Managerial Accounting 02

Blocksof rial
had a problem. With no cashdivMotor Company n 1999,Nissan idendsand a net lossof over Y684 billionyen (approximately $4.1 bilI lio n),CE O CarlosGhosn kne w h e h a d t o d o s o me t h in g . n h is wo rd s : "The /ackof profit is like a fever.When your business not profitable, is is that's a serioussignalthat something wrong. Eitherthe productsare or is not right,or marketing inefficient, the cost baseis too high-something is wrong. lf you ignorea fever,you can get very sick.lf you ignore u n profitability, the situationc a n o n ly wo rs e n . " G h o s n la u n c h e dt h e P/anthat turned the companyaroundby designingand NissanRevival , m arketingnew models,inve s t in gin n e w p la n t t e c h n o lo g ie ss la s h in g most profitableproducts. the supplycosts,and emphasizing company's annualoperatingincometops Y861billionyen Fiveyearslater,Nissan's ( ap proximately billion). $7.6
46
Chapter 2
Nissan's operatingmarginis now the highestin the automotive industry, and it is payingits shareholders cashdividendsat record levels. Before Nissancould attack its problems, it had to know where its costs were incurred and whether it could control those costs by making different decisions. Was the company spendingtoo much in production, us in g o u t d a t e d e q u ip me n t a n d t e c h n o lo g ie s ?W a s i t spending enou g h o n d e s ig n in g n e w p ro d u c t s t h a t b e t t e r me t c u s tomers' needsand desires? Was it targetingthe right audiences its in television advertising? this chapter, talk about many costs:costs In we that both managers and management accountants must understand to successfully a business. run
Sources; NissanUSA.com; Nissan-Global.com; Nissan and Motor Co., Ltd..Annual Reports 2002, 2003, 2004. n
LearningObjectives
ffi Oistinguish among service, merchandising, manufacturing and
companies
Ml ffi
Oescribe value the chain andits elements Oistinguish between directandindirect costs
ldentifythe inventoriable productcostsand period costsof merchandising manufacturing and firms Prepare financial the statements service, for merchandising, and manufacturing companies
costs that arerelevant irrelevant decision and for making ffil Oescribe
Classify costsas fixed or variableand calculate total and averagecostsat differentvolumes
tF
Do far, we have seen how managerial accounting provides information that managers use to run their businesses more efficiently. Managers must understand basic managerial accounting terms and conceptsbefore they can use the information to make good decisions.This terminology provides the "common ground" through which managers and accountants communicate. \Tithout a common understanding of these concepts, managers may ask for (and accountants may provide) the w Io n g i n fo rm a ti o nformaki ngdeci si ons.A syouw i l l see,di fferenttypesofco st s are useful for different purposes. Both managers and accountants must have a clear understanding of the situation and the types of costs that are relevant to the decision at hand.
\-/
Accounting Blocksof Managerial Building
47
Sectorsand the ValueChain Three Business

Before we talk about specific types of costs, let's consider the three most common types of companies and the businessactivities in which they incur costs.
and Service,Mlerchandising, ManufacturingCornpanies

Organizations other than not-for-profits and governmental agenciesare in business to generate profits for their owners. The primary means of generating that profit generally fall into one of three categories:
Distinguish among merchandising, service, and manufacturing comPanres
ServiceCompanies
Service companies are in businessto sell intangible services-such as health care, insurance, and consulting-rather than tangible products. Recall from the last chapter that service firms now make up the largest sector of the U.S. economy, providing jobs to over 55% of the workforce. For servicecompanies such as eBay (online auction), H&R Block (tax return preparation), and Accountemps (temporary personnel services),salariesand wages often make up over 70'/" of their costs. Becauseservice companies sell services,they generally don't have Inventory or Cost of Goods Sold accounts. Some service providers caffy a minimal amount of supplies inventory; however, this inventory is used for internal operations-not sold for profit. In addition to labor costs, servicecompanies incur costs to develop new services,advertise, and provide customer service.
MerchandisingCompanies
ITal-Mart, and Foot Locker resell suchas Amazon.com, Merchandising companies buys books, for Amazon.com, example, productsthey buy from suppliers. tangible at customers higherpricesthan what it paysits them to CDs, and DVDs and resells includeretailers(suchas companies own suppliers thesegoods.Merchandising for suchasyou. Wholesalers, to consumers Retailers sell Home Depot)and wholesalers. mark often referredto as "middlemenr"buy productsin bulk from manufacturers, merchandising comBecause productsto retailers. up the prices,and then sellthose companies paniessell tangibleproducts,they have inventory.Even merchandising inventorythan haveinventory;they just have/ess that usejust-in-time(JIT) systems inventoryis the cost merchanmerchandise The cost of their non-JITcompetitors. in plus all costsnecessary get the merchandise placeand to pay for the goods disers the import dutiesor tariffs. Because readyto sell,includingfreight-incostsand any usuallyreportsjust sheet balance entireinventoryis readyfor sale,a merchandiser's Inventory.Merchandisers one inventory accountcalledInventory or Merchandise products and locations for new stores,to also incur other coststo identify new service' advertise and selltheir products,and to providecustomer
Manufacturing Companies
Manufacturing companies use labor, plant, and equipment to convert faw materials into new finished products. For example, Nissan's production workers use the company's factories (plant and equipment) to transform raw materials such as steel and tires into high-performance automobiles. Manufacturers sell their products to retailers or wholesalers at a price that is high enough to cover their costs and generatea profit.
48
Chapter 2
Becauseof their broader range of activities, manufacturers have three types of inventory (pictured in Exhibit 2-1):
Manufacturers' ThreeTypesof Inventory
-----------l>
---------F
,'..,..,.'.,.,.,: 1. Raw materialsinventory: All raw materialsusedin manufacturizg.Nissan's raw materialsincludesteel,glass,carpeting,tires, upholsteryfabric, engines, and other automobilecomponents. also includes It other physicalmatirials usedin the plant, suchas machinelubricantsand janitorial supplies. 2. Work in process inventory:Goodsthat arepartway throughthe manwfacturing process not yet complete. Nissan,the work in process bwt At inventoryconsists of partially completed vehicles. 3. Finished goodsinventory completed goods that hauenot yet beensold.Nissan is in business sell completed to cars,not work in process. Manufacturers sell their finishedgoodsinventoryto merchandisers. Nissan,for example,sellsits completed automobiles retail dealerships. to Somemanufacturers, suchas The Original MattressFactory, their productsdirectlyto consumers. sell Exhibit 2-2 summarizes differences the amongservice, merchandising, and manufacturin companies. g Service,Merchandising,and ManufacturingCompanies
ServiceColmpralries Examples Advertising agencies Banks Law firms Insurance companies
Intangible services
g M m:ch anr-{isinilompnnics
Amazon.com Kroger ITal-Mart Wholesalers
Tangible products purchased from suppliers
&tanrmf lrring Cornpanics ;;tcf Procter& Gamble DaimlerChrysler Dell Computer Nissan
New tangible producrs made as w orkers and equi pment convert raw materials into new finished products
't'l
rir,
;f,:
ir ii.i ::
i,,'
Primary Output
til
Type(s)of Inventory
None
Inventory (or Merchandise Inventory)
Raw materials inventory Work in process inventory Finished goods inventory
ai
11,,,.:t':1, f: lr,rrar:,:.::t..,t:rrfi::l r:i,;,,:,,it:1:i,r:,:,_,t1,:,,:,f:,:i tt.: ri:r:.irl r.:j .:f,:,r I I i, 1.,,
I I,,,,,r:r- ,r,
49
ffi
Inc.? What type of company is Outback Steakhouse, &,ffi s ip, f mS;om e c o mp a n i e s d o n ' t fi t n i c e l y i n to one of the three categori esdi sr Outback has some elements of a servicecompany (it serveshuncussed previously. g ry pat r ons ) ,s om e e l e me n ts o f a m a n u fa c tu rl n gcompany (i ts chefs convert raw company (i t a int i n g r edient s o f ini s h e dme a l s ), n d s o me e l e mentsof a merchandi si ng reallya hybrid of the three bottles of wine and beer).Outback is seilsready-to-serve types of companieswe just discussed.
As the "Stop & Think" shows, not all companies are strictly service, merchandising, or manufacturing firms. Recall from Chapter 1 that the U.S. economy is shifting more toward service. Many traditional manufacturers, such as General Electric fGE;, h"rr. developed profitable service segments that provide much of their company's profits. General Motors now earns more from its financing and insurance operations than it does from car sales. Even merchandising firms are getting into the "service game" by selling extended warranty contracts on merih"ttdir. sold. Retailers offer extended warranties on products ranging from furniture and major appliances to sporting equipment and consumer electronics. \flhile the merchandiser recognizes a liability for these warranties' the price charged to customers for the warranties greatly exceedsthe company's cost of fulfilling its warranty obligations.
lvlakeUp the ValueChain? Actlvilties WhichHustmess

Many people describe Nissan, Dell Computet, and Coca-Cola as manufacturing .o-p"ni.r. But it would be more accurate to say that these are companies that do companiesthat do manufacturing also do many other manufacturing.'$7hy? Because things. Nissan also conducts researchto determine what type of new technology to integrate into next year's models. Nissan designs the new models based on its researchand then produces, markets, distributes, and servicesthe cars' These activities form Nissan'svalue chain-the activities that add value to products and services. To set a selling price or to determine how profitable the Xterra model is, Nissan must know how much it costs to research,design, produce, market, distribute, and service the product. In other words, Nissan can't set selling prices high enough to just cover the costs of production. Pricing decisionsrequire Nissan to calculate the of the value full cost of the Xterra, including costs incurred across all six elements chain oictured in Exhibit 2-3.
the D escri be value chai nand i ts elem ent s
TheValueChain
Ghain Value
.l
.:-r:r:ri::r1t::tr,,
rii:::lrrl::
r:i :!i::::l
50
Chapter2
Researchand Development (R&Dl: Researching and deueloping new or improued products or seruicesand the processes for producing them. Nissan continually engagesin researching and developing new technologies to incorporate in its vehicles (such as GPS systems,"smart keys," and automatic headlamps)and in its manufacturing plants (such as manufacturing robotics). Nissan's GREEN program aims at developing fuel cells for vehicles, new ultra-low emission vehicles, new hybrid vehicles, and better fuel economy on existing models. Nissan currently spendsover Y300 billion (approximately $2.6 billion) ayear in R&D. Design: Detailed engineering of products and seruicesand the processesfor prodwcing them.Nissan's CEO describesdesign as the "interface between customers and the brand." Nissan's designersneed to fulfill customers' desiresfor vehicle style, features, safety, and quality. Nissan's goal is to engineer its products to create "total customer satisfaction." (Nissan has embraced total quality management.)As a result, Nissan employs over 500 designers in North America and introduced 1.2 new models as part of its revival plan. Designers consider not only what the customers want but also how to mass-produce the vehicles. BecauseNissan produces over 3 million vehiclesper year, engineersmust design production processes to be flexible (to allow for new features and models) and efficient. These initiatives cost a lot of money. Nissan's new technical center alone cost over $ 1 1 8 million to build. Despite these costs, new models and production designswere critical to Nissan's turnaround. Production or Purchasesz Resourceswsed to prodwce a prodwct or seruice or to pwrchase finished merchandise intended for resale. For a manufacturer such a s N i s s a n , t he producti on acti vi ty i n the val ue chai n i ncl udes the cost s incurred to make the vehicles. These costs include raw materials (such as s te e l ), p l a n t l abor (such as machi ne operators' w ages and benefi ts) , and manufacturing overhead (such as plant utilities and equipment depreciation). For a merchandisersuch as Best Bu5 this value-chain activity includes the cost of inventory, such as CDs, TVs, and PCs that the company buys to re s e l l to c u stomers. It al so i ncl udes al l costs associ atedw i th getti n g t he i n v e n to ry to the store ready for sal e, i ncl udi ng frei ght-i n costs an d any import duties and tariffs. As part of Nissan's revival plan, it opened new manufacturing facilities, including a state-of-the-art facllity in Canton, Mississippi. Nissan's new investments in plant and equipment cost over Y377 btllion (approximately $3.3 billion). Thesecosts are part of the production stageof the value chain. Nissan was also able to cut some production costs. Nissan slashed purchasing costs over 20% by working with suppliers of major components, such as tires, engines, and steel.To cut costs through JIT production, some of Nissan's suppliers have moved their own manufacturing facilities right next door to Nissan's! Marketing: Promotion and aduertisingof prodwcts or seruices. The goal of marketing is to createconsumer demand for products and services. Nissan usesprint advertisementsin magazinesand newspapers,billboards, and television advertisingto market its vehicles. But Nissan's revival plan includes much more than simply advertisingtheir new models. Part of its marketing effort was directed at the dealershipsthat sold its vehicles.Nissan worked with dealerships make them more to effective and attractive to consumersshopping for cars so that customerswould "sensequality" when walking into a Nissan dealership'sshowroom. As a result, most dealerships improved their cosmeticappearance and interior layout.
5t
Distribution: Deliuery of products or seruicesto customers.Nissan sells most of its vehicles through traditional dealerships.However, more customers are ordering "build-your-own" vehiclesthrough Nissan's'web site. People who are willing to wait a short time can have the features they want rather than settle for one of the vehiclesin stock at the local dealership.Forrester Research,an independent researchfirm specializing in the impact of technology on businessand consumers, expects build-to-order car salesto account for 21'oh of all new car sales by 2010, up from 5,,/oin 2001,.1Nissan's distribution costs include the costs of shipping the vehiclesto retailers and customers and the costs of setting up and administering \Web-basedsales portals. Other industries use different distribution mechanisms. Tupperware primarily sells its products through home-based parties. Amazon.com sells only through the Internet. Until recently, Lands' End sold only through catalogs and the'Sfeb. Now, it also distributes its products through Sears' retail outlets. \WebVantried, but failed, to create an online delivery-only grocery store. Customer Service:Swpport prouided for cwstornersafter the sale. Nissan incurs substantial customer service costs, especiallyin connection with warranties on new car sales.Nissan generally warranties its vehicles for the first three years and/or 36,000 miles, whichever comes first. Nissan cut warranty costs by Y41.million in 2004. How? Through total quality management (TQM). Nissan testseuery vehicle rolling off the Canton plant production line before shipping it out. Nissan also emphasizesquality right from the start, beginning with R&D.
ActivitiesAcrossthe ValueChain Coordinating

