Chapter 4

Introduction to
Managerial
Accounting
Learning Objectives

1. Define managerial
accounting and understand
how it is used
2. Describe the differences
between service,
merchandising, and
manufacturing companies
3. Classify costs for service,
merchandising, and
manufacturing companies

16-2
Learning Objectives

4. Prepare an income
statement and schedule of
cost of goods manufactured
for a manufacturing
company and calculate cost
per item
5. Calculate cost per service
for a service company and
cost per item for a
merchandising company
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Learning Objective 1

Define managerial
accounting and understand
how it is used

16-4
Why Is Managerial Accounting
Important?

16-5
 Financial Versus Managerial
Accounting
• Financial accounting:
– Financial statements are used by investors,
creditors, and government authorities.
• Managerial accounting:
– Reports are generated for planning.
• One planning tool is the budget.
– Controlling involves evaluating the plan and
comparing the actual results to the budget.
– Weighing the costs against the benefits is
called cost/benefit analysis.

16-6
Financial Versus Managerial
Accounting

16-7
 Management Accountability

• Management accountability is the

manager’s responsibility to the various
stakeholders to wisely manage the
organization’s resources.
• Stakeholders have an interest in the
business and include the following:
– Customers
– Creditors
– Suppliers
– Investors
16-8
Management Accountability

16-9
 Today’s Business Environment

• Shift toward a service economy

• Global competition
• Time-based competition:
– Enterprise Resource Planning (ERP) systems
integrate companies data.
– E-commerce allows companies to sell products
to customers around the world.
– Just-in-Time (JIT) Management is an inventory
management tool.

16-10
 Today’s Business Environment

• Total Quality Management (TQM) is a

philosophy of continuous improvement in
products and processes.
– Creates a culture of cooperation.
– Each step adds value to the end product, and this
is referred to as the value chain.
• The economic, social, and environmental
impact of doing business is referred to as the
triple bottom line, which includes:
– Profits
– People
– Planet

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Ethical Standards

16-12
Learning Objective 2

Describe the differences

between service,
merchandising, and
manufacturing companies

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 How Do Service, Merchandising, and
Manufacturing Companies Differ?
• Service companies sell their time, skill,
and knowledge.
– All of their costs are period costs and are
expensed in the period incurred.
• Merchandising companies resell products
they previously bought from suppliers.
– Cost of goods sold is an inventoriable product
cost, also called a product cost.
• Manufacturing companies create products
that customers want.
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 Manufacturing Companies

• Manufacturing companies convert raw

materials into finished products.
• The three types of inventory are:
– Raw Materials Inventory (RM)
• Materials used to manufacture a product.
– Work-in-Process Inventory (WIP)
• Goods that have been started but are not compete.
– Finished Goods Inventory (FG)
• Completed goods that have not yet been sold.

16-15
How Do Service, Merchandising, and
Manufacturing Companies Differ?

16-16
Learning Objective 3

Classify costs for service,

merchandising, and
manufacturing companies

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How Are Costs Classified?

16-18
 Product Costs

• Direct materials (DM)

• Raw materials used in production
• Direct labor (DL)
• Labor of employees working on the products
• Manufacturing overhead (MOH)
• The indirect product costs associated with
production, including:
• Indirect materials
• Indirect labor
• Factory costs for rent, utilities, insurance, etc.

16-19
Product Costs

16-20
 Prime and Conversion Costs
• Prime costs combine direct costs of direct
materials and direct labor.
• Conversion costs are the costs to convert
raw materials into finished goods: direct
labor plus manufacturing overhead.

16-21
Learning Objective 4

Prepare an income statement

and schedule of cost of goods
manufactured for a
manufacturing company and
calculate cost per item

16-22
 How Do Manufacturing Companies
Determine the Cost of
Manufactured Products?
• Income statement
– Calculating cost of goods sold
• The Finished Goods Inventory account provides
information for the cost of goods sold section of the
income statement
– Gross profit
• Gross profit = Net Sales Revenue – Cost of Goods
Sold
– Operating income
• Operating income = Gross profit – sales and
administrative expenses

16-23
Calculating Cost of Goods Sold

16-24
 Calculating Cost of Goods
Manufactured
• Cost of goods manufactured is the
manufacturing costs of the goods that
finished the production process in a given
accounting period.
– Costs are determined from activities that took
place in the past.

16-25
Calculating Cost of Goods
Manufactured

16-26
Calculating Cost of Goods
Manufactured

16-27
Flow of Costs Through the Inventory
Accounts

16-28
 Calculating Unit Product Cost

• Managers make decisions on pricing products

based on unit cost.
– Cost per unit is found by dividing cost of goods
manufactured by total units produced.
– The cost per unit is used to determine the Cost of
Goods Sold for the units sold to customers.

16-29
Learning Objective 5

Calculate cost per service for a

service company and cost per
item for a merchandising
company

16-30
 How Is Managerial Accounting
Used in Service and Merchandising
Companies?
Managers of service and merchandising
organizations make decisions on pricing
based on cost per service or cost per
item.

