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Managerial Accounting, Third Canadian Edition Class Notes

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    Chapter 1 Introduction to Managerial Accounting LEARNING OBJECTIVES : When your students have finished studying this chapter, they should be able to: 1. Identify managers’ four primary responsibilities. 2. Distinguish financial accounting from managerial accounting. 3. Describe organizational structure and the roles and skills required of management accountants within the organization. 4. Describe the role of CPA Canada and apply its guidelines for ethical behavior. 5. Discuss and analyze the implications of regulatory and business trends. 6. Describe a lean production system. 7. Describe and use the costs of quality framework. OVERVIEW This chapter provides an overview of the focus of management accounting and its role in organizations. Section One: The chapter introduces managerial accounting along with the fundamental principle of the text, which is the importance of using managerial accounting data in decision - making. Students are introduced to the importan ce of cost of goods sold and decision - making by discussing the primary responsibilities of a managerial accountant: planning, directing, controlling, and decision - making. Section Two: To help students understand the managerial accounting focus, financial and managerial accounting are contrasted and compared. Managerial accounting has internal users relying on relevant information prepared specifically for management’s needs and financial accounting has external users using reliable and objective information in the form of financial statements. Section Three: The importance of using managerial accounting for decision - making is illustrated through the presentation of organizational structures and the roles and skills required of management accountants. In addition to their traditional costing and

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    reporting roles, management accountants also play an important role in developing budgets that influence the organization’s culture and strategy. Section Four: The importance of ethics is underscored. Ethical dilemmas are discussed and the Code of Professional Ethics for Management Accountants is outlined. This section also looks at Management accountants’ professional associations. Professional accountants are now represented by the Chartered Professional Accountants of Canada (CPA Canada) in addition to the provincial associations (eg CPA Ontario). The three legacy accounting bodies in Canada are also discussed. Section Five: The next section of the chapter presents the implications of regulatory and business trends. These include the Sarbanes - Oxley Act of 2002, IFRS, XBRL, the shift towards a service economy, competition in the global marketplace, sustainability and social responsibility, time - based competition, advanced information systems, and e - commerce . Section Six : T raditional production systems are compared to lean production systems. The advantages and drawbacks of lean production are discussed and the concept of just - in - time inventories is introduced. Total quality management is presented as a key to succeeding in the global economy and ISO 9001:2008 is also discussed . Differences between traditional and lean production systems are presented including the differences in equipment arrangement between the two systems. Section Seven : The chapter concludes with a discussion of the costs of quality framework and the four costs of quality: prevention, appraisal, internal failure, and external failure costs. This framework is used to aid managers in their decision making

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    CHAPTER 1: OUTLINE 1 . Identify managers’ four primary responsibilities { LO 1 } Management accounting can be described as the process of identifying, measuring, accumulating, analyzing, preparing, interpreting, and communicating information that helps managers fulfill organizational objectives. Management accounting can be further divided into processes of planning and control. Planning entails setting objectives and specifying how those objectives will be attained. Controlling entails implementing plans and using feedback to attain objectives. The management accountant’s role can be broken down into the following activities: 1. Planning: This involves setting goals and objectives for the company and determining how to achieve them. This aspect quantifies the likely results of possible courses of action and often recommends the best course of action to follow. Problem - solving is especially important for long - range planning and special decisions. 2. Directing : This means overseeing the day to day operations of a company. Involves the reporting and interpreting of information that helps managers focus on operational problems, imperfections, inefficiencies and opp ortunities. 3. Controlling : This means evaluating the results of business operations against the plan and making adjustments to meet its goals. Scorekeeping enables both internal and external parties to evaluate the organization’s performance and position. 4. Decision Making : is central to all of the above activities. Managerial accounting gathers, summarizes, and reports cost and revenue data relevant to the decisions being made in the planning, directing and controlling phases. TEACHING TIPS {LO1} TIP #1 Exhibit 1 - 1 highlights Managers Four Primary Responsibilities . May want to draw this table on the board (or show on PPT) and then discuss and write the main points of each type of responsibility. TIP #2: After covering managers’ four primary responsibilities, consider offering the following example: A manager may wish to expand a company’s custodial service from only cleaning private homes to also cleaning corporate offices and plants. This goal is then developed into a budget (planning). That budget is analyzed thoroughly to determine both the price points and how to market the service (directing). After comparing the budget to the actual results, the managerial accountant determines that the expansion into the new market is somewhat slower than expected and decides to change its marketing strategy (controlling). Decision - making is the fourth responsibility and occurs at all levels of the process. For example, if the marketing strategy works and the corporation proceeds toward meeting its goals, the managerial accountant focuses attention on which new services will be offered, how much to charge for the services, and if loyalty discounts should be given to existing customers who purchase these services ( decision - making ). TIP#3 In teams or in partners, have students complete E1 - 26 B Managers’ Responsibilities , which should take about five minutes. Call on a student to give the answers.

