Finished goods $120,000Work in process 50,000Raw materials 20,000 190,000

Prepaid expenses 13,000

Total current assets $366,000

THE

NAVIGATOR

✔

SELF-STUDY QUESTIONS

Answers are at the end of the chapter1. Managerial accounting:

(a) is governed by generally accepted ac-counting principles.

(b) places emphasis on special-purpose in-formation.

(c) pertains to the entity as a whole and ishighly aggregated.

(d) is limited to cost data.

2. Which of the following is not one of the cat-egories in Standards of Ethical Conduct forManagement Accountants?

(a) Confidentiality. (c) Integrity.(b) Competence. (d) Independence.

3. The management of an organization performsseveral broad functions. They are:(a) planning, directing and motivating, and sell-

ing.(b) planning, directing and motivating, and con-

trolling.(c) planning, manufacturing, and controlling.(d) directing and motivating, manufacturing, and

controlling.

(SO 1)

(SO 1)

(SO 2)

Note: All asterisked Questions, Exercises, and Problems relate to material in the appendix to the chapter.


(SO 5)

(SO 6)

(SO 7)

(SO 3)

(SO 4)

(SO 3)

(SO 3)

4. Direct materials are a:

Product Manufacturing PeriodCost Overhead Cost

(a) Yes Yes No(b) Yes No No(c) Yes Yes Yes(d) No No No

5. Indirect labor is a:(a) nonmanufacturing cost.(b) raw material cost.(c) product cost.(d) period cost.

6. Which of the following costs would be includedin manufacturing overhead of a computer man-ufacturer?(a) The cost of the 3�

12

�-inch disk drives.(b) The wages earned by computer assemblers.(c) The cost of the memory chips.(d) Depreciation on testing equipment.

7. Which of the following is not an element of man-ufacturing overhead?(a) Sales manager’s salary.(b) Plant manager’s salary.(c) Factory repairman’s wages.(d) Product inspector’s salary.

8. For the year, Redder Company has cost ofgoods manufactured of $600,000, beginningfinished goods inventory of $200,000, and end-ing finished goods inventory of $250,000. Thecost of goods sold is:(a) $450,000.(b) $500,000.(c) $550,000.(d) $600,000.

9. A cost of goods manufactured schedule showsbeginning and ending inventories for:(a) raw materials and work in process only.(b) work in process only.(c) raw materials only.(d) raw materials, work in process, and fin-

ished goods.

10. In a manufacturer’s balance sheet, three in-ventories may be reported: (1) raw materials,(2) work in process, and (3) finished goods. In-dicate in what sequence these inventories gen-erally appear on a balance sheet.(a) (1), (2), (3)(b) (2), (3), (1)(c) (3), (1), (2)(d) (3), (2), (1)

QUESTIONS

1. (a) “Managerial accounting is a field of accountingthat provides economic information for all in-terested parties.” Do you agree? Explain.

(b) Pat Gonzalez believes that managerial account-ing serves only manufacturing firms. Is Pat cor-rect? Explain.

2. Distinguish between managerial and financial ac-counting as to (a) primary users of reports, (b) typesand frequency of reports, and (c) purpose of reports.

3. How does the content of reports and the verificationof reports differ between managerial and financialaccounting?

4. (a) Identify the four categories of ethical standardsfor management accountants.

(b) Is the responsibility of the management accoun-tant limited to only his or her own acts? Explain.

5. Karen Gish is studying for the next accounting mid-term examination. Summarize for Karen what sheshould know about management functions.

6. “Decision making is management’s most importantfunction.” Do you agree? Why or why not?

7. Sue Sablow is studying for her next accounting exam-ination. Explain to Sue what she should know aboutthe differences between the income statements for amanufacturing and for a merchandising company.

8. Bob Jackson is unclear as to the difference betweenthe balance sheets of a merchandising company anda manufacturing company. Explain the difference toBob.

9. How are manufacturing costs classified?

10. Gene Toni claims that the distinction between directand indirect materials is based entirely on physicalassociation with the product. Is Gene correct? Why?

11. Jane Diaz is confused about the differences betweena product cost and a period cost. Explain the differ-ences to Jane.

12. Identify the differences in the cost of goods sold sec-tion of an income statement between a merchandis-ing company and a manufacturing company.

13. The determination of the cost of goods manufacturedinvolves the following factors: (A) beginning work inprocess inventory, (B) total manufacturing costs, and(C) ending work in process inventory. Identify themeaning of x in the following formulas:

(a) A � B � x

(b) A � B � C � x

14. Sajjad Manufacturing has beginning raw materialsinventory $12,000, ending raw materials inventory$18,000, and raw materials purchases $180,000.What is the cost of direct materials used?

