Managerial Accounting|Business Finance
LESSON ASSIGNMENTS 5
LESSON 1: COST CONCEPTS AND TYPES OF ACCOUNTING 7
LESSON 2: TOOLS FOR MANAGEMENT AND AIDS TO DECISION MAKING 39
LESSON 3: BUDGETS, ANALYSIS, AND PERFORMANCE MEASUREMENT FOR DECISION MAKING 67
LESSON 4: CAPITAL, CASHFLOWS, AND FINANCIAL STATEMENT ANALYSIS 97
SELF-CHECK ANSWERS 121
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YOUR COURSE Welcome to the world of Managerial Accounting! It’s a practical world of analysis, interpretation, and problem solving. This study guide is designed to help you develop an understanding of the topic in conjunction with your textbook, Managerial Accounting. There are four lessons in the study guide, each containing three or four assignments. Most assignments conclude with suggested exercises and problems selected from the textbook, and each assignment concludes with a self-check. The answers to the self-checks are found at the back of the study guide. At the end of each lesson is an examination. The examinations consist of multiple-choice questions drawn from topics covered by your textbook. You’ll have to work through transactions, complete calculations and financial statements, and analyze and interpret your results to answer the questions. You’ll also need to keep your eye on the goal of sound decision making.
Whatever your major, understanding how to apply what you learn in this Managerial Accounting course to everyday busi- ness situations can help make you a more effective decision maker. May your judgment be sound and your choices lead you to success.
OBJECTIVES When you complete this course, you’ll be able to
n Understand cost classifications as applied to preparing financial statements, predicting cost behavior, and making decisions
n Understand the flow of cost in job-order costing and use activity-based absorption costing to compute product costs
n Understand the flow of process costing, computing the cost per equivalent unit using the weighted-average method and FIFO method, and allocating department costs using the direct and step-down methods
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n Explain how changes in activity affect contribution margin and net operating income and examine cost-volume- profit relationships, such as margin of safety and break-even points
n Explain how variable costing differs from absorption costing and prepare income statements using the differ- ent approaches as tools for management
n Understand activity-based costing and how it differs from a traditional costing system
n Understand budgets, the process used to create budgets, and the preparation of various kinds of budgets
n Compute and record various variances
n Understand and compute various performance measurements
n Prepare differential analysis as a key to decision making
n Evaluate calculations for capital budgeting decisions
n Prepare a statement of cash flows using the direct and indirect methods and compute free cash flow
n Compute and interpret financial ratios
YOUR TEXTBOOK Your textbook for this course is Managerial Accounting, Fifteenth Edition, by Ray H. Garrison, Eric W. Noreen, and Peter C. Brewer. Professor Garrison teaches at Brigham Young University, Provo, Utah. Professor Noreen teaches at the University of Washington. Professor Brewer teaches at Wake Forest University, Winston-Salem, North Carolina. Each author has published a number of scholarly pieces in academic journals and has years of accounting experience.
Instructions to Students2
PROGRAM MATERIALS The course provides you with the following materials:
1. Your textbook, Managerial Accounting, Fifteenth Edition, by Ray H. Garrison, Eric W. Noreen, and Peter C. Brewer, which contains the reading assignments, exercises, and problems.
2. This study guide, which contains reading, exercises, problems, and self-check assignments, as well as the self-check answers.
3. The answers to these textbook problems are found on your student portal as a Solution Manual under the sec- tion for Managerial Accounting.
A STUDY PLAN This study guide is intended to help you achieve the maxi- mum benefit from the time you spend on this course. It doesn’t replace the textbook in any way. It serves as an introduction to material that you’ll read in the book and as an aid to assist you in understanding this material. This study guide provides your assignments in four lessons. Each lesson contains three or four assignments, a set of textbook problems and exercises for most assignments, a self-check for each assignment, and a comprehensive examination on the material covered in the lesson. Be sure to complete all work related to a lesson before moving on to the next lesson.
For each lesson, do the following:
1. Read the introduction to the lesson in this study guide.
2. Read the assigned pages in your textbook.
3. Be sure to work through any review problems and the solutions at the end of a chapter if applicable.
4. Do only what’s assigned to you in the study guide. If the textbook references Web sites, CDs, DVDs, or other sup- plemental material and it hasn’t been assigned to you in the study guide, then you aren’t responsible for it. This includes any “Applying Excel” exercise in the textbook.
Instructions to Students 3
5. Complete the self-check in this study guide for each assignment in the lesson. Remember: Do not send in your answers to the self-checks.
6. Determine your own progress by comparing your answers for the self-checks to the answers given in the answer section of this study guide.
7. Review the material covered in the lesson and complete the corresponding examination.
At any point in your studies, you can e-mail your instructor for further information or clarification of your study materials. Your instructor’s guidance and suggestions should be very helpful to you as you progress with your course. However, your instructors can’t help you with exam questions.
Now, review the lesson assignments and then begin your study of Managerial Accounting with Lesson 1, Assignment 1. When you’ve completed Lesson 1 and the associated self-checks, complete your first examination. Good luck and have fun!
Instructions to Students4
Lesson 1: Cost Concepts and Types of Costing For: Read in the Read in study guide: the textbook:
Assignment 1 Pages 7–10 Pages 1–18, 23–25
Assignment 2 Pages 10–18 Pages 27–49, 67–69, 73–79
Assignment 3 Pages 19–27 Pages 83–111, 130–133, 138–140
Assignment 4 Pages 27–38 Pages 148–163, 172–177, 180–183
Examination 061400 Material in Lesson 1
Lesson 2: Tools for Management and Aids to Decision Making For: Read in the Read in study guide: the textbook:
Assignment 5 Pages 39–45 Pages 187–214
Assignment 6 Pages 45–51 Pages 233–258, 279–282
Assignment 7 Pages 52–59 Pages 286–314, 331–338
Assignment 8 Pages 60–66 Pages 342–369
Examination 061401 Material in Lesson 2
Lesson 3: Budget Analysis and Performance Measurements for Decision Making For: Read in the Read in study guide: the textbook:
Assignment 9 Pages 67–71 Pages 393–409
Assignment 10 Pages 72–80 Pages 427–447, 459–465, 471–472
Assignment 11 Pages 81–89 Pages 477–479, 512–519, 524–528
Assignment 12 Pages 90–96 Pages 531–557
Examination 061402 Material in Lesson 3
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Lesson 4: Capital, Cashflows, and Financial Statement Analysis For: Read in the Read in study guide: the textbook:
Assignment 13 Pages 97–106 Pages 583–605, 621–625, 627–631
Assignment 14 Pages 107–112 Pages 634–657, 671–673
Assignment 15 Pages 113–119 Pages 675–697
Examination 061403 Material in Lesson 4
Lesson Assignments6
Note: To access and complete any of the examinations for this study
guide, click on the appropriate Take Exam icon on your student portal.
