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chapter
16(1)
Managerial Accounting
Concepts and Principles
______________________________________________
OPENING COMMENTS
Chapter 16(1) introduces students to managerial accounting and the manufacturing process. Students will
learn how managerial accounting is used in the management decision process. They will also be exposed
to the terminology used to describe costs related to manufacturing.
Students learn how costs flow through a manufacturing system.
After studying the chapter, your students should be able to:
2. Define and illustrate the following costs: direct and indirect costs; direct materials, direct labor, and
factory overhead costs; and product and period costs.
4. Describe the uses of managerial accounting information.
KEY TERMS
continuous process improvement
controller
controlling
conversion costs
cost
cost object
cost of finished goods available for sale
306 Chapter 16(1) Managerial Accounting Concepts and Principles
cost of goods manufactured
cost of goods sold
cost of merchandise sold
decision making
direct costs
direct labor cost
direct materials cost
directing
factory burden
factory overhead cost
feedback
financial accounting
finished goods inventory
indirect costs
line department
management by exception
STUDENT FAQS
• Why is conversion cost considered to be direct labor and factory overhead?
• Why is direct and indirect cost so important to understand?
• Why is product and period cost so important to understand?
• Why do we have to maintain all these costs for each specific job?
• Why is direct labor both a prime and a conversion cost? Isn’t that double accounting?
Chapter 16(1) Managerial Accounting Concepts and Principles 307
OBJECTIVE 1
Describe managerial accounting and the role of managerial accounting in a business.
SYNOPSIS
Managerial accounting provides information to internal users. Managers use this information to control,
plan, and evaluate the performance of the business. Managerial accounting information includes historical
data to evaluate performance and estimated data to assist in making future decisions. Financial accounting
is reported at fixed intervals and provides information to assist external users in making decisions. These
external users include shareholders, creditors, government agencies, and the general public.
Departments in a company can be either line or staff departments. Line departments are directly involved
in providing goods and services to the company’s customers. Managers in these line positions are
responsible for their department’s manufacturing and selling of goods. Staff departments provide services,
Key Terms and Definitions
• Continuous Process Improvement - A management approach that is part of the overall total
quality management philosophy. The approach requires all employees to constantly improve
processes of which they are a part or for which they have managerial responsibility.
• Controller - The chief management accountant of a division or other segment of a business.
• Controlling - A phase in the management process that consists of monitoring the operating
results of implemented plans and comparing the actual results with the expected results.
• Decision Making - A component inherent in the other management processes of planning,
directing, controlling, and improving.
308 Chapter 16(1) Managerial Accounting Concepts and Principles
This feedback allows management to isolate significant variations for further investigation and
possible remedial action.
• Management (or Managerial) Accounting - The branch of accounting that uses both historical
and estimated data in providing information that management uses in conducting daily
operations, in planning future operations, and in developing overall business strategies.
• Management Process - The five basic management functions of (1) planning, (2) directing, (3)
controlling, (4) improving, and (5) decision making.
Relevant Example Exercises and Exhibits
• Example Exercise 16(1)-1 Management Process
• Exhibit 1 – Financial Accounting and Managerial Accounting
• Exhibit 2 – Partial Organization Chart for Callaway Golf Company
• Exhibit 3 – The Management Process
SUGGESTED APPROACH—Differences in Financial and Managerial
Accounting
Use Transparency Master (TM) 16(1)-1 to review the basic differences between financial and managerial
accounting. It is helpful to point out that financial accounting stresses stewardship of assets (a historical
orientation), while managerial accounting stresses the best alternative uses of assets (a future orientation).
CLASS DISCUSSION—Managerial Accounting Reports
WRITING EXERCISE—Managerial Accounting
Instruct your students to write an answer to the following question [TM 16(1)-2]:
Why is it permissible to violate generally accepted accounting principles when preparing reports used
strictly by company management?
Chapter 16(1) Managerial Accounting Concepts and Principles 309
Possible response: Since these reports are for internal use only, they should not provide any influence to
investors about decisions to invest in the company. These reports are for management to aid in the
decision making process. It should be clear to all users that these reports may not follow GAAP.
CLASS DISCUSSION—Management Accountants
The role of the management accountant is to provide management with information needed to plan and
control the operations of a business. The Group Learning Activity below will ask your students to assume
the role of a manager in a variety of business situations. In this role, they must request information from
their company’s management accounting department to assist them in their management functions. This
exercise allows students to experience how management accountants participate in the management
process.
