MM5002 ACCOUNTING

TAKE HOME ASSIGNMENT

September 19, 2017

1. What are the differences between financial and managerial accounting?

2. What are the three inventory accounts used by manufacturing companies? Explain!
3. What are the three manufacturing cost for a manufacturing companies? Explain!
4. Give examples of cost associated with manufacturing overhead.
5. Explain the differences between product and period costs!
6. Explain the difference of variable costs, fixed costs, and mixed costs.
7. What are the assumptions needed in order for Cost-Profit-Analysis (CVP) analysis to be
performed?
8. Explain about the use of operating leverage in CVP analysis.
9. What are the differences and similarities between absorption and variable costing
approaches? Explain!
10. Consider the following scenarios in a manufacturing company:
a. Units produced = units sold
b. Units produced > units sold
c. Units produced < units sold
Using those three scenarios, please explain the consequences for the companys operation
income, when they use absorption cost and variable costing approaches.
1. What are the differences between financial and managerial accounting?
Financial Accounting is the process of recording revenues, expenses, assets and liabilities
which are generally connected with the running business enterprise. Board of directors,
stockholders, financial institutions and other investors are the audience for financial
accounting reports.
Managerial accounting defined by the Association of Centrified and Corportaes Accountants
as the application of accounting and statistical techniques to the specific purpose of
producing and interpreting information designed to assist management in its function of
promoting maximum efficiency and in envisaging, formulating and coordinating future plans
and subsequently in measuring their execution.[1] Management or managerial accounting is
used by managers to make decisions concerning the day-to-day operations of a business.
The table below will explain the major differences between financial accounting and
managerial accounting.
Preparing
Managerial Accountants Financial Accountants
Information
External (Stockholders, creditors,
Users of Internal (Managers who plan for
financial analysts, and government
Information and control an organization)
authorities)
Very detailed, to address specific
Detail of Very general, pertaining to the
decisions to be made by
Information whole company
managers
Accounting In accordance with Generally
In accordance with the needs of
Principles Accepted Accounting Principles
managers and officers
(GAAP) (GAAP)
follows the double entry system in
Accounting By internal controls among business transaction such as
Method managerial accountants recording, classification of business
transaction and summarizing etc
Focuses on segments of an Primary focus on the whole
Subject
organization organization

Requirements Not mandatory Mandatory for external reports

Period of
Prepared as and when required Prepared quarterly / annualy
Time
Prepared as overall performance of
Prepared for the specific needs of the company and presented before
Purposes of
the department manager and/or the potential investors, shareholders,
Report
Chief Executive Officer customers, creditors, regulatory
authorities, suppliers, and employees
 for general purpose

Concentrating future events i.e.

Concentrating only past events and
Concentration likely to be happen events of the
results of the company
company

2. What are the three inventory accounts used by manufacturing companies? Explain!
The three inventory accounts used by manufacturing companies are
Raw Materials Inventory
Raw material is the basic material that is processed and converted into finished goods.
The cost incurred to obtain raw materials that have not yet been placed into production is
reported as raw materials inventory in the current assets section of the balance sheet.
Work-in-Process Inventory
The units that remain incomplete at the end of a period are known as work-in-process
inventory. These units need the addition of more materials, labor or manufacturing
overhead to be completed in the coming period. Like raw materials, work-in-process
inventory is reported in the current assets section of the balance sheet.
Finished Goods Inventory
Finished goods are completed but unsold goods. The total cost incurred to complete these
unsold goods are reported as finished goods inventory along with raw materials and
work-in-process inventory in the current assets section of the balance sheet.

