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had a problem. With no cashdivMotor Company n 1999,Nissan idendsand a net lossof over Y684 billionyen (approximately $4.1 bilI lio n),CE O CarlosGhosn kne w h e h a d t o d o s o me t h in g . n h is wo rd s : "The /ackof profit is like a fever.When your business not profitable, is is that's a serioussignalthat something wrong. Eitherthe productsare or is not right,or marketing inefficient, the cost baseis too high-something is wrong. lf you ignorea fever,you can get very sick.lf you ignore u n profitability, the situationc a n o n ly wo rs e n . " G h o s n la u n c h e dt h e P/anthat turned the companyaroundby designingand NissanRevival , m arketingnew models,inve s t in gin n e w p la n t t e c h n o lo g ie ss la s h in g most profitableproducts. the supplycosts,and emphasizing company's annualoperatingincometops Y861billionyen Fiveyearslater,Nissan's ( ap proximately billion). $7.6
46
Chapter 2
Nissan's operatingmarginis now the highestin the automotive industry, and it is payingits shareholders cashdividendsat record levels. Before Nissancould attack its problems, it had to know where its costs were incurred and whether it could control those costs by making different decisions. Was the company spendingtoo much in production, us in g o u t d a t e d e q u ip me n t a n d t e c h n o lo g ie s ?W a s i t spending enou g h o n d e s ig n in g n e w p ro d u c t s t h a t b e t t e r me t c u s tomers' needsand desires? Was it targetingthe right audiences its in television advertising? this chapter, talk about many costs:costs In we that both managers and management accountants must understand to successfully a business. run
Sources; NissanUSA.com; Nissan-Global.com; Nissan and Motor Co., Ltd..Annual Reports 2002, 2003, 2004. n
LearningObjectives
ffi Oistinguish among service, merchandising, manufacturing and
companies
Ml ffi
Oescribe value the chain andits elements Oistinguish between directandindirect costs
ldentifythe inventoriable productcostsand period costsof merchandising manufacturing and firms Prepare financial the statements service, for merchandising, and manufacturing companies
costs that arerelevant irrelevant decision and for making ffil Oescribe
Classify costsas fixed or variableand calculate total and averagecostsat differentvolumes
tF
Do far, we have seen how managerial accounting provides information that managers use to run their businesses more efficiently. Managers must understand basic managerial accounting terms and conceptsbefore they can use the information to make good decisions.This terminology provides the "common ground" through which managers and accountants communicate. \Tithout a common understanding of these concepts, managers may ask for (and accountants may provide) the w Io n g i n fo rm a ti o nformaki ngdeci si ons.A syouw i l l see,di fferenttypesofco st s are useful for different purposes. Both managers and accountants must have a clear understanding of the situation and the types of costs that are relevant to the decision at hand.
\-/
47
ServiceCompanies
Service companies are in businessto sell intangible services-such as health care, insurance, and consulting-rather than tangible products. Recall from the last chapter that service firms now make up the largest sector of the U.S. economy, providing jobs to over 55% of the workforce. For servicecompanies such as eBay (online auction), H&R Block (tax return preparation), and Accountemps (temporary personnel services),salariesand wages often make up over 70'/" of their costs. Becauseservice companies sell services,they generally don't have Inventory or Cost of Goods Sold accounts. Some service providers caffy a minimal amount of supplies inventory; however, this inventory is used for internal operations-not sold for profit. In addition to labor costs, servicecompanies incur costs to develop new services,advertise, and provide customer service.
MerchandisingCompanies
ITal-Mart, and Foot Locker resell suchas Amazon.com, Merchandising companies buys books, for Amazon.com, example, productsthey buy from suppliers. tangible at customers higherpricesthan what it paysits them to CDs, and DVDs and resells includeretailers(suchas companies own suppliers thesegoods.Merchandising for suchasyou. Wholesalers, to consumers Retailers sell Home Depot)and wholesalers. mark often referredto as "middlemenr"buy productsin bulk from manufacturers, merchandising comBecause productsto retailers. up the prices,and then sellthose companies paniessell tangibleproducts,they have inventory.Even merchandising inventorythan haveinventory;they just have/ess that usejust-in-time(JIT) systems inventoryis the cost merchanmerchandise The cost of their non-JITcompetitors. in plus all costsnecessary get the merchandise placeand to pay for the goods disers the import dutiesor tariffs. Because readyto sell,includingfreight-incostsand any usuallyreportsjust sheet balance entireinventoryis readyfor sale,a merchandiser's Inventory.Merchandisers one inventory accountcalledInventory or Merchandise products and locations for new stores,to also incur other coststo identify new service' advertise and selltheir products,and to providecustomer
Manufacturing Companies
Manufacturing companies use labor, plant, and equipment to convert faw materials into new finished products. For example, Nissan's production workers use the company's factories (plant and equipment) to transform raw materials such as steel and tires into high-performance automobiles. Manufacturers sell their products to retailers or wholesalers at a price that is high enough to cover their costs and generatea profit.
48
Chapter 2
Becauseof their broader range of activities, manufacturers have three types of inventory (pictured in Exhibit 2-1):
-----------l>
---------F
,'..,..,.'.,.,.,: 1. Raw materialsinventory: All raw materialsusedin manufacturizg.Nissan's raw materialsincludesteel,glass,carpeting,tires, upholsteryfabric, engines, and other automobilecomponents. also includes It other physicalmatirials usedin the plant, suchas machinelubricantsand janitorial supplies. 2. Work in process inventory:Goodsthat arepartway throughthe manwfacturing process not yet complete. Nissan,the work in process bwt At inventoryconsists of partially completed vehicles. 3. Finished goodsinventory completed goods that hauenot yet beensold.Nissan is in business sell completed to cars,not work in process. Manufacturers sell their finishedgoodsinventoryto merchandisers. Nissan,for example,sellsits completed automobiles retail dealerships. to Somemanufacturers, suchas The Original MattressFactory, their productsdirectlyto consumers. sell Exhibit 2-2 summarizes differences the amongservice, merchandising, and manufacturin companies. g Service,Merchandising,and ManufacturingCompanies
ServiceColmpralries Examples Advertising agencies Banks Law firms Insurance companies
Intangible services
g M m:ch anr-{isinilompnnics
Amazon.com Kroger ITal-Mart Wholesalers
Tangible products purchased from suppliers
&tanrmf lrring Cornpanics ;;tcf Procter& Gamble DaimlerChrysler Dell Computer Nissan
New tangible producrs made as w orkers and equi pment convert raw materials into new finished products
't'l
rir,
;f,:
ir ii.i ::
i,,'
Primary Output
til
Type(s)of Inventory
None
ai
I I,,,,,r:r- ,r,
49
ffi
Inc.? What type of company is Outback Steakhouse, &,ffi s ip, f mS;om e c o mp a n i e s d o n ' t fi t n i c e l y i n to one of the three categori esdi sr Outback has some elements of a servicecompany (it serveshuncussed previously. g ry pat r ons ) ,s om e e l e me n ts o f a m a n u fa c tu rl n gcompany (i ts chefs convert raw company (i t a int i n g r edient s o f ini s h e dme a l s ), n d s o me e l e mentsof a merchandi si ng reallya hybrid of the three bottles of wine and beer).Outback is seilsready-to-serve types of companieswe just discussed.