THE

NAVIGATOR

✔

Brief Exercises 239

Distinguish between manager-ial and financial accounting.(SO 1)

Identify ethical standards.(SO 1)

Identify the three manage-ment functions.(SO 2)

Classify manufacturing costs.(SO 3)

Classify manufacturing costs.(SO 3)

Identify product and periodcosts.(SO 4)

15. Jam Manufacturing Inc. has beginning work inprocess $27,200, direct materials used $240,000, di-rect labor $200,000, total manufacturing overhead$150,000, and ending work in process $32,000. Whatare total manufacturing costs?

16. Using the data in Q15, what are (a) the total cost ofwork in process and (b) the cost of goods manufac-tured?

17. In what order should manufacturing inventories belisted in a balance sheet?

*18. How, if at all, does the accounting cycle differ be-tween a manufacturing company and a merchandis-ing company?

*19. What typical account balances are carried into thecost of goods manufactured columns of the manu-facturing work sheet?

*20. Prepare the closing entries for (a) ending work inprocess and raw materials inventories and (b) man-ufacturing summary. Use XXXs for amounts.

BRIEF EXERCISES

BE5-1 Complete the following comparison table between managerial and financial ac-counting.

Financial Accounting Managerial Accounting

Primary usersType of reportsFrequency of reportsPurpose of reportsContent of reportsVerification

BE5-2 The Institute of Management Accountants has promulgated ethical standards formanagerial accountants. Identify the four specific standards.

BE5-3 Listed below are the three functions of the management of an organization.

1. Planning 2. Directing and motivating 3. Controlling

Identify which of the following statements best describes each of the above functions.(a) ____ require(s) management to look ahead and to establish objectives. A key objec-

tive of management is to add value to the business.(b) ____ involve(s) coordinating the diverse activities and human resources of a company

to produce a smooth-running operation. This function relates to the implementationof planned objectives.

(c) ____ is the process of keeping the activities on track. Management must determinewhether goals are being met and what changes are necessary when there are devia-tions.

BE5-4 Determine whether each of the following costs should be classified as direct ma-terials (DM), direct labor (DL), or manufacturing overhead (MO).(a) ____Frames and tires used in manufacturing bicycles.(b) ____Wages paid to production workers.(c) ____Insurance on factory equipment and machinery.(d) ____Depreciation on factory equipment.

BE5-5 Indicate whether each of the following costs of an automobile manufacturerwould be classified as direct materials, direct labor, or manufacturing overhead.(a) ____Windshield. (e) ____Factory machinery lubricants.(b) ____Engine. (f) ____Tires.(c) ____Wages of assembly line worker (g) ____Steering wheel.(d) ____Depreciation of factory machinery. (h) ____Salary of painting supervisor.

BE5-6 Identify whether each of the following costs should be classified as product costsor period costs.(a) ____Manufacturing overhead. (d) ____Advertising expenses.(b) ____Selling expenses. (e) ____Direct labor.(c) ____Administrative expenses. (f) ____Direct material.

Classify manufacturing costs.(SO 3, 4)

Compute total manufactur-ing costs and total cost ofwork in process.(SO 6)

Prepare current assets sec-tion.(SO 7)

Determine missing amountsin computing total manufac-turing costs.

(SO 6)

Determine missing amountsin computing cost of goodsmanufactured.(SO 6)

Identify work sheet columnsfor selected accounts.(SO 8)

BE5-7 Presented below are Hyde Company’s monthly manufacturing cost data relatedto its personal computer products.(a) Utilities for manufacturing equipment $116,000(b) Raw material (CPU, chips, etc.) $85,000(c) Depreciation on manufacturing building $880,000(d) Wages for production workers $191,000

Enter each cost item in the following table, placing an “X” under the appropriate headings.

Product Costs

Direct Direct FactoryMaterials Labor Overhead

(a)(b)(c)(d)

BE5-8 Buslik Manufacturing Company has the following data: direct labor $242,000,direct materials used $180,000, total manufacturing overhead $208,000, and beginningwork in process $25,000. Compute (a) total manufacturing costs and (b) total cost of workin process.

BE5-9 In alphabetical order below are current asset items for Ivy Company’s balancesheet at December 31, 2002. Prepare the current assets section (including a completeheading).

Accounts receivable $200,000Cash 62,000Finished goods 75,000Prepaid expenses 38,000Raw materials 68,000Work in process 87,000

BE5-10 Presented below are incomplete 2002 manufacturing cost data for HyunCorporation. Determine the missing amounts.

Direct Direct Total Materials Labor Factory Manufacturing

Used Used Overhead Costs

(a) $35,000 $61,000 $ 50,000 ?(b) ? $75,000 $120,000 $296,000(c) $55,000 ? $111,000 $300,000

BE5-11 Use the same data from BE5–10 above and the data below. Determine the miss-ing amounts.

Total Work Work Cost ofManufacturing in Process in Process Goods

Costs (1/1) (12/31) Manufactured

(a) ? $120,000 $86,000 ?(b) $296,000 ? $98,000 $321,000 (c) $300,000 $463,000 ? $715,000

*BE5-12 A work sheet is used in preparing financial statements for Lawney Manufac-turing Company. The following accounts are included in the adjusted trial balance: Fin-ished Goods Inventory $28,000, Work in Process Inventory $21,600, Raw Materials Pur-chases $175,000, and Direct Labor $140,000. Indicate the work sheet column(s) to whicheach account should be extended.