You should not have to enter the examination numbers. These numbers
are for reference only if you have reason to contact Student CARE.
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Cost Concepts and Types of Costing
ASSIGNMENT 1: MANAGERIAL ACCOUNTING: AN OVERVIEW Read this assignment. Then read pages 1–18 and 23–25 in your textbook.
What is Managerial Accounting? At one time, managerial accounting was all about managing by the numbers. Today, managerial accounting is about creating value; however, the numbers are still important in cre- ating that value.
Financial accounting is concerned with reporting the num- bers, whereas managerial accounting is concerned with providing information so that managers can (1) plan the use of budgets, (2) control the use of performance reports, and (3) make decisions that will add value to the business. Exhibit 1- 1 on page 2 of your textbook provides a comparison between financial accounting and managerial accounting. Note that all financial reporting must comply with rules, such as generally accepted accounting principles (GAAP) and international fnancial reporting standards (IFRS).
Why Does Managerial Accounting Matter to Your Career? Exhibit 1-3 on page 6 of your textbook relates managerial accounting to three business majors—marketing, supply chain management, and human resource management. Yet, that exhibit could easily be expanded to many other majors or areas of study, such as the business major of hospitality management or an area of study such as project manage- ment. It’s a fundamental subject for Certified Management Accountants (CMA) or Certified Public Accountants (CPA).
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Managers of companies have three main activities. First, they need to plan. Managers must be able to look at the choices they have from where they are to make decisions in keeping with the company’s strategy and objectives. Second, good managers know how to delegate, direct, and motivate people to get things done. In short, they need to be leaders. Lastly, managers must be able to look at the results and adjust to what’s happening to maintain the course. They must be able to control the situation. If they must make an adjustment throughout any of the processes, they must be able to decide the best course of action. Being able to make decisions is at the heart of all good managers.
Managerial Accounting: Beyond the Numbers Successful managers use six different perspectives that go beyond measurement skills to add value when planning, controlling, and decision making.
1. An Ethics Perspective
2. A Strategic Management Perspective
3. An Enterprise Risk Management Perspective
4. A Corporate Social Responsibility Perspective
5. A Process Management Perspective
6. A Leadership Perspective
While the goal of a business is to make money, in today’s world how a business goes about making that money and the impact of decisions made from a social perspective are just as important. The public (people) are less tolerant to environ- mental concerns, such as oil spills, pollution, and dumping. They look unfavorably at a company that uses child and slave labor. Therefore, today’s manager not only needs to manage by the numbers, but must also go beyond the numbers.
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Appendix 1A: Corporate Governance It seems as if every month there’s a headline story about top executive management that, through mismanagement, leaves shareholders harmed or at least wary. Enron and Qualcomm are examples. However, the vast majority of companies have effective corporate governance that puts the best interest of the stockholders before the interests of top management. Left unchecked, there will be those who will take advantage. In 2002, The Sarbanes-Oxley Act was created to protect and build stockholders’ confidence by improving the reliability of companies’ reporting information.
Self-Check 1 At the end of each section of Managerial Accounting, you’ll be asked to pause and check
your understanding of what you’ve just read by completing a “Self-Check” exercise.
Answering these questions will help you review what you’ve studied so far. Please
complete Self-Check 1 now.
Questions 1–10: Indicate whether each of the following sentences is True or False.
______ 1. Managerial accounting must follow GAAP/IFRS.
______ 2. Financial accounting is not mandatory for external reports.
______ 3. A detailed plan for the future is usually expressed in formal quantitative terms as
a budget.
______ 4. A CMA designation is not a globally respected credential that will increase your
credibility if you plan to become an accounting major.
______ 5. Ethical behavior is the foundation of managerial accounting.
(Continued)
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Self-Check 1 ______ 6. The Leadership Perspective enables a company to attract customers by distinguishing
itself from competitors.
______ 7. A process used by a company to identify risks and develop responses is a part of enter-
prise risk management
______ 8. Corporate social responsibility considers stakeholders when making decisions.
______ 9. Process Management involves only the business process and the value chain.
______ 10. Leaders need to understand how intrinsic motivation, extrinsic incentives and cognitive
bias influence human behavior.
Check your answers with those on page 121.
ASSIGNMENT 2: MANAGERIAL ACCOUNTING AND COST CONCEPTS Read this assignment. Then read pages 27–49, 67–69, and 73– 79 in your textbook.
Cost Classifications for (1) Assigning Costs to Cost Objects and (2) Manufacturing Companies There are three basic manufacturing cost categories:
n Direct materials
n Direct labor
n Manufacturing overhead
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Direct materials and direct labor can further be broken down into direct materials and indirect materials and direct labor and indirect labor. Now the categories look like this:
1. Direct materials
a. Direct materials
b. Indirect materials
2. Direct labor
a. Direct labor
b. Indirect labor
3. Manufacturing overhead (all other manufacturing costs)
When considering manufacturing costs, we’re talking about the costs to manufacture a product to sell. The product is the finished good and is part of our inventory, which is on the bal- ance sheet. An entry is then made to move that inventory, once it’s sold, to our cost-of-goods-sold (COGS) account, which is on the income statement.