As the "Stop & Think" shows, not all companies are strictly service, merchandising, or manufacturing firms. Recall from Chapter 1 that the U.S. economy is shifting more toward service. Many traditional manufacturers, such as General Electric fGE;, h"rr. developed profitable service segments that provide much of their company's profits. General Motors now earns more from its financing and insurance operations than it does from car sales. Even merchandising firms are getting into the "service game" by selling extended warranty contracts on merih"ttdir. sold. Retailers offer extended warranties on products ranging from furniture and major appliances to sporting equipment and consumer electronics. \flhile the merchandiser recognizes a liability for these warranties' the price charged to customers for the warranties greatly exceedsthe company's cost of fulfilling its warranty obligations.
TheValueChain
Ghain Value
.l
.:-r:r:ri::r1t::tr,,
rii:::lrrl::
r:i :!i::::l
50
Chapter2
Researchand Development (R&Dl: Researching and deueloping new or improued products or seruicesand the processes for producing them. Nissan continually engagesin researching and developing new technologies to incorporate in its vehicles (such as GPS systems,"smart keys," and automatic headlamps)and in its manufacturing plants (such as manufacturing robotics). Nissan's GREEN program aims at developing fuel cells for vehicles, new ultra-low emission vehicles, new hybrid vehicles, and better fuel economy on existing models. Nissan currently spendsover Y300 billion (approximately $2.6 billion) ayear in R&D. Design: Detailed engineering of products and seruicesand the processesfor prodwcing them.Nissan's CEO describesdesign as the "interface between customers and the brand." Nissan's designersneed to fulfill customers' desiresfor vehicle style, features, safety, and quality. Nissan's goal is to engineer its products to create "total customer satisfaction." (Nissan has embraced total quality management.)As a result, Nissan employs over 500 designers in North America and introduced 1.2 new models as part of its revival plan. Designers consider not only what the customers want but also how to mass-produce the vehicles. BecauseNissan produces over 3 million vehiclesper year, engineersmust design production processes to be flexible (to allow for new features and models) and efficient. These initiatives cost a lot of money. Nissan's new technical center alone cost over $ 1 1 8 million to build. Despite these costs, new models and production designswere critical to Nissan's turnaround. Production or Purchasesz Resourceswsed to prodwce a prodwct or seruice or to pwrchase finished merchandise intended for resale. For a manufacturer such a s N i s s a n , t he producti on acti vi ty i n the val ue chai n i ncl udes the cost s incurred to make the vehicles. These costs include raw materials (such as s te e l ), p l a n t l abor (such as machi ne operators' w ages and benefi ts) , and manufacturing overhead (such as plant utilities and equipment depreciation). For a merchandisersuch as Best Bu5 this value-chain activity includes the cost of inventory, such as CDs, TVs, and PCs that the company buys to re s e l l to c u stomers. It al so i ncl udes al l costs associ atedw i th getti n g t he i n v e n to ry to the store ready for sal e, i ncl udi ng frei ght-i n costs an d any import duties and tariffs. As part of Nissan's revival plan, it opened new manufacturing facilities, including a state-of-the-art facllity in Canton, Mississippi. Nissan's new investments in plant and equipment cost over Y377 btllion (approximately $3.3 billion). Thesecosts are part of the production stageof the value chain. Nissan was also able to cut some production costs. Nissan slashed purchasing costs over 20% by working with suppliers of major components, such as tires, engines, and steel.To cut costs through JIT production, some of Nissan's suppliers have moved their own manufacturing facilities right next door to Nissan's! Marketing: Promotion and aduertisingof prodwcts or seruices. The goal of marketing is to createconsumer demand for products and services. Nissan usesprint advertisementsin magazinesand newspapers,billboards, and television advertisingto market its vehicles. But Nissan's revival plan includes much more than simply advertisingtheir new models. Part of its marketing effort was directed at the dealershipsthat sold its vehicles.Nissan worked with dealerships make them more to effective and attractive to consumersshopping for cars so that customerswould "sensequality" when walking into a Nissan dealership'sshowroom. As a result, most dealerships improved their cosmeticappearance and interior layout.
5t
Distribution: Deliuery of products or seruicesto customers.Nissan sells most of its vehicles through traditional dealerships.However, more customers are ordering "build-your-own" vehiclesthrough Nissan's'web site. People who are willing to wait a short time can have the features they want rather than settle for one of the vehiclesin stock at the local dealership.Forrester Research,an independent researchfirm specializing in the impact of technology on businessand consumers, expects build-to-order car salesto account for 21'oh of all new car sales by 2010, up from 5,,/oin 2001,.1Nissan's distribution costs include the costs of shipping the vehiclesto retailers and customers and the costs of setting up and administering \Web-basedsales portals. Other industries use different distribution mechanisms. Tupperware primarily sells its products through home-based parties. Amazon.com sells only through the Internet. Until recently, Lands' End sold only through catalogs and the'Sfeb. Now, it also distributes its products through Sears' retail outlets. \WebVantried, but failed, to create an online delivery-only grocery store. Customer Service:Swpport prouided for cwstornersafter the sale. Nissan incurs substantial customer service costs, especiallyin connection with warranties on new car sales.Nissan generally warranties its vehicles for the first three years and/or 36,000 miles, whichever comes first. Nissan cut warranty costs by Y41.million in 2004. How? Through total quality management (TQM). Nissan testseuery vehicle rolling off the Canton plant production line before shipping it out. Nissan also emphasizesquality right from the start, beginning with R&D.
Design costs to develop each client's ad campargn. Marketing costs to obtain new clients. Distribwtion costs to get the ads to the media. Customer sentice costs to address each client's concerns.
lDave Hirshchman, "Coming soon: buib-to-order cars deliuered in 10-15 days," The Atlanta Journal Constitution, March 25,2001, p. Q1.