Correspondingly, three inventory accounts are needed, those are

Raw Materials Inventory account

When raw material is purchased, the cost of the raw material will be posted to the Raw
Material Inventory account. Raw Material Inventory Account will store the value of raw
materials received but not yet issued to production department.
Work-in-Process Inventory account
When the raw material is transferred to production department, the cost of the material
will be transferred from Raw Material Inventory Account to WIP Inventory
Account. Direct Manufacturing Labor Cost and Manufacturing Overhead Cost will also
be debited into WIP Inventory Account.
Finished Goods Inventory account
When the finished good is completed, the WIP Inventory Account will be credited with
the total manufacturing cost and the cost will be debited into Finished Goods
Inventory account.
3. What are the three manufacturing cost for a manufacturing companies? Explain!
Manufacturing costs are the costs necessary to convert raw materials into products. All
manufacturing costs must be attached to the units produced for external financial reporting
under US GAAP. The resulting unit costs are used for inventory valuation on the balance
sheet and for the calculation of the cost of goods sold on the income statement.
Manufacturing costs are typically divided into 3 categories:
- Direct Material Costs
Direct material costs refer to the raw materials that actually create the product in
question. This is the cost of the materials which become part of the finished product.
- Direct Labor Costs
Direct labor costs, also known as labor costs, refer to any funding given to workers who
produce and build the products in question. This is the cost of the wages of the
individuals who are physically involved in converting raw materials into a finished
product.
- Factory Overhead or Manufacturing Overhead Costs
Factory overhead costs are those associated with the manufacturing process, excluding
the raw materials and labor funding. Factory overhead refers to all other costs incurred
in the manufacturing activity which cannot be directly traced to physical units in an
economically feasible way. Overhead costs also cover any maintenance or rebuilding of
the manufacturing facilities, such as expanding the production line or adding new
lighting in the factory. Any expense or cost that does not fit into direct material costs
and labor costs may fall into the manufacturing overhead category. Factory overhead is
also described as indirect manufacturing costs

4. Give examples of cost associated with manufacturing overhead

Factory overhead costs arent directly incurred when producing a product but nonetheless
have a direct impact on production costs, the value of the product, and by extension, how
much profit is left after all expenses are covered. Some examples of manufacturing overhead
expenses include:
Indirect material
Indirect materials costs are manufacturing overhead for materials that assist in product
manufacturing but cannot be assigned to any one product. Most indirect materials are
consumable, such as lubricants for the machinery, products used to clean the machinery,
light bulbs to light the factory, glue, tape, and janitorial supplies. Since tracking each
individual indirect material used is not cost-effective, cost accountants spread these costs
over the entire product inventory. Example of indirect material : welding rods, glues, and
product wrappers.
Indirect labor
Indirect labor in manufacturing overhead relates to your employees that are one step
removed from the employees actually creating the product. The salaries of your plant
 managers, foremen, supervisors and quality control inspectors are indirect labor. Also
included in your indirect labor costs are the salaries for security guards, janitors, fork lift
drivers and machine repairmen. Cost accountants can account for indirect labor costs
through allocation or through activity-based costing. In activity-based costing, every
employee indirectly involved with the product keeps a log of the time spent on each job,
and the total cost is assigned to that product. Example of indirect labor : salary for the
maintenance staff, technical support staff, etc.
Depreciation
Over time, the machinery used to create the product, along with the factory building,
depreciate in value. Unlike utility expenses, depreciation is a fixed manufacturing
overhead cost. Cost accountants can use straight-line depreciation to allocate
depreciation costs based on a number of factors, such as the number of products
produced or square footage of the building. Depreciation should not fluctuate unless an
extraordinary event, such as replacing old machinery or purchasing a new building,
occurs. Example :
Machine depreciation This includes the depreciation cost of manufacturing equipment;
this is separate and apart from the depreciation cost of assets that the sales and
administrative staff use.
Rent This would include rent that is paid for the manufacturing or assembly facilities.
Property taxes This is the tax that is paid for the land on which the factory sits, or the
proportion of which is directly attributable to the manufacturing process.
Factory maintenance supplies Any supplies or expenses that are incurred to keep the
factory running. This may include items such as grease for the machines and
replacement parts.
Utilities
Heating, electricity, natural gas and water are manufacturing overhead costs that
fluctuate with the amount of product being produced. Because the usage varies, the costs
are considered variable costs. Cost accountants track variable costs and allocate them
over the entire product inventory. Utility costs should increase and decrease in step with
the amount of product produced. A divergence could point out a problem. For example,
if the electric bill is $1,000 for every 1,000 products produced, but changes to $1,500
while product production remains unchanged, a small-business owner would want to
investigate the reasons for the jump in the electric bill.