Understanding what costs are associated with manufacturing a product is important because not all expenses in a business are manufacturing costs. These are known as nonmanufacturing costs. This includes selling and administrative costs.
Our income statement will show our sales, less our COGS. This provides our gross margin (or gross profit). From our gross margin we then deduct our selling and administrative expenses to get our net income (or net profit/loss).
What about something like janitorial services? Doesn’t the janitor clean the public restrooms, the offices, and quite possi- bly the manufacturing floor? Or what about an electric bill for lighting? You get one bill for the entire facility, yet not all of the electricity is being used to manufacture the product. Later in your textbook, you’ll learn what to consider in these situations. For now, it’s important to understand that not all expenses are associated with manufacturing overhead.
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Cost Classifications for Preparing Financial Statements There are other ways to look at costs. As a manager, you can look at manufacturing costs and nonmanufacturing costs. The manufacturing costs are also known as product costs. Product costs are looked at irrespective of time. Internally, using this information is appropriate. What happens when the information is to go to external users? Financial accounting uses the matching principle, which matches the revenues with the expenses for the specific period in time. All of the costs that aren’t product costs, such as selling and administrative expenses, are period costs. These are considered when there’s a need for financial statements to be created.
To break down the information for even further use, two additional categories are created—prime costs and conversion costs. Prime costs are direct material and direct labor. Conversion costs are direct labor and manufacturing overhead.
Costs are costs. That’s the basic information a manager has to work with. From this basic (raw) data, different companies will group the information differently depending on their needs. However, all companies will follow generally accepted accounting principles (GAAP), especially when the informa- tion will be provided to external users.
Cost Classifications for Predicting Cost Behavior Costs can be further broken up into two categories—fixed costs and variable costs. Exhibit 2-4 on page 37 of your text- book shows the difference in behavior between variable and fixed costs. Variable costs change in direct proportion to the level of activity, whereas fixed costs stay the same regardless of the level of activity. However, both must be taken within context, which is known as the relevant range.
Exhibit 2-2 on page 35 of your textbook illustrates variable and fixed cost behavior. It varies in direct proportion to changes in activity level. This is why the variable graph on the left has a slope—the total cost of the meal changes. Yet,
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the fixed graph on the right doesn’t change. However, variable costs must be variable in relation to something—that’s the activity base. The activity base in the graphs is the total cost of meals and the cost of building rental.
Variable costs can also have differing behavior patterns—true variable costs and step-variable costs. True variable costs, such as direct labor, vary in direct proportion to the level of production activity. Step-variable costs increase or decrease in response to wide changes in activity.
On the other hand, fixed costs remain the same within the relevant range of activity. Exhibit 2-3 on page 36 of your text- book depicts fixed costs and the relevant range. Fixed costs that are used for planning purposes are either committed or discretionary fixed costs.
Exhibit 2-5 on page 38 of your textbook shows mixed cost behavior. It has elements of both fixed and variable costs and is represented by a straight line.
The Analysis of Mixed Costs Various methods are used in the analysis of mixed costs.
1. Scattergraph method
2. High-low method
3. Least-squares regression method
4. Multiple regression analysis method
The scattergraph method is rarely used, due to the nature of quickly estimating fixed and variable costs, and is inappropri- ate for financial analysis. However, it does have a use. If it confirms that the relationship between the fixed and variable costs is linear, then the high-low method or least-squares regression method can be used.
The high-low method is fairly simple to use. However, it does have a major drawback—it uses only two data points, which isn’t enough to produce accurate results. If data points are chosen from periods of unusual activity, the data points aren’t truly representative of normal cost behavior during
Managerial Accounting14
normal periods. Although this is a drawback, it’s a better alternative to the scattergraph method (see Exhibit 2-7 on page 42 of your textbook).
The least-squares regression method uses all of the data points. Computer software can easily handle many data points and provide further statistical analysis.
The least-squares regression method is driven by one factor; the multiple regression analysis method is used when the cost is driven by more than one factor. The principles are the same as in the least-squares method, but the computations become increasingly difficult.
Traditional and Contribution Format Income Statements Exhibit 2-9 on page 44 of your textbook provides a comparison of the traditional approach to creating an income statement versus the contribution approach to creating an income state- ment. While the traditional approach is often sufficient for external reporting purposes, internally the lumping together of fixed and variable costs is a hindrance to managers, who need the distinction between the fixed and variable costs to facilitate planning, control, and decision making. The variable costs are deducted from sales to create the contribution margin, from which the fixed expenses are then deducted to calculate the net operating income.
Cost Classifications for Decision Making Just as we assign different classifications to different costs in the manufacturing process, we also assign costs different classifications to be used for the decision-making process. These classifications are the differential costs and revenues, opportunity costs, and sunk costs. These can be thought of as “unseen” costs.
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As a manager looking at differential costs and revenues, you’re looking at the difference between two alternatives. As an example, you make and sell jewelry—bracelets, to be exact. They cost $0.60 each to manufacture. You nor- mally price them at $3.00 each. Here’s an alternative. What if you sell them at $3.00 each or two for $5.00? Which is the better alternative? This illustrates making decisions when looking at differential costs and revenues. (There’s no answer to this specific example because you don’t have enough infor- mation, such as how many you sell for a given period of time and/or how many you would expect to sell during that same period of time.)
Opportunity costs are the potential benefits given up when you select one alternative over another, and sunk costs are costs already incurred that can’t be changed by any decision you’ll make.
Making decisions is at the heart of being a manager. Consideration for costs other than what’s in front of you on the paper is also important.
Appendix 2A: Least-Squares Regression Computations Least-squares regression computations can be calculated by hand. However, software programs, such as Microsoft Excel, can be used to do the calculations. In a perfect world, statis- tical applications are used.
An understanding of the concept of least squares regression is required. However, you will not need to perform the calcu- lations using Excel or other computer software as this is beyond the scope of this subject.