52
Chapter 2
Costs are classified as either direct or indirect with respect to the cost object. A direct cost is a cost that can be traced to the cost object. For example, say the cost object is one Xterra. Nissan can trace the cost of tires to a specific Xterra; therefore, the tires are a direct cost of the vehicle. An indirect cost is a cost that relates to the cost object but cannot be traced to it. For example,Nissan incurs substantialcost to run the Xterra manufacturing plant, including utilities, property taxes, and depreciation on the plant and equipment. Nissan cannot build an Xterra without incurring these costs, so the costs are related to the Xterra. However, it's impossibleto trace a specificamount of these costs to one Xterra. Therefore, these costs are indirect costs of an Xterra. As shown in Exhibit 2-4, the same costs can be indirect with respect to one cost object yet direct with respectto another cost object. For example, plant and equipment
depreciation, property taxes, and utilities are indirect costs of an Xterra. However, if management wants to know how much it costs to run the Canton manufacturing plant, the plant becomesthe cost object; so the same depreciation, tax, and utility costs are direct costs of the manufacturing facility. Whether a cost is direct or indirect depends on the specifiedcost object. In most cases,we'll be talking about a unit of product (such as one Xterra) as the cost object. If a company wants to know the total cost attributable to a cost object, it must assign all dtrect and indirect costs to the cost object. Assigning a cost simply means that you are "attaching" a cost to the cost object.'Sfhy? Becausethe cost object causedthe company to incur that cost. In determining the cost of an Xterra, Nissan assignsboth the cost of the tires and the cost of running the manufacturing plant to the Xterras built at the plant. Nissan assignsdirect costs to each Xterra by tracing those costs to specific units, or batches.However, becauseNissan cannot trace indirect costs to specific units or batches,it must allocate these costs to the vehiclesproduced at the plant.'We will discussthe allocation process in more detail in the next chapter; but for now, think of allocation as dividing up the indirect costs over all of the units produced, just as you might divide a pizza amongfriends. Exhibit 2-5 illustrates these concepts.
l|.,
li
ffirii
\X/hy is this terminology important? Becauseit helps managers understand how accountants arrive at cost figures. Direct costs are traced to cost objects so th at m anager s an d a c c o u n ta n ts a re c o n fi d e nt that the amount of di rect cost assignedto a cost object is very accurate. For example, managers are confident i n t he t ir e c os t a s s i g n e d to o n e X te rra b e cause they can trace a parti cul ar Xterra's four tires (plus a spare tire) back to a specific invoice. In contrast, indirect costs are allocated rather than traced; so the amount of indirect cost a ss igned t o a c os t o b j e c t i s mo re o f a n e s ti mate. A s a resul t, managers and a cc ount ant s ar e l e s s c o n fi d e n t i n th e a mo u nt of i ndi rect cost assi gned each Xterra. Managers know the total amount of indirect costs from paying utility and tax bills and recording depreciation expense.However, the diuision of the total amount of indirect costs among the vehiclesis lessprecise.Therefore, managers are less confident in the amount of indirect cost that should be assignedto the cost object (for example, the amount of utilities cost that should be assigned to a particular Xterra).
54
Chapter 2
ldentify the inventoriable product costs and period costs of merchandisingand manufacturingfirms
55
Inventory -r
of Cost g o o d s so l d
0perating expenses
56
Chapter 2
Silop o<Think,..
for What arethe inventoriable costs a service suchas H&RBlock? firm Ar*ruu+g*r: firmssuchas H&R Blockhaveno inventory products sale. Service of for todayand storedup to selllater. Services cannotbe produced Because firms service haveno inventory they haveno inventoriable costs.Instead, they haveonly period costs that areexpensed incurred. as
FroductCost
Manufacturing companies' inventoriable costs include only those costs incurred during the production element of the value chain. As shown in Exhibit 2-7, manufacturers such as Nissan incur three types of manufacturing costs when making a product (the product is the cost object): direct materials, direct labor, and manufacturing overhead.
i1i'.
Direct Materials (DM)
Manufacturers convert raw materials into finished products. Direct materials are the primary raw materials that become a physical part of the finished product. Xterra's direct materials include steel, tires, engines, upholstery, carpet, and dashboard instruments such as the speedometerand odometer. Nissan can trace the cost of these materials (including freight-in and any other charges,such as import duties, necessaryto obtain the materials) to specific units or batches of vehicles;thus, they are direct costs of the vehicles.
57
o Indirect material includes materials used in the plant that are not easily traced to individual units. For example, indirect materials often include janitorial supplies, oil and lubricants for the machines, and any physical components of the finished product that are inexpensive.For example, Nissan might treat the invoice sticker placed on each vehicle'swindow as an indirect material. Even though the cost of the sticker (about $0.10) couldbetraced to the vehicle,it wouldn't make much sensero do so. Why? Becausethe cost of tracing the sticker to the vehicle outweighs the benefit management receivesfrom the increased accuracyof the information. Therefore, Nissan treats the cost of the sticker as indirect material, which becomespart of manufacturing overhead. . Indirect labor includes the cost of all employeesin the plant other than those employeesdirectly converting the raw materials into the finished product. For wages,and benefitsof plant example,at Nissan, indirect labor includesthe salaries, forklift opefators, plant security officers, plant ianitors, and plant supervisors. . Other indirect manufacturing costs include insurance and depreciation on the plant, plant equipment depreciation, plant property taxes, plant repairs and maintenance, and plant utilities. Indirect manufacturing costs have groWn in recent years as manufacturers automate their plants. These costs continue to increaseas manufacturers install the latest technology.
In summary, manufactwring ouerhead includes only those indirect costs that are related to tbe manufactwring plant.Insurance and depreciation on the plant's building and equipment are indirect manufacturing costs, so they are part of manufacturing overhead. In contrast, depreciation on deliuery trucks is not a
Chapter 2
manufacturing cost. Delivery is part of the distribution element of the value c h a i n , s o i ts c o st i s a di stri buti on expense (a peri od expense).S i mi l arl S aut o insurance for the sales force's vehicles is part of the marketing element of the value chain, so its cost is a marketing expense (a period expense). These two expenses are not part of manufacturing overhead because they do not relate to production at the plant.
59
for automobiles manufactured in the United States, the cost of health care assigned to the vehicle is greater than the cost of the steel in the vehicle! Throughout the remainder of this book, any referencesto wages or salariesalso include the cost of fringe benefits.