Many of the value-chain activities occur in the order discussedhere. However, managers cannot simply work on R&D and not think about customer service until after selling the car. Rather, cross-functional teams work on R&D, design, production, marketing, distribution, and customer service simultaneously. As ihe t."-s develop new model features, they also plan how to produce, market, and distribute the redesigned vehicles. They also consider how the new design will affect warranty costs. Recall from the last chapter that management accountants typically participate in these cross-functional teams. Even at the highest level of global operations, Nissan used cross-functional teams to implement its revival plans. The value chain in Exhibit 2-3 also reminds managers to control costs over the value chain as a whole. For example, Nissan spendsmore in R&D and product design to increasethe quality of its vehicles,which, in turn, reducescustomer service costs. Even though R&D and design costs are higher, the total cost of the vehicleas measured throughout the entire value chain-is lower as a result of this tradeoff. Enhancing its reputation for high-quality products may also enable Nissan to increasesalesor to charge higher selling prlces. The value chain applies to service and merchandising firms as well as manufacturing firms. For example, an advertising agency such as Saatchi & Saatchi incurs:
a a a a
Design costs to develop each client's ad campargn. Marketing costs to obtain new clients. Distribwtion costs to get the ads to the media. Customer sentice costs to address each client's concerns.
lDave Hirshchman, "Coming soon: buib-to-order cars deliuered in 10-15 days," The Atlanta Journal Constitution, March 25,2001, p. Q1.
52
Chapter 2
Determiningthe Coststo Servea Customer or to Make a Product

How do companies such as eBay, Amazon.com, and Nissan determine how much it costs to serve a customer, fill an order, or produce an Xterra? Before we can answer this question, let's first consider some of the specializedlanguage that accountants use when referring to costs. Distinguish between directand indirect costs
Cost Objects, Direct Costsuand Indirect Costs

A cost object is anything for which managers want a separatemeasurementof cost. Nissan's cost objects may include the followrng: . Individual products (the Xterra, Pathfinder, and Altima) o Alternative marketing strategies (salesthrough dealers versus built-to-order \il/eb sales) . . Geographic segmentsof the business(United States,Europe, Japan) Departments (human resources,payroll, legal)
Costs are classified as either direct or indirect with respect to the cost object. A direct cost is a cost that can be traced to the cost object. For example, say the cost object is one Xterra. Nissan can trace the cost of tires to a specific Xterra; therefore, the tires are a direct cost of the vehicle. An indirect cost is a cost that relates to the cost object but cannot be traced to it. For example,Nissan incurs substantialcost to run the Xterra manufacturing plant, including utilities, property taxes, and depreciation on the plant and equipment. Nissan cannot build an Xterra without incurring these costs, so the costs are related to the Xterra. However, it's impossibleto trace a specificamount of these costs to one Xterra. Therefore, these costs are indirect costs of an Xterra. As shown in Exhibit 2-4, the same costs can be indirect with respect to one cost object yet direct with respectto another cost object. For example, plant and equipment
The SameCost Can Be Director Indirect, Depending the CostObject on
Accounting Building Blocksof Managerial
depreciation, property taxes, and utilities are indirect costs of an Xterra. However, if management wants to know how much it costs to run the Canton manufacturing plant, the plant becomesthe cost object; so the same depreciation, tax, and utility costs are direct costs of the manufacturing facility. Whether a cost is direct or indirect depends on the specifiedcost object. In most cases,we'll be talking about a unit of product (such as one Xterra) as the cost object. If a company wants to know the total cost attributable to a cost object, it must assign all dtrect and indirect costs to the cost object. Assigning a cost simply means that you are "attaching" a cost to the cost object.'Sfhy? Becausethe cost object causedthe company to incur that cost. In determining the cost of an Xterra, Nissan assignsboth the cost of the tires and the cost of running the manufacturing plant to the Xterras built at the plant. Nissan assignsdirect costs to each Xterra by tracing those costs to specific units, or batches.However, becauseNissan cannot trace indirect costs to specific units or batches,it must allocate these costs to the vehiclesproduced at the plant.'We will discussthe allocation process in more detail in the next chapter; but for now, think of allocation as dividing up the indirect costs over all of the units produced, just as you might divide a pizza amongfriends. Exhibit 2-5 illustrates these concepts.
AssigningDirectand lndirectCoststo Cost Objects
l|.,
li
ffirii
\X/hy is this terminology important? Becauseit helps managers understand how accountants arrive at cost figures. Direct costs are traced to cost objects so th at m anager s an d a c c o u n ta n ts a re c o n fi d e nt that the amount of di rect cost assignedto a cost object is very accurate. For example, managers are confident i n t he t ir e c os t a s s i g n e d to o n e X te rra b e cause they can trace a parti cul ar Xterra's four tires (plus a spare tire) back to a specific invoice. In contrast, indirect costs are allocated rather than traced; so the amount of indirect cost a ss igned t o a c os t o b j e c t i s mo re o f a n e s ti mate. A s a resul t, managers and a cc ount ant s ar e l e s s c o n fi d e n t i n th e a mo u nt of i ndi rect cost assi gned each Xterra. Managers know the total amount of indirect costs from paying utility and tax bills and recording depreciation expense.However, the diuision of the total amount of indirect costs among the vehiclesis lessprecise.Therefore, managers are less confident in the amount of indirect cost that should be assignedto the cost object (for example, the amount of utilities cost that should be assigned to a particular Xterra).
54
Chapter 2
ldentify the inventoriable product costs and period costs of merchandisingand manufacturingfirms
Product Costs'for Internal DecisionlVlaking and External Reporting

Let's look more carefully at how companies determine the costs of one of the most common cost objects: products. As a manager,you'll want to focus on the products that are most profitable. But which products are these? To determine a product's profitability you subtract the cost of the product from its selling price. But how do you calculate the cost of the product? Most companies use two different definitions of product costs: (1) full product costs for internal decision making and (2) inventoriable product costs for external reporting. Let's see what they are and how managers use each type of cost.
Full Product Costs for Internal DecisionMaking

Full productcostsincludethe costsof all resources wsed throwghowt ualwe the chain. For Nissan,the full product cost of a particularmodel is the total cost to research, design, manufacture, market,and distributethe model, as well as to service the customers who buy it. Beforelaunching a new model, managers predict the full product costsof the vehicleto set a sellingprice that will coverall costs plus return a profit. Nissanalso compares eachmodel'ssaleprice to its full cost to determine which models are most profitable. PerhapsXterras are more profitable than Pathfinders. Marketing can then focus on advertising and promoting the most profitablemodels.We'll talk more about full costsin Chapter8, wherewe discuss business decisions. For the next few chapters, we'll concentrate primarily on productcosts. inventoriable
Inventoriable Product Costs for External Reporting

GAAP does not allow companies to use full product costs when reporting the cost of their inventories in the financial statements. For external reporting, GAAP allows only a portion of the full product cost to be treated as an inventoriable product cost. GAAP specifieswhich costs are inventoriable product costs and which costs are not. Inventoriable product costs include only the costs incurred during the "production or purchases" stage of the value chain (seeExhibit 2-6). Inventoriable product costs are treated as an asset (inventory) until the product is sold. 'When the product is sold, these costs are removed from inventory and expensed as cost of goods sold. Since inventoriable product costs include only costs incurred during the production or purchases stage of the value chain, all cost incurred in the other stages of the value chain must be expensed in the period in which they are incurred. Hence, we refer to R&D, design, marketing, distribution, and customer servicecosts as period costs. Period costs are often called "operating costs" or 'qselling,general, and administrative costs" (SG&A). Period costs are neuer part of an inventory asset account. Period costs are expensedin the period in which they are incurred. Exhibit 2-6 shows that a company's full product cost has rwo components: inventoriable product costs (those costs treated as part of inventory until the product is sold) and period costs (thosecostsexpensed the current period regardless when in of inventory is sold). GAAP requires this distinction for external financial reporting. Study the exhibit carefully to make sure you understand how the two components of full product costs-inventoriable product costs and period costs-affect the income statementand balancesheet. Now that you understand the difference between inventoriable product costs and period costs, let's take a closer look at the costs that are inventoriable in merchandising and manufacturing companies. Inventoriable costs include only those costs incurred at the purchase stage in merchandising companies and at the producti o n s ta g ei n ma n ufacturi ng compani es.
55
ProductCosts,and PeriodCosts Full ProductCosts,Inventoriable
Inventory -r
of Cost g o o d s so l d
0perating expenses
Inventoriab!e Companies' Merchandising Product frost

Merchandising companies' inventoriable costs include only the cost of purchasing the inventory from suppliers plus any costs incurred to get the merchandise to the merchandiser'splace of businessand ready for sale. Typicallg these additional costs include freight-in costs and import duties or tariffs, if any. \fhy does their inventory include freight-in charges?Think of the last time you purchased a shirt from a catalog such as J.Crew. The catalog may have shown the shirt's price as $30, but by the time you paid the shipping and handling charges, the shirt really cost you around $35. Likewise, merchandising companies pay freight charges to get the goods to their place of business(plus import duties if the goods were manufactured overseas). These chargesbecome part of the cost of their inventory. For instance,Home Depot's inventoriable costs include what the company paid for its store merchandise plus freight-in and import duty charges. Home Depot it sells the merchandise. records these costs in an asset account-Inventory-untll not Home Depot. Therefore, Once the merchandisesells,it belongs to the customef, Home Depot takes the cost out of the inventory account and records it as an expense-the cost of goods sold. Home Depot expensescosts incurred in other elements of the value chain as period costs, such as employee salaries,advertising expenses,and store operating costs (for example, utilities and depreciation). Some companies, such as Pier 1 Imports, refer to their cost of goods sold as "cost of sales." However, we use the more specific tetm cost of goods so/d throughout the text becauseit more aptly describesthe actual cost being expensed in the account-the inventoriable product cost of the goods themselves,not the total cost of making the sale (which would include selling and marketing costs).
56
Chapter 2
Silop o<Think,..
for What arethe inventoriable costs a service suchas H&RBlock? firm Ar*ruu+g*r: firmssuchas H&R Blockhaveno inventory products sale. Service of for todayand storedup to selllater. Services cannotbe produced Because firms service haveno inventory they haveno inventoriable costs.Instead, they haveonly period costs that areexpensed incurred. as
tVlanufacturing omp*nies' lnventorf; fl ahfis
FroductCost
Manufacturing companies' inventoriable costs include only those costs incurred during the production element of the value chain. As shown in Exhibit 2-7, manufacturers such as Nissan incur three types of manufacturing costs when making a product (the product is the cost object): direct materials, direct labor, and manufacturing overhead.
Summaryof the ThreeTypesof Manufacturing Costs
i1i'.
Direct Materials (DM)
Manufacturers convert raw materials into finished products. Direct materials are the primary raw materials that become a physical part of the finished product. Xterra's direct materials include steel, tires, engines, upholstery, carpet, and dashboard instruments such as the speedometerand odometer. Nissan can trace the cost of these materials (including freight-in and any other charges,such as import duties, necessaryto obtain the materials) to specific units or batches of vehicles;thus, they are direct costs of the vehicles.
Direct Labor (DL)