GROUP LEARNING ACTIVITY—Managerial Accounting in the Management
Process
Divide the class into small groups. Handouts 16(1)-1 through 16(1)-5 each presents a manager who needs
information that can be supplied by managerial accounting. Assign each of the groups one of these
scenarios. Ask them to read the scenario and list the information that the manager should request from the
management accounting department.
Possible responses:
Handout 16(1)-3: As the new sales manager focusing on Buddy at this time, I would want to know the
following information for the company and for each sales representative individually:
Total sales
Sales returns
310 Chapter 16(1) Managerial Accounting Concepts and Principles
Uncollectable accounts
Selling expenses
GROUP LEARNING ACTIVITY—Organizational Chart
Ask your students to work in groups to construct an organizational chart for your college. You may want
to give them a list of major departments/divisions within the organization. Once the chart is complete,
instruct students to identify staff and line functions.
SUGGESTED APPROACH—Management Process
Cover the five basic phases of the management process:
a. Planning—used by management to develop the organization’s objectives (goals) and to translate
these objectives into courses of action.
1. Strategic planning—long-term courses of action to achieve goals usually in five to ten years
2. Operational planning—short-term courses of action.
INTERNET ACTIVITY—Resources for Management Accountants
Direct your students to visit the Institute of Management Accountants’ (IMA) Web site at
http://www.imanet.org/index.asp. The IMA is the professional organization supporting management
accountants. To familiarize students with the resources available to management accountants through the
IMA, instruct your students to print out one or more of the following: the IMA’s mission, information on
Chapter 16(1) Managerial Accounting Concepts and Principles 311
the IMA Ethics Center, the IMA’s Statement of Ethical Professional Practice, or information on the CMA
certification.
OBJECTIVE 2
Describe and illustrate the following costs: direct and indirect costs; direct materials, direct
labor, and factory overhead costs; and product and period costs.
SYNOPSIS
Manufacturing businesses use unique terminology to describe their accounting process. The payment of
cash or the commitment to pay cash in the future is called cost. Direct costs can be directly connected to a
specific cost object. Indirect costs are those that cannot be traced conveniently to the product.
Manufacturing costs can be divided into three categories: direct materials, direct labor, and factory
Key Terms and Definitions
• Conversion Costs - The combination of direct labor and factory overhead costs.
• Cost - A payment of cash (or a commitment to pay cash in the future) for the purpose of
generating revenues.
• Cost Object - The object or segment of operations to which costs are related for management’s
use, such as a product or department.
• Direct Costs - Costs that can be traced directly to a cost object.
312 Chapter 16(1) Managerial Accounting Concepts and Principles
Relevant Example Exercises and Exhibits
• Example Exercise 16(1)-2 Direct Materials, Direct Labor, and Factory Overhead
• Example Exercise 16(1)-3 Prime and Conversion Costs
• Example Exercise 16(1)-4 Product and Period Costs
• Exhibit 4 – Guitar-Making Operations of Legend Guitars
• Exhibit 5 – Direct Costs of Legend Guitars
• Exhibit 6 – Indirect Costs of Legend Guitars
• Exhibit 7 – Classifying Direct and Indirect Costs
• Exhibit 8 – Manufacturing Costs of Legend Guitars
• Exhibit 9 – Prime Costs and Conversion Costs
• Exhibit 10 – Examples of Product Costs and Period Costs—Legend Guitars
• Exhibit 11 – Product Costs, Period Costs, and the Financial Statements
SUGGESTED APPROACH
Begin by contrasting merchandising and manufacturing operations. Remind students that merchandisers
purchase a product and sell it. Manufacturers purchase parts and raw materials, make a product, and sell
it. You may want to ask your students to list examples of service, merchandising, and manufacturing
companies.
WRITING EXERCISE—Manufacturing Costs
Ask your students to write the headings of two large columns: title the first column “Product Costs” and
the second column “Period Costs.” Under the “Product Costs” column, divide into three subheadings,
LECTURE AID—Period Costs
Objective 2 also introduces the term “period costs.” These costs are selling and administrative expenses.
TM 16(1)-6 adds these costs to the diagram previously shown on TM 16(1)-5.
GROUP LEARNING ACTIVITY—Concepts and Terminology
Divide the class into groups of three with one in the middle as a recorder. Give two minutes of working
Chapter 16(1) Managerial Accounting Concepts and Principles 313
Use the Instructor’s Resource CD to show correct answers as you progress quickly through these. Again,
stress to the students at the end that they must know how to classify these costs or they will miss many
answers in the future.