(losts Perriod
. Always recorded as an expense . Never considered part of inventory
Merchandising company
. All costs along the value chain except for the purchaseselement . For example, salaries,depreciation expense, utilities, insurance, property taxes, advertising, and f.reieht-out
Manufacturing company
. All costs along the value chain except for the production element . For example, R&D; freight-out; all expenses for executive headquarters (separate from plant), including depreciation, utilities, insurance, and property taxes; advertising; and CEOt salary
60
Chaoter2
Decision Guidelines
Burtorrrrc Br-ocrsor MarulcenrruAccouNTlNG
Dell engagesin manufacturing when it assembles computers, merchandising when it sellsthem on its \7eb site, and its support seruicessuch as start-up and implementation services.Dell had to make the following types of decisionsas it developed its accounting systems.
Decision
How do you distinguish among service,merchandising, and manufacturing companies?How do their balance sheetsdiffer?
Guidelines
Seruicecompanies: . provide customerswith intangible services . Have no inventories on the balance sheet Mer chandising comp anies: . Resell tangible products purchased ready-made from suppliers . Have only one category of inventory Manufa ctur ing comp ani es: . Use labor, plant, and equipmenqto transform raw materials into new finished prfdu.t, o Have three categoriesof inventory: 1. Raw materials inventory 2. \7ork in processinventory 3. Finished goods inventory
All of the elements the valuechain,including: of . R&D . Design . Productionor Purchases o Marketing . Distribution o Customer Service
Both direct and indirect costs are assignedto cost objects. Direct costs are traced to cost objects, whereas indirect costs are allocated to cost obiects.
'!7hat
costs should be assignedto cost objects such as products, departments, and geographic segments?
Which product costsare usefulfor internaldecision making,and which productcostsare usedfor external reporting? What costsare inventoriable under GAAP?
Managersusefull product costsfor productpricing and profitability decisions. However,GAAP requires compaproduct costs external niesto.u:e only for .inuentoriable trnanclalreportlng.
. Seruicecompanies:No inventoriable product costs . Merchandising companies: Purchasesand all costs of getting the merchandiseto its place of business(for example, freight-in and import duties) c Manufactwring companies: Direct materials, direct labor, and manufacturing overhead Inventoriable product costs are initially treated as assets (Inventory) on the balance sheet.These costs are expensed(as cost of goods sold) on the income statements when the oroducts are sold.
ffirmbEemS ffiwffiY&$Y?ffitr3fl
Requirements 1. Classify each of the following businesscosts into one of the six value chain elements: a. b. c. d. e. f. Costs associatedwith warranties and recalls Cost of shipping finished goods to overseascustomers Costs a pharmaceutical company incurs to develop new drugs Cost of a 30-secondcommercial during the Super Bowl Cost of making a new product prototype Cost of assemblylabor used in the plant
2. For a manufacturing company, identify the following as either an inventoriable product cost or a period cost. If it is an inventoriable product cost, classify it as direct materials, direct labor, or manufacturing overhead. a. b. c. d. e. f. g. h. Depreciation on plant equipment Depreciationon salespeople's automobiles Insurance on plant building Marketing manager'ssalary Cost of major components of the finished product Assembly-line workers' wages Costs of shipping finished products to customers Forklift operator's salary
ffim$wxtfrwwum
Requirement I a. Customer service b. Distribution c. Research Develooment and d. Marketing e. Design f. Production
Requirement 2
a. Inventoriable product cost; manufacturing overhead b. Period cost c. Inventoriable product costl manufacturing overhead d. Period cost e. Inventoriable product cost; direct materials f. Inventoriable product cost; direct labor g. Period cost h. Inventoriable product cost; manufacturing overhead
61
62
Chapter 2
The difference between inventoriable product costs and period costs is important becausethey are treated differently in the financial statements.All costs incurred in the production or purchasesstage of the value chain are inventoriable product costs that remain in inventory accounts until the merchandise is sold-then, these costs become the cost of goods sold. However, costs incurred in all other areas of the value chain (R&D, design,marketing, distribution, and customer service)are period costs, which are expensedon the income statement in the period in which they are incurred. Keep these differencesin mind as we review the financial statementsof service firms (which have no inventory), merchandising companies (which purchase their inventory), and manufacturers (which make their inventory).
Service ffimmpmnf,es
Servicecompanies have the simplest accounting. Exhibit 2-11 shows the income statement of eNow!, a group of e-commerceconsultants. The firm has no inventory and, thus, no inventoriable costs, so eNow!'s income statement has no Cost of Goods Sold. Rather, all of the company's costs are period costs, so they are shown grouped together under operating expenses.
Revenues Operating expenses: Sa la r ye xp ense Office r e n t expense........ Depreciation expense-furniture and equipment M a r ke tin g expense....... T o ta l o perati ngexpenses....... Op e r a tin g in co me........ 5105,000 18,000 3,500 2,500
$160,000
In this textbook, we always use "operating income" rather than "net income" as the bottom line on the income statement since internal managers are particularly concerned with the income generated through operations. To determine "net income," we would have to deduct interest expenseand income taxes from "operating income" and add back interest income. In general, "operating income" is simply the company's income before interest and income taxes.
63
and track lights that it buys to resell, plus freight-in. Merchandisers such as Apex comDute the Cost of Goods Sold as follows:2
Exhibit 2-12 shows Apex's completeincome statement, where we have highlightedthe Cost of Goods sold computation.Notice that the Cost of Goods grossprofit. All Sold is deducted from Sales Revenue determine company's the to (period costs)are then deducted operatingexpenses from grossprofit to arrive at operatingincome.
Merchandiser's lncomeStatement
ManufacturingCompanies
Exhibit 2-13 shows the income statement of Top-Flight, a manufacturer of golf equipment and athletic shoes.Compare its income statementwith the merchandiserb income statement in Exhibit 2-12. The only difference is that the merchandiser (Apex) usespwrchasesand freight-in in computing Cost of Goods Sold, whereas the manufacturer (Top-Flight) uses the cost of goods manufactwred (we've highlighted both in blue). Notice that the term cost of goods manufactured is in the past tense.It is the cost of manufacturing the goods that Top-Flight finished producing during
2To highlight the roles of beginning inventory, purchases, and ending inventory, we assume that Apex uses a periodic inventory system. However, even companies that use perpetual inventory systems during the year recalculate Cost of Goods Sold this way before preparing their annual financial statements.
64
Chapter2
2007. This is the manufacturer's cost to obtain new finished goods that are ready to sell. Thus, it is the counterpart to the merchandiser'spwrchases.