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    2 . Distinguish Financial Accounting from Managerial Accounting {LO 2} At this point, the accounting student has most likely only been exposed to financial accounting. Students sometimes have a difficult time making the adjustment from financial to managerial accounting. This is a great time to review the role of financial accountants in our society and then explain the role of management accountants. In doing so, be sure to also point out some of the similarities between financial and management accounting, as this will help students understand that their study of management accounting focuses on external decision - makers, whereas managerial accounting focuses on internal decision - makers. TEACHING TIPS: {LO 2} TIP #1: Use Exhibit 1 - 2 to emphasize the differences between financial and managerial accounting. Consider presenting the following summa rized version of the chart : Managerial Accounting Financial Accounting Users Internal (e.g. managers) External (e.g. banks) Purpose To assist in management decision making To help external users make investing and lending decisions Primary Accounting Product Any internal accounting report worthwhile by management Financial Statements Content/Format Management determines what is needed in report and how it is formatted Standards (IFRS, ASPE) must be followed Focus Future - oriented Historical basis Emphasis Relevant Data Reliable and Objective Data Business unit Segmented Information Company as a whole Frequency of Reports Dependent on management’s needs Annually and quarterly Audit requirement Not required Independent certified public accountants audit r equired Information required by outside group No Yes. Each province has its own security commissions that require companies to issue audited financial statements Employee Behavioural Implications Considered Carefully Considered First concern is adequacy and disclosure; behavioural implications are secondary. TIP#2: Use the following example: A manager is setting the price of items in the store. In order to make this decision, the manager needs to know the cost of the items, the other organizational costs, the sales prices for other similar items, etc. Of course, these matters are of great importance to an internal management accountant. An external accountant would not make the same decisions; instead, he/she would make decisions based on information contained in the financial statements. TIP #3: Have students complete E1 - 2 8 B Identify users of accounting information (10 minutes). Point out that most decisions impact non - accountants and stress theimportance for non - accounting majors to understand managerial accounting. 3 . Describe Organizational Structure and the Roles and Skills Required of

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    ManagementAccountants within the Organization { LO 3 } Describes the levels of the organizat ion, starting with the highest level, the Board of Directors. Role Responsibility Board of Directors E lected by shareholders to oversee the company Chief Executive Officer Manages company on a daily basis. Chief Financial Officer A ll the company’s financial concerns Chief Operating Officer T he company’s operations, such as R&D, production and distribution Treasurer R aising capital (through issuing stocks and bonds) and investing funds. Controller G eneral financial accounting, managerial accounting and tax reporting Internal Audit Function To ensure that the company’s internal controls and risk management policies are functioning properly Audit Committee Oversees the internal audit department. Independent auditors report directly to the audit committee. Management Accountants Act as internal business advisors. They provide the financial information and in - depth analysis that managers need to make good business decisions. Management accountants needs the following skills:  Solid knowledge of both financial and managerial accounting  Problem - solving and decision making skills  Knowledge of how a business functions  Ability to lead and to work on a team  Professionalism and ethical standards  Oral and written communication skills TEACHING TIPS:{LO3} Tip #1: Exhibit 1 - 3 depicts the Typical Organization Structure Tip #2: Use Exhibit 1 - 4 to discuss The Skills Required of Management Accountants 4 . Describe the Role of CPA Canada and apply its guidelines for ethical behaviour { LO 4 } Professional accountants in Canada are represented by the Chartered Professional Accountants of Canada (CPA Ontario) in addition to provincial accounting associations (e.g. CPA Ontario). Prior the unification process, which began in 2013, there were three professional accounting designations in Canada. The purpose of unification was to bring strength of training, knowledge and practice in one accounting body which is now the CPA . There are three legacy professional accounting organizations in Canada. The Canadian Institute of Chartered Accountants(CICA) which regulated Chartered Accountant s (CA). The Society of Management Accountants of Canada , governed Certified Management Accountants (CMAs). The Certified General Accounta nts Association of Canada awarded members the CGA (Certified General Accountant) designation. In addition to preparing you for a position in an accounting department, studying accounting, and working as a management accountant, can prepare you for the very highest levels of management, such as CEO. A . Standards of ethical conduct A summary of CPA Guidelines for Ethical Behaviour in Exhibit 1 - 5 includes :  Adhering to Rules of Professional Conduct  Competencies

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     Assessing the Situation  Integrity  Conclude/Advise/Communicate Standards of ethical conduct have been adopted by professional accounting organizations because of the reliance by so many parties on the product of accountants. See page 13 for the CPA Cana da Principles of Ethical Conduct which includes:  Professional Behaviour  Integrity and Due Care  Professional Competence  Confidentiality  Objectivity B . Ethical dilemmas Competing obligations to shareholders, customers, suppliers, fellow managers, society, and self and family create ethical dilemmas for management accountants. Many companies have formal codes of ethical conduct that must be signed by employees. However, ethical standards are personal and depend on the values of the individual. Four ethical dilemmas are provi ded in the textbook (pages 11 - 12 ) TEACHING TIPS: {LO4} TIP #1: Many students love to discuss ethical issues. Sometimes students may have ethical issues presented to them in a casual way. Example: A supervisor requests that you don’t record your overtime on your timesheet. This will allow the supervisor to stay within the budget, but it doesn’t properly reflect what is happening within the organization. You feel pressure from the supervisor. Ask students what ethical issues are involved in this example. Ask students how many of them were left unsupervised when they first started a new job. How accurate was their work? Would the students feel responsible for making an error if they had been properly trained? TIP #2: Ask students to assume they work for a company. In this scenario, they will have heard that their company is being sold. The information is confidential, and they can’t speak about it. What would they do if their best friend wanted to buy stock? TIP #3: use E1 - 31 B Ethical dilemma (5 minutes) as a group or partner exercise.