Exercises 241

E5-1 Presented below is a list of costs and expenses usually incurred by Iguana Cor-poration, a manufacturer of furniture, in its factory.

1. Salaries for assembly line inspectors.

2. Insurance on factory machines.

3. Property taxes on the factory building.

4. Factory repairs.

5. Upholstery used in manufacturing furniture.

6. Wages paid to assembly line workers.

7. Factory machinery depreciation.

8. Glue, nails, paint, and other small parts used in production.

9. Factory supervisors’ salaries.

10. Wood used in manufacturing furniture.

InstructionsClassify the above items into the following categories: (a) direct materials, (b) direct la-bor, and (c) manufacturing overhead.

E5-2 Honmura Company reports the following costs and expenses in May.

Factory utilities $ 8,500 Direct labor $69,100Depreciation on factory Sales salaries 49,400

equipment 12,650 Property taxes on factoryDepreciation on delivery trucks 3,500 building 2,500Indirect factory labor 48,900 Repairs to office equipment 1,300Indirect materials 89,800 Factory repairs 2,000Direct materials used 137,600 Advertising 18,000Factory manager’s salary 8,000 Office supplies used 2,640

InstructionsFrom the information, determine the total amount of:(a) Manufacturing overhead.(b) Product costs.(c) Period costs.

E5-3 Karpman Company is a manufacturer of personal computers. Various costs andexpenses associated with its operations are as follows.

1. Property taxes on the factory building.

2. Production superintendents’ salaries.

3. Memory boards and chips used in assembling computers.

4. Depreciation on the factory equipment.

5. Salaries for assembly line quality control inspectors.

6. Sales commissions paid to sell personal computers.

7. Electrical wiring in assembling computers.

8. Wages of workers assembling personal computers.

9. Soldering materials used on factory assembly lines.

10. Salaries for the night security guards for the factory building.

The company intends to classify these costs and expenses into the following categories:(a) direct materials, (b) direct labor, (c) manufacturing overhead, and (d) period costs.

InstructionsList the items (1)–(10). For each item, indicate the cost category to which the item be-longs.

Classify costs into threeclasses of manufacturingcosts.(SO 3)

Determine the total amountof various types of costs.(SO 3, 4)

Classify various costs intodifferent cost categories. (SO 3, 4)

EXERCISES

Determine missing amountsin cost of goodsmanufactured schedule.(SO 5, 6)

Determine the missingamount of different costitems.(SO 6)

Determine the missingamount of different costitems, and prepare acondensed cost of goodsmanufactured schedule.(SO 5, 6)

E5-4 The cost of goods manufactured schedule shows each of the cost elements. Com-plete the following schedule for Salazar Manufacturing Company.

SALAZAR MANUFACTURING COMPANYCost of Goods Manufactured ScheduleFor the Year Ended December 31, 2002

Work in process (1/1) $200,000Direct materials

Raw materials inventory (1/1) ?Add: Raw materials purchases

$158,000

Less: Raw materials inventory (12/31) 7,500

Direct materials used $190,000Direct labor ?Manufacturing overhead

Indirect labor $ 18,000Factory depreciation 36,000Factory utilities 68,000Total overhead 122,000

Total manufacturing costs ?

Total cost of work in process ?Less: Work in process (12/31) 81,000


E5-5 Manufacturing cost data for Hermes Company are presented below.

Case A Case B Case C

Direct materials used (a) $68,400 $130,000Direct labor $ 57,000 86,000 (g)Manufacturing overhead 42,500 81,600 102,000Total manufacturing costs 180,650 (d) 253,700Work in process 1/1/02 (b) 16,500 (h)Total cost of work in process 221,500 (e) 327,000Work in process 12/31/02 (c) 9,000 70,000Cost of goods manufactured 185,275 (f) (i)

InstructionsIndicate the missing amount for each letter (a) through (i).

E5-6 Incomplete manufacturing cost data for Hollis Company for 2002 are presentedas follows.


Direct Direct Total Work in Work in Cost ofMaterials Labor Manufacturing Manufacturing Process Process Goods

Used Used Overhead Costs 1/1 12/31 Manufactured

(1) $117,000 $140,000 $ 77,000 (a) $30,000 (b) $360,000(2) (c) 200,000 132,000 $440,000 (d) $40,000 470,000(3) 80,000 100,000 (e) 255,000 60,000 80,000 (f)(4) 70,000 (g) 75,000 294,000 45,000 (h) 270,000

Instructions(a) Indicate the missing amount for each letter.(b) Prepare a condensed cost of goods manufactured schedule for situation (1) for the

year ended December 31, 2002.

E5-7 Issey Corporation has the following cost records for June 2002.