$5s,000
10,000 $15,000
3We assume that Top-Flight uses its indirect materials as soon as they are purchased rather than storing them in Raw Materials Inventory. In Chapter 3, we expand the discussion to include manufacturers who store indirect materials in the Raw Materials Inventory account until they are used in production.
65
Exhibit 2-15 showsthat Top-Flight begins2007 with $2,000 of partially golf clubs and shoes completed on that remained the plant floor at the closeof business December on 31,,2006. During 2007,Top-Flight's productionplant used$14,000of directmaterials, The sum of $19,000 of direct labor, and $12,000 of manufacturingoverhead. thesethree costs ($45,000)represents total manufacturingcostsincurred the during the year. Adding the total manufacturingcosts incurred during the year ($45,000) the beginning\Xlork Process ($2,OOO; givesthe to in Inventorybalance ($47,000).This figure represents total total manufacturing cosrsto accountfor the manufacturing cost assigned all goodsthe plant worked on during the year.The to plant finishedmost of thesegoodsand sentthem to FinishedGoodsInventory,but some were not finished.By the close of business December31.,2007, on Top-Flight had spent $5,000 on ending work in processinventory that Iay partially completeon the plant floor. The final stepis to figure out the cost of goods manufactwred dwring2007that is, the cost of the goods that Top-Flight finished during 2007. Of the $47,000 total manufacturingcosrsto accountfor during the year,$5,000 has been assigned unfinishedunits in ending work in processinventory.That to meansthe rest of the cost ($42,000)is assigned units that were finished.Topto Flight'scost of goodsmanufactured 2007 Is $42,000($47,000- $5,000). for
66
Chapter 2
Beginning work in progress inventory.....,.. Add: Direct materials used Beginning raw materials inventory"..,.... Purchases of direct materials including freight-in
1., ^-l ^-,.:*-^-* a n u a n y lm port outl es...
$ 9,000 27,000 36,000 (22,000], $14,000 19,000 $ 1,500 3,500 3,000 4,000 12,000 45,000 47,000 (s,000) $42,000
Ava ila b lefo r u se............. Ending raw materials inventory......... Dir e ct m a te r ia lsu se d.............. Direct labor..... Manufacturing overhead: Indirect materials In d ir e ct la b o r ............... Depreciation-plant and equipment.......
Pla n t u tilitie s,insurance,and property taxes............ Manufacturing overhead.......... Total manufacturing costs incurred during year ................ T o ta l m a n u fa ctu r in gcoststo account for.......................... L e ss:En d in g wo r k in processi nventory............................. Costs of goods manufactured..
"For simplicity,we assume that Top-Flight's Raw Materials Inventory accountcontainsonly direct materials bec'ause companyusesindirect materialsas soon as they are purchased. Chaoter 3, we expand the discussion the In to includemanufacturers who store both dlrr rials Inventory accountuntil they are usedin oroduction.
T a k e ti me t o see how the schedul e of cost of Goods Manufact ur ed (Exhibit 2-15) captwes rhe flow of cosrs through the Raw Materials and nflork i n Pro c e s sIn v e n tory accounts. The Income S tatement (E xhi bi t 2-13) cap t ur es the flow of costs through the Finished Goods Inventory account. Some manu-
67
facturers combine the flow of costs through all three inventory accounts into one combined Schedule of C o s t o f G o o d s Manufactured and C ost of Goods So l d , and t hen s h o w o n l y th e re s u l ti n g C o st of Goods S ol d fi gure on the lncome statement.
27 36,000
For simplicity, we assumethat Top-Flight's Raw Materials Inventory account contains only direct materials rhey are purchased.In Chapter 3,_weexpand the discussionto becauseihe company usesindirect mat&ials as soon "s include manufaciurers who store both direct and indirect materials in the Raw Materials Inventory account until they are used in oroduction.
68
Chapter 2
Cas h. . . . . . . . . . . . . . . . Accounts receivable........ ( t I nv ent or yEx h i b i 2 - 1 2 ) . . . . . . . . . . . . Pr : epaid pe n s e s... . . . . . . ex . Totalcr:rrent .. assets ...
69
controllable costs from uncontrollable costs.In the long run, most costs are controllable, meaning management is able to influence or change them. However, in the short run, companies are often "locked in" to certain costs arising from previous decisions.These are called uncontrollable costs. For example, Nissan had little or no control over the property tax and insurance costs of their existing plants. These costs were "locked in" when Nissan built its plants. Nissan could replace existing production facilities with different-sizedplants in different areasof the world that might cost lessto operate, but that would take time. To seeimmediate benefits, management had to changethose costs that were controllable at present. For example, management could control costs of research and development, design, and advertising. Recall that Nissan's management chose to increase rather than decreasethese costs! Management knew it would have to design and market new models to successfullycompete. However, Nissan was able to decrease other controllable costs, such as the price paid for raw materials, by working with its suppliers. In short, management'splans to revitalize the company focused first on costs that were controllable in the short run.
Comparison of RelevantInformation
Differential : Cost : ($86s) I ?) R (70): t9,1,40 2,760
$1,825
Sentra
Car's price S a l e st a x ( 8 % ) ( r o u n d e d to th e n e a r e std o lla r ) Insurance' Total relevant costs '''Ou.t tt* iiu" y.";r (60 pl"n roi..p ih.."" -.*h".)yo.,
Corolla
$37,s38
70
Chapter 2
Another cost that is irrelevant to your decision is the cost you paid for the vehicle you currently own. Say you just bought a Ford F-150 pickup truck two months ago, but you've decided you need a small sedan rather than a pickup truck. The cost of the truck is a sunk cost. Sunk costs are costs that have already been incurred. Nothing you do now can change the fact that you aheady bought the truck. Thus, the cost of the truck is not relevant to your decision of whether to buy the Sentra versus the Corolla. The only thing you can do now is (1) keep your truck or (2) sell it for the best price you can get. Management often has trouble ignoring sunk costs when making decisions,even though they should. Perhaps they invested in a factory or a computer system that no longer servesthe company's needs.Many times, new technology makes management's past investments in older technology look like bad decisions, even though they weren't at the time. Management should ignore sunk costs becauseits decisionsabout the future cannot alter decisionsmade in the past.
Classifycosts as fixed o r varia ble an d calculatetotal and average costs at different volumns
FfixedamdWmrfimh$e ffimwts
without first knowing how their Managerscannotmake good plans and decisions 'We as Costsgenerally behave fixed costsor variablecosts. will spend costsbehave. cost behavior. For now, let's look just at the basics. all of Chapter6 discussing Fixed costsstayconstantin total over a wide rangeof activity levels.For example, to costfor the yearis $3,828 let'ssayyou decide buy the Corolla, so your insurance ($319 per month x 12 months).As shown in Exhibit 2-1.9, your insurance cost staysfixed whetheryou drive your car 0 miles,1,000miles,or 10,000milesduring the year.