Although many manufacturing facilities are highly automated, most still require some direct labor to convert raw materials into a finished product. Direct labor is the cost of compensating employeeswho physically convert raw materials into the company's products. At Nissan, direct labor includes the wages and benefits o f a s s e m b l y w orkers, machi ne operators, and techni ci ans w ho assem ble the parts and wire the electronicsto build the completed vehicle. These costs are direct with respect to the cost object (the vehicle) becauseNissan can trace the ti m e e a c h o f th e se empl oyees spends w orki ng on speci fi c uni ts or bat ches of vehicles.
57
Manufacturing Overhead (MOH)

The third production cost is manufacturing overhead. Manufacturing overhead includes all manufacturing costs other than direct materials and direct labor. Manufacturing overhead includes all indirect costs of production. Manufacturing overhead is also referred to as factory overhead becauseall of these costs relate to the factory. Manufacturers must incur these costs to produce their products; but becausethese costs are indirect, they can't be traced to individual units or batches. As a result, the amount of manufacturing overhead that should be assignedto each completed unit is more uncertain. The allocation process (discussedin Chapter 3) estimatesthe amount of manufacturing overhead to assign to each completed unit. As shown in Exhibit 2-8, manufacturing overhead includes indirect materials, indirect labor, and other indirect manufacturing costs.
of Components Manufacturing Overhead
o Indirect material includes materials used in the plant that are not easily traced to individual units. For example, indirect materials often include janitorial supplies, oil and lubricants for the machines, and any physical components of the finished product that are inexpensive.For example, Nissan might treat the invoice sticker placed on each vehicle'swindow as an indirect material. Even though the cost of the sticker (about $0.10) couldbetraced to the vehicle,it wouldn't make much sensero do so. Why? Becausethe cost of tracing the sticker to the vehicle outweighs the benefit management receivesfrom the increased accuracyof the information. Therefore, Nissan treats the cost of the sticker as indirect material, which becomespart of manufacturing overhead. . Indirect labor includes the cost of all employeesin the plant other than those employeesdirectly converting the raw materials into the finished product. For wages,and benefitsof plant example,at Nissan, indirect labor includesthe salaries, forklift opefators, plant security officers, plant ianitors, and plant supervisors. . Other indirect manufacturing costs include insurance and depreciation on the plant, plant equipment depreciation, plant property taxes, plant repairs and maintenance, and plant utilities. Indirect manufacturing costs have groWn in recent years as manufacturers automate their plants. These costs continue to increaseas manufacturers install the latest technology.
In summary, manufactwring ouerhead includes only those indirect costs that are related to tbe manufactwring plant.Insurance and depreciation on the plant's building and equipment are indirect manufacturing costs, so they are part of manufacturing overhead. In contrast, depreciation on deliuery trucks is not a
Chapter 2
manufacturing cost. Delivery is part of the distribution element of the value c h a i n , s o i ts c o st i s a di stri buti on expense (a peri od expense).S i mi l arl S aut o insurance for the sales force's vehicles is part of the marketing element of the value chain, so its cost is a marketing expense (a period expense). These two expenses are not part of manufacturing overhead because they do not relate to production at the plant.
Prflmre and C*mv*rsf;effi floets

Managers and accountants sometimestalk about certain combinations of manufacturing costs. As shown in Exhibit 2-9,prime costs refer to the combination of direct materials and direct labor. Prime costs used to be the primary costs of production. However, as companies have automated production with expensive machinery, manufacturing overhead has become a greatet cost of production. Conversion costs refer to the combination of direct labor and manufacturing overhead. These are the costs of conuertin-s direct materials into finished goods.
Primeand Conversion Costs
ffiirmc* amd$mdfin'eet il-mhmn ffietmpmmsmtflmnt

The cost of direct and indirect labor includes more than the salariesand wages paid to the plant employees.The cost also includes company-paid fringe benefits such as health insurance, retirement plan contributions, payroll taxes, and paid vacations.Thesecosts are very expensive.Health insurancepremiums, which have seen double-digit increasesfor many years, often amount to $500 to $1,000 per month for each employee electing family coverage. Many companies also contribute an amount equal to 3o/" to 6'/" of their employees'salariesto companys p o n s o re d re ti rement 401(k) pl ans. E mpl oyers must pay Federal Insur ance Contributions Act (FICA) payroll taxes to the federal government for Social Security and Medicare, amountingto 7.65o/oof each employee's gross pay. In addition, most companies offer paid vacation and other benefits. Together, these fringe benefits usually cost the company an additional 35% beyond gross salaries and wages. Thus, an assembly-line worker who makes a $40,000 salary cosrs Nissan another $14,000 (= $40,000 x 35%) in fringe benefits. Believeit or nor,
59
for automobiles manufactured in the United States, the cost of health care assigned to the vehicle is greater than the cost of the steel in the vehicle! Throughout the remainder of this book, any referencesto wages or salariesalso include the cost of fringe benefits.
Frrydust ffiew*ew: f;s'uwemma.imbfie ffiws*smr FerEmd ffirosts?

Exhibit 2-10 summarizes the differences between inventoriable product costs and period costs for service, merchandising, and manufacturing companies. Study this exhibit carefully. When are such costs as depreciation, insurance, utilities, and property taxes inventoriable product costs? Only when those costs are related to the manufacturing plant. \fhen those costs are related to nonmanufacturing activities such as R&D or marketing, they are treated as period costs. Servicecompanies and merchandisers do no manufacturing, so they always treat depreciation, insurance, utilities, and property taxes as period costs.When you studied financial accounting, you studied nonmanufacturing firms. Therefore, salaries, depreciation, insurance, and taxes were always expensed.
ProductCostsand PeriodCostsfor Service, Inventoriable Companies and Merchandising, Manufacturing

I r r ve r tto r i,rb lc ltr tt.lu .' t ( t-rsts
(losts Perriod
. Always recorded as an expense . Never considered part of inventory
Acc<lnnting'['reatnrent . Initially recorded as inventory

. Expensed only when inventory is sold
T1'pcof Cornpatry: Service company

. All costs along the value chain . For example, salaries,depreciation expense, utilities, insurance, properti/ taxes, and advertising
Merchandising company
. Purchasesof merchandise . Freight-in; customs and duties
. All costs along the value chain except for the purchaseselement . For example, salaries,depreciation expense, utilities, insurance, property taxes, advertising, and f.reieht-out
Manufacturing company
. Directmaterials . Directlabor . Manufacturing overhead(including indirectlabor,and indirectmaterials, other indirect manufacturingcosts)
. All costs along the value chain except for the production element . For example, R&D; freight-out; all expenses for executive headquarters (separate from plant), including depreciation, utilities, insurance, and property taxes; advertising; and CEOt salary
60
Chaoter2
Decision Guidelines
Burtorrrrc Br-ocrsor MarulcenrruAccouNTlNG
Dell engagesin manufacturing when it assembles computers, merchandising when it sellsthem on its \7eb site, and its support seruicessuch as start-up and implementation services.Dell had to make the following types of decisionsas it developed its accounting systems.
Decision
How do you distinguish among service,merchandising, and manufacturing companies?How do their balance sheetsdiffer?
Guidelines
Seruicecompanies: . provide customerswith intangible services . Have no inventories on the balance sheet Mer chandising comp anies: . Resell tangible products purchased ready-made from suppliers . Have only one category of inventory Manufa ctur ing comp ani es: . Use labor, plant, and equipmenqto transform raw materials into new finished prfdu.t, o Have three categoriesof inventory: 1. Raw materials inventory 2. \7ork in processinventory 3. Finished goods inventory
Xfhat business activities add valueto companies?
All of the elements the valuechain,including: of . R&D . Design . Productionor Purchases o Marketing . Distribution o Customer Service
Both direct and indirect costs are assignedto cost objects. Direct costs are traced to cost objects, whereas indirect costs are allocated to cost obiects.
'!7hat
costs should be assignedto cost objects such as products, departments, and geographic segments?
Which product costsare usefulfor internaldecision making,and which productcostsare usedfor external reporting? What costsare inventoriable under GAAP?
Managersusefull product costsfor productpricing and profitability decisions. However,GAAP requires compaproduct costs external niesto.u:e only for .inuentoriable trnanclalreportlng.
. Seruicecompanies:No inventoriable product costs . Merchandising companies: Purchasesand all costs of getting the merchandiseto its place of business(for example, freight-in and import duties) c Manufactwring companies: Direct materials, direct labor, and manufacturing overhead Inventoriable product costs are initially treated as assets (Inventory) on the balance sheet.These costs are expensed(as cost of goods sold) on the income statements when the oroducts are sold.
How are inventoriable product costs treated on the financial statements?
ffirmbEemS ffiwffiY&$Y?ffitr3fl
Requirements 1. Classify each of the following businesscosts into one of the six value chain elements: a. b. c. d. e. f. Costs associatedwith warranties and recalls Cost of shipping finished goods to overseascustomers Costs a pharmaceutical company incurs to develop new drugs Cost of a 30-secondcommercial during the Super Bowl Cost of making a new product prototype Cost of assemblylabor used in the plant
2. For a manufacturing company, identify the following as either an inventoriable product cost or a period cost. If it is an inventoriable product cost, classify it as direct materials, direct labor, or manufacturing overhead. a. b. c. d. e. f. g. h. Depreciation on plant equipment Depreciationon salespeople's automobiles Insurance on plant building Marketing manager'ssalary Cost of major components of the finished product Assembly-line workers' wages Costs of shipping finished products to customers Forklift operator's salary
ffim$wxtfrwwum
Requirement I a. Customer service b. Distribution c. Research Develooment and d. Marketing e. Design f. Production
Requirement 2
a. Inventoriable product cost; manufacturing overhead b. Period cost c. Inventoriable product costl manufacturing overhead d. Period cost e. Inventoriable product cost; direct materials f. Inventoriable product cost; direct labor g. Period cost h. Inventoriable product cost; manufacturing overhead
Building Blocksof Managerial Accounting
61
62
Chapter 2
lnventoriableProductCostsand Period Costsin Financial Statements

Preparethe financial statementsfor service, m ercha nd isin g, nd a manufacturing comp an res
The difference between inventoriable product costs and period costs is important becausethey are treated differently in the financial statements.All costs incurred in the production or purchasesstage of the value chain are inventoriable product costs that remain in inventory accounts until the merchandise is sold-then, these costs become the cost of goods sold. However, costs incurred in all other areas of the value chain (R&D, design,marketing, distribution, and customer service)are period costs, which are expensedon the income statement in the period in which they are incurred. Keep these differencesin mind as we review the financial statementsof service firms (which have no inventory), merchandising companies (which purchase their inventory), and manufacturers (which make their inventory).
Service ffimmpmnf,es
Servicecompanies have the simplest accounting. Exhibit 2-11 shows the income statement of eNow!, a group of e-commerceconsultants. The firm has no inventory and, thus, no inventoriable costs, so eNow!'s income statement has no Cost of Goods Sold. Rather, all of the company's costs are period costs, so they are shown grouped together under operating expenses.
Service Gompany lncomeStatement
Revenues Operating expenses: Sa la r ye xp ense Office r e n t expense........ Depreciation expense-furniture and equipment M a r ke tin g expense....... T o ta l o perati ngexpenses....... Op e r a tin g in co me........ 5105,000 18,000 3,500 2,500
$160,000
(13 0,000 ) 30,000 $
In this textbook, we always use "operating income" rather than "net income" as the bottom line on the income statement since internal managers are particularly concerned with the income generated through operations. To determine "net income," we would have to deduct interest expenseand income taxes from "operating income" and add back interest income. In general, "operating income" is simply the company's income before interest and income taxes.
pamies Menchamd fistng *mr'*n

In contrast with service companies, merchandisers' income statementsfeature Cost of Goods Sold as the major expense.Consider Apex Showrooms, a merchandiser of Iighting fixtures. Apex's only inventoriable costs are for the purchase of chandeliers
63
and track lights that it buys to resell, plus freight-in. Merchandisers such as Apex comDute the Cost of Goods Sold as follows:2
Exhibit 2-12 shows Apex's completeincome statement, where we have highlightedthe Cost of Goods sold computation.Notice that the Cost of Goods grossprofit. All Sold is deducted from Sales Revenue determine company's the to (period costs)are then deducted operatingexpenses from grossprofit to arrive at operatingincome.
Merchandiser's lncomeStatement
ManufacturingCompanies
Exhibit 2-13 shows the income statement of Top-Flight, a manufacturer of golf equipment and athletic shoes.Compare its income statementwith the merchandiserb income statement in Exhibit 2-12. The only difference is that the merchandiser (Apex) usespwrchasesand freight-in in computing Cost of Goods Sold, whereas the manufacturer (Top-Flight) uses the cost of goods manufactwred (we've highlighted both in blue). Notice that the term cost of goods manufactured is in the past tense.It is the cost of manufacturing the goods that Top-Flight finished producing during
2To highlight the roles of beginning inventory, purchases, and ending inventory, we assume that Apex uses a periodic inventory system. However, even companies that use perpetual inventory systems during the year recalculate Cost of Goods Sold this way before preparing their annual financial statements.
64
Chapter2
2007. This is the manufacturer's cost to obtain new finished goods that are ready to sell. Thus, it is the counterpart to the merchandiser'spwrchases.
$5s,000
Grossprofit expenses: Operating salaryexpense Sales Deliveryexpense O per at ing om e . . . . . . . inc -
25,000 3,000 7,000
10,000 $15,000
Calculatingthe Cost of Goods Manufactured

