Feature Story

Managerial Accounting Basics

Managerial accounting provides economic and financial information for managers and other internal users. Understanding managerial accounting will be vital to your future success in business. You don't believe us? Let's look at some examples of some of the crucial activities of employees at Current Designs, and where those activities are addressed in this textbook.

In order to know whether it is making a profit, Current Designs needs accurate information about the cost of each kayak (Chapters 20 and 21). And to stay profitable, Current Designs must adjust the number of kayaks it produces in light of changes in economic conditions and consumer tastes. It then needs to understand how changes in the number of kayaks it produces impact its production costs and profitability (Chapter 22). Further, Current Designs’ managers must often consider alternative courses of action. For example, should the company accept a special order from a customer, produce a particular kayak component internally or outsource it, or continue or discontinue a particular product line (Chapter 26)?

In order to plan for the future, Current Designs prepares budgets (Chapter 23), and it then compares its budgeted numbers with its actual results to evaluate performance and identify areas that need to change (Chapters 24 and 25). Finally, it sometimes needs to make substantial investment decisions, such as the building of a new plant or the purchase of new equipment (Chapter 26).

Someday, you are going to face decisions just like these. You may end up in sales, marketing, management, production, or finance. You may work for a company that provides medical care, produces software, or serves up mouth-watering meals. No matter what your position is and no matter what your product, knowledge of managerial accounting will increase your chances of business success. Put another way, in business you can either guess, or you can make an informed decision. As the CEO of Microsoft once noted: “If you're supposed to be making money in business and supposed to be satisfying customers and building market share, there are numbers that characterize those things. And if somebody can't speak to me quantitatively about it, then I'm nervous.”

Comparing Managerial and Financial Accounting

There are both similarities and differences between managerial and financial accounting. First, each field of accounting deals with the economic events of a business. For example, determining the unit cost of manufacturing a product is part of managerial accounting. Reporting the total cost of goods manufactured and sold is part of financial accounting. In addition, both managerial and financial accounting require that a company's economic events be quantified and communicated to interested parties. Illustration 19-1 summarizes the principal differences between financial accounting and managerial accounting.

Management Functions

Managers’ activities and responsibilities can be classified into three broad functions:

1. Planning.

2. Directing.

3. Controlling.

Illustration 19-1 Differences between financial and managerial accounting

In performing these functions, managers make decisions that have a significant impact on the organization.

Planning requires managers to look ahead and to establish objectives. These objectives are often diverse: maximizing short-term profits and market share, maintaining a commitment to environmental protection, and contributing to social programs. For example, Hewlett-Packard, in an attempt to gain a stronger foothold in the computer industry, has greatly reduced its prices to compete with Dell. A key objective of management is to add value to the business under its control. Value is usually measured by the trading price of the company's stock and by the potential selling price of the company.

Directing involves coordinating a company's diverse activities and human resources to produce a smooth-running operation. This function relates to implementing planned objectives and providing necessary incentives to motivate employees. For example, manufacturers such as Campbell Soup Company, General Motors, and Dell must coordinate purchasing, manufacturing, warehousing, and selling. Service corporations such as American Airlines, Federal Express, and AT&T must coordinate scheduling, sales, service, and acquisitions of equipment and supplies. Directing also involves selecting executives, appointing managers and supervisors, and hiring and training employees.

The third management function, controlling, is the process of keeping the company's activities on track. In controlling operations, managers determine whether planned goals are being met. When there are deviations from targeted objectives, managers must decide what changes are needed to get back on track. Scandals at companies like Enron, Lucent, and Xerox attest to the fact that companies must have adequate controls to ensure that the company develops and distributes accurate information.

How do managers achieve control? A smart manager in a very small operation can make personal observations, ask good questions, and know how to evaluate the answers. But using this approach in a larger organization would result in chaos. Imagine the president of Current Designs attempting to determine whether the company is meeting its planned objectives, without some record of what has happened and what is expected to occur. Thus, large businesses typically use a formal system of evaluation. These systems include such features as budgets, responsibility centers, and performance evaluation reports—all of which are features of managerial accounting.

