C02 Instr PPT Mowen4Ce

POWERPOINT PRESENTATION TO
ACCOMPANY
CORNERSTONES
OF MANAGERIAL
ACCOUNTING
FOURTH CANADIAN EDITION
BY
MOWEN/HANSEN/HEITGER/McCONOMY/WITT
Presentation Revised by
Robert G. Ducharme
University of Waterloo
2-1 Copyright © 2022 Cengage Canada

Chapter 2
Basic Managerial
Accounting Concepts

Learning Objectives
After studying this chapter, you should be able to:
1. Explain the meaning of cost and how costs are
assigned to products and services.
2. Define the various costs of manufacturing
products and providing services as well as the
costs of selling and administration.
3. Prepare income statements for manufacturing
and service organizations.

CPA Competencies
CPA Competencies included in this chapter:
3.3.1 Evaluates cost classifications and costing methods for

management of ongoing operations
3.3.2 Evaluates and applies cost management techniques
appropriate for specific costing decisions
3.3.4 Recommends cost management improvements across the
entity
3.5.1 Performs sensitivity analysis
3.5.2 Evaluates sustainable profit maximization and capacity
management performance
3.7.1 Analyses the implications of management incentive schemes
and employee compensation methods

Cost and Cost Assignment
• Determine the cost of products, services, customers,
and other items to managers.
• Cost is the amount of cash or cash equivalent
sacrificed for goods and/or services that bring a
current or future benefit to the organization.
• In a profit-making firm, these benefits usually mean
revenues.

Cost and Profit
• As costs are used up in the production of revenues,
they are said to expire.
• Expired costs are called expenses.
• For a company to remain viable, revenues must be
greater than expenses.

Income Statement
On the income statement, expenses are deducted from
revenues to determine net income (also called profit).
Revenue − Expenses
Income
= Profit
Statement

Profit vs. Loss
Revenues > Costs = Profits
Revenues = Costs = Zero profits
Revenues < Costs = Losses

Cost and Price
Example of cost:
• A furniture manufacturer buys lumber for $10,000.
• The cost of the lumber is the amount given up:
$10,000.
• Price is the amount we charge our customers for
our products or services.
Be careful! Cost and price are not the same thing.

Cost Accumulation
• Accumulating costs is the way that costs are
measured and recorded.
• Received telephone bill:
Phone Bill
$150
• Recorded in Telephone Expense account:
Telephone Expense
Bal. $800
+ $150
$950
Accumulating Costs
• This is helpful, but managers
Telephone Expense also need to know which
Bal. $800 departments used the $950
+ $150 in Telephone Expense.
$950 • In other words, managers
want to know how costs are
assigned to cost objects.

Assigning Costs
Assigning costs is the way that a cost is linked to some

cost object.
To support
What is the
manufacturing?
cost object ?????
for the
phone call?
?????
To support selling
the product?
Cost Objects
• Managerial accounting systems are structured to
measure and assign costs.
• A cost object is any item such as a product, customer,
department, project, geographic region or plant, for
which costs are measured and assigned.
• Items for which costs are measured and assigned
• Examples:
• Products
• Services
• Customers
• Departments
• Geographic regions

Assigning Costs to Cost Objects
• Costs can be assigned to cost objects in a number of
ways.
• The choice of a method depends on a number of
factors, such as the need for accuracy.
• Some methods are more accurate but time consuming.
• Others are simpler but not as precise.
• The objective is to measure and assign costs as well as
possible, given management objectives.

Assigning Costs
Sales Dept.
$350 Telephone Expense
Bal. $800
+ $150
Manufacturing
$950
Dept.
$600
• Let’s say the Telephone Expense was incurred by the
sales department and the manufacturing
department. The accountant assigns the Telephone
Expense to the two cost objects.
• Sales Department and Manufacturing Department
are cost objects.
Cost Classification
• In managerial accounting, costs are classified
according to the decision-making needs of
management.
• Different costs are used for different purposes.
• Cost definitions can vary according to the objective
being served.
• Costs can be classified into groups by using a variety
of criteria.

Cost Classification
Direct and Indirect Costs
Direct Costs Indirect Costs
• Easily and accurately • Cannot be easily
traced to a cost object traced to a cost
• Relationship between the object
cost and the object can • Relationship
be physically observed between the cost and
the object not easily
observed
• Assigned through
allocation
Cost Classification
Assigning to Cost Objects
• Direct and indirect costs occur in service
businesses as well.
• Some businesses refer to indirect costs as
overhead costs or support costs.

Cost Classification
In Relation to Cost Object
In relation to Cost Type Description

Cost Objects Direct Traceable
Indirect Non-traceable
Since indirect costs are not traceable, these costs

need to be allocated/assigned.