The cost of goods manufactured summarizesthe cost of activities that take place in a manufacturing plant over the period. Let's begin by reviewing these activities. Exhibit 2-1,4 reminds us that the manufacturer starts by buying direct materials, which are stored in Raw Materials Inventory until they are needed for production. During production, the company uses direct labor and manufacturing overhead to convert direct materials into a finished product. These are all inventoriable product costs because they are related to manufacturing. All units being worked on are in ril7ork in ProcessInventory. \flhen the units are Inventory into FinishedGoods Inventory. completed,they move out of Work in Process Finished goods are the only inventory that is ready to sell. The cost of the finished goods that the manufacturer sells becomes its Cost of Goods Sold on the income statement. Costs the manufacturer incurs in other (nonmanufacturing) elements of the value chain are operating expenses,or period costs, that are expensed in the period incurred. Exhibit 2-14 shows that these operating expenses are deducted from gross profit to obtain operating income. Exhibit 2-15 shows how Top-Flight computes its cost of goods manufacturedthe cost of the goods the plant finished during 2007 . The computation of the cost of goods manufactured summarizes the activities and related costs incurred on TopFlight's plant floor throughout 2007.For simplicitS we'll assume that Top-Flight's raw materials inventory contains only direct materials.3
3We assume that Top-Flight uses its indirect materials as soon as they are purchased rather than storing them in Raw Materials Inventory. In Chapter 3, we expand the discussion to include manufacturers who store indirect materials in the Raw Materials Inventory account until they are used in production.
65
Inventoriable Manufacturing Costsand PeriodCosts Company:

Balance Sheet
Purchases of direct materials ---------> prus rrergnl-rn Inventoria ble c0sts D ir eclabor t Manufacturing overhead* ----------> equals Gross Profit mtnus F&D'expenSes Design expehses Marketing expenses Distribution expenses Customer service exDenses
* Examples: plant plant Indirect labor, supplies, insurance, depreciation. insurance When and and depreciation to manufacturing, areinventoriable; they relate relate they when to nonmanufacturing functions, areperiod they costs.
0perating expenses (period costsl
equals 0perating Income
Exhibit 2-15 showsthat Top-Flight begins2007 with $2,000 of partially golf clubs and shoes completed on that remained the plant floor at the closeof business December on 31,,2006. During 2007,Top-Flight's productionplant used$14,000of directmaterials, The sum of $19,000 of direct labor, and $12,000 of manufacturingoverhead. thesethree costs ($45,000)represents total manufacturingcostsincurred the during the year. Adding the total manufacturingcosts incurred during the year ($45,000) the beginning\Xlork Process ($2,OOO; givesthe to in Inventorybalance ($47,000).This figure represents total total manufacturing cosrsto accountfor the manufacturing cost assigned all goodsthe plant worked on during the year.The to plant finishedmost of thesegoodsand sentthem to FinishedGoodsInventory,but some were not finished.By the close of business December31.,2007, on Top-Flight had spent $5,000 on ending work in processinventory that Iay partially completeon the plant floor. The final stepis to figure out the cost of goods manufactwred dwring2007that is, the cost of the goods that Top-Flight finished during 2007. Of the $47,000 total manufacturingcosrsto accountfor during the year,$5,000 has been assigned unfinishedunits in ending work in processinventory.That to meansthe rest of the cost ($42,000)is assigned units that were finished.Topto Flight'scost of goodsmanufactured 2007 Is $42,000($47,000- $5,000). for
66
Chapter 2
Schedule of Cost of Goods Manufactured
Beginning work in progress inventory.....,.. Add: Direct materials used Beginning raw materials inventory"..,.... Purchases of direct materials including freight-in
1., ^-l ^-,.:*-^-* a n u a n y lm port outl es...
$ 9,000 27,000 36,000 (22,000], $14,000 19,000 $ 1,500 3,500 3,000 4,000 12,000 45,000 47,000 (s,000) $42,000
Ava ila b lefo r u se............. Ending raw materials inventory......... Dir e ct m a te r ia lsu se d.............. Direct labor..... Manufacturing overhead: Indirect materials In d ir e ct la b o r ............... Depreciation-plant and equipment.......
Pla n t u tilitie s,insurance,and property taxes............ Manufacturing overhead.......... Total manufacturing costs incurred during year ................ T o ta l m a n u fa ctu r in gcoststo account for.......................... L e ss:En d in g wo r k in processi nventory............................. Costs of goods manufactured..
"For simplicity,we assume that Top-Flight's Raw Materials Inventory accountcontainsonly direct materials bec'ause companyusesindirect materialsas soon as they are purchased. Chaoter 3, we expand the discussion the In to includemanufacturers who store both dlrr rials Inventory accountuntil they are usedin oroduction.
Flow of Costs Through Inventory Accounts

Exhibit 2-1.6 diagrams the flow of costs rhrough Top-Flight's three inventory accounts. Notice how the final amount at each stage flows into the next stage. The format is the same for all three inventory accounts: o Each inventory account starts with a beginning inventory balance. ' Top-Flight adds coststo each inventory account (it adds direct materi alspurchased to Raw Materials Inventory; it adds direct materials wsed,direct labor, and manufacturing overhead to \7ork in ProcessInventory; and it adds the cost of goods manufactured to Finished Goods Inventory). ' Top-Flight subtractsthe ending inventory balanceto find out how much inventory passedthrough the account during the period and on to the next stage. Atall stages, the flow of costs follows the flow of physical goods.
T a k e ti me t o see how the schedul e of cost of Goods Manufact ur ed (Exhibit 2-15) captwes rhe flow of cosrs through the Raw Materials and nflork i n Pro c e s sIn v e n tory accounts. The Income S tatement (E xhi bi t 2-13) cap t ur es the flow of costs through the Finished Goods Inventory account. Some manu-
67
facturers combine the flow of costs through all three inventory accounts into one combined Schedule of C o s t o f G o o d s Manufactured and C ost of Goods So l d , and t hen s h o w o n l y th e re s u l ti n g C o st of Goods S ol d fi gure on the lncome statement.
Top-Flight's Flowof CostsThrough InventoryAccounts
27 36,000
For simplicity, we assumethat Top-Flight's Raw Materials Inventory account contains only direct materials rhey are purchased.In Chapter 3,_weexpand the discussionto becauseihe company usesindirect mat&ials as soon "s include manufaciurers who store both direct and indirect materials in the Raw Materials Inventory account until they are used in oroduction.
Hffectson the Balance Sheet

Now that we've looked at the income statement, let's turn our attention to the balance sheet. The only difference in the balance sheetsof service, merchandising, and manufacturing companies relates to inventories. Exhibit 2-17 shows how the current asset sectionsof eNO'S7! (servicecompany), Apex Showrooms (merchandisingcompany)' and Top-Flight (manufacturing company) might dlffer at the end of 2007. eNOW! has no inventory at all, Apex Showrooms has a single category of inventory, and Top-Flight has three categoriesof inventory (raw materials, work in process, and finished goods).
68
Chapter 2
Current AssetSections of Balance Sheets
Ca sh ..... Acco u n ts r e cei vabl e........ Pr e p a ide xp e nses.................... T o ta l cu r r e n t assets ..............
$ 4,000 5,000 1,000 $;10,000
Cas h. . . . . . . . . . . . . . . . Accounts receivable........ ( t I nv ent or yEx h i b i 2 - 1 2 ) . . . . . . . . . . . . Pr : epaid pe n s e s... . . . . . . ex . Totalcr:rrent .. assets ...
$ 4,000 5,000 13,000 1,000 $23,000
Other Cost Terffrsfor Planning and Decision Making

So far in this chapter,we have discussed direct versusindirect costs and inventoriable product costs versus period costs. Now let's turn our attention to other cost terms that managersand accountantsuse when planning and making decisions.
Describe costs that are relevant and irrelevantfor decision making
Wwrmwm ffi*mtrm$frmfu$e L#msmsruts"w$Hmfu$e ffims*s

As discussed the chapter opening story, Nissan knew that it had to make changesif in it was to stay in business. But what changesto make? Management had to distinguish
69
controllable costs from uncontrollable costs.In the long run, most costs are controllable, meaning management is able to influence or change them. However, in the short run, companies are often "locked in" to certain costs arising from previous decisions.These are called uncontrollable costs. For example, Nissan had little or no control over the property tax and insurance costs of their existing plants. These costs were "locked in" when Nissan built its plants. Nissan could replace existing production facilities with different-sizedplants in different areasof the world that might cost lessto operate, but that would take time. To seeimmediate benefits, management had to changethose costs that were controllable at present. For example, management could control costs of research and development, design, and advertising. Recall that Nissan's management chose to increase rather than decreasethese costs! Management knew it would have to design and market new models to successfullycompete. However, Nissan was able to decrease other controllable costs, such as the price paid for raw materials, by working with its suppliers. In short, management'splans to revitalize the company focused first on costs that were controllable in the short run.
ffimtmwmmt flrre$ewmmt mmd ffimsts

Decision making involves identifying various courses of action and then choosing among them. When managersmake decisions,they focus on those costs and revenues that are relevant to the decision. For example, Nissan wanted to build a new stateof-the-art production facility. After considering alternative locations, management decided to build the facility in Canton, Mississippi. The decision was based on relevant information such as the differential cost of building and operating the facility in Canton versus building and operating the facility in other potential locations. Differential cost refers to the difference in cost between two alternatives. Say you want to buy a new car. You narrow your decision to two choices:the Nissan Sentra or the Toyota Corolla. As shown in Exhibit 2-1.8, the Sentra you like costs $14,480, whereas the Corolla costs $15,345. Becausesalestax is basedon the salesprice, the Corolla's salestax is higher.However, your lnsuranceagent quotes you a higher price to insure the Sentra ($365 per month versus $319 per month for the Corolla). All of thesecostsare relevantto your decisionbecause they differ betweenthe two cars. Other costsare not relevant to your decision.For example, both cars run on regular unleadedgasolineand have the samefuel economy ratings, so the cost of operating the vehicles is about the same, Likewise, you don't expect cost differences in servicing the vehicles becausethey both carry the same warranty and have received excellent quality ratings in Conswmer Reports. Becauseyou project operating and maintenancecoststo be the same for both cars, thesecostsare irrelevant to your decision. In other words, they won't influence your decision either way. Based on your analysis,the differential cost is $1,825 in favor of the Corolla. Does this mean that you will choosethe Corolla? Not necessarily. The Sentramay have somecharacteristics you like better, such as a particular paint color, more comfortable seating,or more trunk space.When making decisions, management must also consider qualitative factors (such as effect on employeemorale) in addition to differential costs.
Comparison of RelevantInformation
Differential : Cost : ($86s) I ?) R (70): t9,1,40 2,760
$1,825
Sentra
Car's price S a l e st a x ( 8 % ) ( r o u n d e d to th e n e a r e std o lla r ) Insurance' Total relevant costs '''Ou.t tt* iiu" y.";r (60 pl"n roi..p ih.."" -.*h".)yo.,
Corolla
$14,480 1,1 8 5 21,900
$37,s38
70
Chapter 2
Another cost that is irrelevant to your decision is the cost you paid for the vehicle you currently own. Say you just bought a Ford F-150 pickup truck two months ago, but you've decided you need a small sedan rather than a pickup truck. The cost of the truck is a sunk cost. Sunk costs are costs that have already been incurred. Nothing you do now can change the fact that you aheady bought the truck. Thus, the cost of the truck is not relevant to your decision of whether to buy the Sentra versus the Corolla. The only thing you can do now is (1) keep your truck or (2) sell it for the best price you can get. Management often has trouble ignoring sunk costs when making decisions,even though they should. Perhaps they invested in a factory or a computer system that no longer servesthe company's needs.Many times, new technology makes management's past investments in older technology look like bad decisions, even though they weren't at the time. Management should ignore sunk costs becauseits decisionsabout the future cannot alter decisionsmade in the past.
Classifycosts as fixed o r varia ble an d calculatetotal and average costs at different volumns
FfixedamdWmrfimh$e ffimwts
without first knowing how their Managerscannotmake good plans and decisions 'We as Costsgenerally behave fixed costsor variablecosts. will spend costsbehave. cost behavior. For now, let's look just at the basics. all of Chapter6 discussing Fixed costsstayconstantin total over a wide rangeof activity levels.For example, to costfor the yearis $3,828 let'ssayyou decide buy the Corolla, so your insurance ($319 per month x 12 months).As shown in Exhibit 2-1.9, your insurance cost staysfixed whetheryou drive your car 0 miles,1,000miles,or 10,000milesduring the year.
FixedCost Behavior
3' e) l, I 1ii,
il
g. $3,828
6
o g o o
L tll
ril
I.
;i
ll
': 1:
Milesdriven
ti;r'
However, the total cost of gasoline to operate your car varies depending on whether you drive 0 miles, 1,000 miles, or 10,000 miles. The more miles you drive, the higher your total gasoline cost for the year. If you don't drive your car at all, you won't incur any costs for gasoline.Your gasoline costs are variable costs, as s h o w n i n Ex h i b i t 2-20.Y ari abl e costs change i n total i n di rect proportion t o changesin volume. To accuratelyforecastthe total cost of operating your Corolla during the year, you need to know which operating costs are fixed and which are variable.
71
Variable Cost Behavior
How ManufacturingCosts Behave