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    5 . Discuss and Analyze the Implications of Regulatory and Business Trends { LO 5 } 1. Sarbanes - Oxley Act: Teaching Tip : R emember that many of today’s students probably don’t remember businesses before accounting scandals. Students have likely become cynical about accounting practices based on news media. Ask students to identify what would give them confidence in the accounting decisions of an organization. 2. International Financial Reporting Standards (IFRS): Teaching Tip: students may be familiar with GAAP depending on when they took their financial course . Explain the impact of globalization and how it created a need for consistent reporting standards. The securities commissions of many countries have recently moved to adopt IFRS for all publicly traded companies. 3. Extensible Business Reporting Language (XBRL): Teaching Tip: consider presenting advantages of XBRL in chart format. XBRL allows companies to release financial and business information in a format that can be more easily analysed by different users. 4. Shifting Economy: Teaching Tip: ask students if they think Apple manufactures its own headphones or if they are manufactured by an outside company. Ask them what information might be part of Apple’s decision: How much it would cost Apple to make the headphones? How much would it cost to have someone else make them? If someone else made them, could that manufacturing space be used for additional funds? 5. Social Responsibility and the Triple Bottom Line Sustainability – ability to meet the needs of the present without compromising the ability of future generations to meet their own needs. Triple Bottom Line – company’s performance should not only be viewed in terms of its ability to generate economic profit for its owners, but also by its impa ct on people and the planet. Sustainability has three factors: profit, people, planet. Green initiatives (environmental responsibility) – companies are finding ways of doing business that have fewer negative consequences for the earth’s resources. 6. E - Commerce : Teaching Tip : In order to survive in a competitive, globally wired economy, companies use the internet in budgeting, planning, selling and customer service. Discuss with the students how e - commerce is an important means of supply - chain management. Ask how many students bought their textbooks online. Why/why not?

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    6 . Describe a Lean Production System {LO 6 } Traditional Production Systems (“push systems”) : once the production schedule has been determined, products are pushed through the manufacturing process and then stored in finished goods inventory until sold. Lean Production: primary goal is to eliminate the waste of time and money that accompanies large inventories. Lean companies adopt a just - in - time (JIT) inventory system where materials are purchased just in time to be used in production and finished goods are made just in time for customer delivery. JIT is a demand - pull system where raw materials are ordered when the customer places the order. Then, small batches of product are made quickly to meet the customer needs. The quick production and low inventory maintained in a JIT system requires a quality product be produced in order to have the product reach the customer in a timely manner. Companies that adopt lean production have several common characteristics that help minimize the amount of inventory on hand yet enable the company to meet customer needs. Characteristics include: 1. Production occurs in self - sustained cells 2. Broad employee roles 3. Small batches produced just in time 4. Shortened set up times 5. Shortened manufacturing cycle times 6. Emphasis on quality 7. Supply - chain management While there are many advantages to a lean production system, companies leave themselves vulnerable as there are no inventory buffers. If their supplier runs out of raw materials, the company will not be able to meet their production needs. TEACHING TIP S : TIP#1: JIT management is easily illustrated by using milk as an example. If a company bought more milk than the space allowed on a store shelf, where would it be kept? Can it be kept cold? Is it worth paying for the refrigeration? How long can it be held to keep it fresh? JIT is more economical if the store does not buy large quantities of milk, but instead buys small amounts of milk more often. TIP #2 : Use Exhibit 1 - 8 to demonstrate the differences between a traditional and lean production system. TIP #3 : Use Exhibit 1 - 9 to demonstrate the equipment arrangement in Traditional and Lean Production Systems. TIP #4 : Have students complete E1 - 35 B Lean Production Cost - Benefit Analysis (5 minutes) in teams or partners. TIP #5 : Have students complete E1 - 36 B Differentiate between Traditional and Lean Production (5 minutes) in teams or partners.

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    7 . Describe and use the Costs of Quality Framework { LO 7 } Lean companies strive for high - quality production as the system only produces what is needed. As such, companies implement total quality management (TQM). The goal of TQM is to provide customers with superior products and services. As part of TQM, companies prepare Cost of Quality Reports. These reports categorize and list the costs incurred by the company related to quality. Quality related costs fall into four categories: 1. Prevention costs – costs incurred to avoid producing poor quality goods or services. 2. Appraisal costs – costs incurred to detect poor quality goods or services. 3. Internal failure costs – costs incurred on defective units before delivery to customers. 4. External failure costs – costs incurred because the defective goods or services are not detected until after delivery to customers. TEACHING TIPS {LO7 } TIP #1: Make it clear to students that the goal of total quality management (TQM) is to provide customers with superior products and services. This is accomplished by each business function in the value chain examining its own activities, improving quality, and eliminating defects and waste. TIP #2: Students can better understand the benefits of TQM if they understand that the quality costs and benefits are hard to measure. Explain to student that the biggest benefit of TQM is the reduction of unhappy customers who would never return. Unhappy customers do not appear directly in the accounting records, so TQM programs emphasize nonfinancial measures such as the number of customer complaints. TIP #3: Use EXHIBIT 1 - 1 0 to provide examples of the four types of quality costs. TIP #4: Have students complete E1 - 37 B Prepare a Cost of Quality Report (15 minutes).

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    CHAPTER1:STUDENTSUMMARYHANDOUT 1. Managers’ four pri m ary responsibilities a. Planning b. Directing c. Controlling d. Decision - Making 2. Differences between Fi n ancial Acc o untingandManagerialAccounting 3. Organizational structure and how manage m ent accountants fit in a. Changing roles b. Skillsrequi r ed 4. The CP A and ethical guidelines a. Professional Behaviour b. Integrity and Due Care c. Competence d. Confidentiality e. Objectivity 5. Regulatory and business trends a. Competition in today’s global marketplace 6. Describe a lean production system. 7. Describe and use the costs of quality framework.