Indirect factory labor $ 4,500 Factory utilities $ 400Direct materials used 20,000 Depreciation, factory equipment 1,400Work in process, 6/1/02 3,000 Direct labor 25,000Work in process, 6/30/02 3,500 Maintenance, factory equipment 1,300Finished goods, 6/1/02 5,000 Indirect materials 2,200Finished goods, 6/30/02 7,500 Factory manager’s salary 3,000

Prepare a cost of goodsmanufactured schedule anda partial income statement.(SO 5, 6)

Exercises 243

Instructions(a) Prepare a cost of goods manufactured schedule for June 2002.(b) Prepare an income statement through gross profit for June 2002 assuming net sales

are $97,100.

E5-8 Hippo Manufacturing Company produces blankets. From its accounting recordsit prepares the following schedule and financial statements on a yearly basis.(a) Cost of goods manufactured schedule.(b) Income statement.(c) Balance sheet.

The following items are found in its ledger and accompanying data.1. Direct labor 9. Factory maintenance salaries2. Raw materials inventory, 1/1 10. Cost of goods manufactured3. Work in process inventory, 12/31 11. Depreciation on delivery equipment4. Finished goods inventory, 1/1 12. Cost of goods available for sale5. Indirect labor 13. Direct materials used6. Depreciation on factory machinery 14. Heat and electricity for factory7. Work in process, 1/1 15. Repairs to roof of factory building8. Finished goods inventory, 12/31 16. Cost of raw materials purchases

InstructionsList the items (1)–(16). For each item, indicate by using the appropriate letter or letters,the schedule and/or financial statement(s) in which the item will appear.

E5-9 An analysis of the accounts of Lanier Manufacturing reveals the following man-ufacturing cost data for the month ended June 30, 2002.

Inventories Beginning Ending

Raw materials $9,000 $11,100Work in process 5,000 8,000Finished goods 8,000 6,000

Costs incurred:Raw materials purchases $64,000, direct labor $50,000, manufacturing overhead$19,900. The specific overhead costs were: indirect labor $5,500, factory insurance$4,000, machinery depreciation $4,000, machinery repairs $1,800, factory utilities$3,100, miscellaneous factory costs $1,500.

Instructions(a) Prepare the cost of goods manufactured schedule for the month ended June 30, 2002.(b) Show the presentation of the ending inventories on the June 30, 2002, balance sheet.

E5-10 Jazz Motor Company manufactures automobiles. During September 2002 thecompany purchased 5,000 head lamps at a cost of $9 per lamp. Jazz withdrew 4,650lamps from the warehouse during the month. Fifty of these lamps were used to replacethe head lamps in autos used by traveling sales staff. The remaining 4,600 lamps wereput in autos manufactured during the month.

Of the autos put into production during September 2002, 90% were completed andtransferred to the company’s storage lot. Of the cars completed during the month, 70%were sold by September 30.

Instructions(a) Determine the cost of head lamps that would appear in each of the following accounts

at September 30, 2002: Raw Materials, Work in Process, Finished Goods, Cost ofGoods Sold, and Selling Expenses.

(b) Write a short memo to the chief accountant, indicating whether and whereeach of the accounts in (a) would appear on the income statement or on the balancesheet at September 30, 2002.

*E5-11 Data for Lanier Manufacturing are presented in Exercise 1-9.

InstructionsPrepare a partial work sheet for Lanier Manufacturing.

Indicate in which scheduleor financial statement(s)different cost items willappear.(SO 5, 6, 7)

Prepare a cost of goodsmanufactured schedule, andpresent the endinginventories of the balancesheet.(SO 5, 6, 7)

Determine the amount ofcost to appear in variousaccounts, and indicate inwhich financial statementsthese accounts would appear.(SO 5, 6, 7)

Prepare a partial work sheetfor a manufacturing firm.(SO 8)

Classify manufacturing costsinto different categories andcompute the unit cost.(SO 3, 4)


PROBLEMS: SET A


P1-1A Snapper Company specializes in manufacturing a unique model of bicyclehelmet. The model is well accepted by consumers, and the company has enough or-ders to keep the factory production at 10,000 helmets per month (80% of its full ca-pacity). Snapper’s monthly manufacturing cost and other expense data are as fol-lows.

Rent on factory equipment $ 6,000Insurance on factory building 1,500Raw materials (plastics, polystyrene, etc.) 70,000Utility costs for factory 900Supplies for general office 300Wages for assembly line workers 46,000Depreciation on office equipment 800Miscellaneous materials (lubricants, solders, etc.) 1,100Factory manager’s salary 5,700Property taxes on factory building 400Advertising for helmets 11,000Sales commissions 7,000Depreciation on factory building 1,500

Instructions(a) Prepare an answer sheet with the following column headings.

Product Costs

Cost Direct Direct Manufacturing Period Item Materials Labor Overhead Costs

Enter each cost item on your answer sheet, placing the dollar amount under the ap-propriate headings. Total the dollar amounts in each of the columns.