Decision-making is not a separate management function. Rather, it is the outcome of the exercise of good judgment in planning, directing, and controlling.

Organizational Structure

Most companies prepare organization charts to show the interrelationships of activities and the delegation of authority and responsibility within the company. Illustration 19-2 shows a typical organization chart.

Stockholders own the corporation, but they manage it indirectly through a board of directors they elect. The board formulates the operating policies for the company or organization. The board also selects officers, such as a president and one or more vice presidents, to execute policy and to perform daily management functions.

The chief executive officer (CEO) has overall responsibility for managing the business. As the organization chart on the next page shows, the CEO delegates responsibilities to other officers.

Responsibilities within the company are frequently classified as either line or staff positions. Employees with line positions are directly involved in the company's primary revenue-generating operating activities. Examples of line positions include the vice president of operations, vice president of marketing, plant managers, supervisors, and production personnel. Employees with staff positions are involved in activities that support the efforts of the line employees. In a company like General Electric or Facebook, employees in finance, legal, and human resources have staff positions. While activities of staff employees are vital to the company, these employees are nonetheless there to serve the line employees who engage in the company's primary operations.

Illustration 19-2 Corporation's organization chart

The chief financial officer (CFO) is responsible for all of the accounting and finance issues the company faces. The CFO is supported by the controller and the treasurer. The controller's responsibilities include (1) maintaining the accounting records, (2) maintaining an adequate system of internal control, and (3) preparing financial statements, tax returns, and internal reports. The treasurer has custody of the corporation's funds and is responsible for maintaining the company's cash position.

Also serving the CFO is the internal audit staff. The staff's responsibilities include reviewing the reliability and integrity of financial information provided by the controller and treasurer. Staff members also ensure that internal control systems are functioning properly to safeguard corporate assets. In addition, they investigate compliance with policies and regulations, and in many companies they determine whether resources are being used in the most economical and efficient fashion.

The vice president of operations oversees employees with line positions. For example, the company might have multiple plant managers, each of whom would report to the vice president of operations. Each plant would also have department managers, such as fabricating, painting, and shipping, each of whom would report to the plant manager.

Business Ethics

All employees within an organization are expected to act ethically in their business activities. Given the importance of ethical behavior to corporations and their owners (stockholders), an increasing number of organizations provide codes of business ethics for their employees.

CREATING PROPER INCENTIVES

Companies like Amazon.com, IBM, and Nike use complex systems to monitor, control, and evaluate the actions of managers. Unfortunately, these systems and controls sometimes unwittingly create incentives for managers to take unethical actions. For example, because the budget is also used as an evaluation tool, some managers try to “game” the budgeting process by underestimating their division's predicted performance so that it will be easier to meet their performance targets. On the other hand, if the budget is set at unattainable levels, managers sometimes take unethical actions to meet the targets in order to receive higher compensation or, in some cases, to keep their jobs.

For example, at one time, airline manufacturer Boeing was plagued by a series of scandals including charges of over-billing, corporate espionage, and illegal conflicts of interest. Some long-time employees of Boeing blame the decline in ethics on a change in the corporate culture that took place after Boeing merged with McDonnell Douglas. They suggest that evaluation systems implemented after the merger to evaluate employee performance gave employees the impression that they needed to succeed no matter what actions were required to do so.

As another example, manufacturing companies need to establish production goals for their processes. Again, if controls are not effective and realistic, problems develop. To illustrate, Schering-Plough, a pharmaceutical manufacturer, found that employees were so concerned with meeting production quantity standards that they failed to monitor the quality of the product, and as a result the dosages were often wrong.

CODE OF ETHICAL STANDARDS

In response to corporate scandals, the U.S. Congress enacted the Sarbanes-Oxley Act (SOX) to help prevent lapses in internal control. One result of SOX was to clarify top management's responsibility for the company's financial statements. CEOs and CFOs must now certify that financial statements give a fair presentation of the company's operating results and its financial condition. In addition, top managers must certify that the company maintains an adequate system of internal controls to safeguard the company's assets and ensure accurate financial reports.