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    CHAPTER1:ASSIGN M E NTGRID Assignme n t T o pic(s) Le a r ning Obje c t i v e (s) Estim a ted Time in Min u tes Le v el of Difficu l ty Av a il a ble in Excel Templates Short Exerc i ses S1 - 1 Rolesof m a n agers 1 5 Easy S1 - 2 Contrast m a n agerialand financialacc o unting 2 5 Easy S1 - 3 Accounting r o lesinthe organization 3 5 Easy S1 - 4 Roleofinternalauditf unction 3 5 Easy S1 - 5 I m portanceofethical standards 4 5 Easy S1 - 6 Violationsofethical standards 4 5 Easy S1 - 7 Identi f ycurrentco m p etitive tools 5 5 Easy S1 - 8 Understand key terms 6 & 7 5 Easy S1 - 9 Identify lean production characteristics 6 5 Easy S1 - 10 Classify costs of quality 7 5 Easy S1 - 11 Quality initiative decisions 7 10 Medium S1 - 12 Categorize different costs of quality 7 5 Easy Exerci s es(S e t A) E1 - 13A Manager ' sresponsibilities 1 5 Easy X E1 - 14A Definekeyt e r m s 1&2 5 Easy E1 - 15A Identifyusersofaccounting I nfor m ation 3 10 Easy E1 - 16A Classifyroleswithinthe O rganization 3 5 Easy E1 - 17A Professionalorganization andcertificat i on 4 5 Easy E1 - 18A Ethicaldilemma 4 5 Easy E1 - 19A Classifyethical R esponsibilit i es 4 10 Easy E1 - 20A Definekeyt e r m s 5 10 Easy E1 - 21A Summar i zetheSarbanes - OxleyAct 5 10 Medium E1 - 22A Leanproduct i oncost - benefit A nal y sis 6 5 Medium E1 - 23A Differentiate between traditional and lean production 6 5 Medium E1 - 24A Prepare a Cost of Quality Report 7 30 Difficult E1 - 25A Classify costs and make a quality - initiative decision 7 10 Medium Exerci s es(S e t B)

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    E1 - 26B Manager ' sresponsibilities 1 5 Easy E1 - 27B Definekeyt e r m s 1&2 5 Easy E1 - 28B Identifyusersofaccounting I nfor m ation 3 10 Easy X E1 - 29B Classifyroleswithinthe O rganization 3 5 Easy E1 - 30B Professionalorganization andcertificat i on 4 5 Easy E1 - 31B Ethicaldilemma 4 5 Easy E1 - 32B Classify ethical responsibilities 4 10 Easy E1 - 33B Definekeyt e r m s 5 10 Easy E1 - 34B SummarizetheSarbanes - 5 10 Medium Assignme n t T o pic(s) Le a r ning Obje c t i v e (s) Estim a ted Time in Min u tes Le v el of Difficu l ty Av a il a ble in Excel Templates OxleyAct E1 - 35B Leanproduct i oncost - benefit A nal y sis 6 5 Medium E1 - 36B Differentiate between traditional and lean production production 6 10 Medium E1 - 37B Prepare a Cost of Quality Report 7 3 0 Difficult E1 - 38B Classify cost and make a quality - initiative decision 7 15 Medium Problems(S e t A) P1 - 39A Manag e m entprocess e san daccountingi n formation 1&2 P1 - 40A Ethicaldilemmas 4 10 Medium P1 - 41A ERP,cost - benefitanal y sis 5 15 - 20 Medium P1 - 42A E - c o mmerce co st - benefit A nal y sis 5 10 Medium X P1 - 43A Continuati o nofP1 - 42A : revisedest i mates 5 15 Difficult Problems(S e t B) P1 - 44B Manag e m entprocess e sand accountingi n formation 1&2 10 Easy P1 - 45B Ethicaldilemmas 4 10 Medium P1 - 46B ERPcost - benefitanal y sis 5 20 Medium X P1 - 47B E - c o mmerce co st - benefit A nal y sis 5 10 Medium P1 - 48B Continuati o nofP1 - 47B : revisedest i mates 5 15 Difficult Other Decision Case A1 - 49 Ethicalstandards 4 5 Easy

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    EthicalIssue I1 - 50 Ethicaldil e mma 4 5 - 10 Easy TeamProject T1 - 51 Interviewingalocal c o m p anyaboutecomme rc e 5 60 Difficult Discussion andAnal y sis All 60 Medium Application andAnal y sis All 30 - 60 Medium

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    N a m e Date Section CHAPTER1 TEN - MINUTEQUIZ Circle the letter of the best respo n se. 1. Which of the following are a m anager’sfour pri m ary responsibilities? A . Budgeting, Directing, Controlling,Decision - Making B. Budgeting, Planning, C ontrolling,Decision - Making C. Planning, Directing, Contr o lling, Decision - Making D . Budgeting, Planning, Directing, Controlling 2. Which of the following is an exa m ple of controlling? A . Manage m ent decides to open a n e w storage facility in Canada. B. After co m p a ring budget to actual, m a nag e m ent adjusts its plan to keep the co m pany on goal. C. After revie w ing the daily sales, m anage m ent revises its staffing schedule. D . Manage m ent sets goals to m eetin the next fiscal year. 3. Which of the following is TRUE about m an a gerial accounting vs. financial accounting? A. Both m anagerial and financial repor t s are prepared quarterly and annually. B. Managerial accounting is pri m arily uti l ized by internal users, while financial accounting is pri m arily uti l ized by external users. C. The pri m ary infor m ation characteristics for m anagerial acco u nting are r e liability and obje c ti v ity, while t h e pri m ary i nf or m ation c hara c te r i stic f or f i nanci a l accounting is relevance. D. The CP A requires m anagerial acco u nting reportsand the S E C requires financial accounting reports. 4. Which of the following statements is FALSE? A. Managers are concerned with the internal use of accounting information. B. Managerial accounting information relies heavily on its reliability and objectivity. C. Managerial accounting reports are not required by any authoritative body. D. Managerial accounting information must be relevant. 5. Which of the following state m ents is FALSE? A. The treasurer and controller r epo r t di r ectly to the CFO. B. The COO is responsible for the co m p any’s operations. C. The board of directors hires the CEO to m anage the co m pany on a daily basis. D. The int e rnal audit de p art m entreportssolely to t h e CFO. 6. The individual responsible for m an a ging all ofthe operations of the organization, such as