Cost Classification
In Relation to Changes in Activity Levels

Activity Levels Fixed Total cost remains fixed
with activity level
Variable Total cost varies with
activity level
Mixed Part fixed, part variable

Cost Classification
In Relation to the Classification in the Financial
Statements
Classifications Product costs Inventoriable costs such as direct

in the Financial materials, direct labour, and
Statements manufacturing overhead
Period costs Non-inventoriable costs

(expensed immediately)
– or –
Prime Direct materials and direct labour
Conversion Direct labour and manufacturing

overhead
Cost Classification
• Different costs are used for different purposes.
• Classification helps make sense of a great variety
of costs.

Cost Classification
Other Categories of Costs
Variable cost
• Increases in total as output increases, and
decreases in total as output decreases
Fixed cost
• Total does not increase as output increases,
and does not decrease as output decreases
Mixed cost
• Increases in total as output increases, and
decreases in total as output decreases

Product and Service Costs
Output
One of the most important cost objects of a company
is its output.
Two types of output:
• Products produced by manufacturing organizations
• Services produced by services organizations

Service Costs
• Services are tasks or activities performed for
a customer or an activity performed using an
organization’s products or facilities.
• Insurance coverage, medical care, dental care,
funeral care, and accounting are examples of
service activities.
• Car rental, video rental, and skiing are examples
of services where the customer uses an
organization’s products or facilities.

Service Costs (continued)
• Services differ from products in many ways.
1 Services are intangible.
2 Services are perishable.
Services require direct contact

3 between providers and buyers.

Types of Costs
Product costs
• Associated with the manufacture of goods or the
provision of services
Period costs
• All other costs (i.e., non-manufacturing costs)

Product Costs
• Product (manufacturing) costs are those costs,
both direct and indirect, of producing a product in
a manufacturing firm or of acquiring a product in
a merchandising firm and preparing it for sale.
• Only costs in the production section of the value chain
are included in product costs.

Product Costs (continued)
• Product costs are inventoried.
• Product costs are first added to an inventory account
and remain in inventory until sold, at which time
they are transferred to cost of goods.
• For financial reporting, product costs are classified as
• direct materials
• direct labour
• manufacturing overhead

Product Costs
Direct Materials
• Direct materials are materials that are a part of the
final product and can be directly traced to the goods
being produced.
• Materials cost can be directly charged to products
because physical observation can be used to
measure the quantity used by each product.
• Materials that become part of a product usually are
classified as direct materials.

Product Costs
Direct Labour
• Direct labour is the labour that can be directly
traced to the goods being produced.
• Physical observation can be used to measure the amount
of labour used to produce a product.
• Those employees who convert direct materials into a
product are classified as direct labour.
• A company can also have indirect labour costs.
• Indirect labour is included in overhead and, therefore,
is an indirect cost rather than a direct cost.

Product Costs
Manufacturing Overhead
• All product costs, other than direct materials and
direct labour, are considered manufacturing
overhead.
• Manufacturing overhead is also known as factory
burden or indirect manufacturing costs.
• Costs are included as manufacturing overhead if
they cannot be traced to the cost object of interest
(e.g., unit of product).

Product Costs
Manufacturing Overhead (continued)
• Costs are included as manufacturing overhead if
they cannot be traced to the cost object of interest
(e.g., unit of product).
• The manufacturing overhead cost category includes
a variety of items:
• Examples: depreciation on plant buildings and equipment,
janitorial and maintenance labour, plant supervision,
materials handling, power for plant utilities, and plant
property taxes

Product Costs
Calculating Total Product Cost
• The total product cost equals the sum of direct
materials, direct labour, and manufacturing overhead:
Total product cost = Direct materials cost +
Direct labor cost + Manufacturing overhead cost
• The unit product cost equals total product cost
divided by the number of units produced:
Per-unit cost = Total product cost ÷
Number of units produced

Product Costs
Prime and Conversion Costs
• Product costs of direct materials, direct labour,
and manufacturing overhead can be grouped into
prime cost and conversion cost:
• Prime cost is the sum of direct materials cost and direct
labor cost.
Prime cost = Direct materials + Direct labour
• Conversion cost is the sum of direct labour cost and
manufacturing overhead cost.
Conversion cost = Direct labour + Manufacturing overhead

Period Costs
• Costs of production are assets that are carried in
inventories until the goods are sold.
• Other costs, such as period costs, are not carried
in inventory.
• Period costs are all costs that are not product costs
(i.e., all areas of the value chain except for production).

Period Costs
• Examples of period costs are office supplies,
research and development activities, the CEO’s
salary, and advertising.
• The level of period costs can be significant, and
controlling them may bring greater cost savings than
the same effort exercised in controlling production
costs.

Period Costs
• Period costs typically are expensed in the period in
which they are incurred.
• If a period cost is expected to provide an economic
benefit (i.e., revenues) beyond the next year, then
it is recorded as an asset (i.e., capitalized) and
allocated to expense through depreciation
throughout its useful life.

