Chapter 2 Building Blocks of Managerial Accounting 1 What are the Most Common Business Sectors and Their Activities a Service Companies In business to sell intangible services such as health care insurance banking and consulting i Make up the largest sector of the U S economy ii Don t generally have an inventory that is sold for profit iii Incur costs to provide services develop new services advertise and provide customer service 1 Salaries benefits make up about 70 of costs b Merchandising Companies Resell tangible products that are bought from suppliers at higher prices than what they pay on their suppliers i Retailers Sell to direct consumers ii Wholesalers Middlemen who buy products in bulk from manufacturers mark up the prices and sell products to retailers iii Cost of Inventory Cost merchandisers pay for goods costs necessary to get the merchandise in place and ready to sell freight costs import duties tariffs c Manufacturing Companies Use labor plant and equipment to convert raw materials into finished products sell products to retailers or wholesalers at a price that is high enough to convert their costs and generate a profit i Raw Materials Inventory All raw materials used in manufacturing ii Work In Process Inventory Goods that are partway through the manufacturing process but not yet complete iii Finished Goods Inventory Completed goods that have not yet been sold d Which Business Activities Make up the Value Chain i Value Chain The activities that add value to the company s products and services 1 Research and Development Researching and developing new or improved products or services and the processes for producing them 2 Design Detailed engineering of products and services and the processes for producing them 3 Production or Purchases Resources used to produce a product or service or to purchase finished merchandise intended for resale 4 Marketing Promotion and advertising of products or services creates consumer 5 Distribution Delivery of products or services to customers 6 Customer Service Support provided for customers after the sale demand 2 How do Companies Define Cost a Cost Object Anything for which managers want a separate measurement of cost i Examples Individual units different models alternative marketing strategies geographic segments of the business departments b Direct Cost Cost that can be traced to a specific cost object i Example The cost object is a Toyota Prius Tires used to produce the Prius are direct c Indirect Cost Cost that relates to the cost object but cannot be traced to it i Example Toyota cannot build a Prius without incurring utilities taxes and depreciation d Total Cost of a Cost Object All direct indirect costs e Allocation Dividing up the total indirect costs over all of the units produced less precise f Costs for Internal Decision Making and External Reporting i To determine products profitability you subtract the cost of the product from its selling costs costs price ii Total Costs for Internal Decision Making Total costs include all the resources used throughout the value chain 1 Before launching a new product managers predict the total costs of the product to set a selling price that will cover all costs plus return a profit iii Inventorial Product Costs for External Reporting GAAP only allows a portion of the total cost to be treated as an inventorial product cost GAAP specifies which costs are inventorial product cost and which are not 1 Inventorial Product costs include ONLY the costs incurred during the production or purchases stage of the value chain a Costs are treated as assets until the product is sold When they are sold they are removed from inventory and the cost is now part of cost of goods sold 2 Costs incurred in any other stage of the value chain are recorded as expenses in the period in which they are incurred These are known as period costs a Period costs are often called operating expenses or selling general and g Merchandising Companies Inventorial Product Costs administrative expenses i Include only the cost of purchasing the inventory from suppliers plus any costs incurred to get the merchandise to the merchandiser s place of business and ready for sale 1 Ae Freight in costs import duties tariffs 2 Recorded as an asset Inventory account until the merchandise is sold Then it is recorded as an expense Cost of Goods Sold h Manufacturing Companies Inventoriable Product Costs i Include only the costs incurred during the production element of the value chain 1 Direct Materials Primary raw materials that become a physical part of the finished product carpet etc a Example A car s direct materials include steel tires engines upholstery 2 Direct Labor The cost of compensating employees who physically convert raw materials into the company s products 3 Manufacturing Overhead All manufacturing costs other than direct materials and direct labor All indirect manufacturing costs a Indirect Materials Materials used in the manufacturing plant that are not easily traced to individual units i Janitor supplies oil and lubricants and any physical components of the finished product that are inexpensive b Indirect Labor The cost of all employees in the plant other than those employees directly converting the raw materials into a finished product c Other Indirect Manufacturing Costs Plant related costs such as insurance and depreciation on the plant and plant equipment plant property taxes plant repairs and maintenance and plant utilities i Prime Conversion Costs i Prime Costs Direct Materials Direct Labor ii Conversion Costs Direct Labor Manufacturing Overhead 1 Converting direct materials into finished goods 3 How are Inventoriable Period Costs and Period Costs Shown in the Financial Statements a Service Companies Service companies do not have an inventory therefore they do not have an inventoriable period costs or cost of goods sold All costs are period costs so they are expensed in the current period as operating expenses b Merchandising Companies Cost of good sold is the major expense c Manufacturing Companies Instead of purchases freight in and import duties to calculate COGS like merchandising companies manufacturers use cost of goods manufactured i Calculating Cost of Goods Manufactured Summarizes the cost of activities that take place in a manufacturing plant over the period 1 Manufacturer starts by buying direct materials which are stored in Raw Materials Inventory 2 Direct materials used in production are transferred out
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