(b) Compute the cost to produce one helmet

P1-2A Galex Company, a manufacturer of stereo systems, started its production in Oc-tober 2002. For the preceding 3 years Galex had been a retailer of stereo systems. Aftera thorough survey of stereo system markets, Galex decided to turn its retail store into astereo equipment factory.

Raw materials cost for a stereo system will total $70 per unit. Workers on the pro-duction lines are on average paid $10 per hour. A stereo system usually takes 5 hours tocomplete. In addition, the rent on the equipment used to assemble stereo systems amountsto $4,500 per month. Indirect materials cost $5 per system. A supervisor was hired tooversee production; her monthly salary is $2,700.

Janitorial costs were $1,300 monthly. Advertising costs for the stereo system will be$8,500 per month. The factory building depreciation expense is $7,200 per year. Propertytaxes on the factory building will be $6,000 per year.


Product Costs


Assuming that Galex manufactures, on average, 1,300 stereo systems per month, en-ter each cost item on your answer sheet, placing the dollar amount per month un-der the appropriate headings. Total the dollar amounts in each of the columns.

(b) Compute the cost to produce one stereo system.

Problems: Set A 245

P1-3A Incomplete manufacturing costs, expenses, and selling data for two differentcases are as follows.

Case

1 2

Direct Materials Used $ 7,600 (g)Direct Labor 6,000

$8,000

Manufacturing Overhead 5,000 4,000Total Manufacturing Costs (a) 19,000Beginning Work in Process Inventory 1,000 (h)Ending Work in Process Inventory (b) 3,000Sales 24,500 (i)Sales Discounts 2,500 1,400Cost of Goods Manufactured 16,000 22,000Beginning Finished Goods Inventory (c) 3,300Goods Available for Sale 18,000 (j)Cost of Goods Sold (d) (k)Ending Finished Goods Inventory 3,400 2,500Gross Profit (e) 7,000Operating Expenses 2,500 (l)Net Income (f) 3,000

Instructions(a) Indicate the missing amount for each letter.(b) Prepare a condensed cost of goods manufactured schedule for Case 1.(c) Prepare an income statement and the current assets section of the balance sheet for Case

1. Assume that in Case 1 the other items in the current assets section are as follows:Cash $4,000, Receivables (net) $15,000, Raw Materials $600, and Prepaid Expenses $400.

P1-4A The following data were taken from the records of Gamma Manufacturing Com-pany for the fiscal year ended June 30, 2002.

Raw Materials Factory Insurance $ 4,600Inventory 7/1/01 $ 48,000 Factory Machinery

Raw Materials Depreciation 15,000Inventory 6/30/02 39,600 Freight-in on Raw Materials

Finished Goods Purchased 8,600Inventory 7/1/01 96,000 Factory Utilities 24,600

Finished Goods Office Utilities Expense 8,650Inventory 6/30/02 95,900 Sales 547,000

Work in Process Sales Discounts 4,200Inventory 7/1/01 19,800 Plant Manager’s Salary 29,000

Work in Process Factory Property Taxes 9,600Inventory 6/30/02 17,600 Factory Repairs 1,400

Direct Labor 147,250 Raw Materials Purchases 89,800Indirect Labor 24,460 Cash 32,000Accounts Receivable 27,000

Instructions(a) Prepare a cost of goods manufactured schedule.(b) Prepare an income statement through gross profit.(c) Prepare the current assets section of the balance sheet at June 30, 2002.

P1-5A Istanbul Company is a manufacturer of computers. Its controller resigned in Oc-tober 2002. An inexperienced assistant accountant has prepared the following incomestatement for the month of October 2002.

Indicate the missing amountof different cost items, andprepare a condensed cost ofgoods manufacturedschedule, an incomestatement, and a partialbalance sheet.(SO 5, 6, 7)

Prepare a cost of goodsmanufactured schedule, apartial income statement,and a partial balance sheet.(SO 5, 6, 7)

Prepare a cost of goods man-ufactured schedule and a correct income statement.(SO 5, 6)

Complete a work sheet;prepare a cost of goodsmanufactured schedule, anincome statement, and abalance sheet; journalize andpost the closing entries.(SO 8)

ISTANBUL COMPANYIncome Statement

For the Month Ended October 31, 2002

Sales (net) $780,000Less: Operating expenses

Raw materials purchased $260,000Direct labor cost 190,000Advertising expense 92,000Selling and administrative salaries 75,000Rent on factory facilities 60,000Depreciation on sales equipment 45,000Depreciation on factory equipment 35,000Indirect labor cost 25,000Utilities expense 12,000Insurance expense 8,000 802,000

Net loss $(22,000)

Prior to October 2002 the company had been profitable every month. The company’spresident is concerned about the accuracy of the income statement. As his friend, you havebeen asked to review the income statement and make necessary corrections. After exam-ining other manufacturing cost data, you have acquired additional information as follows.

1. Inventory balances at the beginning and end of October were:

October 1 October 31


2. Only 70% of the utilities expense and 60% of the insurance expense apply to factoryoperations. The remaining amounts should be charged to selling and administrativeactivities.