16-31
Cost-Volume-Profit Analysis

16-32
Learning Objectives

1. Determine how changes

in volume affect costs
2. Calculate operating
income using
contribution margin and
contribution margin
ratio
3. Use cost-volume-profit
(CVP) analysis for profit
planning

20-33
Learning Objectives

4. Use CVP analysis to

perform sensitivity
analysis

20-34
Learning Objective 1

Determine how changes

in volume affect costs

20-35
 How Do Costs Behave When
There Is a Change in Volume?
• Some costs change as the volume of sales
increases or decreases. Other costs are
not affected by changes in volume.
• Different types of costs are:
– Variable costs
– Fixed costs
– Mixed costs

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 Variable Costs

• Variable costs remain constant per unit

but change in total as volume changes.

20-37
Variable Costs

20-38
Fixed Costs

20-39
Fixed Costs

20-40
Fixed Costs

20-41
 Mixed Costs

• Mixed costs have both fixed and variable

components.

20-42
Mixed Costs

20-43
 High-Low Method

• A method to separate mixed costs into

variable and fixed components is the high-
low method.

20-44
 High-Low Method

• Use three steps to separate the variable

and fixed costs.
• Step 1: Identify the highest and lowest
levels of activity and calculate the variable
cost per unit.

20-45
 High-Low Method

• Now that we have calculated the variable

costs per unit, we can calculate the
portion of the mixed costs that relates to
the fixed costs.
• Step 2: Calculate the total fixed costs.

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 High-Low Method

• Using the variable costs per unit and the

fixed costs per unit, we can determine the
total mixed costs at various levels of
productivity.
• Step 3: Create and use an equation to
show the behavior of a mixed cost.

20-47
 Relevant Range and Relativity

• The relevant range is the range of volume

where total fixed costs and variable costs
per unit remain constant.

20-48
Learning Objective 2

Calculate operating
income using contribution
margin and contribution
margin ratio

20-49
 What Is Contribution Margin, And How Is
It Used to Compute Operating Income?

• A traditional income statement classifies

costs by function:
– Product costs
– Period costs
• A contribution margin income statement
classifies costs by behavior:
– Variable costs
– Fixed costs

20-50
 Contribution Margin

• The difference between net sales revenue

and variable costs is the contribution
margin.
• It is called contribution margin because it
is the amount that contributes to covering
fixed costs.

20-51
 Unit Contribution Margin

• The contribution margin can be expressed

as a unit amount.
• Note: The terms unit contribution margin
and contribution margin per unit are used
interchangeably.

20-52
 Contribution Margin Ratio

• A third way to express contribution margin

is as a ratio.
• Contribution margin ratio is the ratio of
contribution margin to net sales revenue.

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Contribution Margin Income Statement

20-54
Learning Objective 3

Use cost-volume-profit
(CVP) analysis for profit
planning

20-55
 How Is Cost-Volume-Profit (CVP)
Analysis Used?
• Managers use information about cost
behavior to make business decisions.
• Cost-volume-profit (CVP) analysis is a
planning tool that looks at the
relationships among costs and volume and
how they affect profits (or losses).

20-56
 Assumptions

• The price per unit does not change as

volume changes.
• Managers can classify each cost as
variable, fixed, or mixed.
• The only factor that affects total costs is
change in volume, which increases or
decreases variable and mixed costs.
• Fixed costs do not change.
• There are no changes in inventory levels.

20-57
 Target Profit—Three Approaches

• CVP analysis can be used to estimate the

amount of sales needed to achieve a
target profit.
• There are three methods of estimated
sales required to make a profit:
– Equation approach
– Contribution margin approach
– Contribution margin ratio approach

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 The Equation Approach

• An equation can be used to estimate the

number of units a company needs to sell
to achieve target profit or total sales
revenue.

20-59
 The Equation Approach

• If Smart Touch Learning desires a target

profit of $6,000, using the equation
approach, it finds it needs to sell 80 units.

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 The Contribution Margin Approach

• The contribution margin approach is a

shortcut method of computing the
required sales in units.
• The equation approach is rewritten to
derive the following equation:

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 Contribution Margin Ratio Approach
• The contribution margin ratio approach computes required
sales in terms of sales dollars rather than in units.

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 Breakeven Point—A Variation of
Target Profit
• The breakeven point calculation is a
variation of the target profit calculation.
• The breakeven point is the point at which
total revenues equal total costs.
• The same three approaches used for
target profit can be used to determine the
breakeven point.

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Breakeven Point—A Variation of
Target Profit

20-64
CVP Graph—A Graphic Portrayal

20-65
Learning Objective 4

Use CVP analysis to

perform sensitivity
analysis

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 How Is CVP Analysis Used for
Sensitivity Analysis?
• Managers can use CVP relationships to
conduct sensitivity analysis.
• Sensitivity analysis is a “what if” technique
that estimates profit or loss results if sales
price, cost, volume, or underlying
assumptions change.

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 Changes in the Sales Price

• If the sales price changes from $500 to

$475, the number of units needed to
breakeven increases from 54 to 60.

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 Changes in Variable Costs

• If one of Smart Touch Learning’s suppliers

raises prices and variable costs increase
from $275 to $285, the number of units
needed to break even increases from
54 to 56.

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 Changes in Fixed Costs

• If Smart Touch Learning’s fixed costs

increase from $12,000 to $15,000, the
number of units needed to break even
increases from 54 to 67.

20-70
How Is CVP Analysis Used for
Sensitivity Analysis?

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