Another result of SOX is that companies now pay more attention to the composition of the board of directors. In particular, the audit committee of the board of directors must be comprised entirely of independent members (that is, non-employees) and must contain at least one financial expert. Finally, the law substantially increases the penalties for misconduct.

To provide guidance for managerial accountants, the Institute of Management Accountants (IMA) has developed a code of ethical standards, entitled IMA Statement of Ethical Professional Practice. Management accountants should not commit acts in violation of these standards. Nor should they condone such acts by others within their organizations. We include the IMA code of ethical standards in Appendix I. Throughout the remaining chapters, we will address various ethical issues managers face.

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Managerial Cost Concepts

In order for managers at a company like Current Designs to plan, direct, and control operations effectively, they need good information. One very important type of information is related to costs. Managers should ask questions such as the following.

1. What costs are involved in making a product or performing a service?

2. If we decrease production volume, will costs decrease?

3. What impact will automation have on total costs?

4. How can we best control costs?

To answer these questions, managers need reliable and relevant cost information.

We now explain and illustrate the various cost categories that companies use.

Manufacturing Costs

Manufacturing consists of activities and processes that convert raw materials into finished goods. Contrast this type of operation with merchandising, which sells merchandise in the form in which it is purchased. Manufacturing costs are classified as direct materials, direct labor, and manufacturing overhead.

DIRECT MATERIALS

To obtain the materials that will be converted into the finished product, the manufacturer purchases raw materials. Raw materials are the basic materials and parts used in the manufacturing process.

Raw materials that can be physically and directly associated with the finished product during the manufacturing process are direct materials. Examples include flour in the baking of bread, syrup in the bottling of soft drinks, and steel in the making of automobiles. A primary direct material of many Current Designs’ kayaks is polyethylene powder. Some of its high-performance kayaks use Kevlar^®.

Some raw materials cannot be easily associated with the finished product. These are called indirect materials. Indirect materials have one of two characteristics: (1) They do not physically become part of the finished product (such as lubricants used by Current Designs in its equipment and polishing compounds used for the finishing touches on kayaks). Or, (2) they are impractical to trace to the finished product because their physical association with the finished product is too small in terms of cost (such as cotter pins and lock washers). Companies account for indirect materials as part of manufacturing overhead.

DIRECT LABOR

The work of factory employees that can be physically and directly associated with converting raw materials into finished goods is direct labor. Bottlers at Coca-Cola, bakers at Sara Lee, and equipment operators at Current Designs are employees whose activities are usually classified as direct labor. Indirect labor refers to the work of factory employees that has no physical association with the finished product, or for which it is impractical to trace costs to the goods produced. Examples include wages of factory maintenance people, factory time-keepers, and factory supervisors. Like indirect materials, companies classify indirect labor as manufacturing overhead.

MANUFACTURING OVERHEAD

Manufacturing overhead consists of costs that are indirectly associated with the manufacture of the finished product. Overhead costs include manufacturing costs that cannot be classified as direct materials or direct labor. Manufacturing overhead includes indirect materials, indirect labor, depreciation on factory buildings and machines, and insurance, taxes, and maintenance on factory facilities.

One study of manufactured goods found the following magnitudes of the three different product costs as a percentage of the total product cost: direct materials 54%, direct labor 13%, and manufacturing overhead 33%. Note that the direct labor component is the smallest. This component of product cost is dropping substantially because of automation. Companies are working hard to increase productivity by decreasing labor. In some companies, direct labor has become as little as 5% of the total cost.

Allocating direct materials and direct labor costs to specific products is fairly straightforward. Good recordkeeping can tell a company how much plastic it used in making each type of gear, or how many hours of factory labor it took to assemble a part. But allocating overhead costs to specific products presents problems. How much of the purchasing agent's salary is attributable to the hundreds of different products made in the same plant? What about the grease that keeps the machines humming, or the computers that make sure paychecks come out on time? Boiled down to its simplest form, the question becomes: Which products cause the incurrence of which costs? In subsequent chapters, we show various methods of allocating overhead to products.