Instructions(a) Prepare a schedule of cost of goods manufactured for October 2002.(b) Prepare a correct income statement for October 2002.

*P1-6A Everheart Manufacturing Company uses a simple manufacturing accounting sys-tem. At the end of its fiscal year on August 31, 2002, the adjusted trial balance containsthe following accounts.

Debits Credits

Cash $ 16,700 Accumulated Depreciation $353,000Accounts Receivable (net) 62,900 Notes Payable 45,000Finished Goods Inventory 56,000 Accounts Payable 38,200Work in Process Inventory 27,800 Income Taxes Payable 9,000Raw Materials Inventory 37,200 Common Stock 352,000Plant Assets 890,000 Retained Earnings 205,300Raw Materials Purchases 236,500 Sales 996,000Direct Labor 280,900 $1,998,500Indirect Labor 27,400Factory Repairs 17,200Factory Depreciation 19,000Factory Manager’s Salary 40,000Factory Insurance 11,000Factory Property Taxes 12,900Factory Utilities 13,300Selling Expenses 98,500Administrative Expenses 115,200Income Tax Expense 36,000

$1,998,500


Problems: Set B 247

Physical inventory accounts on August 31, 2002, show the following inventory amounts:Finished Goods $54,600, Work in Process $23,400, and Raw Materials $46,500.

Instructions(a) Enter the adjusted trial balance data on a work sheet in financial statement order

and complete the work sheet.(b) Prepare a cost of goods manufactured schedule for the year.(c) Prepare an income statement for the year and a balance sheet at August 31, 2002.(d) Journalize the closing entries.(e) Post the closing entries to Manufacturing Summary and to Income Summary.



PROBLEMS: SET BP1-1B Kanjo Company specializes in manufacturing motorcycles. The company hasenough orders to keep the factory production at 1,000 motorcycles per month. Kanjo’smonthly manufacturing cost and other expense data are as follows.

Maintenance costs on factory building $ 300Factory manager’s salary 5,000Advertising for motorcycles 10,000Sales commissions 5,000Depreciation on factory building 700Rent on factory equipment 5,000Insurance on factory building 3,000Raw materials (frames, tires, etc.) 20,000Utility costs for factory 800Supplies for general office 200Wages for assembly line workers 40,000Depreciation on office equipment 500Miscellaneous materials (lubricants, solders, etc.) 1,000


Product Costs


Enter each cost item on your answer sheet, placing the dollar amount under the ap-propriate headings. Total the dollar amounts in each of the columns.

(b) Compute the cost to produce one motorcycle.

P1-2B Match Company, a manufacturer of tennis rackets, started production in No-vember 2002. For the preceding 5 years Match had been a retailer of sports equipment.After a thorough survey of tennis racket markets, Match decided to turn its retail storeinto a tennis racket factory.

Raw materials cost for a tennis racket will total $20 per racket. Workers on the pro-duction lines are paid on average $13 per hour. A racket usually takes 2 hours to com-plete. In addition, the rent on the equipment used to produce rackets amounts to $1,000per month. Indirect materials cost $3 per racket. A supervisor was hired to oversee pro-duction; her monthly salary is $3,500.

Janitorial costs are $1,200 monthly. Advertising costs for the rackets will be $6,000per month. The factory building depreciation expense is $8,400 per year. Property taxeson the factory building will be $4,320 per year.


Product Costs



Indicate the missing amountof different cost items, andprepare a condensed cost ofgoods manufacturedschedule, an incomestatement, and a partialbalance sheet.(SO 5, 6, 7)

Prepare a cost of goodsmanufactured schedule, apartial income statement,and a partial balance sheet.(SO 5, 6, 7)

Prepare a cost of goodsmanufactured schedule anda correct income statement.(SO 5, 6)

Assuming that Match manufactures, on average, 2,000 tennis rackets per month, en-ter each cost item on your answer sheet, placing the dollar amount per month un-der the appropriate headings. Total the dollar amounts in each of the columns.

(b) Compute the cost to produce one racket.

P1-3B Incomplete manufacturing costs, expenses, and selling data for two different casesare as follows.

Case1 2

Direct Materials Used $ 8,300 (g)Direct Labor 3,000

$4,000

Manufacturing Overhead 4,000 5,000Total Manufacturing Costs (a) 22,000Beginning Work in Process Inventory 1,000 (h)Ending Work in Process Inventory (b) 2,000Sales 21,500 (i)Sales Discounts 1,500 1,200Cost of Goods Manufactured 12,800 21,000Beginning Finished Goods Inventory (c) 4,000Goods Available for Sale 17,300 (j)Cost of Goods Sold (d) (k)Ending Finished Goods Inventory 1,200 2,500Gross Profit (e) 6,000Operating Expenses 2,700 (l)Net Income (f) 2,800

Instructions(a) Indicate the missing amount for each letter.(b) Prepare a condensed cost of goods manufactured schedule for Case 1.(c) Prepare an income statement and the current assets section of the balance sheet for

Case 1. Assume that in Case 1 the other items in the current assets section are as fol-lows: Cash $3,000, Receivables (net) $10,000, Raw Materials $700, and Prepaid Ex-penses $200.