Most companies have both fixed and variable costs. Manufacturing companies such as Nissan know that their direct materials are variable costs. The more cars Nissan makes, the higher its total cost for tires, steel,and parts. The behavior of direct labor is harder to characterize. Salaried employees are paid a fixed amount per year. Hourly wage earnersare paid only when they work. The more hours they work, the more they are paid. Nonetheless, direct labor is generally treated as a variable cost because the more cars Nissan produces, the more assembly-line workers and machine operators it must employ. Manufacturing overhead includes both variable and fixed costs. For example, the cost of indirect materials is variable, while the cost of property tax, insurance, and straight-line depreciation on the plant and equipment is fixed. The cost of utilities is partially fixed and partially variable. Factories incur a certain level of utility costi just to keep the lights on. However, when more cars are produced, more electricity is used to run the production equipment. Exhibit 2-21 summarizesthe behavior of manufacturing costs.
The Behavior of Manufacturing Costs
il
,i]i1];l]:i;i!:!1i!ill:1!l!li::ii]:4i]i:i!]1i'11i!i]ii]:|]ii:|i|]i!:!:]!il]1!t!|}:i1i:l::::]::i:lijiii1i:li
72
Chapter 2
Total and Average Gosts ealcuEating

\fhy is cost behavior important? Managers need to understand how costs behaveto predict total costs and calculate averagecosts.In our example, we'll look at Nissan's total and averagemanwfacturizg costs; but the same principles apply to nonmanufacturing costs. Let's say Nissan wants to predict the total cost of manufacturing 10,000 Xterras next year. To do so, Nissan must know its total fixed manufacturing costs and the variable cost of manufacturing each vehicle (direct material + direct labor + variable manufacturing overhead). Let's say total fixed manufacturing costs for the year at the Xterra plant are $20,000,000 and the variable cost of manufacturing each Xterra is $5,000. How much total manufacturing cost should Nissan budget for the year? Nissan calculatesit as follows:
\7hat is the averagecost of manufacturing each Xterra next year? It's the total cost divided by the number of units:
can they managers decidethey needto produceL2,000Xterrasinstead, If Nissan's predicttotal costsas follows? simply
.V/hy? Because auerage the costper wnit is NOT appropriatefor No! They cannot! predictingtotal costs differentleuels owtpzl.Nissan's managers shouldforecast at of on total cost based cost behavror:
cost of $80 million lessthan the fauby predictionof Why is the correctforecasted stemsfrom fixed costs.Remember, Nissan incurs $84 million? The difference costs whetherit makes10,000vehicles 12,000 or $20 million of fixed manufacturing costsare spread vehicles. Nissanmakesmore Xterras,the fixed manufacturing As cost declines. Nissanendsup making If so overmorevehicles, the average per vehicle manufacturingcost per Xterra decreases follows: as L2,000vehicles, new average the
$80,000,000 ^-.--/ p e r v e h i c l e( r o u n d e d ) =b 6 . 6 6 --# 12,000 vehicles
73
The averagecost per unit is lower when Nissan produces more vehiclesbecause it is using the fixed manufacturing costs more efficiently-taking the same $20 million of resourcesand making more vehicleswith it.
Finallg a marginal cost is the cost of making one more unit. Fixed costs will not change when Nissan makes one more Xterra unless the plant is operating at 100o/o capacity (24 hours aday,7 days a week, 365 days a year) and simply cannot make one more unit. (If that's the case, Nissan will need to incur additional costs to expand the plant.) So, the marginal cost of a unit is simply its variable cost. As you have seen,management accountantsand managersuse specializedterms 'Sfithout for discussingcosts. They use different costs for different purposes. a solid understanding of theseterms, managers are likely to make serious judgment errors.
74
Chapter2
Decision Guidelines
Butorvc Blocrs or Manlcenral AccouNTrNG
As a manufacturer, Dell needs to know how to calculate its inventoriable product costs for external reporting. Dell also needsto know many characteristicsabout its costs (that is, which are controllable, which are relevant to different decisions,which are fixed, and so forth) in order to plan and make decisions.
Decision
How do you compute cost of goods sold?
Guidelines
. Seruice companies: costof goodssold because No they don't selltangiblegoods . Merchandising comparues: Beginninginventory plus freight-in and import duties.if an)' + Purchases = Cost of goodsavailable sale for Ending inventory = Cost of goodssold . Manufacturi ng comp ies an : Beginningfinished goodsinventory + Cost of goodsmanufactured = Cost of goodsavailable sale for Endinefinishedsoodsinventorv = Cost of goodssold
How do you computethe cost of goodsmanufactured for a manufacturer?
Beginning work in process inventory + Total manufacturingcostsincurredduring year

(direct materials used directlabor+ manufacnrring + overhead) = Total manufacturing costs to account for - Ending work in process inventory = Cost of goods manufactured
How do managers decide which costs are relevant to their decisions?
Costs are relevant to a decision when they differ between alternatives and affect the future. Thus, differential costs are relevant, whereas sunk costs and costs that don't differ are not relevant.
How shouldmanagers forecast total costsfor different productionvolumes?
To forecast total costs,managers shouldcompute: Total - I'il + (Variable perunit x Numberof units) cost cost txed costs "
Managers should not :use product's aueragecost to a forecast total costs becauseit will change as production volume changes.As production increases, the average cost per unit declines (becausefixed costs are spread over more units).
Problerm A Summary
Requirements 1. Show how to compute cost of goods manufactured. Use the following amounts:direct materialsused ($24,000),direct labor ($9,000),manufacturing overhead($17,000), beginningwork in processinventory ($5,000;, and ending work in processinventory ($4,000). 2. Auto-USA spent $300 million in total to produce 50,000 cars this year. The $300 million breaks down as follows: The company spent $50 million on fixed costs to run its manufacturing plants and $5,000 of variable costs to produce each car. Next year, it plans to produce 60,000 cars using the existing pr oduc t ion f aci l i ti e s . 'S7hat a. is the current dueragecost per car this year? b. c. d. Assuming there is no change in fixed costs or variable costs per unit, what is the total forecasted cost to produce 60,000 cars next year? What is the forecastedaueragecost per car next year? \X/hy does the averagecost per car vary between years?
Smf,uftf;mns
Requirement I Cost of goodsmanufactured:
Requirement
a. Total cost + Number of units = Current averagecost $300 million + 50,000 cars = $6,000 per car b. Total fixed costs + Total variable costs = Total projected costs $50 million + (60,000 cars X $5,000 per car) = $350 million c. Total cost + Number of units = Projected averagecost $3S0 million + 60,000 cars = $5,833 per car d. The average cost per car decreases becauseAuto-USA will use the same fixed costs ($50 million) to produce more cars next year. Auto-USA will be using its resourcesmore efficiently, so the ayeragecost per unit will decrease.
75
RgVigVlf
Accounting of BuildingBlocks Managerial
wAccounting Vocabulary
Allocate. (p. 53) To assign an indirect cost to a cost obiect. Assign. (p. 53) To attach a cost to a cost obiect. Average cost. (p, 72) The total cost divided by the numberof units. Controllable Gosts, (p. 69) or Coststhat can be influenced changedby management. Conversion Costs. (p. 58) of The combination direct labor and manufacturing overheadcosts. Gost Object. (p, 52) want a separate Anythingfor which managers of measurement costs. Cost of Goods Manufactured. (p. 63) (or cost of the The manufacturing plant-related) goods that finishedthe productionprocessthis oeriod. Customer Service. (p. 51) Support providedfor customersafter the sale. Design. (p. 5O) Detailedengineering productsand services of for and the processes producingthem. Differential Cost. (p, 69) The difference cost betweentwo alternative in coursesof action. Direct Cost. (p. 52) A cost that can be traced to a cost obiect. Direct Labor. (p. 56) who The cost of compensating employees physically into the comconvertraw materials pany'sproducts;laborcosts that are directly traceableto the finishedproduct. Direct Materials. (p. 56) Primaryraw materials that becomea physical part of a finishedproductand whose costs are traceableto the finishedproduct. Distribution. (p, 5l) Delivery productsor servicesto customers. of Finished Goods Inventoty. (p. 48) Completedgoods that havenot yet been sold. Fixed Costs. (p.7O) Coststhat stay constantin total despitewide changesin volume. Full Product Gosts. (p. 54) used throuqhoutthe The costs of all resources valuechain for a product. Indirect Gost, (p. 52) A cost that relatesto the cost obiect but cannot be traced to it. Indirect Labor. (p. 57) Laborcosts that are ditficultto trace to specific products. Indirect Materials. (p, 57) Materials whose costs are difficultto trace to specificproducts. Inventoriable Product Costs. (p, 54) All costs of a productthat GMP requirescompanies to treat as an asset (inventory)for exterThesecosts are not nal financialreporting. expenseduntilthe product is sold. Manufacturing Company. (p. 47) A companythat uses labor,plant,and equipment to convertraw materials into new finished oroducts. Manufacturing Overhead. (p. 57) All manufacturing costs other than direct materialsand direct labor.Also called factory cost. overheadand indirectmanufacturing Marginal Cost. (p. 73) The cost of producingone more unit. Marketing. (p. 5O) Promotionand advertising productsor of servrces. Merchandising Company. (p, 47) A companythat resells tangibleproductspreviously bought from suppliers. Period Gosts. (p. 54) Operatingcosts that are expensedin the period in which thev are incurred.
76
Chapter 2
Prime Costs. (p. 58) The combination direct materialand direct of labor costs. Production or Purchases. (p. 50) Resources used to producea productor service or to purchase finishedmerchandise intended for resale. Raw Materials Inventory. (p. 48) (directmaterials All raw materials and indirect materials) yet used in manufacturing. not Research and Development (R&D), (p. 50) Researching and developingnew or improved productsor servicesor the processes profor ducingthem. Retailer. (p. 47) Merchandising companythat sellsto consumers. Service Gompany. (p. 47) A companythat sells intangible servicesrather than tangibleproducts. Sunk Gost. (p. 7O) A cost that has alreadvbeen incurred.
TFace. (p. 53) To assignadirect cost to a cost object. Uncontrollable Gosts. (p. 69) Coststhat cannot be changedor influenced in the short run by management. Value Chain. (p. 49) The activities that add valueto a firm's products and services.IncludesR&D,design,production marketing, distribution, or purchases, and customer service. Variable Gosts. (p. 7O) Costs that changein total in direct proportion to changesin volume. Wholesaler.(p.47) Merchandising companiesthat buy in bulk from manufacturers, mark up the prices,and then sellthose oroductsto retailers. Work in Process Inventory. (p. 48) Goodsthat are partwaythroughthe manufacturing processbut not yet complete.
wQ,uickCheck
L.
'Wal-Mart a, b. c. d. is a: servlcecompany retailer wholesaler manufacturer
2 , \7hich is not an element of Nissan's value chain?

a, b. c. d. administrativecosts cost of shipping cars to dealers salariesof engineerswho update car design cost of print ads and television commercials
3 . For Nissan, which is a direct cost with respectto the Xterra?