Alternative Terminology
Some companies use terms such as factory overhead, indirect manufacturing costs, and burden instead of manufacturing overhead.

Product versus Period Costs

Each of the manufacturing cost components—direct materials, direct labor, and manufacturing overhead—are product costs. As the term suggests, product costs are costs that are a necessary and integral part of producing the finished product. Companies record product costs, when incurred, as inventory. These costs do not become expenses until the company sells the finished goods inventory. At that point, the company records the expense as cost of goods sold.

Period costs are costs that are matched with the revenue of a specific time period rather than included as part of the cost of a salable product. These are non-manufacturing costs. Period costs include selling and administrative expenses. In order to determine net income, companies deduct these costs from revenues in the period in which they are incurred.

Illustration 19-3 summarizes these relationships and cost terms. Our main concern in this chapter is with product costs.

Alternative Terminology
Product costs are also called inventoriable costs.

Illustration 19-3 Product versus period costs

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Manufacturing Costs in Financial Statements

The financial statements of a manufacturer are similar to those of a merchandiser. For example, you will find many of the same sections and same accounts in the financial statements of Procter & Gamble that you find in the financial statements of Dick's Sporting Goods. The main differences between their financial statements occur in two places: the cost of goods sold section in the income statement and the current assets section in the balance sheet.

Income Statement

Under a periodic inventory system, the income statements of a merchandiser and a manufacturer differ in the cost of goods sold section. Merchandisers compute cost of goods sold by adding the beginning merchandise inventory to the cost of goods purchased and subtracting the ending merchandise inventory. Manufacturers compute cost of goods sold by adding the beginning finished goods inventory to the cost of goods manufactured and subtracting the ending finished goods inventory. Illustration 19-4 shows these different methods.

A number of accounts are involved in determining the cost of goods manufactured. To eliminate excessive detail, income statements typically show only the total cost of goods manufactured. A separate statement, called a Cost of Goods Manufactured Schedule, presents the details. (See the discussion on page 904 and Illustration 19-7.)

Illustration 19-5 shows the different presentations of the cost of goods sold sections for merchandising and manufacturing companies. The other sections of an income statement are similar for merchandisers and manufacturers.

Illustration 19-4 Cost of goods sold components

Helpful Hint We assume a periodic inventory system in this illustration.

Illustration 19-5 Cost of goods sold sections of merchandising and manufacturing income statements

Cost of Goods Manufactured

An example may help show how companies determine the cost of goods manufactured. Assume that on January 1, Current Designs has a number of kayaks in various stages of production. In total, these partially completed units are called beginning work in process inventory. The costs the company assigns to beginning work in process inventory are based on the manufacturing costs incurred in the prior period.

Current Designs first incurs manufacturing costs in the current year to complete the work that was in process on January 1. It then incurs manufacturing costs for production of new orders. The sum of the direct materials costs, direct labor costs, and manufacturing overhead incurred in the current year is the total manufacturing costs for the current period.

We now have two cost amounts: (1) the cost of the beginning work in process and (2) the total manufacturing costs for the current period. The sum of these costs is the total cost of work in process for the year.

At the end of the year, Current Designs may have some kayaks that are only partially completed. The costs of these units become the cost of the ending work in process inventory. To find the cost of goods manufactured, we subtract this cost from the total cost of work in process. Illustration 19-6 (page 904) shows the formula for determining the cost of goods manufactured.

Illustration 19-6 Cost of goods manufactured formula

Cost of Goods Manufactured Schedule

The cost of goods manufactured schedule reports cost elements used in calculating cost of goods manufactured. Illustration 19-7 shows the schedule for Current Designs (using assumed data). The schedule presents detailed data for direct materials and for manufacturing overhead.

Illustration 19-7 Cost of goods manufactured schedule

Review Illustration 19-6 and then examine the cost of goods manufactured schedule in Illustration 19-7. You should be able to distinguish between “Total manufacturing costs” and “Cost of goods manufactured.” The difference is the effect of the change in work in process during the period.

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Balance Sheet

The balance sheet for a merchandising company shows just one category of inventory. In contrast, the balance sheet for a manufacturer may have three inventory accounts, as shown in Illustration 19-8.