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    product packaging, is the: A. B. C. D. COO. CFO. CEO. CP A. 7. Which of the following skills is NOT required of m anag e m e nt accountants? A. B. C. D. Analyti c al s kills Ability to work on a t ea m Oral and written com m unication skills Speak a foreign language 8. Manage m ent accountants m ust co m p ly with a ll o fthe f ollowing ethi c al st andards EXCEPT: A . R eporting ethical b reac h es to t h e CMA. B. M aintaining professional co m petence. C. P erfor m i ng duties with credibility. D . P reserving confidentiality of info r m a tion. 10 . Which of the following is NOT an important result of the Sarbanes - Oxley Act of 2002? A. Sti ff er penalties and i m prison m ent were in s t itut e d f or white c oll a r c r i m es. B. The audit committee m u st be independ e nt and include a financial expert. C. E m ployees are responsible for the fin a ncial reporting c o m pleted in their depart m ent. D. CA fi r m s h a ve li m itations on non - a u dit service for audit clients. ANS WE RKEYTOCHAPTER1QUIZ 1. C 2. B 3. B 4. B 5. D 6. A 7. D 8. A 9. B 10. C 9. Which of the following is NOT a current business trend? A. Total Quality Management B. Inventoriesdeliveredinlarge quantities at a discount C. Ti m e sensitivity for purchase, delivery, & service D. ISO quality standar d s

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    Chapter 2 Building Blocks of Managerial Accounting LEARNING OBJECTIVES: When your students have finished studying this chapter, they should be able to: 1. Distinguish among service, merchandising, and manufacturing companies. 2. Describe the value chain and its elements. 3. Distinguish between direct and indirect costs. 4. Identify the inventoriable product costs and period costs of merchandising and manufacturing firms. 5. Prepare the financial statements for service, merchandising, and manufacturing companies. 6. Describe costs that are relevant and irrelevant for decision making. 7. Classify costs as fixed or variable and calculate total and average costs at different volumes. OVERVIEW This chapter examines different cost classifications. Managers and management accountants need to have a common understanding of concepts to ensure the right type of information is provided for the decision being made. They must have a clear understanding of the situation and the types of costs that are relevant. Section One: Distinguishes the three types of sectors: service, manufacturing and merchandising . The handling of inventories and costs for both merchandising and manufacturing firms are covered (product and period costs). The three levels of inventory of manufacturers are identified. Section Two: Describes the different components of the value chain and how these components are coordinated. Section Three: Describes a cost object and distinguishes between indirect and direct costs explaining the difference between traced and allocated. Also , describes factors influencing costs. Section Four: Describes the three manufacturing cost categories, Direct Materials, Direct Labour and Factory Overhead. Prime costs and Conversion costs are defined and explained.

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    Section Five : Describes and explains product and period costs for the preparation of financial statements. This section also demonstrates the flow of costs through inventory accounts facilitated by preparation of the schedule of cost of goods manufactured. Section Six : Defines relevance and provides examples of when costs are relevant for decision making. Sunk costs are also presented. Section Seven : The behavior of variable and fixed costs is discussed. Variable costs change in proportion to changes in the cost driver, whereas fixed costs in total are unaffected by cost - driver activity.

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    CHAPTER 2: OUTLINE 1 . Distinguish among service, merchandising, and manufacturing companies. {L O. 1 } Service  in business to sell in tangible services  Generally , do not have inventory. If there is inventory it is generally for supplies and used in operations (not to make profit).  Example: health care, insurance, banking, consulting Merchandising  resell tangible products they buy from suppliers .  Wholesalers: buy products in bulk from manufacturers, mark up the prices and then sell these products to retailers.  Retailers: buys products from their suppliers and sells them to consumers (i.e. you and me)  They have inventory Manufacturing  use labour, plant, and equipment to convert raw materials into new finished products.  Typically sell products to retailers or wholesalers at a price that is high enough to cover their costs and generate a profit. While merchandising companies have a single inventory item (finished goods inventory) listed on their balance sheets, manufacturing companies have the following categories: Direct - Materials Inventory – materials on hand and awaiting use in the production process. Work - In - Process Inventory – goods undergoing the production process but not yet fully completed. Costs include appropriate amounts of the three major manufacturing costs (i.e., direct material, direct labor, and factory overhead). Finished - Goods Inventory – goods fully completed but not yet sold. TEACHING TIPS: {LO1} TIP #1 : Exhibit 2 - 2 provides a summary of the three types of companies, provides examples of each, and indicates the type of inventory they have. TIP# 2: Students need to understand that manufacturing companies have a broad range of production activities that require tracking in three kinds of inventory: raw materials (RM), work in process (WIP), and finished goods (FG). Students should understand that all three of these inventories are assets. TIP # 3 : Have students work in teams or with a partner and complete E2 - 3 3 B Identify types of companies and their inventories (5 minutes). Call on a student to report the answers.