Appendix 2B: Cost of Quality— Quality Cost Reports Manufacturers constantly struggle to produce high-quality products. The objective is to have high quality of conformance, which is a product that meets or exceeds expectations. In
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obtaining this, a quality cost is associated with the manufac- turing of the product. These quality costs are perceived as prevention costs, appraisal costs, internal failure costs, external failure costs, and distribution of quality costs. An assessment of these costs can be seen in quality cost reports. The information can be used to improve the product, which brings the manager back full circle to performing his three main activities—planning, directing, and motivating. He controls and uses that information to improve upon the processes using the company’s strategy and meeting its objectives.
International Aspects of Quality The International Organization for Standardization (ISO) cre- ated control guidelines known as the ISO 9000 standards, largely due to the effects caused by the work of W. Edwards Deming when he was hired to help management in Japan after World War II. (Through his teachings, companies like SONY and Honda became household brand names that exemplified quality. Would-be business managers are well advised to study the works of Deming. While some of the concepts he imple- mented in Japan have made their way into textbooks, many have not. However, his written works can be purchased and are well worth the read and will have a profound effect in your business if implemented.) An ISO 9000 certification is the “international gold standard” when it comes to quality and is not limited to manufacturing. The AICPA (American Institute of Certified Public Accountants) became the first professional organization to be ISO 9000-certified.
Review Problems Be sure to go over and fully understand the “Review Problems” at the end of each chapter/appendix as they apply many of the concepts found in the chapter.
Lesson 1 17
TexTbook ProbleMS for ASSignMenT 2
Exercises: #2–1 (page 53), #2–2, #2–3, #2–4 (page 54),
#2–5, #2–6 (page 55), #2–7 (page 56), #2–11,
#2–12 (page 57), #2–13 (page 58)
Problems: #2–19, #2–20 (page 61), #2–21 (page 62), #2–
22, #2–23 (page 63), #2–24, #2–25 (page 64)
Appendix 2B: #2B–2 (page 80), #2B–3 (page 81),
#2B–4 (page 82)
Check your answers in the Textbook Exercises and
Problem Solutions Supplement.
Self-Check 2 Questions 1–20: Indicate whether each of the following sentences is True or False.
______ 1. Selling costs can be either direct or indirect costs.
______ 2. A direct cost is a cost that can’t be easily traced to the particular cost object
under consideration.
______ 3. Property taxes and insurance premiums paid on a factory building are examples of
period costs.
______ 4. Conversion cost equals product cost less direct labor cost.
______ 5. Thread that is used in the production of mattresses is an indirect material that is
therefore classified as manufacturing overhead.
______ 6. Direct labor is a part of prime cost, but not conversion cost.
______ 7. Conversion cost is the sum of direct labor cost and direct materials cost.
(Continued)
Managerial Accounting18
Self-Check 2 ______ 8. Direct material costs are generally fixed costs.
______ 9. Product costs are recorded as expenses in the period in which the related products are sold.
______ 10. Depreciation on manufacturing equipment is a product cost.
______ 11. Manufacturing salaries and wages incurred in the factory are period costs.
______ 12. Depreciation on office equipment would be included in product costs.
______ 13. Rent on a factory building used in the production process would be classified as a
product cost and as a fixed cost.
______ 14. A fixed cost remains constant if expressed on a unit basis.
______ 15. Total variable cost is expected to remain unchanged as activity changes within
the relevant range.
______ 16. The R2 (i.e., R-squared) is a measure of the goodness-of-fit in
least-squares regression.
______ 17. When analyzing a mixed cost, you should always plot the data in a scattergraph, but it
is particularly important to check the data visually on a scattergraph when the R2 from
a least squares regression is low. A quick look at the scattergraph can reveal that there
is little relation between the cost and the activity or that the relation is something
other than a simple straight line.
______ 18. Quality of conformance is the degree to which an actual product meets its design
specifications and is free of defects or other problems that might affect appearance
or performance.
______ 19. An increase in appraisal costs will usually result in a decrease in internal failure costs.
______ 20. Internal failure costs result from identification of defects during the appraisal process.
Such costs may include scrap, rejected products, rework, and downtime.
Check your answers with those on page 121.
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ASSIGNMENT 3: JOB-ORDER COSTING Read this assignment. Then read pages 83–111, 130–133, and 138–140 in your textbook.
Job-Order Costing—An Overview Process costing can be thought of as creating the same prod- ucts over long periods of time, such as a table where you obtain the wood, cut it up, assemble it, and finally paint it. The table goes through a “process” to create a finished good.
Job-order costing can be thought of as creating many different products for a specific period of time. For example, take the con- struction of a convenience store. There are many different “jobs” that need to occur, such as building the building, laying out the floor plan, assembling and installing walk-in coolers, installing air conditioning/heating, electrical, plumbing, etc. All of this is contracted to be completed by a specific date.
Jobs need to be measured to know how far along the project is and how much more needs to be done until completion. Measuring is done through documentation and recorded on job-cost sheets. (See Exhibit 3-2 on page 87 of your text- book for an example.) Direct materials are recorded using bill of materials and materials requisition forms. Direct labor can be found on time cards. Manufacturing overhead is more complicated.
Manufacturing overhead is based on allocation. A common allocation base that’s used is estimated direct-labor hours to calculate a predetermined overhead rate. The predetermined overhead rate is then multiplied by the actual direct labor hours to calculate how much overhead needs to be applied against a specific job. The allocation base is the cost driver and doesn’t have to be labor. It’s whatever makes sense for that particular job.
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Exhibit 3-5 on page 94 of your textbook shows the costflows and classifications in a manufacturing company. Understanding the flow will give you a structure for working with all of the data and information you’ll receive during the course of a job.
Job-Order Costing—The Flow of Costs, Schedules of Goods Manufactured, and Cost of Goods Sold Exhibits 3-6 through 3-8 on pages 95–98 of your textbook illustrate the flow of costs for job-order costing. Understanding these exhibits is crucial to understanding the journal entries to be made for a job. Exhibit 3-9 on page 100 of your textbook provides a summary of the journal entries, and Exhibit 3-10 on page 101 provides the effects on the general ledger accounts using T-accounts. Exhibits 3-11 and 3-12 on pages 102 and 104 of your textbook shows the reporting via the schedule of cost of goods manufactured and cost of goods sold along with the income statement. These exhibits provide a visual representation of the flow of information.