a. b. c. d. depreciation on plant and equipment cost of vehicle engine salary of engineerwho rearrangesplant layout cost of customer hotline
77
4. Ifhich of the followingis not part of Nissan's manufacturing overhead? a. b. c. d. insurance on plant and equipment depreciation on its North American corporate headquarters in Nashville plant property taxes plant utilities
5. In computing cost of goods sold, which of the following is the manufacturer's counterpart to the merchandiser'spurchases? a. b. c. d. direct materials used total manufacturing costs incurred during the period total manufacturing costs to account for cost of goods manufactured
Questions 6,7, and 8 refer to the following list. Suppose Nissan reports (in millions of dollars)'
that Nissanused(in millions)? 6. What is the cost of the materials a. 99 b. 100 c. 101 d. 1.06 (in 7. What is the cost of goodsmanufactured millions)? 149 a. b. 150 c. 151
d. 1.s2
8. \fhat is the cost of goodssold (in millions)? a. 150 b. 1.52 c. 153 d. 1.s4
7A
Chapter 2
9. \Which of the following is irrelevant to most businessdecisions?

a. b. c. differential costs sunk costs variable costs
d. qualitative factors 'lfhich 10. of the following is true? a. b. c. d. Total fixed costs increaseas production volume increases. Total fixed costs decreaseas production volume decreases. Total variable costs increaseas production volume increases. Total variable costs stay constant as production volume increases.
Ouick Check Answers

?'0t q'6 p'8 p'L)'9 P 's q'v q ' o ' 7 q ' I
For Internet Exercises,Excel in Practice,and additional online activities, go to this book's Web site at www.prenhall.com/bamber.
79
AssessYour Progress
mLearning Objectives
among service, merchandising, manufacturing and companies ffit Distinguish ffit Describethe valuechainand its elements ffiTDistinguishbetweendirect and indirectcosts ldentifythe inventoriable product costsand period costsof merchandising and ffit manufacturing firms
ffi
Prepare financial the statements service, for merchandising, manufacturing and companies Describe coststhat are relevantand irrelevant decisionmaking for Classify costsas fixed or variableand calculate total and averagecostsat different volumes
m
M
wShort Exercises
s2-1
'Sfhich The current asset sections of the balance sheets of three companies follow. company is a service company? Which is a merchandiser?V/hich is a manufacturer? How can you tell?
Indentify type of companyfrom balancesheets(Leaming Obiectiue 1)
s2-2
fdentify types of companies and inventories (LearningObiectiue1) Fill in the blankswith one of the following terms:manwfacturing, seruice, merchandising, retailer(s),wholesaler(s), raw materialsinuentory,merchandise inuentory,work in processinuentory,finished goods inuentory,freight-in, tbe cost of merchandise. generally haveno rnventory. a. companies b. Boeingis a company. c. Merchandisers' inventoryconsists of and -.
80
Chapter2
d.
companies carry three types of inventories: and -.
company. e. Prudential Insurance Company ts a and include companies f. Two types of o
Direct materials are stored in -.
h. Searsis a company. i. Manufacturers sell from their stock of
i.
Labor costs usually account for the highest percentageof companies' costs.
k. Partially completed units are kept in the -.
s2-3
2) Give examples of value chain functions (LearningObiectiue firm) might Give an example coststhat E*TRADE (an onlinebrokerage of functionsin the value chain' Provide incur in eachof the six business decideto anotherexamplethat showshow E"TRADE might deliberately the functionsto reduce costs spendmore moneyon one of the six business functions. in other business 2) Labelvalue chain functions (Leaming Obiectiue functions for List the correctvalue chain element eachof the six business described below. a. Deliveryof productsand services for and b. Detailedengineering productsand services the processes proof them ducing of c. Promotionand advertising product or services and new or improvedproductsor services the processes d. Investigating for producingthem after the sale e. Supportprovidedto customers f. Resources usedto makea product or obtain finishedmerchandise 2) Cfassify costs by value chain function (Leaming Obiectiue (HP's)costsas one of the six business Classifyeachof Hewlett-Packard's functionsin the valuechain. Depreciation Roseville, California,plant on ^. site supportcenter\Web b. Costsof a customer suchas c. Transportation coststo deliverlaserprintersto retailers BestBuy lab d. Depreciation research on e. Cost of a prime-timeTV ad featuringthe new HP logo new printer who are developing f. Salaryof scientists HP laboratories at
technologies
o D
s2-4
s2-5
Purchaseof plastic used in printer casings Salary of engineerswho are redesigning the printer's on-off switch Depreciation on delivery vehicles Plant manager's salary
h
I
81
s2-6
Gfassify costs as direct or indirect (Learning Objectiue 3) Classify the following as direct or indirect costs with respect to a local Blockbuster store (the store is the cost object). In addition, state whether Blockbuster would trace or allocate these costs to the store. a. b. c. d. e. f. g. h. Store utilities The CEO's salary The cost of the DVDs The cost of national advertising The wages of store employees The cost of operating the corporate payroll department The cost of Xbox, PlayStation, and Nintendo games The cost of popcorn and candy sold at the store
s2-7
Give examples of manufacturing costs (Leaming Obiectiue4) ConsiderMarvin \Tindows' manufacturing plant. Give two examples eachof of the following: a. Direct materials b. Directlabor c. Indirectmaterials d. Indirectlabor e. Other manufacturing overhead
s2-8
Gfassify inventoriable and period costs (LearningObiectiue 4) Classify eachof Georgia-Pacific's as eitherinventoriable costs productcostsor period costs. is Georgia-Pacifica manufacturer paper, of Iumber, buildingmaterial products. and a. Depreciation the gypsumboardplant on b. Purchase lumberto be cut into boards of c. Life insurance CEO on d. Salaries scientists of studyingwaysto speed forestgrowth e. Cost of new softwareto track inventoryduring production f. Cost of electricity one of Georgia-Pacific's papermills at g. Salaries Georgia-Pacific's executives top of h. Cost of chemical appliedto lumberto inhibit mold from developing i. Cost of TV adspromotingenvironmental awareness
s2-9
Cfassify a manufacturer's costs (Learning Objectiue4) Classifyeachof the following costsas a period cost or an inventoriable product cost. If you classifythe cost as an inventoriableproduct cost, further classifyit as direct material(DM), directlabor (DL), or manufacturing (MOH). overhead productionequipment a, Depreciation automated on b. Telephone bills relatingto customer service center call paid to assembly-line c. Wages and benefits workersin the manufacturing plant d. Repairsand maintenance factoryequtpment on e. Lease paymenton administrative headquarters f. Salaries paid to quality control inspectors the plant in g. Propertyinsurance-40% of building is usedfor sales and administration;600/o of buildingis usedfor manufacturing h. Standard packaging materials usedto package individualunits of product for sale(for example, cerealboxesin which cerealis packaged)
a2
Chapter 2
S2-10
Classify costs incurred by a dairy processing company (Learning Objectiue 4) Each of the following costs pertains to DairyPlains, a dairy processing company. Classify each of the company's costs as a period cost or an inventoriable product cost. Further classifyinventoriable product costs as direct material (DM), direct labor (DL), or manufacturing overhead (MOH).
Period Cost or Inventoriable Product Cost ?
Cost
I. Cost of milk purchased from local dairy farmers
DM, DL, or MOH?
2. Lubricants used in running bottling machines 3 . Depreciation on refrigerated trucks used to collect raw
frorn local dairy farmers
milk
4 . Property tax on dairy processingplant fo 5. T e l e v i s i o na d v e rtise m e n ts r Da ir yPla in s'p r o d u cts 6. Gasoline used to operate refrigerated trucks delivering
finished dairy products to grocery stores 7. Company president's annual bonus 8. Plastic gallon containers in which rnilk is packaged 9. Depreciation on marketing department's computers 10. Wages and salariespaid to nachine operators at dairy processingplant 11. Researchand development on improving milk pasreurlzailon process
S2-11
4) Determine total manufacturing overhead (LearningObiectiue include March records the Suppose company's cameras. manufactures disposable Snap's costin March? overhead total manufacturing the itemsdescribed below.\7hat is Snap's
Glue for camera frames on Depreciatiorlexpense company cars fo u s e db y s a l e s rc e ... ................ e P lirn td e p re c i a ti o n x p e n s e I nte re s te x p e n s e ....... s Co mp a n y p re s i d e n t' s a 1 a ry ..... ..... salary Plant supervisor's j a n i to r' s s a l a ry ....... P la n t e O il fo r:m a n u fa c tu ri n g q u i p me nt.................. F-lashbulbs 3,000 10' 00t) 2,000 25,000 4,000 1,000 25 50,000
250
83
S2-12
Compute Cost of Goods Sold for a merchandiser (Learning Objectiue5) Giventhe following informationfor CircuitsPlus,an electronics e-tailer, computethe cost of goodssold.
.i i tfl l r i i f. fi 1 :!r r r '.- .:' t.!- t r r r 'i ' r ii lr1. l
S2-13
Prepare a retailer's income statement (Leaming Obiectiue S) SalonSecrets a retail chain specializing salon-quality is in hair careproducts. During the year,SalonSecrets had salesof $38,230,000. The companybeganthe year with inventoryand endedthe year with $3,920,000of inven$3,270,000of merchandise tory. During the year,SalonSecrets purchased of inventory. $23,450,000 merchandise The company's general, selling, and administrative expenses totaled$6,115,000 for the year.Prepare SalonSecrets' incomestatement the year. for Recalculate Cost of Goods Manufactured (LearningObiectiueS) Turn to Exhibit2-t5.If directmaterial purchases freight-in and were$20,000rather than $27,000,what would be the cost of directmaterialsusedand the cost of goods (Othercosts manufactured? remainthe same in Exhibit2-15.) as Cafculate direct materials used (LearningObjectiueS) You are a new accounting intern at Sunny's Bikes.Your bossgivesyou the following information and asksyou to computethe cost of direct materialsused(assume that the company's raw materials inventorycontainsonly directmaterials).
S2-14
S2-15
s2-16 Compute Gost of Goods Manufactured (LearningObjectiueS)

Smith Manufacturing found the following information in their accountingrecords: $524,000of directmaterialstsed, $223,000of directlabor, and$742,000of manufacturing overhead.The work in Process Inventory accounthad a beginningbalanceof $76,000and an endingbalance $85,000.compute the company's of cost of Goods Manufactured.
84
Chapter 2
S2-17
Consider relevant information (Learning Obiectiue 6) You've been offered an entry-level marketing position at two highly respectablefirms: one in Los Angeles, California, and one in Sioux Falls, South Dakota. I7hat quantitative and qualitative information might be relevant to your decision? S7hatcharacteristics about this information make it relevant? Classify costs as fixed or variable (Learning Obiectiue 7) Classify each of the following personal expensesas either fixed or variable. In some cases,your answer may depend on specific circumstances.If so, briefly explain your answel a. b. c. d. e. f. g. Apartment rental Television cable service Cost of groceries \Vater and sewer bill Cell phone bill Health club dues Bus fare
52-18
w Exercises
E2-19 fdentify types of companies and their inventories (LearningObjectiue1) with one of the terms listedhere.You may usea Completethe following statements term more than once,and sometermsmay not be usedat all.
a. b. c. d. e. f. g.
produce their own inventory. typically have a single category of inventory. do not have tangible products intended for sale. resell products they previously purchased ready-made from suppliers' use their workforce and equipment to transform raw materials into new finished products. sell to consumers. Swaim, a company based in North Carolina, makes furniture. Partially completed sofas are Completed sofas that remain unsold in the warehouse Fabric and wood are -. are -. For Kellogg's, corn, cardboard boxes, and waxed paper liners are classified as - . buy in bulk from manufacturers and sell to retailers -
h. i.
85
E2-2O Cfassify costs along the value chain for a retailer (LearningObjectiue 2) Suppose RadioShack incurredthe following costsat its Charleston, SouthCarolina,store:
t nl
Requirements 1. Usethe following format to classifyeachcost accordingto its placein the valuechain.
2. Compute the total costs for each value-chain category. 3. How much are the total inventoriable product costs?
E2-21 Classifycosts afongthe valuechainfor a manufacturer (LeamingObiectiues 3) 2, Suppose cellphone the manufacturer Samsung Electronics provides following the
information for its costs last month (in hundreds of thousands):
Requirements
L Use the following format to classify each cost according to its place in the value chain. (Hint: You should have at least one cost in each value-chain function.)
2. Compute the total costs for each value-chain category. 3. How much are the total inventoriable product costs? 4, How much are the total prime costs? 5. How much are the total conversion costs? 86 Chapter2
E2-22 Classify costs as direct or indirect (Learning Obiectiue 3)

Classify each of the following costs as a direct cost or an indirect cosl assuming the cost object is the produce department (fruit and vegetabledepartment) of a local grocery store. a. b. c. d. e. f. Produce manager'ssalary Cost of the produce Store utilities Bags and twist ties provided to customers in the produce department for packaging fruits and vegetables Depreciation expenseon refrigerated produce display shelves Cost of shopping carts and baskets
C. Wages of checkout clerks h. Cost of grocery store's advertisementflyer placed in the weekly newspaper i. j. k. l. Store manager'ssalary Cost of equipment used to peel and core pineapples at the store Free grocery delivery serviceprovided to senior citizens Depreciation on self-checkoutmachines
E2-23 Define cost terms (Leaming Objectiues 3, 4)