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    2 . Describe the value chain and its elements. {L O. 2} a. Research and development - researching and developing new or improved products or services and the processes for producing them. b. Design – detailed engineering of products and services and the processes for producing them. c. Production or purchases – resources used to produce a product or service or to purchase finished merchandise intended for resale. d. Marketing – promotion and advertising of products or services. e. Distribution – delivery of products or services to consumers. f. Customer service – support provided for customers after sale. Coordinating activities across the value chain Most of the value chain activities occur in the above order. However, each element is not worked on independently without considering other elements. For example, managers consider the customer service they are able to provide to customers and how the product could be marketed in the R & D phase. 3 . Distinguish between direct and indirect costs. {LO. 3} Cost - a sacrifice or giving up of resou rces for a particular purpose. Cost Object - is something for which managers want a separate measurement of the cost of (e.g., a product, a department, a sales region, a program, or something else for which decisions are made). Direct Costs – a cost that can be easily traced to the cost object; identified specifically and exclusively with a given cost objective in an economically feasible way. Indirect Costs - not identified specifically and exclusively with a given cost objective in an economically feasible way Managers prefer to classify many costs as direct whenever it is "economically feasible" because it gives them greater confidence in their costs of products and services (i.e., less subjectivity). A particular cost can be direct for one cost objective but indirect for others. TEACHING TIPS {LO 3} TIP #1 Determining if costs are direct or indirect depends on the cost object. Use Exhibit 2 - 4 to demonstrate this concept. Also consider the following example: ABC Entertainment Store sells DVD’s and CD’s. The store subscribes to a monthly DVD magazine which discusses the most current titles. If the cost object is the entire DVD product line, the cost of the magazine subscription can be classified as a direct cost. However, if the cost object is a single DVD (pick a current popular movie to explain to students ), the magazine subscription cost can no longer be directly traced to that single DVD. It would be classified as an indirect cost of the single DVD .

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    4 . Identify the inventoriable product costs and period costs of merchandising and manufacturing firms. {LO. 4} Direct - Materials Costs – the primary raw materials that are physically identified as a part of the finished product and that may be traced to the manufactured goods in an economically feasible way. Direct - Labo u r Costs - the cost of compensating employees who physically convert raw materials into the finished product; the labor costs that can be traced specifically and exclusively to the manufactured goods in an economically feasible way Manufacturing Overhead Costs (Indirect Manufacturing Costs or Manufacturing Overhead) - include all costs other than direct material or direct labor that are associated with the manufacturing process (e.g., power, supplies, indirect labor, supervisory salaries, property taxes, ren t, insurance, and depreciation); has three components: indirect materials, indirect labour, and other indirect manufacturing costs. Product Costs - costs (e.g., direct materials, direct labor, and factory overhead) initially identified with goods produced or purchased for resale (i.e., inventory) and become expenses (i.e., cost of goods sold) only when the inventory is sold. Period Costs - costs ( called operating expenses, or selling, general and administration expenses) that are deducted as expenses during the current period without going through the inventory stage. Prime costs – include Direct Materials Costs and Direct Labour Costs. Conversion costs - include Direct Labour Costs and Manufacturing Overhead Costs. TEACHING TIPS: {LO4} TIP #1: EXHIBIT 2 - 6 depicts total costs, inventoriable product costs, and period costs . TIP #2: EXHIBIT 2 - 9 summarizes the accounting treatment for inventoriable and period costs for each type of sector . Note that manufacturing companies have three categories of product costs while only one is present for merchandisers. TIP #3: Break down manufacturing overhead into three sub - categories to help students remember what types of costs are classified as overhead. The following subcategories can be used: (1) indirect materials (i.e. lubricant for machines), (2) indirect labor (i.e. factory supervisor), and (3) other (all other costs needed to run the factory such as power). TIP #4: After discussing product costs (DM, DL, MOH), period costs, prime costs and conversion costs, have students complete E2 - 37B Classify and calculate a manufacturer’s costs (10 minutes) in teams and report their answers. 5 . Prepare the financial statements for service, merchandising, and

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    manufacturing companies. {L O. 5 } a. Service company – simplest income statement as they do not sell products, thus there is no cost of goods sold. b. Merchandising companies – income statement includes cost of goods sold (CoG S) , which is generally the largest cost on the income statement. Cost of goods sold is the cost of the the products that the company purchases from its suppliers. Cost of goods sold = beginning finished goods inventory + purchases – ending inventory c. Manufacturing companies – income statement includes cost of goods sold, however the calculation is different from a merchandising firm as a manufacturing company makes their goods instead of buying them. Before the company can determine the cost of products sold (to include on the income statement), they must first determine the cost of all the finished products during the period, referred to as cost of goods manufactured. i. Cost of goods manufactured (CoGM) – summarizes the cost of activities that take place in a manufacturing plant over the period. CoGM = direct materials used + direct labor + manufacturing overhead +beginning work in process – ending work in process Essentially, CoGM is the cost of all the products that left the production factory during the period and were transferred to the finished goods warehouse (or retail store). CoGS = beginning finished goods inventory + CoGM – ending finished goods inventory Typically, manufacturing and merchandising companies treat selling and administrative expenses in the same manner, but the detail of COGS differs. ii. Flow of costs through inventory accounts – all product costs (raw materials, direct labor, and manufacturing overhead) of a manufacturing company flow from the balance sheet (through inventory accounts) and eventually are expensed on the income statement once the goods are sold (expensed as cost of goods sold). d. Balance sheet comparisons - w hile merchandising companies have a single inventory item listed on their balance sheets, manufacturing companies have three (raw materials, work in progress, finished goods)