FixedCost Behavior
3' e) l, I 1ii,
il
g. $3,828
6
o g o o
L tll
ril
I.
;i
ll
': 1:
Milesdriven
ti;r'
However, the total cost of gasoline to operate your car varies depending on whether you drive 0 miles, 1,000 miles, or 10,000 miles. The more miles you drive, the higher your total gasoline cost for the year. If you don't drive your car at all, you won't incur any costs for gasoline.Your gasoline costs are variable costs, as s h o w n i n Ex h i b i t 2-20.Y ari abl e costs change i n total i n di rect proportion t o changesin volume. To accuratelyforecastthe total cost of operating your Corolla during the year, you need to know which operating costs are fixed and which are variable.
71
il
,i]i1];l]:i;i!:!1i!ill:1!l!li::ii]:4i]i:i!]1i'11i!i]ii]:|]ii:|i|]i!:!:]!il]1!t!|}:i1i:l::::]::i:lijiii1i:li
72
Chapter 2
\7hat is the averagecost of manufacturing each Xterra next year? It's the total cost divided by the number of units:
can they managers decidethey needto produceL2,000Xterrasinstead, If Nissan's predicttotal costsas follows? simply
.V/hy? Because auerage the costper wnit is NOT appropriatefor No! They cannot! predictingtotal costs differentleuels owtpzl.Nissan's managers shouldforecast at of on total cost based cost behavror:
cost of $80 million lessthan the fauby predictionof Why is the correctforecasted stemsfrom fixed costs.Remember, Nissan incurs $84 million? The difference costs whetherit makes10,000vehicles 12,000 or $20 million of fixed manufacturing costsare spread vehicles. Nissanmakesmore Xterras,the fixed manufacturing As cost declines. Nissanendsup making If so overmorevehicles, the average per vehicle manufacturingcost per Xterra decreases follows: as L2,000vehicles, new average the
73
The averagecost per unit is lower when Nissan produces more vehiclesbecause it is using the fixed manufacturing costs more efficiently-taking the same $20 million of resourcesand making more vehicleswith it.
Finallg a marginal cost is the cost of making one more unit. Fixed costs will not change when Nissan makes one more Xterra unless the plant is operating at 100o/o capacity (24 hours aday,7 days a week, 365 days a year) and simply cannot make one more unit. (If that's the case, Nissan will need to incur additional costs to expand the plant.) So, the marginal cost of a unit is simply its variable cost. As you have seen,management accountantsand managersuse specializedterms 'Sfithout for discussingcosts. They use different costs for different purposes. a solid understanding of theseterms, managers are likely to make serious judgment errors.
74
Chapter2
Decision Guidelines
Butorvc Blocrs or Manlcenral AccouNTrNG
As a manufacturer, Dell needs to know how to calculate its inventoriable product costs for external reporting. Dell also needsto know many characteristicsabout its costs (that is, which are controllable, which are relevant to different decisions,which are fixed, and so forth) in order to plan and make decisions.
Decision
How do you compute cost of goods sold?
Guidelines
. Seruice companies: costof goodssold because No they don't selltangiblegoods . Merchandising comparues: Beginninginventory plus freight-in and import duties.if an)' + Purchases = Cost of goodsavailable sale for Ending inventory = Cost of goodssold . Manufacturi ng comp ies an : Beginningfinished goodsinventory + Cost of goodsmanufactured = Cost of goodsavailable sale for Endinefinishedsoodsinventorv = Cost of goodssold
Costs are relevant to a decision when they differ between alternatives and affect the future. Thus, differential costs are relevant, whereas sunk costs and costs that don't differ are not relevant.
To forecast total costs,managers shouldcompute: Total - I'il + (Variable perunit x Numberof units) cost cost txed costs "
Managers should not :use product's aueragecost to a forecast total costs becauseit will change as production volume changes.As production increases, the average cost per unit declines (becausefixed costs are spread over more units).
Problerm A Summary
Requirements 1. Show how to compute cost of goods manufactured. Use the following amounts:direct materialsused ($24,000),direct labor ($9,000),manufacturing overhead($17,000), beginningwork in processinventory ($5,000;, and ending work in processinventory ($4,000). 2. Auto-USA spent $300 million in total to produce 50,000 cars this year. The $300 million breaks down as follows: The company spent $50 million on fixed costs to run its manufacturing plants and $5,000 of variable costs to produce each car. Next year, it plans to produce 60,000 cars using the existing pr oduc t ion f aci l i ti e s . 'S7hat a. is the current dueragecost per car this year? b. c. d. Assuming there is no change in fixed costs or variable costs per unit, what is the total forecasted cost to produce 60,000 cars next year? What is the forecastedaueragecost per car next year? \X/hy does the averagecost per car vary between years?
Smf,uftf;mns
Requirement I Cost of goodsmanufactured:
Requirement
a. Total cost + Number of units = Current averagecost $300 million + 50,000 cars = $6,000 per car b. Total fixed costs + Total variable costs = Total projected costs $50 million + (60,000 cars X $5,000 per car) = $350 million c. Total cost + Number of units = Projected averagecost $3S0 million + 60,000 cars = $5,833 per car d. The average cost per car decreases becauseAuto-USA will use the same fixed costs ($50 million) to produce more cars next year. Auto-USA will be using its resourcesmore efficiently, so the ayeragecost per unit will decrease.