Complete the following statementswith one of the terms listed here. You may use a term more than once, and some terms may not be used at all.
a. b. c. d. e. f. g. h. i. j. k. l.
can be traced to cost obiects. are expensedwhen incurred. are the combination of direct materials and direct labor. Compensation includes wages' salaries,and -. until sold' are treated as include costs from only the production or purchaseselement of the value chain. are allocatedto cost objects. Both direct and indirect costs are to -' include costs from every element of the value chain. are the combination of direct labor and manufacturing overhead. are expensedas when sold. of production.
Manufacturing overhead includes all -
a7
E2-24
Classify and calculate a manufacturer's costs (LearningObjectiues 4) 3, An airline manufacturerincurred the followins costs last month (in thousands of dollars):
Requirements L. If the cost object is an airplane, classifyeach cost as one of the following: direct material (DM), direct labor (DL), indirect labor (IL), indirect materials (IM), other manufacturing overhead (other MOH), or period cost. (Hint: Set up a column for eachtype of cost.) What is the total for each type of cost? 2, Calculate total manufacturing overhead costs. 3, Calculate total inventoriable product costs. 4. Calculate total prime costs. 5. Calculatetotal conversioncosts. 6. Total period costs. E2-25 Prepare the current assest section of the balance sheet (Leaming Objectiue 5) Consider the following selectedamounts and account balancesof Lords:
Show how Lords reports current assetson the balance sheet. Not alI data are used. Is Lords a service company, a merchandiser, or a manufacturer? How do you know?
88
Chapter 2
E2-26
Prepare a retailer's income statement (Learning Obiectiue5) in specializing an Pets, e-tailbusiness RobbieRobertsis the soleproprietorof Precious Pets'salestotaled $987,000 Precious high-endp.t giftt and accessories. the saleof relating to during 2007. During the year,the companyspent $56,000 on expenses 'Web maintenanci; and $25,000on wrapping,boxing,and on marketing; site $22,000 Petsalsospent$642,000on inventorypurPrecious shippingthe goodsto customers. The on freight-incharges. companystartedthe year chases an additional$21,000 and on hand and endedthe year with $15,000 of inventory' with $17,000 of inventory Pets'2007incomestatement. Precious Prepare Compute direct materials used and cost of goods manufactured (Learning Obiectiue 5) at Danielle'sDie-cutsis preparingits Cost of GoodsManufacturedSchedule year-end. recordsshow the following: The Raw MaterialsInventoryaccount Danielle's accounting of of balance $13,000andan endingbalance $17,000.Duringtheyear, had a beginning Danielle purchased$58,000 of direct materials.Direct labor for the year totaled 'Workin Process The to amounted $152,000. overhead manufacturing $123,000;while of balance $15,000' andan ending of balance $21,000 had Invenrory account a beginning Computethe Cost of GoodsManufacturedfor the year.(Hint: The first stepis to calcuusedduringthe year.Model your answerafter Exhibit 2-15.) latethe directmaterials Compute cost of goods manufactured and cost of goods sold (Learning Objectiue 5) and cost of goodssold for Strike Compute the 2007 cost of goodsmanufactured that raw materials below Assume Marine Companyusingthe amountsdescribed inventorycontainsonly directmaterials.
E2-27
E2-29
5) Obiectiue Prepareincome statement (Learning E2-29 Continues E2-28':, inE2-28. Assume for statement StrikeMarineCompany Prepare 2007income the 2007. during at unitsof its product a priceof $12each sold thai thecompany 32,000 5) obiectiue E2-30 Work backwardsto find missingamounts(Learning
Smooth Sounds manufactures and sells a new line of MP3 players. Unfortunately, Smooth Soundssuffered seriousfire damageat its home office. As a result, the accounting records for October were partially destroyed-and completely jumbled. Smooth Sounds has hired you to help figure out the missing pieces of the accounting ptzzle. Assume that Smooth Sounds' raw materials inventory contains only direct materials. continued. . . Accounting Blocksof Managerial Building 89
'::,9 , , ooo,
Work in process inventory, October 1 Rgvenues October in ...............,........,.....:.....-. Grossprofit in October.. Directrnaterials usedin October,,...,...., 1,..,......... Raw materials inventory, October3 1....;.......,.. Manufacturingoverhead October in
Requirement F i n d th e fo l l o w i n g a mounrs: a. b. c. Cost of goods sold in October Beginning raw materials inventory Ending finished goods inventory (Hint: You may find Exhibits 2-15 and 2-16 helpful.)
$.'t1,5-00,,., ,4,300' .', : '3;9$6,.,, 0 ' 27,000', 12,000 9,000 3,000 6,300
E2'31
Determine whether information is relevant (Learning objectiue 6) Classify each of the following costs as relevant or irrelevant to the decision at hand and briefly explain your reason. a. b. c. d. e. Cost of operating automated production machinery versus the cost of direct labor when deciding whether to automare production Cost of computers purchased six months ago when deciding whether to upgrade to computers with a faster processingspeed Cost of purchasing packaging materials from an outside vendor when deciding whether to continue manufacturing the packaging materials in-house The property tax rates in different locales when deciding where to locate the company's headquarters The type of gas (regular or premium) used by delivery vans when deciding which make and model of van to Durchasefor the company's delivery van fleet Depreciation expenseon old manufacturing equipment when deciding whether to replaceit with newer equipment The fair market value of old manufacturing equipment when deciding whether to replaceit with new equipment The interest rate paid on invesredfunds when deciding how much inventory to keep on hand The cost of land purchased rhree years ago when deciding whether to build on th e l a n d n o w o r w ai t tw o more years The total amount of the restaurant's fixed costs when deciding whether to add additional items to the menu
f. g. h. i. f.
90
Chapter 2
E2-32
6, Describe other cost terms (Learning Obiecti'ues 7) with one of the termslisted here.You may usea Completethe following statements term more than once.and sometermsmay not be usedat all.
1 aosfR
a.
Managers cannot influence
in the short run.
when production volume decreases. decrease b. Total c. For decision-making purposes, costs that do not differ between alternatives are d. e. f. g. h. Costs that have already been incurred are called Total stay constant over a wide range of production volumes. is the difference in cost between two alternative coursesof action. The is the cost of making one more unit. The product's not the product's and -, A product's at different production volumes. to forecast total costs should be used
E2-33 Classify costs as fixed or variable (Leaming Obiectiue 7)

Classify each of the following costs as fixed or variable: a. b. c. d. e. f. g. h. i. j. k. l. Thread used by a garment manufacturer Property tax on a manufacturing facility Yearly salariespaid to salesstaff Gasoline used to operate delivery vans Annual contract for pest (insect)control Boxes used to package breakfast cereal at Kellogg's Straight-line depreciation on production equipment Cell phone bills for salesstaff-contract billed at $.03 cents per minute 'Wages paid to hourly assembly-lineworkers in the manufacturing plant Monthly leasepayment on administrative headquarters Commissions paid to the sales staff-51" of salesrevenue Credit card transaction fee paid by retailer-$0 .20 per transaction plus 2o/oof the salesamount Cost of ice cream sold at Baskin-Robbrns Cost of shampoo used at a hair salon
m. Annual businesslicensefee from city n. o.
E2-34 Compute total and average cosls (Lean ing Obiectiue 7)

Fizzy-CoIa spends $1 on direct materials, direct labor, and variable manufacturing overhead for every unit (12-pack of soda) it produces. Fixed manufacturing overhead costs $5 million per year. The plant, which is currently operating at only 75% ol capacity,produced 20 million units this year. Management plans to operate closer to full capacity next year, producing 25 million units. Management doesn't anticipate any changesin the prices it pays for materials, labor, and overhead. continued . . . Accounting Building Blocksof Managerial 91
Requirements a. b. c. d. e. f. g. \fhat is the current total product cost (for the 20 million units), including fixed and variable costs? What is the current averageproduct cost per unit? \What is the current fixed cost per unit? what is the forecastedtotal product cost next year (for the 25 million units)? \ffhat is the forecastedaverageproduct cost next year? \7hat is the forecastedfixed cost per unit? Why does the averageproduct cost decreaseas production increases?
w PrOblems (problem A) ser

P2-35A Cfassify costs along the value chatn (Leaming Objectiues 2,4) ShaZamCola produces lemonlime soda.The productionprocess a startswith workers mixing the lemon syrup and lime flavors in a secretrecipe.The companyenhances the combined syrupwith caffeine. Finally,ShaZamdilutes mixture with carbonated the water. ShaZamCola incursthe following cosrs(in thousands):
Requirements L Usethe following format to classify eachof these costsaccording its placein the to valuechain.(Hint:You shouldhaveat leastonecostin eachvalue-chain function.)
9I.i. : ,l
92
Chapter2
2.
Compute the total costs for each value-chain category.
3. How much are the total inventoriable product costs? 4. Supposethe managersof the RB{D and designfunctions receiveyear-endbonuses based on meeting their unit's target cost reductions. Sfhat are they likely to do? How might this affect costs incurred in other elements of the value chain? P2-36A Prepare income statements (Learning Obiectiue 5) Part One:In2007,Hannah Summit opened Hannah's Pets, a small retail shop selling pet supplies. On December 31,2007, her accounting records show the following:
Requirement for Pets,a merchandiser, the year ended for Preparean incomestatement Hannah'S December 31,2007. her to so Part Two: Hannah'sPetssucceeded well that Hannah decided manufacture 2008, own brand of pet toys-Best FriendsManufacturing.At the end of December her accounting recordsshow the following:
Requirements for Prepare schedule cost of goodsmanufactured BestFriends of a 31, Manufacturingfor the yearendedDecember 2008. for 2. Prepare incomestatement BestFriendsManufacturingfor the year ended an December 31.,2008. l.
continwed . . . Accounting Building Blocksof Managerial
93
3. How does the format of the income statement for Best Friends Manufacturinq differ from the income statement of Hannah's Pets? Part Three: Show the ending inventories that would appear on these balance sheers: 1, Hannah's Petsat December 31.2007 2. BestFriendsManufacturing at December31, 2008 P2-37A Fill in missing amounts (Learning Objectiue 5) Certain item descriptions and amounts are missing from the monthly scheduleof cost of goods manufactured below and the income statement of Tretinik Manufacturing. F i l l i n th e mi s s i n si tems.
Beginning Add: Direct :
$ 21,ooo
Beginning raw materials inventory Pu r ch a s es di rect materi al s of En d in g r aw rnateri al s nventory i Dir e ct Dir e ct Manufacturing overhead Total Total Less:Ending costs costs
166,000 X (2s,000)
Co st o f g o o d s so ld: Be g r n n in g ,,,,,, $11.5,000
Co st o f g o ods Ending _ Cost of goods sold
X 209,000 254,000 99,000 X
Grossprofit
exDenses: M a r ke tin g expense, Administrative expense, lncome
154,000
$x
94
Chapter 2
P2-38A fdentify relevant information (Learning Objectiue 6) You receive two job offers in the same big city. The first job is close to your parents' house, and they have offered to let you live at home for a year so you won't have to incur expensesfor housing, food, or cable TV. This job pays $30'000 per year. The secondjob is far from your parents' house, so you'll have to rent an apartment with parking ($6,000 per year), buy your own food ($2'400 per year), and pay for your per year). This job pays $35,000 per year. You still plan to do own cable TV ($eOO laundry at your parents' house once a week if you live in the citS and you plan to go into the city once a week to visit with friends if you live at home. Thus, the cost of operating your car will be about the same either way. In addition, your parents refuse to pay for your cell phone service($720 per year), and you can't function without it. Requirements a. b. c. d. Based on this information alone, what is the net difference between the two alternatives (salary,net of relevant costs)? '!7hy? 'S7hat information is irrelevant? \fhat qualitative information is relevant to your decision? Assume that you really want to take Job #2, but you also want to live at home to 'What new quantitative and qualitative information will you need to cut costs. incorporate into your decision?
P2-39A Calculate the total and average costs (Learning Obiectiue 7) The owner of Pizza-HouseRestaurant is disappointed becausethe restaurant has been averaging 3,000 pizza salesper month, but the restaurant and wait staff can make and serve 5,000 pizzas per month. The variable cost (for example, ingredients) of each pizza is $2.00. Monthly fixed costs (for example, depreciation, property taxes, businesslicense,and manager'ssalary) are $6,000 per month. The owner wants cost information about different volumes so that he can make some operating decisions.
Requirements he with thecostinformation wants. the L. Fill in thechartbelow provide owner to