5. Explain the differences between product and period costs!

Product costs are initially recorded within the inventory asset. Once the related goods are
sold, these capitalized costs are charged to expense. This accounting is used to match the
revenue from a product sale with the associated cost of goods sold, so that the entire effect of
a sale transaction appears within one income statement.
 Examples of product costs are direct materials, direct labor, and allocated factory overhead.
Examples of period costs are general and administrative expenses, such as rent, office
depreciation, office supplies, and utilities.
Period costs are sometimes broken out into additional subcategories for selling activities and
administrative activities. Administrative activities are the most pure form of period costs,
since they must be incurred on an ongoing basis, irrespective of the sales level of a business.
Selling costs can vary somewhat with product sales levels, especially if sales commissions
are a large part of this expenditure.
Product costs are sometimes broken out into the variable and fixed subcategories. This
additional information is needed when calculating the break even sales level of a business. It
is also useful for determining the minimum price at which a product can be sold while still
generating a profit.

6. Explain the difference of variable costs, fixed costs, and mixed costs.
Fixed Costs:
Fixed cost is a cost which does not change in total for a given time period despite wide fluc-
tuations in output or volume of activity. The ICMA (U.K.) defines fixed cost as a cost
which tends to be unaffected by variations in volume of output. Fixed costs depend mainly
on the affluxion of time and do not vary directly with volume or rate of output. These costs,
also known as standby costs, capacity costs or period costs, arise primarily because of the
provision of facilities, physical and human, to carry on business operations.
Fixed costs enable a business firm to do a business, but they are not purely incurred for
manufacturing. Examples of fixed costs are rent, property taxes, supervising salaries,
depreciation on office facilities, advertising, insurance, etc. They accrue or are incurred with
 the passage of time and not with the production of the product or the job. This is the reason
why fixed costs are expressed in terms of time, such as per day, per month or per year and
not in terms of unit. It is totally illogical to say that a supervisors salary is so much per unit.

Fixed costs can be classified in the following categories for the purpose of analysis:
(i) Committed Costs:
Fixed costs that cannot be changed so quickly are committed costs, so called to express the idea
that managers have made a commitment that cannot be readily changed. Such costs are primarily
incurred to maintain the companys facilities and physical existence, and over which
management has little or no discretion.
They cannot be easily or quickly eliminated. Plant and equipment depreciation, taxes, insurance
premium, rate and rent charges are examples of committed costs. Depreciation being a
committed fixed cost arises from past managerial decisions and can not be changed without a
permanent action such as disposing of the asset to which the depreciation applies.
(ii) Managed Costs:
Managed costs are related to current operations which must continue to be paid to ensure the
continued operating existence of the company, e.g., management and staff salaries.
(iii) Discretionary Costs:
Some fixed costs can be quickly altered by managerial action and are called discretionary costs.
They are also known as programmed costs. Discretionary costs are not related to current
operations or activities and are subject to management discretion and control. These costs result
from special policy decisions, management programmes, new researches, etc. Such costs can be
avoided at managements discretion in a relatively short period of time as compared to
committed costs. Some examples of such costs are research and development costs, marketing
programmes, new system development costs.

ADVERTISEMENTS:
Deciding whether a cost is committed or discretionary, is not always possible just by knowing
what the cost is for (rent, salaries, research and development, etc.). For example, rent might or
might not be committed cost depending on the terms of the rental agreement.
Discretionary costs present unique problems in cost management because managers must
determine whether the level of the discretionary activitythe cost driveris appropriate. For
example, should the company hire another research scientist? Should it reduce the number of
pages in the annual report? Should it discontinue a particular training program? The larger
question is often whether the company should even be performing the activity at all. Should the
company pay tuition for employees taking courses? Should the company make charitable
contributions?
Unfortunately, discretionary costs are often the first to be attacked in cost-reduction programs,
perhaps partly because their effects are not immediately apparent. Managers must consider the
long- run effects of cutting such discretionary costs as research and product development,
management training programs, and programs to upgrade worker skills.

(iv) Step Costs:

Step costs are also known as step-fixed costs or step-variable costs. A step cost is constant for a
given amount of output and then increased in a fixed amount at a higher output level. For
example, in a manufacturing company, one supervisor is required at a salary of Rs 10,000 p.m.
for every 50 workers.
So long as 50 workers or less than that are working, the-supervision costs will be Rs 10,000 p.m.
But as soon as the 51st worker is employed, the cost of supervision increases by Rs 10,000 p.m.
to Rs 20,000. The cost of supervision remains fixed at Rs 20,000 if not more than 100 workers
are working. But it will go up if more than 100 workers have been employed. Exhibit 2.5
exhibits the behaviour pattern of step costs.