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    TEACHING TIPS: {LO5} TIP #1: Students can never review too many financial statements. The coverage of the management accountant’s role in service, merchandising and manufacturing companies is a great time to review the income statement. This can be done by reviewing Exhibits 2 - 11, 2 - 12, and 2 - 13 and by contrasting the differences. Emphasize the logical flow of all three types of income statements. TIP #2: The schedule of cost of goods manufactured summarizes the activities that take place in a manufacturing plant over the period (Exhibit 2 - 15) . Emphasize that the schedule of cost of goods manufactured must be prepared before the income statement as it’s needed to compute cost of goods sold for a manufacturer (Exhibit 2 - 13) . Work through an example (E2 - 2 6 A) of a schedule and the cost of goods sold calculation on the board. When presenting the CoGM Schedule, break it down into four parts to help students remember the sections needed (1. Direct materials, 2. Direct Labor, 3. Factory Overhead and 4. Analysis of WIP Inventory accounts). TIP #3 : Use Exhibits 2 - 14 and 2 - 16 to explain the logical flow of costs in a manufacturing environment. Point out that the first two inventories (RM and WIP) show up on the schedule, while the third inventory (FG) shows up on theincome statement (as part of the cost of goods sold calculation) . I t may be helpful to show the flow of costs through use of T - accounts (rather than using numbers, write descriptions in the T - account). This will set a good foundation when journal entries for a manufacturing company are presented in the chapter on job - costing. 6 . Describe costs that are relevant and irrelevant for decision making . {LO 6 } Controllable vs. uncontrollable costs Controllable – management is able to influence or change them. Uncontrollable – costs that are “locked in” due to previous decisions. Relevant and irrelevant costs Relevant information is the predicted future costs and revenues that will differ among alternatives. Although past data may be helpful in predicting future costs and revenues, past data is irrelevant in making future decisions. i. Differential cost – difference in cost between two alternatives (relevant cost). ii. Sunk cost – costs that have already been incurred. Future decisions cannot change past costs. Thus, sunk costs are classified as irrelevant and not considered in decision making.

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    7 . Classify costs as fixed or variable and calculate total and average costs at different volumes. {LO. 7 } Variable and fixed costs refer to how cost behaves with respect to changes in a particular cost driver. Fixed Costs:  stay constant in total over a wide range of activity levels .  Examples include real estate taxes, real estate insurance, many executive salaries, and space rentals.  See EXHIBIT 2 - 19 for a graph of fixed cost behavior within the relevant range. Variable Cost s:  a cost that changes in direct proportion to changes in the cost driver . Each unit costs the same, however, as activity increases, total cost increases.  Examples include the costs of materials, merchandise, parts, supplies, commissions, and many types of labor.  See EXHIBIT 2 - 20 for a graph of variable cost behavior within a relevant range. Relevant Range - the limits (i.e. time period and/or activity) of cost - driver activity within which a specific relationship between costs and the cost driver is valid. TEACHING TIPS {LO7} : TIP #1: Describe variable and fixed costs with an example familiar to students. You can use the costs required to operate their vehicle. Explain how each liter of gas costs the same, however, the more kilometers driven, their total cost of gas will increase (given the same price of gas). The cost of gas is considered a variable cost. On the other hand, their insurance company provides a yearly insurance rate. Regardless of whether they drive 10km, 100km or 1000km, the cost of insurance stays constant, making it a fixed cost. TIP #2 : Explain the concept of relevant range and fixed costs. For example, a clothing manufacturing company, has the capacity to make 1000 shirts each month. The relevant ran ge for cost classification is 0 to 1000 shirts. In this range, fixed costs remain constant. However, if the company wants to double production, they will need to purchase more sewing machines and have to rent a bigger factory. Once the company operates outside the relevant range, total fixed costs will increase. TIP #3 : Use the following chart to summarize variable and fixed costs. The understanding and ability to differentiate between these costs will remain crucial for subsequent topics. Cost In Total Per Unit Fixed Cost Remains Constant regardless of activity Inverse relationship with activity (decreases as activity increases) Variable Cost Increases as activity increases Remains Constant

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    CHAPTE R 2 : STUDE N T SUMMAR Y HANDOUT 1. The three m ost com m on types of companies a. Service b. Merchandising i . Retailers ii . Wholesalers c. M anufacturing i . Raw m aterials ii . Work in process iii . Finished goods 2. Value Chain a. Research a n d Development b. Design c. Production or Purchases d. Marketing e. Distrib u tion f . Custo m er Service 3. Cost Objects a. D i rect Cos t s b. Indirect Costs 4. Costs for internal d eci s i o n m aking and external reporting a. Total costs for internal decision m aking b. Inventoriable product costsfor external reporting i . Specified inventoriable costs ii . Period costs (operating expenses) 5. Inventoriable Product C ostsfor Merchandising Co m panies a. Cost of the m erchandise itself b. Freight - in and any i m port duties 6. Inventoriable Product C osts for Manufacturing C o m panies a. Direct M aterials b. Direct Labour c. Manufacturing Overhead i . Indir e ct m ateri a l s ii . Indirectlabour iii . Other indirect m anufacturing costs d. Pri m e and Conversion costs e. Additional labour co m p ensation costs

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    7. Inco m e State m ents a. Service C o mpanies b. Merchandising Co m panies c. Manufacturing Co m panies i . Calculating Cost of Goods Manufactured ii . Flow of costs through t h e accounts 8. Co m paring Balance Sheets 9. Other Cost Ter m s a. Controllable versus uncontrollable costs b. Relevant and irrelevant costs c. Fixed and variable costs d. Calcul a ting tot a l and av e rage co s t s

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    CHAPTER2:ASSIGN M E NTGRID Assignment Topic(s) Learning Objec t iv e ( s ) Estimated Time in Minutes(s) Level of Diffic u lty AvailableinE xcel Template s ShortExerc i ses S2 - 1 Identifytypeofco m p any fromba l ancesheets 1 5 Easy S2 - 2 Identifytypesofco m p ani e s &inventories 1 5 Easy S2 - 3 Labelvaluechainfuncti on s 2 5 Easy S2 - 4 Classifycostsby valuechain functions 2 5 Easy S2 - 5 Classifycostsaseitherdir e ct or indirect orindirect 3 5 Easy S2 - 6 Classifyinv e ntoriable productcostsandperiod costs 4 5 Easy S2 - 7 Classifya m a nufacturer ’ s cost 4 5 Easy S2 - 8 Classify costs inc u rred b y a dairy processing co m pany 4 5 Easy S2 - 9 Deter m ine total m anufacturing overhead 4 5 Easy S2 - 10 Co m pute Cost of Goods Sold for a merchandiser 5 5 Easy S2 - 11 Prepare a retailer’s inco m e state m ent 5 5 Easy S2 - 12 Calculate direct m aterials used 5 5 Easy S2 - 13 Co m pute Cost of Goods Manufactured 5 5 Easy S2 - 14 Consider relevant in f or m ation 6 5 Easy S2 - 15 Classify costs as fixed or variable 7 5 Easy Exerci s es(S e tA) E2 - 16A Identify types of co m panies and their inventories 1 5 Easy E2 - 17A Classify costs along the value ch a i n f or a ret a il e r 2 10 Easy E2 - 1 9 A Classify costs along the value chain for a 2&3 10 Easy