P1-4B The following data were taken from the records of Mauro Manufacturing Com-pany for the year ended December 31, 2002.

Raw Materials Factory Insurance $ 5,400Inventory 1/1/02 $ 45,000 Factory Machinery

Raw Materials Depreciation 7,700Inventory 12/31/02 44,200 Freight-in on Raw Materials

Finished Goods Purchased 3,900Inventory 1/1/02 85,000 Factory Utilities 15,900

Finished Goods Office Utilities Expense 8,600Inventory 12/31/02 77,800 Sales 475,000

Work in Process Sales Discounts 3,500Inventory 1/1/02 9,500 Plant Manager’s Salary 30,000

Work in Process Factory Property Taxes 6,100Inventory 12/31/02 8,000 Factory Repairs 800

Direct Labor 145,100 Raw Materials Purchases 64,600Indirect Labor 19,100 Cash 28,000Accounts Receivable 27,000

Instructions(a) Prepare a cost of goods manufactured schedule.(b) Prepare an income statement through gross profit.(c) Prepare the current assets section of the balance sheet at December 31.

P1-5B Chelsea Company is a manufacturer of toys. Its controller, Marie Klinger, re-signed in August 2002. An inexperienced assistant accountant has prepared the follow-ing income statement for the month of August 2002.

Group Decision Case 249♦♦

CHELSEA COMPANYIncome Statement

For the Month Ended August 31, 2002

Sales (net) $670,000Less: Operating expenses

Raw materials purchased $200,000Direct labor cost 150,000Advertising expense 75,000Selling and administrative salaries 70,000Rent on factory facilities 60,000Depreciation on sales equipment 55,000Depreciation on factory equipment 35,000Indirect labor cost 20,000Utilities expense 10,000Insurance expense 5,000 680,000

Net loss $ (10,000)

Prior to August 2002 the company had been profitable every month. The company’spresident is concerned about the accuracy of the income statement. As her friend, youhave been asked to review the income statement and make necessary corrections. Afterexamining other manufacturing cost data, you have acquired additional information asfollows.

1. Inventory balances at the beginning and end of August were:

August 1 August 31


2. Only 60% of the utilities expense and 70% of the insurance expense apply to factoryoperations; the remaining amounts should be charged to selling and administrativeactivities.

Instructions(a) Prepare a cost of goods manufactured schedule for August 2002.(b) Prepare a correct income statement for August 2002.

B R O A D E N I N G Y O U R P E R S P E C T I V E

GROUP DECISION CASE

BYP5-1 Intermix Manufacturing Company specializes in producing fashion outfits. OnJuly 31, 2002, a tornado touched down at its factory and general office. The inventoriesin the warehouse and the factory were completely destroyed as was the general officenearby. Next morning, through a careful search of the disaster site, however, Ed Loder,the company’s controller, and Susan Manning, the cost accountant, were able to recovera small part of manufacturing cost data for the current month.

“What a horrible experience,” sighed Ed. “And the worst part is that we may not haveenough records to use in filing an insurance claim.”

“It was terrible,” replied Susan. “However, I managed to recover some of the manu-facturing cost data that I was working on yesterday afternoon. The data indicate that ourdirect labor cost in July totaled $250,000 and that we had purchased $345,000 of rawmaterials. Also, I recall that the amount of raw materials used for July was $350,000. ButI’m not sure this information will help. The rest of our records are blown away.”

“Well, not exactly,” said Ed. “I was working on the year-to-date income statementwhen the tornado warning was announced. My recollection is that our sales in July were$1,250,000 and our gross profit ratio has been 40% of sales. Also, I can remember thatour cost of goods available for sale was $790,000 for July.”

“Maybe we can work something out from this information!” exclaimed Susan. “Myexperience tells me that our manufacturing overhead is usually 60% of direct labor.”

“Hey, look what I just found,” cried Susan. “It’s a copy of this June’s balance sheet,and it shows that our inventories as of June 30 are Finished goods $36,000, Work inprocess $22,000, and Raw materials $19,000.”

“Super,” yelled Ed. “Let’s go work something out.”In order to file an insurance claim Intermix Company must determine the amount

of its inventories as of July 31, 2002, the date of the tornado touchdown.

InstructionsWith the class divided into groups, determine the amount of cost in the Raw Materials,Work in Process, and Finished Goods inventory accounts as of the date of the tornadotouchdown.

MANAGERIAL ANALYSIS

BYP5-2 Tennis, Anyone? is a fairly large manufacturing company located in the south-ern United States. The company manufactures tennis rackets, tennis balls, tennis cloth-ing, and tennis shoes, all bearing the company’s distinctive logo, a large green questionmark on a white flocked tennis ball. The company’s sales have been increasing over thepast 10 years.