Period Costs

Selling Costs
• Those costs necessary to market, distribute, and
service a product or service are selling costs.
Order-
getting EXAMPLES
- Sales Personnel
- Salaries &
Commissions
- Advertising
EXAMPLES
- Warehousing Order-
- Shipping filling
- Customer Service

Administrative Costs
• Administrative costs include research, development,
and general administration of the organization and
cannot be assigned to either selling or production.
• General administration ensures that the various
activities of the organization are integrated so that
the overall mission of the firm is realized.

Administrative Costs
• Examples of general administrative costs are
executive salaries, legal fees, printing the annual
report, and general accounting.
• Research and development costs are the costs
associated with designing and developing new
products and must be expensed in the period
incurred.

Direct and Indirect Period Costs
• It is often helpful to distinguish between direct
period costs and indirect period costs.
• Indirect labour is included in overhead.
• Service companies distinguish between direct
period costs and indirect period costs.
• These costs do not affect the calculation of
inventories or COGS for service companies.
• Correct classification affects numerous decisions and
planning and control activities for managers.

Direct and Indirect Period Costs
Direct Period Cost:

Chef’s Salary
EXAMPLE:
Restaurant
Indirect Period
Cost:
Disposable Napkins

Types of Business Operations
Merchandising Service
Operations Operations
Manufacturing
Operations

Financial Statements for
Manufacturing Operations
• The cost of a manufactured product includes the
cost of materials used in making the product as well
as the cost of converting those materials into a
finished product.
• Thus, the cost of a finished product includes the
following:
• Direct materials cost
• Direct labour cost
• Manufacturing (factory) overhead cost

Balance Sheet for
Manufacturing Operations
Three types of inventory in the balance sheet:
Raw Work-in- Finished

materials process goods
inventory inventory inventory

Inventory Reporting for
Merchandising Operations

Cost of Goods Manufactured
• A manufacturer makes the products it sells using
direct materials, direct labour, and factory overhead.
• The total cost of making products that are available
for sale during the period is called the cost of goods
manufactured (COGM).

• To determine the cost of goods sold, first the cost
of goods manufactured needs to be calculated.
• The cost of goods manufactured is often determined
by preparing a statement of cost of goods
manufactured.

Income Statement for a
Manufacturing Business

Three-step sequence:
Step 1:
• Determine the cost of direct materials
used.
Step 2:
• Determine the total manufacturing costs
incurred.
Step 3:
• Determine the cost of goods
manufactured.

Direct Materials Used
• Only the amount used on products produced
during the current period
• Consider beginning and ending inventory levels.
• Key point: purchases do not equal materials used.

CORNERSTONE 2.1
Calculating Direct Materials Used in Production

Information:
• On May 1, BlueDenim had $68,000 of materials
in inventory.
• During the month of May, the company purchased
$210,000 of materials.
• On May 31, materials inventory equalled $22,000.
Required:
Calculate the direct materials used in production for
the month of May.

CORNERSTONE 2.1 • SOLUTION
Calculating Direct Materials Used in Production
Beginning + Purchases ‒ Ending = Materials used

materials materials in production
inventory inventory
$68,000 + $210,000 ‒ $22,000 = $256,000
What about work-in-process inventory?

CORNERSTONE 2.2
Calculating COGM
Information:
• During the month of May, the company purchased
$210,000 of materials.
• On May 31, materials inventory equalled $22,000.
• During the month of May, BlueDenim Company
incurred
• direct labour cost of $135,000
• manufacturing overhead of $150,000

CORNERSTONE 2.2
Calculating COGM
Inventory information:
May 1 May 31
Materials $68,000 $22,000
Work in process 50,000 16,000
Required:
1. Calculate the cost of goods manufactured for May.
2. Calculate the cost of one pair of jeans, assuming
115,000 pairs of jeans were completed during May.

Calculating COGM
1. Direct materials $256,000

Direct labour 135,000
Manufacturing overhead 150,000
Total manufacturing cost $541,000
Work in process, May 1 50,000
Work in process, May 31 (16,000)
Cost of goods manufactured $575,000

Calculating COGM
2.

CORNERSTONE 2.3
Calculating COGS
Information:
• On May 1, BlueDenim Company had 10,000 units
in finished goods inventory costing $50,000.
• On May 31, the company had 26,000 units in
finished goods inventory costing $130,000.
Required:
1. Calculate the cost of goods sold for May.
2. Calculate the number of pairs of jeans sold
during May.