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    Assignment Topic(s) Learning Objec t iv e ( s ) Estimated Time in Minutes(s) Level of Diffic u lty Availablein Excel Temp lates m anufacturer E2 - 20 A Classify costs as direct or indirect 3 5 Easy X E2 - 2 1 A Define cost ter m s 3&4 10 Easy E2 - 2 2 A Classify andcalc u late a m anufacturer’s costs 3&4 10 Easy E2 - 2 3 A Prepare the curre n t as s ets section of the balance sheet 5 10 Medium X E2 - 2 4 A Prepare a retailer’s inco m e state m ent 5 10 Medium X E2 - 2 5 A Co m pute direct m aterials used and cost of goods m anufactured 5 10 Medium E2 - 2 6 A Co m pute cost of goods m anufactured and cost of goods sold 5 10 Medium E2 - 2 7 A Continues E 2 - 2 6 A: Prepare inc o m e state m ent 5 10 Medium E2 - 2 8 A W ork backwards to fi n d m i ssing a m ounts 5 10 Medium E2 - 2 9 A Deter m ine whether in f or m ation is r e leva n t 6 5 Easy E2 - 30 A Describe o t h er cost t e r m s 6&7 5 Easy E2 - 3 1 A Classify costs as fixed or variable 7 10 Medium X E2 - 3 2 A Co m pute total and averagecosts 7 10 Medium Exerci s es(S e tB) E2 - 3 3 B Identify types of co m panies and their inventories 1 5 Easy E2 - 3 4 B Classify costs along the value ch a i n f or a ret a il e r 2 10 Easy E2 - 3 6 B Classify costs along the value chain for a m anufacturer 2&3 10 Easy E2 - 3 7 B Classify costs as direct or indirect 3 5 Easy E2 - 3 8 B Define cost ter m s 3&4 10 Easy E2 - 3 9 B Classify andcalc u late a m anufacturer’s costs 3&4 10 Easy

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    E2 - 40 B Prepare the curre n t as s ets section of the balance sheet 5 10 Medium E2 - 41 B Prepare a retailer’s inco m e state m ent 5 10 Medium E2 - 4 2 B Co m pute direct m aterials used and cost of goods m anufactured 5 10 Medium E2 - 4 3 B Co m pute cost of goods m anufactured and cost of goods sold 5 10 Medium E2 - 4 4 B Continues E 2 - 4 3 B: Prepare inc o m e state m ent 5 10 Medium E2 - 4 5 B W ork backwards to fi n d m i ssing a m ounts 5 10 Medium E2 - 4 6 B Deter m ine whether in f or m ation is r e leva n t 6 5 Easy E2 - 4 7 B Describe o t h er cost t e r m s 6&7 5 Easy E2 - 4 8 B Classify costs as fixed or variable 7 10 Medium E2 - 4 9 B Co m pute total and averagecosts 7 10 Medium Problems(S e tA) P2 - 50 A Classify costs along the value chain 2 &4 10 Medium P2 - 51 A Prepareinc o m e state m ents 5 10 Difficult P2 - 5 2 A Fill in m i ssing a m ounts 5 15 Medium P2 - 5 3 A Identify relevant in f or m ation 6 15 - 20 Difficult P2 - 5 4 A Calcul a t e t h e tot a l and averagecosts 7 15 Difficult Problems(S e tB) P2 - 5 5 B Classify costs along the value chain 2 &4 10 Medium P2 - 5 6 B Prepareinc o m e state m ents 5 10 Difficult

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    Assignment Topic(s) Learning Objective ( s) Estimated Time in Minutes(s) Levelof Difficulty Available in Excel Templates P2 - 5 7 B Fill in m i ssing a m ounts 5 15 Medium P2 - 5 8 B Identify relevant in f or m ation 6 15 - 20 Difficult P2 - 5 9 B Calcul a t e t h e tot a l and averagecosts 7 15 Difficult Other Decision Ca s e A 2 - 60 Deter m ine ending inventory balances 5 15 Medium Discussion andAnal y sis All 60 Medium Application andAnal y sis All 30 - 60 Medium

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    N a m e Date Section CHAPTER2 TEN - MINUTEQUIZ Circle the letter of the best respo n se. 1. A portion of a co m pany’s inventory is shown below: Sales $350,000 Cost of Goods Sold: Beginning Inventory $ 15,000 Purchases 250,000 Cost of Goods Available for Sale 265,000 Less: Ending Inventory 13,000 Cost of Goods Sold 252,000 Gross Profit $ 98,000 W hat type o fco m pany is ill u st r ate d ? A . Service Corporation B. Merchandising Corporation C. Manufacturing Corporation D . Not - for - profit Corporation 2. Which of the following is NOT a value chain activity? A. Research&Develop m ent B. Production C. Distrib u tion D. Quality Co n t rol 3. Which of the following is a direct cost in the production oftire j a cks f or a m achine shop? A. Utiliti e s B. Taxes C. Steel D. Rent 4. Which of the following is an indirect costin the construction cost of a ho m e for a buildingcompany? A . Insuran c e B. Paint C. L u m ber D. Carpeting

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