Remember, direct material has two components: direct material and indirect materials. Raw materials need to be purchased. A materials requisition form provides the information for direct and indirect materials. All of it is raw materials and is credited to the raw materials account. However, the raw materials are categorized as direct and indirect materials. The indirect mate- rials are debited to manufacturing overhead, while the direct materials are recorded in two different places—a debit to work in process and also to the job-cost sheets. Think of this as recording and accounts receivable or accounts payable. You hit the accounts receivable or accounts payable general ledger account, but you also must enter it into the specific receivable or payable account in the subsidiary ledger.
The same happens with direct labor. It has two components and is entered the same exact way as direct materials; the only difference is that for labor you use time cards, whereas for
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materials you use materials requisition forms and/or bills of materials. If you understand how to allocate materials, you understand how to allocate labor.
Manufacturing overhead costs are handled differently. These costs are applied directly by debiting the manufacturing overhead general ledger account as they occur. How are they applied to work in process? The predetermined over- head rate is used to apply overhead costs to each job. (See Exhibit 3-8 on page 98 in your textbook.) The applied overhead is credited to the manufacturing overhead account, while the debits are entered on the job-cost sheets and to the work-in- process account.
Nonmanufacturing costs don’t go in the manufacturing overhead account. Nonmanufacturing costs are selling and administrative expenses and should be recorded in the appro- priate expense accounts.
When the job is completed, an additional entry is made for the amount on the job-cost sheet, out of the work-in-process account and into the finished-goods account. (Finished goods = inventory available for sale.) When the finished good is delivered to the customer, it needs to be reduced by recording the entry to move the amount of the finished good to COGS and recording the sale.
Underapplied and Overapplied Overhead—A Closer Look The predetermined overhead rate is an estimate. Because it’s an estimate, there’s almost always a difference from the actual overhead costs in the work-in-process account. It’s either underapplied or overapplied. This difference needs to be corrected. Whether it’s underapplied or overapplied will determine what journal entry needs to be made when clos- ing out the manufacturing overhead account to the COGS account. Exhibit 3-13 on page 105 illustrates a summary of the overhead concepts.
The question may arise as to why we don’t close the entire balance to the COGS account in the first place. The answer lies in accuracy—we assign the overhead costs to where they
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should have gone in the first place, had it not been for the errors created by using the estimate in the predetermined overhead rate.
When you first contract for a job, you base the sale price on your estimate of what you think the costs will be. You gener- ally have a good idea as to what your labor hours are going to be, but this is still an estimate. Your crew may take more time, or they may take less time. You can get pretty accurate costs for materials because you need to purchase them to do the job. When determining your manufacturing overhead, you’ll estimate using the predetermined overhead rate. Again, your estimate may be over or under what you actually incurred. You always need to be thinking in terms of how much you estimated. This is what the actual costs are. You need to ask how much you’re overapplied or underapplied, and then you need to make the appropriate adjustment.
Exhibit 3-14 on page 108 of your textbook provides a general model of cost flows. Again, build a framework in your mind and understand it.
Job-Order Costing in Service Companies Job-order costing in service companies—such as law firms, accounting firms, and so on—is very much like that in manu- facturing companies even though they don’t produce a product. They still have labor, and, depending on the type of service, they may have materials. They’ll also have to account for overhead .
Appendix 3A: Activity-Based Absorption Costing While Chapter 3 showed the method used for a traditional absorption system, this appendix will present an alternative approach called activity-based absorption costing. This approach differs in that it assigns the manufacturing overhead based upon the “activities” performed to make the product. One approach isn’t better than the other. While less
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commonly used, the activity-based absorption costing fits the needs of businesses where the traditional approach doesn’t. Exhibits 3A-1 and 3A-2 on pages 131 and 132 of your text- book illustrate the differences in the two approaches.
Appendix 3B: The Predetermined Overhead Rate and Capacity Previous discussions looked at the predetermined overhead rate. What if capacity is the cost driver and is limited? The calculation is the same, but the limited capacity must be taken into consideration.
Review Problems Be sure to go over and fully understand the “Review Problems” at the end of each chapter/appendix as they apply many of the concepts found in the chapter.
TexTbook ProbleMS for ASSignMenT 3
Exercises: #3–1, #3–2, #3–3, #3–4 (page 115),
#3–5, #3–6, #3–7 (page 116), #3–11 (page 117),
#3–18 (page 121)
Problems: #3–26 (page 126), #3–27 (page 127)
Appendix 3A: #3A–1 (page 133), #3A–2 (page 134),
#3A–4 (page 135)
Appendix 3B: #3B–1 (page 140), #3B–2 (page 141)
Check your answers in the Textbook exercises and
Problem Solutions Supplement.
Managerial Accounting24
Self-Check 3 Questions 1–10: Indicate whether each of the following sentences is True or False.
______ 1. Job-order costing is usually not used in service organizations such as hospitals and
law firms.
______ 2. The three cost categories appearing on a job-cost sheet are selling expense, manufacturing
expense, and administrative expense.
______ 3. To improve the accuracy of unit costs, most companies recompute the predetermined
overhead rate each month.
______ 4. Use of a single, plantwide overhead rate is generally appropriate only for very large
manufacturing companies.
______ 5. The following journal entry would be made to apply overhead cost to jobs in a job-order
costing system:
______ Work in Process XXX
Manufacturing Overhead XXX
______ 6. When completed goods are sold, the transaction is recorded as a debit to cost of goods
sold and a credit to work in process.
______ 7. Actual manufacturing overhead costs are traced to specific jobs.
______ 8. A credit balance in the manufacturing overhead account at the end of the year means
that overhead was underapplied.
______ 9. The sum of all amounts transferred from the work-in-process account and into the
finished-goods account represents the cost of goods manufactured for the period.