Illustration 19-8 Inventory accounts for a manufacturer

Finished Goods Inventory is to a manufacturer what Inventory is to a merchandiser. Each of these classifications represents the goods that the company has available for sale.

The current assets sections presented in Illustration 19-9 (page 906) contrast the presentations of inventories for merchandising and manufacturing companies. Manufacturing companies generally list their inventories in the order of their liquidity—the order in which they are expected to be realized in cash. Thus, finished goods inventory comes first. The remainder of the balance sheet is similar for the two types of companies.

Illustration 19-9 Current assets sections of merchandising and manufacturing balance sheets

Each step in the accounting cycle for a merchandiser applies to a manufacturer. For example, prior to preparing financial statements, manufacturers make adjusting entries. The adjusting entries are essentially the same as those of a merchandiser. The closing entries are also similar for manufacturers and merchandisers.

Cost Concepts—A Review

You have learned a number of cost concepts in this chapter. Because many of these concepts are new, we provide here an extended example for review. Suppose you started your own snowboard factory, Terrain Park Boards. Think that's impossible? Burton Snowboards was started by Jake Burton Carpenter, when he was only 23 years old. Jake initially experimented with 100 different prototype designs before settling on a final design. Then Jake, along with two relatives and a friend, started making 50 boards per day in Londonderry, Vermont. Unfortunately, while they made a lot of boards in their first year, they were only able to sell 300 of them. To get by during those early years, Jake taught tennis and tended bar to pay the bills.

Here are some of the costs that your snowboard factory would incur.

1. The materials cost of each snowboard (wood cores, fiberglass, resins, metal screw holes, metal edges, and ink) is $30.

2. The labor costs (for example, to trim and shape each board using jig saws and band saws) are $40.

3. Depreciation on the factory building and equipment (for example, presses, grinding machines, and lacquer machines) used to make the snowboards is $25,000 per year.

4. Property taxes on the factory building (where the snowboards are made) are $6,000 per year.

5. Advertising costs (mostly online and catalogue) are $60,000 per year.

6. Sales commissions related to snowboard sales are $20 per snowboard.

7. Salaries for factory maintenance employees are $45,000 per year.

8. The salary of the plant manager is $70,000.

9. The cost of shipping is $8 per snowboard.

Illustration 19-10 shows how Terrain Park Boards would assign these manufacturing and selling costs to the various categories.

Illustration 19-10 Assignment of costs to cost categories

Remember that total manufacturing costs are the sum of the product costs—direct materials, direct labor, and manufacturing overhead. If Terrain Park Boards produces 10,000 snowboards the first year, the total manufacturing costs would be $846,000 as shown in Illustration 19-11.

Illustration 19-11 Computation of total manufacturing costs

Knowing the total manufacturing costs, Terrain Park Boards can compute the manufacturing cost per unit. Assuming 10,000 units, the cost to produce one snowboard is $84.60 ($846,000 ÷ 10,000 units).

In subsequent chapters, we will use extensively the cost concepts discussed in this chapter. So study Illustration 19-10 carefully. If you do not understand any of these classifications, go back and reread the appropriate section in this chapter.

Product Costing for Service Industries

Much of the U.S. economy has shifted toward an emphasis on services. Today, more than 50% of U.S. workers are employed by service companies. Airlines, marketing agencies, cable companies, and governmental agencies are just a few examples of service companies. How do service companies differ from manufacturing companies? One difference is that services are consumed immediately. For example, when a restaurant produces a meal, that meal is not put in inventory, but it is instead consumed immediately. An airline uses special equipment to provide its product, but again, the output of that equipment is consumed immediately by the customer in the form of a flight. And a marketing agency performs services for its clients that are immediately consumed by the customer in the form of a marketing plan. For a manufacturing company, like Boeing, it often has a long lead time before its airplane is used or consumed by the customer.

