Chapter 16 – Management Accounting: A Business Partner
Financial and Managerial Accounting, 17/e 16-1
16 MANAGEMENT ACCOUNTING:
A BUSINESS PARTNER
Chapter Summary
The introduction to management accounting begins with an overview of the
design requirements of a managerial accounting system. The system must allocate
decision-making authority over a company’s resources. Second, it must furnish the
information to support decision-making by managers. Finally, the system must generate
the information needed to evaluate and reward performance.
The chapter then proceeds to analyze the design of a system to account for
manufacturing operations. Manufacturing costs are first classified into direct material,
direct labor and manufacturing overhead. With these definitions established, we
introduce the critical distinction between product and period costs. This discussion in turn
lays the foundation for introducing the manufacturing inventory accounts: raw materials,
work-in-process, and finished goods.
The flow of costs through the inventory accounts is explained with the help of an
extended illustration. The example includes a detailed analysis of the process of applying
overhead using a predetermined rate. We explain both the mechanics and the rationale
underlying overhead application at this point, and call attention to the potential
weaknesses of volume based applications that will be addressed in later chapters.
The chapter closes with the development of financial statements for a
manufacturing company. The schedule of cost of goods manufactured is introduced as a
supplement to the financial statements intended to assist managers in evaluating the
overall costs of manufactured products.
Learning Objectives
1. Explain the three principles guiding the design of management accounting systems.
2. Describe the three basic types of manufacturing costs.
3. Distinguish between product costs and period costs.
4. Describe how manufacturing costs flow through perpetual inventory accounts.
5. Distinguish between direct and indirect costs.
6. Prepare a schedule of the cost of finished goods manufactured.
Chapter 16 – Management Accounting: A Business Partner
Brief topical outline
A Management accounting: basic framework
1 Management accounting’s role in assigning decision-making authority
2 Management accounting’s role in decision making
3 Management accounting’s role in performance evaluation and rewards
4 Accounting systems: a business partner ‒ see Case in Point (page 727)
B Accounting for manufacturing operations
1 Classifications of manufacturing costs
2 Product costs versus period costs – see Ethics, Fraud & Corporate
Governance (page 729)
3 Product costs and the matching principle
4 Inventories of a manufacturing business ‒ see Case in Point (page 730)
5 The flow of costs parallels the flow of physical goods
6 Accounting for manufacturing costs: an illustration
7 Direct materials
8 Direct labor
9 Manufacturing overhead
a Recording overhead costs
10 Direct and indirect manufacturing costs
11 Work in process inventory, finished goods inventory, and the cost of
goods sold ‒ see Your Turn (page 735)
12 The need for per-unit cost data
13 Determining the cost of finished goods manufactured
a Purpose of the schedule
14 Financial statements of a manufacturing company
C Concluding remarks
Topical coverage and suggested assignment
Homework Assignment
(To Be Completed Prior to Class)
Class
Meetings on
Chapter
Topical
Outline
Coverage
Discussion
Questions
Brief
Exercises
Exercises
Critical
Thinking
Cases
1
A
1, 2, 3
1, 5, 10
2, 7
2
B
6, 9, 11
3, 6
1, 3, 4
1
3
B-C
12, 14, 15
8, 10
6, 9, 13
Chapter 16 – Management Accounting: A Business Partner
Financial and Managerial Accounting, 17/e 16-3
Comments and observations
Teaching objectives for Chapter 16
Beginning with this chapter, we shift our focus from financial accounting to managerial
accounting. In presenting this first managerial chapter, our classroom objectives are to:
1 Introduce the design requirements for a management accounting system.
2 Introduce the concept of product costs, and explain how and when product costs
ultimately are deducted from revenue.
3 Describe the three basic types of manufacturing costs; equate manufacturing costs
with product costs.
4 Illustrate and explain the “flow” of manufacturing costs through perpetual
inventory records.
5 Identify the three types of inventory that may be held by a manufacturing
company. Show students that the cost of the work in process and finished goods
inventories consists of manufacturing costs (product costs).
6 Identify manufacturing overhead as all manufacturing costs other than direct
materials and direct labor. Give various examples of costs classified as
manufacturing overhead.
7 Distinguish between direct and indirect manufacturing costs; explain why
manufacturing overhead is an indirect cost.
8 Explain the purpose, content, and format of a schedule of cost of finished goods
manufactured. Illustrate the preparation of this statement, and explain its
relationship to the Work in Process Inventory account and to the income
statement.