Step-fixed costs or step-variable costs exist because of indivisibility of resources; many

resources cannot be acquired in infinitely divisible increments. An airline cant fly fractions of
planes to provide exactly as many seats as passengers demand; it can fly only an entire airplane.
Similarly, companies usually cannot rent space one square foot at a time. Nor can they hire part-
time people for some jobs; it is difficult to hire a sales manager or controller for six or eight
months of the year. However, the growing use of temporary employees (temps) is a way of
confronting the indivisibility problem.
Should we plan step-variable costs as if they were mixed, though the fixed component changes
within the relevant range? Should we consider them variable, even though they do not vary
between steps? Both approaches are used in practice, which means that actual costs will differ
from cost pre-dictions under either alternative. Managers are more likely to treat a cost as
variable if the steps are relatively short and as fixed if the steps are relatively long (measured
horizontally).

Variable Costs:
Variable costs are those costs that vary in total amount directly and proportionately with the
output. There is a constant ratio between the change in the cost and change in the level of output.
Direct material cost and direct labour cost are the costs which are generally variable costs. For
example, if direct material cost is Rs 50 per unit, then for producing each additional unit, a direct
material cost of Rs 50 per unit will be incurred.
That is, the total direct material cost increases in direct proportion to increase in units
manufactured. However, it should be noted that it is only the total variable costs that change as
more units are produced; the per unit variable cost remains constant. Variable cost is always
expressed in terms of units or percentage of volume; it cannot be stated in terms of time. Exhibit.
2.6 shows behaviour of variable costs in total and on a per unit basis.
Exhibit 2.6 shows graphically the behaviour pattern of direct material cost. For the every
increase in the units produced there is a proportionate increase in the cost when production
increases in direct proportion at the constant rate of Rs 50 per unit. The variable cost line is
shown as linear rather than curvilinear. That is, on a graph paper, a variable cost line appears as
unbroken straight line in place of a curve. Variable cost per unit is shown by constant.

Mixed Costs:
Mixed costs are costs made up of fixed and variable elements. They are a combination of semi-
variable costs and semi-fixed costs. Because of the variable component, they fluctuate with
volume; because of the fixed component, they do not change in direct proportion to output.
Semi-fixed costs are those costs which remain constant upto a certain level of output after which
they become variable as shown in Exhibit 2.9.
Semi-variable cost is the cost which is basically variable but whose slope may change abruptly
when a certain output level is reached as shown in Exhibit 2.10. An example of a mixed cost is
the earnings of a worker who is paid a salary of Rs 1,500 per week (fixed) plus Re. 1 for each
unit completed (variable). If he increases his weekly output from 1,000 units to 1,500 units, his
earnings increase from Rs 2500 to Rs 3,000.

7. What are the assumptions needed in order for Cost-Profit-Analysis (CVP) analysis to
be performed?
Key Assumption of CVP Analysis
Selling price is constant.
Costs are linear and can be accurately divided into variable (constant per unit) and fixed
(constant in total) elements.
In multiproduct companies, the sales mix is constant.
In manufacturing companies, inventories do not change (units produced = units sold).

8. Explain about the use of operating leverage in CVP analysis!

Operating leverage is a measure of how sensitive net operating income is to percentage
changes in sales. It is a measure, at any given level of sales, of how a percentage change in
sales volume will affect profits

9. What are the differences and similarities between absorption and variable costing
approaches? Explain!
Absorption costing, which is also known as full costing or traditional costing, captures
both fixed and variable manufacturing costs into the unit cost of a particular product.
Therefore, the cost of a product under absorption costing consists of direct material,
direct labour, variable manufacturing overhead, and a portion of a fixed manufacturing
overhead absorbed using an appropriate base.
Since absorption costing takes all the potential costs into accounts in the calculation of
per unit cost, some people believe that it is the most effective method to calculate the unit
cost. This approach is simple. Moreover, under this method the inventory carries a certain
amount of fixed expenses, so by showing a highly valued closing inventory, the profits
for the period will also be improved. However, this can be used as an accounting trick to
show the higher profits for a particular period by moving fixed manufacturing overhead
from the income statement to the balance sheet as closing stocks.