______ 10. The most common accounting treatment of underapplied manufacturing overhead is to
transfer it to the manufacturing overhead control account.
(Continued)
Lesson 1 25
Self-Check 3 11. Computing unit product costs involves averaging in which of the following?
a. Choice A c. Choice C
b. Choice B d. Choice D
12. In job-order costing, all of the following statements are correct with respect to labor time and
cost except for which one?
a. Time tickets are kept by employees to show the amount of work on specific jobs.
b. The job-cost sheet for a job will contain all direct labor charges to that particular job.
c. Labor cost that can be traced to a job only with a great deal of effort is treated as part of
manufacturing overhead.
d. A machine operator performing routine annual maintenance work on a piece of equipment
would charge the maintenance time to a specific job.
13. In a job-order costing system, the journal entry to record the application of overhead cost to
jobs would include a
a. credit to the manufacturing overhead account.
b. credit to the work-in-process inventory account.
c. debit to cost of goods sold.
d. debit to the manufacturing overhead account.
(Continued)
Job-order Costing Process Costing
A Yes No
B Yes Yes
C No Yes
D No No
Managerial Accounting26
Self-Check 3 14. Ivory Company uses a job-order costing system. Which year-end journal entry could Ivory
make to dispose of (close out) $4,150 of overapplied manufacturing overhead cost?
15. In a job-order costing system, the use of indirect materials would usually be recorded as a
debit to
a. raw materials. c. manufacturing overhead.
b. work in process. d. finished goods.
16. Which account is debited when indirect labor is recorded?
a. Work in process c. Salaries and wages payable
b. Salaries and wages expense d. Manufacturing overhead
17. In a job-order costing system, the amount of overhead cost that has been applied to a job
that remains incomplete at the end of a period is
a. deducted on the income statement as overapplied overhead.
b. closed to cost of goods sold.
c. transferred to finished goods at the end of the period.
d. part of the ending balance of the work-in-process inventory account.
(Continued)
a Finished Goods
Manufacturing Overhead
$4,150
$4,150
b Cost of Goods Sold
Manufacturing Overhead
$4,150
$4,150
c Manufacturing Overhead
Finished Goods
$4,150
$4,150
d Manufacturing Overhead
Cost of Goods Sold
$4,150
$4,150
Lesson 1 27
Self-Check 3 18. If a company applies overhead to jobs on the basis of a predetermined overhead rate, a credit
balance in the manufacturing overhead account at the end of any period means that
a. more overhead cost has been charged to jobs than has been incurred during the period.
b. more overhead cost has been incurred during the period than has been charged to jobs.
c. the amount of overhead cost charged to jobs is greater than the estimated cost for the
period.
d. the amount of overhead cost charged to jobs is less than the estimated overhead cost for
the period.
19. Which situation always results in underapplied overhead?
a. Actual overhead is greater than applied overhead.
b. Actual overhead is less than applied overhead.
c. Estimated overhead is greater than actual overhead.
d. Estimated overhead is less than actual overhead.
20. When closing overapplied manufacturing overhead to cost of goods sold, which of the
following would be true?
a. Work in process will decrease. c. Net income will decrease.
b. Cost of goods sold will increase. d. Gross margin will increase.
Check your answers with those on page 122.
Managerial Accounting28
ASSIGNMENT 4: PROCESS COSTING Read this assignment. Then read pages 144–159, 171–176, and 179–182 in your textbook.
Comparison of Job-Order and Process Costing Process costing can be thought of as creating the same prod- ucts over long periods of time, such as a table where you obtain the wood, cut it up, assemble it, and finally paint it. The table goes through a “process” to create a finished good.
Job-order costing can be thought of as creating many different products for a specific period of time. For example, take the con- struction of a convenience store. There are many different “jobs” that need to occur, such as building the building, laying out the floor plan, assembling and installing walk-in coolers, installing air conditioning/heating, electrical, plumbing, etc. All of this is contracted to be completed by a specific date.
There are similarities between job-order and process costing. Both have the same basic purposes in assigning costs. Both use the same basic manufacturing accounts. Both have the flow of costs going through the manufacturing accounts the same way.
Exhibit 4-1 on page 146 of your textbook relates some of the differences between job-order and process costing. Process-costing accounts for a single product are created on a continuous basis and are generally identical. Costs are accumulated by department, and unit costs are computed by department.
Go back to the example of building a convenience store versus manufacturing a table. The convenience store is one-and-done. The table would need the raw material cut (cutting depart- ment), then assembled (assembly department), and finally painted (painting department) to create the finished good. For the convenience store, all materials, labor, and overhead are applied to that one specific job. With the table, the costs are
Lesson 1 29
allocated between departments because more than one table is being produced and they can be in different stages of the man- ufacturing process.
Cost Flows in Process Costing Exhibit 4-3 on page 147 of your textbook illustrates a T-account model of process costing flows. Notice how the materials, labor, and overhead associated with each individual department flow into the specific work-in-process account. But also notice how the work in process for the first department flows into the sec- ond department, each one building on the next.
Using the table as an example, lumber is piled up outside the building. As the worker from the cutting department gets the lumber and cuts it into legs and tabletops, the cutting department incurs material, labor, and overhead costs. The raw materials are his beginning inventory. The legs and table- tops he cuts become his finished goods, or ending inventory, which is the beginning inventory for the assembly department. At this point in time, there’s already a cost associated with manufacturing the table. This is the work in process created from the cutting department. To this, the assembly depart- ment adds additional costs for the materials, labor, and overhead used to assemble the table and create its finished good or ending inventory, which becomes the beginning inven- tory for the painting department. At this point in time, there’s again a cost associated with the assembled table from both the cutting and assembly department. The painting depart- ment again adds costs for materials, labor, and overhead to the cost of the table, which again becomes a finished good. (This process continues. Many departments are necessary to create the final product, and along the way, each department adds to the final cost to manufacture the product.) An entry is made to move the table from the work-in-process account in the painting department to the finished-goods account and then from the finished-goods account to the COGS account when the table is sold.