75
RgVigVlf
wAccounting Vocabulary
Allocate. (p. 53) To assign an indirect cost to a cost obiect. Assign. (p. 53) To attach a cost to a cost obiect. Average cost. (p, 72) The total cost divided by the numberof units. Controllable Gosts, (p. 69) or Coststhat can be influenced changedby management. Conversion Costs. (p. 58) of The combination direct labor and manufacturing overheadcosts. Gost Object. (p, 52) want a separate Anythingfor which managers of measurement costs. Cost of Goods Manufactured. (p. 63) (or cost of the The manufacturing plant-related) goods that finishedthe productionprocessthis oeriod. Customer Service. (p. 51) Support providedfor customersafter the sale. Design. (p. 5O) Detailedengineering productsand services of for and the processes producingthem. Differential Cost. (p, 69) The difference cost betweentwo alternative in coursesof action. Direct Cost. (p. 52) A cost that can be traced to a cost obiect. Direct Labor. (p. 56) who The cost of compensating employees physically into the comconvertraw materials pany'sproducts;laborcosts that are directly traceableto the finishedproduct. Direct Materials. (p. 56) Primaryraw materials that becomea physical part of a finishedproductand whose costs are traceableto the finishedproduct. Distribution. (p, 5l) Delivery productsor servicesto customers. of Finished Goods Inventoty. (p. 48) Completedgoods that havenot yet been sold. Fixed Costs. (p.7O) Coststhat stay constantin total despitewide changesin volume. Full Product Gosts. (p. 54) used throuqhoutthe The costs of all resources valuechain for a product. Indirect Gost, (p. 52) A cost that relatesto the cost obiect but cannot be traced to it. Indirect Labor. (p. 57) Laborcosts that are ditficultto trace to specific products. Indirect Materials. (p, 57) Materials whose costs are difficultto trace to specificproducts. Inventoriable Product Costs. (p, 54) All costs of a productthat GMP requirescompanies to treat as an asset (inventory)for exterThesecosts are not nal financialreporting. expenseduntilthe product is sold. Manufacturing Company. (p. 47) A companythat uses labor,plant,and equipment to convertraw materials into new finished oroducts. Manufacturing Overhead. (p. 57) All manufacturing costs other than direct materialsand direct labor.Also called factory cost. overheadand indirectmanufacturing Marginal Cost. (p. 73) The cost of producingone more unit. Marketing. (p. 5O) Promotionand advertising productsor of servrces. Merchandising Company. (p, 47) A companythat resells tangibleproductspreviously bought from suppliers. Period Gosts. (p. 54) Operatingcosts that are expensedin the period in which thev are incurred.
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Chapter 2
Prime Costs. (p. 58) The combination direct materialand direct of labor costs. Production or Purchases. (p. 50) Resources used to producea productor service or to purchase finishedmerchandise intended for resale. Raw Materials Inventory. (p. 48) (directmaterials All raw materials and indirect materials) yet used in manufacturing. not Research and Development (R&D), (p. 50) Researching and developingnew or improved productsor servicesor the processes profor ducingthem. Retailer. (p. 47) Merchandising companythat sellsto consumers. Service Gompany. (p. 47) A companythat sells intangible servicesrather than tangibleproducts. Sunk Gost. (p. 7O) A cost that has alreadvbeen incurred.
TFace. (p. 53) To assignadirect cost to a cost object. Uncontrollable Gosts. (p. 69) Coststhat cannot be changedor influenced in the short run by management. Value Chain. (p. 49) The activities that add valueto a firm's products and services.IncludesR&D,design,production marketing, distribution, or purchases, and customer service. Variable Gosts. (p. 7O) Costs that changein total in direct proportion to changesin volume. Wholesaler.(p.47) Merchandising companiesthat buy in bulk from manufacturers, mark up the prices,and then sellthose oroductsto retailers. Work in Process Inventory. (p. 48) Goodsthat are partwaythroughthe manufacturing processbut not yet complete.
wQ,uickCheck
L.
'Wal-Mart a, b. c. d. is a: servlcecompany retailer wholesaler manufacturer
77
4. Ifhich of the followingis not part of Nissan's manufacturing overhead? a. b. c. d. insurance on plant and equipment depreciation on its North American corporate headquarters in Nashville plant property taxes plant utilities
5. In computing cost of goods sold, which of the following is the manufacturer's counterpart to the merchandiser'spurchases? a. b. c. d. direct materials used total manufacturing costs incurred during the period total manufacturing costs to account for cost of goods manufactured
Questions 6,7, and 8 refer to the following list. Suppose Nissan reports (in millions of dollars)'
that Nissanused(in millions)? 6. What is the cost of the materials a. 99 b. 100 c. 101 d. 1.06 (in 7. What is the cost of goodsmanufactured millions)? 149 a. b. 150 c. 151
d. 1.s2
8. \fhat is the cost of goodssold (in millions)? a. 150 b. 1.52 c. 153 d. 1.s4
7A
Chapter 2
d. qualitative factors 'lfhich 10. of the following is true? a. b. c. d. Total fixed costs increaseas production volume increases. Total fixed costs decreaseas production volume decreases. Total variable costs increaseas production volume increases. Total variable costs stay constant as production volume increases.
79
AssessYour Progress
mLearning Objectives
among service, merchandising, manufacturing and companies ffit Distinguish ffit Describethe valuechainand its elements ffiTDistinguishbetweendirect and indirectcosts ldentifythe inventoriable product costsand period costsof merchandising and ffit manufacturing firms
ffi
Prepare financial the statements service, for merchandising, manufacturing and companies Describe coststhat are relevantand irrelevant decisionmaking for Classify costsas fixed or variableand calculate total and averagecostsat different volumes
m
M
wShort Exercises
s2-1
'Sfhich The current asset sections of the balance sheets of three companies follow. company is a service company? Which is a merchandiser?V/hich is a manufacturer? How can you tell?
s2-2
fdentify types of companies and inventories (LearningObiectiue1) Fill in the blankswith one of the following terms:manwfacturing, seruice, merchandising, retailer(s),wholesaler(s), raw materialsinuentory,merchandise inuentory,work in processinuentory,finished goods inuentory,freight-in, tbe cost of merchandise. generally haveno rnventory. a. companies b. Boeingis a company. c. Merchandisers' inventoryconsists of and -.
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Chapter2
d.
i.
Labor costs usually account for the highest percentageof companies' costs.