Then use the completed chart to help you answer the remaining questions.
,00
2. From a cost standpoint, why do companies such as Pizza-HouseRestaurant want to operate near or at full capacity? continued . - Accounting Building Blocksof Managerial 95
3. The owner has been considering ways to increasethe salesvolume. He believes

he could sell 5,000 pizzasa month by cutting the salesprice from $10 a pizza to $9.50. How much extra profit (above the current level) would he generateif he decreasedthe sales ptice? (Hint: Find the restaurant's current monthly profit and compare it to the restaurant's projected monthly profit at the new sales price and volume.)
4. The owner's other idea is to advertise his restaurant on the local radio stations.
If he keeps the salesprice at $10 per pizza, the advertising agency sayshe'll have to spend $10,000 in advertising each month to increasemonthly salesto 5,000 pizzas.How much extra profit (above the current level) would he generateif he kept the salesprice at $10 per pizza but spent $10,000 per month on advertising? Which of the owner's ideas is most profitable?
5. The owner is surprised by your calculations. Becausethe current averageprofit

per pizza is $6.00, he thought the restaurant would make 930,000 of income per month (before advertising costs) if it sold 5,000 pizzas at the normal 910 salesprice. How did the owner arrive at this figure, and why is it wrong?
w PrOblefftS (probtem B) ser

P2-4OB Classify costs along the value chain (Leaming Obiectiues2, 4) Suppose AppleComputer reported followingcosts month(allcosts in millions): the last are
96
Chapter 2
Requirements to eachof thesecostsaccording its placein the t. Usethe following format to classify (Hint:You shouldhaveat leastone costin eachvalue-chain function.) valuechain.
2. Compute the total costs for each category. 3 . How much are the total inventoriable product costs? 4 . Supposethe managers of the R&D and design departments receiveyear-end
bonuses based on meeting their department's target cost reductions. What are they likely to do? How might this affect costs incurred in other elementsof the value chain?
P2-418 Prepare income statements (Leaming Obiectiue5) Memories,a smallretail Terri ShawopenedPrecious Part One: On January'1.,,2007, art. On December 31,2007,her storededicated sellingpictureframes,crafts,and to recordsshow the following: accounting
Requirement Preparean income statementfor PreciousMemories, a merchandiser, for the year endedDecember 2007. 31.,
continwed . . .
Accounting BuildingBlocksof Managerial
97
Part Ttuo: Precious Memories succeededso well that Shaw decided to manufacture her own special brand of picture frames, to be called Forever Manufacturing. At the end of December 2009,her accounting records show the following:
Requirements
1. Prepare schedule cost of goodsmanufactured Forever a of for Manufacturing for the yearendedDecember 31,,2009. 2. Prepare incomestatement Forever for an Manufacturingfor the yearended December 31,2009. 3. How doesthe format of the incomestatement ForeverManufacturingdiffer for from the incomestatement Precious of Memories? Part Three:Showthe endinginventories that would appearon thesebalance sheets: L. Precious Memories December at 3'1,,2007 2, Forever Manufacturingat December 31,2009 P2-428 Filf in missing amounts (LearningObiectiue5) Certainitem descriptions amountsare missingfrom the monthly schedule cost and of of goodsmanufactured incomestatement PacificManufacturingCompany. and of Fill in the missingitems.
98
Chapter2
work in processinventory Add: Direct materials used: materials of direct materials materials
Manufacturing overhead Total Total Less:work in process inventory costs
PACIFICMANUFACTURING COMPANY
April30,2007
revenue
$450,000
. ,. $
Be g in n in g
X X
Costof goods EndingCostof goods sold,, , ,

exDenses: Marketing expenses, Ad m in istr a tive e xp e n se s
X (57,000)
243,000
X ,, $64,000
$ 76,000
P2-438 ldentify relevant information (Learning Objectiue 6) You receive two job offers in the same big city. The first job is close to your parents' house, and they have offered to let you live at home for a year so you won't have to for housing, food, or cable TV. This job pays $45,000 per year. The incur expenses secondlob is far away from your parents' house, so you'll have to rent an apartment with parking ($10,000 per year), buy your own food ($3,000 per year), and pay for your own cable TV ($700 per year). This job pays $50,000 per year.You still plan to do laundry at your parents' house once a week if you live in the city, and you plan to go into the city once a week to visit with friends if you live at home. Thus, the cost of operating your car will be about the same either way. In addition, your parents refuse to pay for your cell phone service ($720 per year), and you can't function without it. conti nued.
99
Requirements a. b. c. d. Based on this information alone. what is the net difference between the two alternatives (salary,net of relevant costs)? \fhat information is irrelevant? Why? 'S7hat qualitative information is relevant to your decision? Assume that you really want to take Job #2, but you also want to live at home to cut costs. lfhat new quantitative and qualitative information will you need to incorporate into your decision?
P2-448
Cafculate total and average costs (Learning Obiectiue 7) The owner of New York Deli restaurant is disappointed becausethe restaurant has been averaging 4,000 sandwich sales per month, but the restaurant can make and serve 6,000 sandwiches per month. The variable cost (for example, ingredients) of each sandwich is $1.25. Monthly fixed costs (for example, depreciation, property taxes, businesslicense,manager'ssalary) are $6,000 per month. The owner wants cost information about different volumes so that he can make some operating decisions. Requirements L. Fill in the chart below to provide the owner with the cost information he wants. Then use the completed chart to help you answer the remaining questions.
2. From a cost standpoint, why do companies suchasNew York Deli want ro

operatenearor at full capacity? 3. The ownerhasbeen considering waysto increase sales the volume. believes He he couldsell6,000sandwichesmonth by cuttingthe sales a pricefrom $6.00a sandwich to $5.50.How much extra profit (above currentlevel)would he generate the if he decreased salesprice?(Hint: Find the deli'scurrentmonthly profit and the compareit to the deli'sprojected monthly profit at the new sales price and volume.)
IOO
Chapter 2
4. The owner's other idea is to advertisehis restaurant on the local radio stations.
If he keeps the salesprice at $6 per sandwich, the advertising agency says he'll have to spend $4,000 in advertising each month to increasemonthly salesto 6,000 sandwiches.How much extra profit (above the current level) would he generateif he kept the salesprice at $6 per sandwich but spent $4,000 per 'sfhich of the owner's two ideas is most profitable? month on advertising?
5. The owner is surprised by your calculations. Becausethe current averageprofit

per sandwich is $3.25, he thought the restaurant would make $19,500 of income per month (before advertising costs) if it sold 6,000 sandwichesat the normal $6.00 salesprice. How did the owner arrive at this figure, and why is it wrong?
Building Accounting Blocksof Managerial
lOl
Apply Your Knowledge

w DecisionCase
Case 2-45. Determine ending inventory balances (Leaming Objectiue 5) switches PowerBoxdesigns and manufactures usedin telecommunications. Serious flooding throughout North Carolina affectedPowerBox'sfacilities. Inventory was completelyruined, and the company'scomputer system,including all accounting records, was destroyed. Beforethe disaster recoveryspecialists cleanthe buildings,AnnettePIum,the companycontroller,is anxiousto salvage whateverrecordsshecan to support an inventory.Sheis standingin what is left of the insurance claim for the destroyed accounting department with PaulLopez,the cost accountant. didn't know mud could smellso bad," Paulsays."\7hat shouldI be look"I ing for?" inventorynumbers,"responds "Don't worry about beginning Annette."We'll get them from last year'sannualreport.We needfirst-quarter costdata." just beforethe storm hit," Paulsays. results "I was working on the first-quarter "Look, my report'sstill in my deskdrawer.But all I can makeout is that for the first quarter,material purchases werc $476,000 and that direct labor, manufacturing (otherthan indirectmaterials), overhead and total manufacturing coststo account for were$505,000,$245,000,and$1.,425,000, respectively. Wait,and costof goods for available sale was $1,340,000." "Great," saysAnnette. "I rememberthat salesfor the period were approximately$1.7 million. Givenour grossprofit of 30%o,that's you shouldneed." all Paulis not sureaboutthat, but decides see to what he can do with this informainventorynumbersare as follows: tion. The beginning . Raw materials, $113,000 . 'Workin process, $229,000 . Finished goods, $154,000 He remembers schedule learnedin collegethat mayhelp him get started. he a Requirements 1. Exhibit 2-1,6resembles schedule Paul has in mind. Useit to determine the the endinginventories raw materials, of work in process, finishedgoods. and 2, Draft an insurance claim letterfor the controller, seeking reimbursement the for PowerBox's flood damage inventory. to insurance representative Gary Streer, is 1122 Main Street, at IndustrialInsurance, Hartford, CT 06268.The policy number is #3454340-23.PowerBox's address 5 Research is Triangle\Wag Raleigh, NC27698.
1O2
Chapter2

Managerial Accounting 02

Uploaded by

Document Information

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Managerial Accounting 02

Uploaded by

Copyright:

Available Formats

Blocksof rial

Accounting Blocksof Managerial Building

Sectorsand the ValueChain Three Business

and Service,Mlerchandising, ManufacturingCornpanies

Distinguish among merchandising, service, and manufacturing comPanres

Manufacturers' ThreeTypesof Inventory

Inventory (or Merchandise Inventory)

Raw materials inventory Work in process inventory Finished goods inventory

11,,,.:t':1, f: lr,rrar:,:.::t..,t:rrfi::l r:i,;,,:,,it:1:i,r:,:,_,t1,:,,:,f:,:i tt.: ri:r:.irl r.:j .:f,:,r I I i, 1.,,

Accounting Blocksof Managerial Building

lvlakeUp the ValueChain? Actlvilties WhichHustmess

the D escri be value chai nand i ts elem ent s

Accounting Blocksof Managerial Building

ActivitiesAcrossthe ValueChain Coordinating

Determiningthe Coststo Servea Customer or to Make a Product

Cost Objects, Direct Costsuand Indirect Costs

The SameCost Can Be Director Indirect, Depending the CostObject on

Accounting Building Blocksof Managerial

AssigningDirectand lndirectCoststo Cost Objects

Product Costs'for Internal DecisionlVlaking and External Reporting

Full Product Costs for Internal DecisionMaking

Inventoriable Product Costs for External Reporting

Accounting Blocksof Managerial Building

ProductCosts,and PeriodCosts Full ProductCosts,Inventoriable

Inventoriab!e Companies' Merchandising Product frost

tVlanufacturing omp*nies' lnventorf; fl ahfis

Summaryof the ThreeTypesof Manufacturing Costs

Direct Labor (DL)

Accounting Building Blocksof Managerial

Manufacturing Overhead (MOH)

of Components Manufacturing Overhead

Prflmre and C*mv*rsf;effi floets

Primeand Conversion Costs

ffiirmc* amd$mdfin'eet il-mhmn ffietmpmmsmtflmnt

Accounting Building Blocksof Managerial

Frrydust ffiew*ew: f;s'uwemma.imbfie ffiws*smr FerEmd ffirosts?

ProductCostsand PeriodCostsfor Service, Inventoriable Companies and Merchandising, Manufacturing

Acc<lnnting'['reatnrent . Initially recorded as inventory

T1'pcof Cornpatry: Service company

. Purchasesof merchandise . Freight-in; customs and duties

. Directmaterials . Directlabor . Manufacturing overhead(including indirectlabor,and indirectmaterials, other indirect manufacturingcosts)

Xfhat business activities add valueto companies?

How are inventoriable product costs treated on the financial statements?

Building Blocksof Managerial Accounting

lnventoriableProductCostsand Period Costsin Financial Statements

Service Gompany lncomeStatement

(13 0,000 ) 30,000 $

pamies Menchamd fistng *mr'*n

Building Blocksof Managerial Accounting

Grossprofit expenses: Operating salaryexpense Sales Deliveryexpense O per at ing om e . . . . . . . inc -

25,000 3,000 7,000

Calculatingthe Cost of Goods Manufactured

Building Blocksof Managerial Accounting

Inventoriable Manufacturing Costsand PeriodCosts Company:

0perating expenses (period costsl

equals 0perating Income

Schedule of Cost of Goods Manufactured

Flow of Costs Through Inventory Accounts

Accounting Blocksof Managerial Building

Top-Flight's Flowof CostsThrough InventoryAccounts

Hffectson the Balance Sheet

Current AssetSections of Balance Sheets

Ca sh ..... Acco u n ts r e cei vabl e........ Pr e p a ide xp e nses.................... T o ta l cu r r e n t assets ..............

$ 4,000 5,000 1,000 $;10,000

Prflmre and Cmvrsf;effi floets

Frrydust ffiewew: f;s'uwemma.imbfie ffiwssmr FerEmd ffirosts?

pamies Menchamd fistng mr'n

Wwrmwm ffimtrm$frmfu$e L#msmsruts"w$Hmfu$e ffimss