This chapter's examples used manufacturing companies because accounting for the manufacturing environment requires the use of the broadest range of accounts. That is, the accounts used by service companies represent a subset of those used by manufacturers because service companies are not producing inventory. Neither the restaurant, the airline, or the marketing agency discussed above produces an inventoriable product. However, just like a manufacturer, each needs to keep track of the costs of its services in order to know whether it is generating a profit. A successful restaurateur needs to know the cost of each offering on the menu, an airline needs to know the cost of flight service to each destination, and a marketing agency needs to know the cost to develop a marketing plan. Thus, the techniques shown in this chapter, to accumulate manufacturing costs to determine manufacturing inventory, are equally useful for determining the costs of performing services.

For example, let's consider the costs that Hewlett-Packard (HP) might incur on a consulting engagement. A significant portion of its costs would be salaries of consulting personnel. It might also incur travel costs, materials, software costs, and depreciation charges on equipment used by the employees to provide the consulting service. In the same way that it needs to keep track of the cost of manufacturing its computers and printers, HP needs to know what its costs are on each consulting job. It could prepare a cost of services performed schedule similar to the cost of goods manufactured schedule in Illustration 19-7 (page 904). The structure would be essentially the same as the cost of goods manufactured schedule, but section headings would be reflective of the costs of the particular service organization.

Many of the examples we present in subsequent chapters will be based on service companies. To highlight the relevance of the techniques used in this course for service companies, we have placed a service company icon next to those items in the text and end-of-chapter materials that relate to nonmanufacturing companies.

Managerial Accounting Today

The business environment never stands still. Regulations are always changing, global competition continues to intensify, and technology is a source of constant upheaval. In this rapidly changing world, managerial accounting must continue to innovate in order to provide managers with the information they need.

Focus on the Value Chain

The value chain refers to all business processes associated with providing a product or performing a service. Illustration 19-12 depicts the value chain for a manufacturer. Many of the most significant business innovations in recent years have resulted either directly, or indirectly, from a focus on the value chain. For example, so-called lean manufacturing, originally pioneered by Japanese automobile manufacturer Toyota but now widely practiced, reviews all business processes in an effort to increase productivity and eliminate waste, all while continually trying to improve quality.

Illustration 19-12 A manufacturer's value chain

Just-in-time (JIT) inventory methods, which have significantly lowered inventory levels and costs for many companies, are one innovation that resulted from the focus on the value chain. Under the JIT inventory method, goods are manufactured or purchased just in time for sale. For example, Dell can deliver a computer within 48 hours of a customer's custom order. However, JIT also necessitates increased emphasis on product quality. Because JIT companies do not have excess inventory on hand, they cannot afford to stop production because of defects or machine breakdowns. If they have to stop production, deliveries will be delayed and customers will be unhappy. For example, a recent design flaw in an Intel computer chip was estimated to cost the company $1 billion in repairs and reduced revenue. As a consequence, many companies now focus on total quality management (TQM) to reduce defects in finished products, with the goal of zero defects. The TQM philosophy has been employed by some of the most successful businesses to improve all aspects of the value chain.

Another innovation, the theory of constraints, involves identification of “bottlenecks”—constraints within the value chain that limit a company's profitability. Once a major constraint has been identified and eliminated, the company moves on to fix the next most significant constraint. General Motors found that by eliminating bottlenecks, it improved its use of overtime labor while meeting customer demand. An application of the theory of constraints is presented in Chapter 26.

Technology has played a big role in the focus on the value chain and the implementation of lean manufacturing. For example, enterprise resource planning (ERP) systems, such as those provided by SAP, provide a comprehensive, centralized, integrated source of information to manage all major business processes—from purchasing, to manufacturing, to sales, to human resources. ERP systems have, in some large companies, replaced as many as 200 individual software packages. In addition, the focus on improving efficiency in the value chain has also resulted in adoption of automated manufacturing processes. Many companies now use computer-integrated manufacturing. These systems often reduce the reliance on manual labor by using robotic equipment. This increases overhead costs as a percentage of total product costs.