Managerial Accounting30
Equivalent Units of Production In table manufacturing, each department would most likely finish off the last piece at the end of the day and call it quits for the day. But what about more complicated products like motors, airplanes, tractors, and so on? At the end of the day, departments most likely won’t have finished their stage of the process. Costs have incurred, but there’s no finished good for that department. This is where the concept of equivalent units of production comes in. It’s the product of number of partially completed units and the percentage of completion of those units with respect to the processing in the department. Equivalent units of production can be calculated using the weighted- average method or the First In, First Out (FIFO) method (which will be covered in Appendix 4A).
Exhibit 4-6 on page 153 of your textbook provides a visual perspective of equivalent units of production. The exhibit shows that at the beginning of the period, there were 200 units that were 30% complete in beginning work in process. At the end of the period, those 200 were completed, along with an additional 4,600 units that were started and com- pleted, totaling 4,800 units finished and transferred to the next department. However, 400 more units had been started but were only 25% completed. To obtain the equivalent units of production, we multiply the 400 units by 25% to get 100 equivalent units. This is the equivalent units that would have been completed for the same period of time if we were able to start and finish each unit instead of starting 400 units at one time but not being able to complete them for one reason or another. We then add the 4,800 units completed to the 100 we would have completed to obtain the 4,900 equivalent units.
Compute and Apply Costs Once we know the equivalent units of production, we can then compute the cost per equivalent unit. We know our costs of the beginning work-in-process inventory. We add costs incurred during the period and divide that by the number of equivalent units to obtain our cost per equivalent unit. This is done for each cost category, and a cost reconciliation report is created if necessary.
Lesson 1 31
Operation Costing Job-order costing and process costing are the most common costing methods. However, one size shoe doesn’t fit all, and there are adaptations for particular situations in between. Operation costing is a method that’s used when a product has both common characteristics and individual characteris- tics—much like shoes. Shoes involve cutting and sewing, yet styles of shoes are very individual. Costing for shoes employs aspects of both job-order costing and process costing. Specific styles of shoes are created in batches, reflecting the aspects of job-order costing. However, shoes are also created in an assembly line–like process and reflect the aspects of process costing. Each manufacturer decides which process to use and when to use it based on the situation at hand.
Appendix 4A: FIFO Method Exhibit 4A-2 on page 173 of your textbook shows a visual perspective of equivalent units of production for the FIFO method, compared with the weighted-average method. The dif- ference is in the treatment of the beginning work in process. While the weighted-average method treats the beginning work in process as completed, the FIFO method considers the com- pleted portion up to that point as water under the bridge. It factors in the amount yet to be completed—in the example, 70% under the FIFO method, compared with 100% under the weighted-average method.
The costs per equivalent unit are also calculated differently under FIFO and don’t take into account the costs of the beginning work-in-process inventory.
On the surface, this may seem easier. However, it’s more complicated than the weighted-average method because the costs of the units transferred out consist of the cost of the beginning work-in-process inventory, the cost to complete the units in the beginning inventory, and the cost of units started and completed during the period. Compare the cost of the ending work-in-process inventory and the units-transferred-
Managerial Accounting32
out schedule for the weighted-average method on page 155 of your textbook with the same schedule for the FIFO method on page 175 and note the differences.
While the weighted-average method is simpler to use, the FIFO method is superior because under the weighted-average method, the manager’s apparent performance in the current period is influenced by what happened in prior periods. Under the FIFO method, a clear distinction is made between costs incurred in differing periods.
Appendix 4B: Service Department Allocations Some large organizations have not only operating depart- ments but also service departments. Three methods are generally used to allocate service costs:
1. Direct method
2. Step-down method
3. Reciprocal method
Using the direct method, page 180 of your textbook explains that “any of the allocation base attributable to the service departments themselves is ignored; only the amount of the allocation base attributable to the operating departments is used in the allocation.” Page 182 explains that “in both the direct and step-down methods, any amount of the allocation base attributable to the service department whose cost is being allocated is always ignored.” Also, “in the step-down method, any amount of the allocation base that is attributable to a service department whose cost has already been allocated is ignored.” Page 182 also states that “the reciprocal method gives full recognition to interdepartmental services.”
Review Problems Be sure to go over and fully understand the “Review Problems” at the end of each chapter/appendix as they apply many of the concepts found in the chapter.
Lesson 1 33
Note: Once you have completed the following textbook exer- cises and problems and the Self-Check, you’ll need to take the Lesson Exam. To access and complete any of the examinations for this study guide, click on the appropriate Take Exam but- ton on your student portal. You shouldn’t have to enter the examination numbers. These numbers are for reference only if you have any reason to contact Student Care. Once you have completed the exam, move on to your next lesson/assignment.
TexTbook ProbleMS for ASSignMenT 4
Exercises: #4–1, #4–2 (page 162), #4–3, #4–4, #4–5, #4–
6, #4–7 (page 163), #4–8 (page 164), #4–11 (page 165)
Problems: #4–15, #4–15 (page 167), #4–16,
#4–17 (page 168)
Appendix 4A: #4A–1, #4A–2, #4A–3 (page 176),
#4A–4 (page 177), #4A–9, #4A-10 (page 178)
Appendix 4B: #4B–1 (page 182), #4B–2, #4B–3, #4B–4,
#4B–5 (page 183), #4B–6 (page 184)
Check your answers in the Textbook exercises and
Problem Solutions Supplement.
Managerial Accounting34
Self-Check 4 Questions 1–10: Indicate whether each of the following sentences is True or False.
______ 1. The following journal entry would be made in a processing costing system when units
that have been completed in the final processing department are transferred to the
finished-goods warehouse:
______ Work in Process XXX
Manufacturing Overhead XXX
______ 2. The “costs to be accounted for” portion of the cost reconciliation report includes
the cost of beginning work-in-process inventory and the cost of ending
work-in-process inventory.
______ 3. The “costs accounted for” portion of the cost reconciliation report includes the cost of
ending work-in-process inventory and the cost of units transferred out.