The tennis racket division has recently implemented several advanced manufactur-ing techniques. Robot arms hold the tennis rackets in place while glue dries, and ma-chine vision systems check for defects. The engineering and design team uses comput-erized drafting and testing of new products. The following managers work in the tennisracket division.

Wayne Gryer, Sales Manager (supervises all sales representatives)Tommye Stevens, technical specialist (supervises computer programmers)Martie Lefever, cost accounting manager (supervises cost accountants)Jack Marler, production supervisor (supervises all manufacturing employees)Tina Roy, engineer (supervises all new-product design teams)

Instructions(a) What are the primary information needs of each manager?(b) Which, if any, financial accounting report(s) is each likely to use?(c) Name one special-purpose management accounting report that could be designed for

each manager. Include the name of the report, the information it would contain, andhow frequently it should be issued.

REAL-WORLD FOCUS

BYP5-3 Anchor Glass Container Corporation, the third largest manufacturer ofglass containers in the U.S., supplies beverage and food producers and consumer prod-ucts manufacturers nationwide. Parent company Consumers Packaging Inc. (TorontoStock Exchange: CGC) is a leading international designer and manufacturer of glasscontainers.


InstructionsWhat factors affect the costs of products sold at Anchor Glass Container Corporation?

COMMUNICATION ACTIVITY

BYP5-4 Refer to Problem 1–5B and add the following requirement.Prepare a letter to the president of the company, Ruth Chelsea, describing the changes

you made. Explain clearly why net income is different after the changes. Keep the fol-lowing points in mind as you compose your letter.

1. This is a letter to the president of a company, who is your friend. The style shouldbe generally formal, but you may relax some requirements. For example, you maycall the president by her first name.

2. Executives are very busy. Your letter should tell the president your main results first(for example, the amount of net income).

3. You should include brief explanations so that the president can understand thechanges you made in the calculations.

RESEARCH ASSIGNMENT

BYP5-5 The December 1995 issue of Management Accounting includes an article byWilliam L. Ferrara entitled “Cost/Management Accounting: The 21st Century Paradigm.”The article contains a historical perspective on management accounting as well as a pre-diction of the future.

InstructionsRead the article and answer the following questions.(a) What are the four eras into which management accounting is divided? (Identify the

dates of each era. These are labeled paradigm A, B, C, and D in the article.)(b) What is the costing/pricing formula shown in Table 1 for paradigm (model) D, the

fourth era?(c) What are the three “provocative new issues” created by the future model of manage-

ment accounting (paradigm D)?

ANCHOR GLASS CONTAINER CORPORATIONManagement Discussion

Research Assignment 251

The following management discussion appeared in a recent annual report of AnchorGlass.

Cost of Products Sold Cost of products sold as a percentage of net sales was89.3% in the current year compared to 87.6% in the prior year. The increase incost of products sold as a percentage of net sales principally reflected the impactof operational problems during the second quarter of the current year at a majorfurnace at one of the Company’s plants, higher downtime, and costs and expensesassociated with an increased number of scheduled capital improvement projects,increases in labor, and certain other manufacturing costs (with no correspondingselling price increases in the current year). Reduced fixed costs from the closingof the Streator, Illinois, plant in June of the current year and productivity and effi-ciency gains partially offset these cost increases.

ETHICS CASE

BYP5-6 Carlos Morales, controller for Tredway Industries, was reviewing productioncost reports for the year. One amount in these reports continued to bother him—adver-tising. During the year, the company had instituted an expensive advertising campaignto sell some of its slower-moving products. It was still too early to tell whether the ad-vertising campaign was successful.

There had been much internal debate as how to report advertising cost. The vicepresident of finance argued that advertising costs should be reported as a cost of pro-duction, just like direct materials and direct labor. He therefore recommended that thiscost be identified as manufacturing overhead and reported as part of inventory costs un-til sold. Others disagreed. Morales believed that this cost should be reported as an ex-pense of the current period, based on the conservatism principle. Others argued that itshould be reported as Prepaid Advertising and reported as a current asset.

The president finally had to decide the issue. He argued that these costs should bereported as inventory. His arguments were practical ones. He noted that the companywas experiencing financial difficulty and expensing this amount in the current periodmight jeopardize a planned bond offering. Also, by reporting the advertising costs as in-ventory rather than as prepaid advertising, less attention would be directed to it by thefinancial community.

Instructions(a) Who are the stakeholders in this situation?(b) What are the ethical issues involved in this situation?(c) What would you do if you were Carlos Morales?

Answers to Self-Study Questions1. b 2. d 3. b 4. b 5. c 6. d 7. a 8. c 9. a 10. d


Remember to go back to the Navigator box on the chapter-opening page andcheck off your completed work.■■✓✓

Documents

Essentials of Accounting Chapter05 - University of Phoenixmyresource.phoenix.edu/secure/resource/ACC220R3/acc_220_week5... · Managerial Cost Concepts • Manufacturing costs •