As overhead costs increased because of factory automation, the accuracy of overhead cost allocation to specific products became more important. Managerial accounting devised an approach, called activity-based costing (ABC), which allocates overhead based on each product's use of particular activities in making the product. In addition to providing more accurate product costing, ABC also can contribute to increased efficiency in the value chain. For example, suppose one of a company's overhead pools is allocated based on the number of setups that each product requires. If a particular product's cost is high because it is allocated a lot of overhead due to a high number of setups, management will be motivated to try to reduce the number of setups and thus reduce its overhead allocation. ABC is discussed further in Chapter 21.

Balanced Scorecard

As companies implement various business practice innovations, managers sometimes focus too enthusiastically on the latest innovation, to the detriment of other areas of the business. For example, by focusing on total quality management, companies sometimes lose sight of cost/benefit considerations. Similarly, in focusing on reducing inventory levels through just-in-time inventory methods, companies sometimes lose sales due to inventory shortages. The balanced scorecard corrects for this limited perspective: This approach uses both financial and nonfinancial measures to evaluate all aspects of a company's operations in an integrated fashion. The performance measures are linked in a cause-and-effect fashion to ensure that they all tie to the company's overall objectives. For example, to increase return on assets, the company could try to increase sales. To increase sales, the company could try to increase customer satisfaction. To increase customer satisfaction, the company could try to reduce product defects. Finally, to reduce product defects, the company could increase employee training. The balanced scorecard, which is discussed further in Chapter 25, is now used by many companies, including Hilton Hotels, Wal-Mart Stores, Inc., and HP.

Corporate Social Responsibility

The balanced scorecard attempts to take a broader, more inclusive view of corporate profitability measures. Many companies, however, have begun to evaluate not just corporate profitability but also corporate social responsibility. In addition to profitability, corporate social responsibility considers a company's efforts to employ sustainable business practices with regard to its employees and the environment. This is sometimes referred to as the triple bottom line because it evaluates a company's performance with regard to people, planet, and profit. Make no mistake, these companies are still striving to maximize profits—in a competitive world, they won't survive long if they don't. In fact, you might recognize a few of the names on the Forbes.com list of the 100 most sustainable companies in the world. Ever hear of General Electric, adidas, Toyota, Coca-Cola, or Starbucks? These companies have learned that with a long-term, sustainable approach, they can maximize profits while also acting in the best interest of their employees, their communities, and the environment.

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Comprehensive DO IT! 1

Comprehensive DO IT! 2

SUMMARY OF LEARNING OBJECTIVES

1 Explain the distinguishing features of managerial accounting. The primary users of managerial accounting reports are internal users, who are officers, department heads, managers, and supervisors in the company. Managerial accounting issues internal reports as frequently as the need arises. The purpose of these reports is to provide special-purpose information for a particular user for a specific decision. The content of managerial accounting reports pertains to subunits of the business, may be very detailed, and may extend beyond the double-entry accounting system. The reporting standard is relevance to the decision being made. No independent audits are required in managerial accounting.

2 Identify the three broad functions of management. The three functions are planning, directing, and controlling. Planning requires management to look ahead and to establish objectives. Directing involves coordinating the diverse activities and human resources of a company to produce a smooth-running operation. Controlling is the process of keeping the activities on track.

3 Define the three classes of manufacturing costs. Manufacturing costs are typically classified as either (1) direct materials, (2) direct labor, or (3) manufacturing overhead. Raw materials that can be physically and directly associated with the finished product during the manufacturing process are called direct materials. The work of factory employees that can be physically and directly associated with converting raw materials into finished goods is considered direct labor. Manufacturing overhead consists of costs that are indirectly associated with the manufacture of the finished product.

4 Distinguish between product and period costs. Product costs are costs that are a necessary and integral part of producing the finished product. Product costs are also called inventoriable costs. Under the expense recognition principle, these costs do not become expenses until the company sells the finished goods inventory. Period costs are costs that are identified with a specific time period rather than with a salable product. These costs relate to nonmanufacturing costs and therefore are not inventoriable costs.

5 Explain the difference between a merchandising and a manufacturing income statement. The difference between a merchandising and a manufacturing income statement is in the cost of goods sold section. A manufacturing cost of goods sold section shows beginning and ending finished goods inventories and the cost of goods manufactured.