9 Explain how the total cost of finished goods manufactured is used to determine
unit cost. Explain the importance of knowing unit cost both to various managerial
decisions and to the preparation of financial statements.
Chapter 16 – Management Accounting: A Business Partner
General Comments
We cannot overstate the importance of students’ thoroughly comprehending the flow of
product costs through the perpetual inventory accounts. This concept is the foundation of
the following chapter. For this reason, we review in class the illustration on pages 1124 –
1125, at least one “flow of costs” homework problem, and often the chapter
Demonstration Problem as well.
In our discussion of the flow of costs, we have deliberately omitted transfers of the costs
of indirect materials and indirect labor from the Materials Inventory and Direct Labor
accounts into the Manufacturing Overhead account. We consider these cost flows to be
an unnecessary refinement in an introductory-level discussion. We have found that
omitting these “special treatment” items helps students to more quickly grasp the basic
flow of manufacturing costs through a perpetual inventory system.
We especially like Problems 3 and 4 as means of illustrating the “flow” of manufacturing
costs. These problems may either be assigned as homework or used as an in-class
exercise or quiz. Problems 11 and 12 are more conceptual problems, intended to
demonstrate the importance of distinguishing between period costs and product costs.
An aside The importance of properly distinguishing between product and period costs
was nowhere more evident than at Chambers Development Co., a prominent firm in the
waste management industry. In 1991, the company was forced to take an after-tax charge
of $27.2 million. This charge reduced the 1991 net income to $1.6 million from a
previously reported net of $28.8 million. The change was due to Chambers’ treating
period costs as if they were product costs. Among costs deferred were portions of
executives’ salaries for time spent on developing new projects. In addition, the company
deferred public relations and legal costs as well as executive travel expenses. For a full
account of Chambers’ questionable treatment of these indirect costs, and the market’s
reaction to the accounting change, see The Wall Street Journal, March 19, 1992.
Chapter 16 – Management Accounting: A Business Partner
Financial and Managerial Accounting, 17/e 16-5
Supplemental Exercises
Group Exercise
You are the chief executive officer of a multinational corporation that operates wholly
owned subsidiaries in several countries. One of the company’s manufacturing plants is
located in Utopia. Utopia provides a corporate income tax break related to the amount of
Utopian labor employed. Specifically, corporate income taxes are reduced by the
company’s ratio of labor costs of Utopian citizens to total manufacturing costs in Utopia.
Discuss how your company could choose to apply overhead so as to maximize the tax
benefit from operating in Utopia.
Internet Exercise
Visit the website of a manufacturing company of your choice. Access a recent annual
report and review management’s letter to the shareholders. In the letter find and report on
examples of decision-making supported by information from the company’s management
accounting system.
Chapter 16 – Management Accounting: A Business Partner
CHAPTER 16 NAME #________
10-MINUTE QUIZ A SECTION
The manufacturing cost accounts of Varsity Manufacturing Co. provide the following
information for the year ended December 31, 2011:
Direct materials used ………………………………………………………………………… $500,000
Direct materials purchased ……………………………………………………………………… $520,000
Direct labor cost assigned to production …………………………………………………… $130,000
Wages paid to direct workers ………………………………………………………………….. $120,000
Manufacturing overhead costs applied to production …………………………………. $190,000
Cost of finished goods manufactured …………………………..…………………………... $850,000
Inventories at the beginning and end of the year were as follows:
Dec. 31 Jan. 1
Materials ……………………………………………………………… $65,000 $ ?
Work in Process …………………………………………………… $15,000 $10,000
Finished Goods ……………………………………………………. $35,000 $65,000
.
Answer the following questions. If you select answer d, indicate the correct amount.
1 Refer to the above data. The total amount of inventory that should appear in the
company’s balance sheet at December 31, 2011 is:
a $115,000. c $85,000.
b $860,000. d Some other amount. $____________
2 Refer to the above data. The total manufacturing costs charged to the Work in
Process Inventory account during 2011 amounted to:
a $850,000. c $810,000.
b $820,000. d Some other amount. $____________
3 Refer to the above data. The total manufacturing costs deducted from revenue in
2011: amounted to:
a $890,000. c $845,000.
b $880,000. d Some other amount. $____________
4 Refer to the above data. The balance in the Materials Inventory account at the
beginning of 2011: was:
a $65,000. c $45,000.
b $85,000. d Some other amount. $____________