OBJECTIVE 3
Describe and illustrate the following statements for a manufacturing business: balance
sheet, statement of cost of goods manufactured, and income statement.
SYNOPSIS
The income statement and balance sheet of a manufacturing business are more complex than service and
merchandising businesses. A manufacturing business has three types of inventory accounts. The materials
inventory account consists of direct and indirect materials that have not yet entered the manufacturing
process. Materials that have entered the manufacturing process but are not yet complete are called the
work in process inventory. The finished goods inventory includes products that have gone completely
Key Terms and Definitions
• Cost of Finished Goods Available for Sale - The beginning finished goods inventory added to
the cost of goods manufactured during the period.
• Cost of Goods Manufactured - The total cost of making and finishing a product.
• Cost of Goods Sold - The cost of finished goods available for sale minus the ending finished
goods inventory.
• Cost of Merchandise Sold - The cost that is reported as an expense when merchandise is sold.
• Finished Goods Inventory - The direct materials costs, direct labor costs, and factory overhead
costs of finished products that have not been sold.
314 Chapter 16(1) Managerial Accounting Concepts and Principles
Relevant Example Exercises and Exhibits
• Example Exercise 16(1)-5 Cost of Goods Sold, Cost of Goods Manufactured
• Exhibit 12 – Balance Sheet Presentation of Inventory in Manufacturing and Merchandising
Companies
• Exhibit 13 – Income Statements for Merchandising and Manufacturing Businesses
• Exhibit 14 – Flow of Manufacturing Costs
• Exhibit 15 – Manufacturing Company—Income Statement with Statement of Cost of Goods
Manufactured
SUGGESTED APPROACH
Contrast a merchandising and manufacturing business. Use your local gas station as a merchandising
business. It buys and then sells students gasoline without doing anything to the product. This type of
The income statement is the first statement that needs preparation in any type of business; so it is with a
manufacturing-type business. Cost of merchandise sold for a merchandising business is figured as shown
below:
Beginning inventory
+ Purchases
= Merchandise available for sale
– Ending inventory
= Cost of merchandise sold
Chapter 16(1) Managerial Accounting Concepts and Principles 315
The calculations involved are:
Beginning Inventory—Raw Materials
+ Net Purchases
= Total Raw Materials Available for Use
– Ending Inventory—Raw Materials
= Raw Materials Placed in Production
The income statement shows the flow of finished goods inventory into the cost of goods sold. [See TM
16(1)-8.]
The calculations are:
OBJECTIVE 4
Describe the uses of managerial accounting information.
SYNOPSIS
Manufacturing accounting can be useful in many ways. The cost of manufacturing can be used by
managers to determine a profitable selling price for their products. Comparing historical costs can help
control costs over time. Performance reports can be used to identify wastes and investigate downtime
issues. Managerial reports can also be used to identify efficiencies and potential savings. Cost reports can
be used to identify break-even points and set bonuses and sales targets.
SUGGESTED APPROACH
Use the related Cases & Projects as a basis for class discussion.
316 Chapter 16(1) Managerial Accounting Concepts and Principles
The managerial accounting reports should reflect the needs and styles of the business. The text provides a
few possible managerial uses of accounting information for the guitar manufacturing business discussed.
These can be used as a starting point to generate discussion of other manufacturing businesses that your
students may suggest or be interested in discussing.
Handout 16(1)-1
Managerial Accounting Scenario 1
The manager of a fabric store has noticed a considerable increase in the amount of
defective fabric being scrapped by his store. Clerks notice the defects (such as
irregularities in the weave or color of fabric) when they cut yardage from bolts of fabric.
These defects usually affect only a small portion of the fabric on a bolt. Therefore, when
a clerk discovers a defect, the “bad spot” is cut from the bolt. The clerk fills out a defect
Handout 16(1)-2
Managerial Accounting Scenario 2
The top management of a fast-food hamburger chain is considering installing point-of-
sale machines that will allow customers to pay for food with an automated teller-
machine card. Previously, the restaurant has accepted only cash.
What information could the management accounting department supply to assist
management with this decision?
Handout 16(1)-3
Managerial Accounting Scenario 3
B Squared Inc. manufactures and sells awnings all over the southeastern United States.
Each state has a sales representative who is paid on commissions. Each salesperson
is responsible for checking the credit of customers as part of the sales process. Buddy
Handout 16(1)-4
Managerial Accounting Scenario 4
You are the newly hired production manager for the XYZ Company manufacturing plant
and have been ask by the VP of manufacturing to provide a budget for the next quarter
production for overhead cost. What information will you need from accounting to assist
in building this report?