Absorption costing includes all costs, including fixed costs, in figuring the cost of
production, while variable costing only includes the variable costs directly related to
production. Companies that use variable costing keep overhead and other fixed-cost
operating expenses separate from production costs.

The fixed costs that differentiate variable and absorption costing are those overhead
expenses, such as salaries and building rental, that do not change with changes in
production levels. A company has to pay its office rent and utility bills every month
regardless of whether it produces 1,000 products or no products at all.
Whichever costing method a company selects to use for accounting purposes, there are
advantages and disadvantages. Variable costing can make it more difficult to determine
ideal pricing, since it does not directly consider all of the costs the company has to cover
to be profitable. However, by looking only at the costs directly associated with
 production, variable costing makes it easier for a company to compare the potential
profitability of manufacturing one product over another.
One of the advantages of absorption costing is that it is the costing method required for a
company to be in compliance with generally accepted accounting principles (GAAP).
Even if a company decides to use variable costing in-house, it is required by law to use
absorption costing in any external financial statements it publishes. Absorption costing is
also the costing method that a company is required to use for calculating and filing its
taxes.
Absorption costing provides a more accurate accounting of net profitability, especially
when a company doesn't sell all of its products in the same accounting period when they
are manufactured. Absorption costing is not as helpful as variable costing for comparing
profitability of different product lines.
Variable costing, which is also known as direct costing or marginal costing considers only the
direct costs as the product cost. Thus, the cost of a product consists of direct material, direct
labour and the variable manufacturing overhead. Fixed manufacturing overhead is considered as
a periodic cost similar to the administrative and selling costs and charged against the periodic
income.
Variable costing generates a clear picture on how the cost of a product changes in an incremental
manner with the change in level of output of a manufacturer. However, since this method does
not consider the overall manufacturing costs in costing its products, it understates the overall cost
of the manufacturer.
The similarity between Absorption Costing and Variable Costing is that the purpose of both
approaches are the same; to value the cost of a product.

10. Consider the following scenarios in a manufacturing company:

Units produced = units sold
Units produced > units sold
Units produced < units sold
Using those three scenarios, please explain the consequences for the companys
operation income, when they use absorption cost and variable costing approaches.
Variable costing enables a company to run cost-volume profit analysis, which is designed
to reveal the company's break-even point in production by determining how many products
a company must manufacture and sell to reach the point of profitability.
 Relation between Effect Relation between
production on variable and
and sales iniventories absorption income
Units produced No change Absorption
= In =
Units sold inventories Variable
Units produced Absorption
> Inventories >
Units sold Increase Variable
Units produced Absorption
< Inventories <
Units sold decrease Variable

Absorption Costing charges all the manufacturing costs into the cost of a product.
Variable costing charges only direct costs (material, labour and variable overhead costs)
into the cost of a product.
Product cost in absorption costing is higher than the cost calculated under variable
costing. In variable costing, cost of the product is lower than the cost calculated under
absorption costing.
Value of closing stocks (in the income statement and balance sheet) is higher under
absorption costing method. In variable costing, value of closing stocks is lower compared
to absorption costing.
In the absorption costing, fixed manufacturing overhead is considered as a unit cost and
charged against the selling price. In variable costing, fixed manufacturing overhead is
considered as a periodic cost and charged from the periodic gross profits.

Absorption Costing and Variable Costing are two main approaches used by manufacturing
organizations to arrive at cost per unit for various decision making purposes. Absorption costing
considers that all the manufacturing costs should be included in per unit cost of a product; thus
other than direct costs it adds a portion of fixed manufacturing cost to calculate product cost. In
contrast, variable costing considers mere direct (variable) costs as product cost. Therefore, two
approaches provide two product cost figures. Having understood their own advantages and
disadvantages, both methods can be used as effective pricing approaches by the manufacturers.
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[2] http://keydifferences.com/difference-between-financial-accounting-and-management-
accounting.html

[3] http://www.clientsfirst-us.com/blog/microsoft-dynamics/dynamics-nav-types-of-inventory-and-
inventory-accounts-for-manufacturing-company/

[4] https://www.accountingformanagement.org/classification-of-inventory/

[5] https://www.accountingcoach.com/blog/what-are-manufacturing-costs

[6] http://www.brighthub.com/office/finance/articles/93275.aspx