Calculating COGS
1. Cost of goods manufactured $575,000

Finished goods, May 1 50,000
Finished goods, May 31 (130,000)
Cost of goods sold $495,000
Reported as an Reported as an
asset on the expense on the
balance sheet income statement

Calculating COGS
2. Number of units sold:

Finished goods, May 1 10,000
Units finished during May 115,000
Finished goods inventory, May 31 (26,000)
Units sold during May 99,000

Income Statement:
Manufacturing Firm
• Gross margin is the difference between sales revenue
and cost of goods sold:
Sales revenue
– Cost of goods sold
= Gross margin
• It shows how much the firm is making over and above

the cost of the units sold.

Income Statement:
Manufacturing Firm (continued)
• Gross margin does not equal operating income or
profit, as it is computed without subtracting selling
and administrative expenses.
• If gross margin is positive, the firm is charging
prices that cover the product cost.

Gross Margin Percentage
• A company can compare gross margin percentage
to the average for its industry to see whether its
experience is within the ballpark range for other
firms in the industry.
• Gross margin percentage varies significantly by
industry.
• Gross margin percentage is calculated as
Gross margin percentage = Gross margin
÷ Sales revenue

CORNERSTONE 2.4
Preparing an Income Statement for a Manufacturing Firm
Information:
• BlueDenim Company sold 99,000 pairs of jeans
in May at a total cost of $495,000.
• Each pair sold at a price of $8.
• BlueDenim also incurred
• commissions equal to 10% of the sales price
• other selling expenses of $120,000
• administrative expenses of $85,000
Required:
Prepare a May income statement for BlueDenim.

Preparing an Income Statement for a Manufacturing Firm
Sales revenue 99,000 pairs of $792,000

Cost of goods sold jeans × $8 495,000
Gross margin $297,000
Less:
$792,000 × 10%
Selling expense:
Commissions $ 79,200
Fixed selling expense 120,000 199,200
Administrative expense 85,000
Operating income $ 12,800

CORNERSTONE 2.5
Calculating the Percentage of Sales Revenue for Each Line on the
Income Statement
Information:
BlueDenim Company’s income statement for the
month of May was shown in Cornerstone 2.4.
Required:
Calculate the percentage of sales revenue represented
by each line of the income statement.

Calculating the Percentage of Sales Revenue for Each Line on the
Income Statement
%*
Sales revenue $792,000 100.0
Cost of goods sold 495,000 62.5
Gross margin $297,000 37.5
Less:
Selling expense:
Commissions $ 79,200
Fixed selling expense 120,000 199,200 25.2
Administrative expense 85,000 10.7
Operating income $ 12,800 1.6

Operating Income
• As you saw in Cornerstone 2.5, selling and
administrative expenses for the period are
subtracted from gross margin to arrive at operating
income.
Operating income = Gross margin
– Selling and administrative expenses
• Operating income is the key figure from the income
statement; it is profit and shows how much the
owners are actually earning from the company.

Income Statement of
a Service Organization
• In a service organization, there is no product to
purchase or to manufacture.
• This means there are no beginning or ending
inventories.
• As a result, there is no cost of goods sold or gross
margin on the income statement.
• Instead, the cost of providing services appears along
with the other operating expenses of the company.

CORNERSTONE 2.6
Income Statement of a Service Organization

Information:
• Komala Information Systems designs and installs
software.
• Last month, Komala had costs of
• software licensing , $5,000
• service technicians, $35,000
• research and development, $55,000
• selling expenses, $5,000
• administrative expenses, $7,000
• Sales totalled $130,000
Required:
Prepare an income statement.
Income Statement of a Service Organization
Sales revenues: $130,000

Less operating expenses:
Software licensing $ 5,000
Service technicians 35,000
Research and development 55,000
Selling expenses 5,000
Administrative expense 7,000 107,000
Operating income $ 23,000

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POWERPOINT PRESENTATION TO

2-1 Copyright © 2022 Cengage Canada

2-2 Copyright © 2022 Cengage Canada

2-3 Copyright © 2022 Cengage Canada

3.3.1 Evaluates cost classifications and costing methods for

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2-6 Copyright © 2022 Cengage Canada

2-7 Copyright © 2022 Cengage Canada

Revenues > Costs = Profits

Revenues = Costs = Zero profits

Revenues < Costs = Losses

2-8 Copyright © 2022 Cengage Canada

Be careful! Cost and price are not the same thing.

2-9 Copyright © 2022 Cengage Canada

2-11 Copyright © 2022 Cengage Canada

Assigning costs is the way that a cost is linked to some

2-13 Copyright © 2022 Cengage Canada

2-14 Copyright © 2022 Cengage Canada

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In relation to Cost Type Description

Since indirect costs are not traceable, these costs

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In relation to Cost Type Description

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Classifications Product costs Inventoriable costs such as direct

Period costs Non-inventoriable costs

Prime Direct materials and direct labour

Conversion Direct labour and manufacturing

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1 Services are intangible.

2 Services are perishable.

Services require direct contact

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Conversion cost = Direct labour + Manufacturing overhead

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Direct Period Cost:

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Raw Work-in- Finished

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