______ 4. The cost per equivalent unit for conversion costs will always be the same under
both the FIFO and the weighted-average methods if there’s no beginning work-in-
process inventory.
______ 5. Under the FIFO process costing method, the equivalent units of production relate only
to work done during the current period.
______ 6. The cost per equivalent unit under the FIFO method of process costing is equal to the
cost of beginning work-in-process inventory plus the costs added during the period, all
divided by the equivalent units of production for the period.
______ 7. In both the direct and step-down methods of allocating service department costs, any
amount of the allocation base that’s attributable to the service department whose cost
is being allocated is ignored.
(Continued)
Lesson 1 35
Self-Check 4 ______ 8. The direct method has the disadvantage that it may leave some service department
costs unallocated.
______ 9. If personnel department expenses are allocated on the basis of the number of employees in
various departments, the number of employees in the personnel department itself must
be included in the allocation base when the step-down method is used.
______ 10. The step-down method requires that an order of allocation be established before service
department costs can be allocated to operating departments.
11. Process costing would be appropriate for each of the following except
a. custom furniture manufacturing. c. grain milling.
b. oil refining. d. newsprint production.
12. An operation costing system is
a. identical to a process costing system except that actual manufacturing overhead costs are
traced to units of product.
b. the same as a process costing system except that direct materials costs are accounted for
in the same way as in job-order costing.
c. the same as a job-order system except that direct materials costs are accounted for in the
same way as in process costing.
d. identical to a job-order costing system except that actual manufacturing overhead costs
are traced to units of product.
13. Assume there’s no beginning work-in-process inventory and the ending work-in-process inven-
tory is 100% complete with respect to materials costs. The number of equivalent units with
respect to materials costs under the weighted-average method is
a. the same as the number of units put into production.
b. less than the number of units put into production.
c. the same as the number of units completed.
d. less than the number of units completed.
(Continued)
Managerial Accounting36
Self-Check 4 14. Assume there’s no beginning work-in-process inventory and the ending work-in-process inventory
is 70% complete with respect to conversion costs. Under the weighted-average method, the
number of equivalent units of production with respect to conversion costs would be
a. the same as the units completed.
b. less than the units completed.
c. the same as the units started during the period.
d. less than the units started during the period.
15. Sala Corporation uses the weighted-average method in its process costing system. The Fitting
Department is the second department in its production process. The data below summarize
the department’s operations in March.
Units Percent Complete with
Respect to Conversion
Beginning work in process inventory . . 9,400 20%
Transferred in from the prior department
during March. . . . . . . . . . . . . . . . . . 45,000
Ending work in process inventory . . . . 4,600 90%
The Fitting Department’s cost per equivalent unit for conversion cost for March was $2.64.
How much conversion cost was assigned to the units transferred out of the Fitting Department
during March?
a. $118,800.00 c. $131,472.00
b. $126,508.80 d. $143,616.00
(Continued)
Lesson 1 37
Self-Check 4 16. Yimron Corporation uses the weighted-average method in its process costing system.
Information for the month of March concerning Department A, the first stage of the company’s
production process, follows:
Materials Conversion Cost
Work in process, beginning . . . . . . . . . $4,000 $3,000
Costs added during March . . . . . . . . . $20,000 $16,000
Costs per equivalent unit . . . . . . . . . . $0.24 $0.20
Units completed and transferred to
the next department . . . . . . . . . . . . 90,000 units
Work in process, ending . . . . . . . . . . . 10,000 units
Materials are added at the beginning of the process. The ending work-in-process inventory is
50% complete with respect to conversion costs. Which cost would be recorded for the ending
work-in-process inventory?
a. $1,700 c. $3,400
b. $2,200 d. $4,400
17. In July, one of the processing departments at Feickert Corporation had a beginning work-in-
process inventory of $23,000 and an ending work-in-process inventory of $16,000. During the
month, $268,000 of costs were added to production, and the cost of units transferred out
from the department was $275,000. In the department’s cost reconciliation report for July, the
total cost to be accounted for would be
a. $39,000. c. $559,000.
b. $291,000. d. $582,000.
(Continued)
Managerial Accounting38
Self-Check 4 18. All production costs have been steadily rising in the Donner Company for several periods. The
company maintains large work-in-process inventories. Donner Company’s cost per equivalent
unit computed using the FIFO method would be
a. the same as that computed under the weighted-average method.
b. higher than that computed under the weighted-average method.
c. lower than that computed under the weighted-average method.
d. lower than, the same as, or higher than that computed under the weighted-average
method.
19. Creer Company uses the FIFO method in its process costing system. Department A had
20,000 units in process at the beginning of January, which were 40% complete with respect to
conversion costs. All materials are added at the beginning of the process in Department A.
The January 1 work-in-process inventory in Department A contained $10,000 in materials cost
and $11,600 in conversion cost. During January, materials costs were $0.50 per equivalent
unit, and conversion costs were $1.50 per equivalent unit. All of the units in the beginning
work-in-process inventory were completed and transferred out during the month. What was
the total cost attached to these units when they were transferred to the next department?
a. $33,600 c. $39,600
b. $37,600 d. $45,600
20. Reciprocal service department costs are
a. allocated to producing departments under the direct method but not allocated to producing
departments at all under the step-down method.
b. allocated to producing departments under the step-down method but not allocated to
producing departments at all under the direct method.
c. not allocated to producing departments under either the direct or the step-down methods.
d. allocated to producing departments under both the direct and step-down methods.
Check your answers with those on page 123.
39
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Tools in Management and Aids to Decision Making
ASSIGNMENT 5: COST-VOLUME- PROFIT RELATIONSHIPS Read this assignment. Then read pages 187–214 in your textbook.
The Basics of Cost-Volume-Profit (CVP) Analysis Understanding the relationship between cost, volume, and profit through analysis is vital in many business decisions. These analysis methods are affected by five factors:
1. Selling prices
2. Sales volume
3. Unit variable costs
4. Total fixed costs
5. Mix of products sold