6 Indicate how cost of goods manufactured is determined. Companies add the cost of the beginning work in process to the total manufacturing costs for the current year to arrive at the total cost of work in process for the year. They then subtract the ending work in process from the total cost of work in process to arrive at the cost of goods manufactured.

7 Explain the difference between a merchandising and a manufacturing balance sheet. The difference between a merchandising and a manufacturing balance sheet is in the current assets section. The current assets section of a manufacturing company's balance sheet presents three inventory accounts: finished goods inventory, work in process inventory, and raw materials inventory.

8 Identify trends in managerial accounting. Managerial accounting has experienced many changes in recent years. Improved practices include a focus on managing the value chain through techniques such as just-in-time inventory, total quality management, activity-based costing, and theory of constraints. The balanced scorecard is now used by many companies in order to attain a more comprehensive view of the company's operations. Finally, companies are now evaluating their performance with regard to their corporate social responsibility.

GLOSSARY

Activity-based costing (ABC) A method of allocating overhead based on each product's use of activities in making the product. (p. 910).

Balanced scorecard A performance-measurement approach that uses both financial and nonfinancial measures, tied to company objectives, to evaluate a company's operations in an integrated fashion. (p. 910).

Board of directors The group of officials elected by the stockholders of a corporation to formulate operating policies and select the officers who manage the company. (p. 896).

Chief executive officer (CEO) Corporate officer who has overall responsibility for managing the business and delegates responsibilities to other corporate officers. (p. 896).

Chief financial officer (CFO) Corporate officer who is responsible for all of the accounting and finance issues of the company. (p. 897).

Controller Financial officer responsible for a company's accounting records, system of internal control, and preparation of financial statements, tax returns, and internal reports. (p. 897).

Corporate social responsibility The efforts of a company to employ sustainable business practices with regard to its employees and the environment. (p. 911).

Cost of goods manufactured Total cost of work in process less the cost of the ending work in process inventory. (p. 903).

Direct labor The work of factory employees that can be physically and directly associated with converting raw materials into finished goods. (p. 900).

Direct materials Raw materials that can be physically and directly associated with manufacturing the finished product. (p. 900).

Enterprise resource planning (ERP) system Software that provides a comprehensive, centralized, integrated source of information used to manage all major business processes. (p. 910).

Indirect labor Work of factory employees that has no physical association with the finished product, or for which it is impractical to trace the costs to the goods produced. (p. 900).

Indirect materials Raw materials that do not physically become part of the finished product or for which it is impractical to trace to the finished product because their physical association with the finished product is too small. (p. 900).

Just-in-time (JIT) inventory Inventory system in which goods are manufactured or purchased just in time for sale. (p. 910).

Line positions Jobs that are directly involved in a company's primary revenue-generating operating activities. (p. 896).

Managerial accounting A field of accounting that provides economic and financial information for managers and other internal users. (p. 894).

Manufacturing overhead Manufacturing costs that are indirectly associated with the manufacture of the finished product. (p. 900).

Period costs Costs that are matched with the revenue of a specific time period and charged to expense as incurred. (p. 901).

Product costs Costs that are a necessary and integral part of producing the finished product. (p. 901).

Sarbanes-Oxley Act (SOX) Law passed by Congress intended to reduce unethical corporate behavior. (p. 898).

Staff positions Jobs that support the efforts of line employees. (p. 896).

Theory of constraints A specific approach used to identify and manage constraints in order to achieve the company's goals. (p. 910).

Total cost of work in process Cost of the beginning work in process plus total manufacturing costs for the current period. (p. 903).

Total manufacturing costs The sum of direct materials, direct labor, and manufacturing overhead incurred in the current period. (p. 903).

Total quality management (TQM) Systems implemented to reduce defects in finished products with the goal of achieving zero defects. (p. 910).

Treasurer Financial officer responsible for custody of a company's funds and for maintaining its cash position. (p. 897).

Triple bottom line The evaluation of a company's social responsibility performance with regard to people, planet, and profit. (p. 911).

Value chain All business processes associated with providing a product or performing a service. (p. 909).