Handout 16(1)-5
Managerial Accounting Scenario 5
You are the newly hired production manager for the XYZ Company manufacturing plant
Type Item Description LO(s) Difficulty Time Est BUSPROG AICPA ACBSP - APC Bloom's EE Excel GL SMH FAI Service Real World Writing Ethics Internet Group
DQ 1 1 Easy 5 min. Analytic Measurement Managerial Characteristics/Terminology Knowledge
DQ 2 1 Easy 5 min. Analytic Measurement Managerial Characteristics/Terminology Knowledge
DQ 3 2 Easy 5 min. Analytic Measurement Managerial Accounting Features/Costs Knowledge
DQ 4 2 Easy 5 min. Analytic Measurement Managerial Accounting Features/Costs Knowledge
DQ 5 2 Easy 5 min. Analytic Measurement Managerial Accounting Features/Costs Knowledge
DQ 6 3 Easy 5 min. Analytic Measurement Managerial Accounting Features/Costs Knowledge
DQ 7 3 Easy 5 min. Analytic Measurement Managerial Accounting Features/Costs Knowledge
DQ 8 3 Easy 5 min. Analytic Measurement Managerial Accounting Features/Costs Knowledge
PE 4A Product and period costs 2 Easy 5 min. Analytic Measurement Managerial Accounting Features/Costs Knowledge x
PE 4B Product and period costs 2 Easy 5 min. Analytic Measurement Managerial Accounting Features/Costs Knowledge x
PE 5A Cost of goods sold, cost of goods manufactured 3 Easy 10 min. Analytic Measurement Managerial Accounting Features/Costs Knowledge x
PE 5B Cost of goods sold, cost of goods manufactured 3 Easy 10 min. Analytic Measurement Managerial Accounting Features/Costs Knowledge x
EX 1 Classifying costs as materials, labor, or factory overhead 2 Easy 10 min. Analytic Measurement Managerial Accounting Features/Costs Knowledge x
EX 2 Classifying costs as materials, labor, or factory overhead 2 Easy 10 min. Analytic Measurement Managerial Accounting Features/Costs Knowledge x
EX 3 Classifying costs as factory overhead 2 Easy 10 min. Analytic Measurement Managerial Accounting Features/Costs Knowledge x
EX 4 Classifying costs as product or period costs 2 Easy 10 min. Analytic Measurement Managerial Accounting Features/Costs Knowledge
EX 5 Concepts and terminology 1,2 Easy 5 min. Analytic Measurement Managerial Characteristics/Terminology Knowledge
EX 6 Concepts and terminology 1,2 Easy 5 min. Analytic Measurement Managerial Characteristics/Terminology Knowledge
EX 15 Statement of cost of goods manufactured for a manufacturing company 3 Moderate 30 min. Analytic Measurement Financial Statements Application x x
EX 16 Cost of goods sold, profit margin, and net income for a manufacturing company 3 Moderate 15 min. Analytic Measurement Financial Statements Application x
EX 17 Cost flow relationships 3 Moderate 30 min. Analytic Measurement Managerial Accounting Features/Costs Application x x
EX 18 Uses of managerial accounting in a service company 10 min. Analytic Measurement Managerial Accounting Features/Costs Application x x
PR 1A Classifying costs 2 Moderate 45 min. Analytic Measurement Managerial Accounting Features/Costs Knowledge
PR 2A Classifying costs 2 Moderate 45 min. Analytic Measurement Managerial Accounting Features/Costs Knowledge
PR 3A Cost classifications for a service company 2 Moderate 45 min. Analytic Measurement Managerial Accounting Features/Costs Knowledge x
PR 4A Manufacturing income statement, statement of cost of goods manufactured 2,3 Challenging 1.5 hours Analytic Measurement Managerial Accounting Features/Costs Application x
PR 5A Statement of cost of goods manufactured and income statement for a manufacturing company 2,3 Challenging 1 hour Analytic Measurement Managerial Accounting Features/Costs Application x x
PR 1B Classifying costs 2 Moderate 45 min. Analytic Measurement Managerial Accounting Features/Costs Knowledge
CP 4 Classifying costs 2 Moderate 1 hour Analytic Measurement Managerial Characteristics/Terminology Application x
CP 5 Using managerial accounting information 4 Easy 30 min. Analytic Measurement Management Functions Application x
CP 6 Classifying costs 2 Moderate 2 hours Analytic Measurement Managerial Accounting Features/Costs Application x
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