s2-3
2) Give examples of value chain functions (LearningObiectiue firm) might Give an example coststhat E*TRADE (an onlinebrokerage of functionsin the value chain' Provide incur in eachof the six business decideto anotherexamplethat showshow E"TRADE might deliberately the functionsto reduce costs spendmore moneyon one of the six business functions. in other business 2) Labelvalue chain functions (Leaming Obiectiue functions for List the correctvalue chain element eachof the six business described below. a. Deliveryof productsand services for and b. Detailedengineering productsand services the processes proof them ducing of c. Promotionand advertising product or services and new or improvedproductsor services the processes d. Investigating for producingthem after the sale e. Supportprovidedto customers f. Resources usedto makea product or obtain finishedmerchandise 2) Cfassify costs by value chain function (Leaming Obiectiue (HP's)costsas one of the six business Classifyeachof Hewlett-Packard's functionsin the valuechain. Depreciation Roseville, California,plant on ^. site supportcenter\Web b. Costsof a customer suchas c. Transportation coststo deliverlaserprintersto retailers BestBuy lab d. Depreciation research on e. Cost of a prime-timeTV ad featuringthe new HP logo new printer who are developing f. Salaryof scientists HP laboratories at
technologies
o D
s2-4
s2-5
Purchaseof plastic used in printer casings Salary of engineerswho are redesigning the printer's on-off switch Depreciation on delivery vehicles Plant manager's salary
h
I
81
s2-6
Gfassify costs as direct or indirect (Learning Objectiue 3) Classify the following as direct or indirect costs with respect to a local Blockbuster store (the store is the cost object). In addition, state whether Blockbuster would trace or allocate these costs to the store. a. b. c. d. e. f. g. h. Store utilities The CEO's salary The cost of the DVDs The cost of national advertising The wages of store employees The cost of operating the corporate payroll department The cost of Xbox, PlayStation, and Nintendo games The cost of popcorn and candy sold at the store
s2-7
Give examples of manufacturing costs (Leaming Obiectiue4) ConsiderMarvin \Tindows' manufacturing plant. Give two examples eachof of the following: a. Direct materials b. Directlabor c. Indirectmaterials d. Indirectlabor e. Other manufacturing overhead
s2-8
Gfassify inventoriable and period costs (LearningObiectiue 4) Classify eachof Georgia-Pacific's as eitherinventoriable costs productcostsor period costs. is Georgia-Pacifica manufacturer paper, of Iumber, buildingmaterial products. and a. Depreciation the gypsumboardplant on b. Purchase lumberto be cut into boards of c. Life insurance CEO on d. Salaries scientists of studyingwaysto speed forestgrowth e. Cost of new softwareto track inventoryduring production f. Cost of electricity one of Georgia-Pacific's papermills at g. Salaries Georgia-Pacific's executives top of h. Cost of chemical appliedto lumberto inhibit mold from developing i. Cost of TV adspromotingenvironmental awareness
s2-9
Cfassify a manufacturer's costs (Learning Objectiue4) Classifyeachof the following costsas a period cost or an inventoriable product cost. If you classifythe cost as an inventoriableproduct cost, further classifyit as direct material(DM), directlabor (DL), or manufacturing (MOH). overhead productionequipment a, Depreciation automated on b. Telephone bills relatingto customer service center call paid to assembly-line c. Wages and benefits workersin the manufacturing plant d. Repairsand maintenance factoryequtpment on e. Lease paymenton administrative headquarters f. Salaries paid to quality control inspectors the plant in g. Propertyinsurance-40% of building is usedfor sales and administration;600/o of buildingis usedfor manufacturing h. Standard packaging materials usedto package individualunits of product for sale(for example, cerealboxesin which cerealis packaged)
a2
Chapter 2
S2-10
Classify costs incurred by a dairy processing company (Learning Objectiue 4) Each of the following costs pertains to DairyPlains, a dairy processing company. Classify each of the company's costs as a period cost or an inventoriable product cost. Further classifyinventoriable product costs as direct material (DM), direct labor (DL), or manufacturing overhead (MOH).
Period Cost or Inventoriable Product Cost ?
Cost
I. Cost of milk purchased from local dairy farmers
2. Lubricants used in running bottling machines 3 . Depreciation on refrigerated trucks used to collect raw
frorn local dairy farmers
milk
4 . Property tax on dairy processingplant fo 5. T e l e v i s i o na d v e rtise m e n ts r Da ir yPla in s'p r o d u cts 6. Gasoline used to operate refrigerated trucks delivering
finished dairy products to grocery stores 7. Company president's annual bonus 8. Plastic gallon containers in which rnilk is packaged 9. Depreciation on marketing department's computers 10. Wages and salariespaid to nachine operators at dairy processingplant 11. Researchand development on improving milk pasreurlzailon process
S2-11
4) Determine total manufacturing overhead (LearningObiectiue include March records the Suppose company's cameras. manufactures disposable Snap's costin March? overhead total manufacturing the itemsdescribed below.\7hat is Snap's
Glue for camera frames on Depreciatiorlexpense company cars fo u s e db y s a l e s rc e ... ................ e P lirn td e p re c i a ti o n x p e n s e I nte re s te x p e n s e ....... s Co mp a n y p re s i d e n t' s a 1 a ry ..... ..... salary Plant supervisor's j a n i to r' s s a l a ry ....... P la n t e O il fo r:m a n u fa c tu ri n g q u i p me nt.................. F-lashbulbs 3,000 10' 00t) 2,000 25,000 4,000 1,000 25 50,000
250
83
S2-12
Compute Cost of Goods Sold for a merchandiser (Learning Objectiue5) Giventhe following informationfor CircuitsPlus,an electronics e-tailer, computethe cost of goodssold.
S2-13
Prepare a retailer's income statement (Leaming Obiectiue S) SalonSecrets a retail chain specializing salon-quality is in hair careproducts. During the year,SalonSecrets had salesof $38,230,000. The companybeganthe year with inventoryand endedthe year with $3,920,000of inven$3,270,000of merchandise tory. During the year,SalonSecrets purchased of inventory. $23,450,000 merchandise The company's general, selling, and administrative expenses totaled$6,115,000 for the year.Prepare SalonSecrets' incomestatement the year. for Recalculate Cost of Goods Manufactured (LearningObiectiueS) Turn to Exhibit2-t5.If directmaterial purchases freight-in and were$20,000rather than $27,000,what would be the cost of directmaterialsusedand the cost of goods (Othercosts manufactured? remainthe same in Exhibit2-15.) as Cafculate direct materials used (LearningObjectiueS) You are a new accounting intern at Sunny's Bikes.Your bossgivesyou the following information and asksyou to computethe cost of direct materialsused(assume that the company's raw materials inventorycontainsonly directmaterials).
S2-14
S2-15
84
Chapter 2
S2-17
Consider relevant information (Learning Obiectiue 6) You've been offered an entry-level marketing position at two highly respectablefirms: one in Los Angeles, California, and one in Sioux Falls, South Dakota. I7hat quantitative and qualitative information might be relevant to your decision? S7hatcharacteristics about this information make it relevant? Classify costs as fixed or variable (Learning Obiectiue 7) Classify each of the following personal expensesas either fixed or variable. In some cases,your answer may depend on specific circumstances.If so, briefly explain your answel a. b. c. d. e. f. g. Apartment rental Television cable service Cost of groceries \Vater and sewer bill Cell phone bill Health club dues Bus fare
52-18
w Exercises
E2-19 fdentify types of companies and their inventories (LearningObjectiue1) with one of the terms listedhere.You may usea Completethe following statements term more than once,and sometermsmay not be usedat all.
a. b. c. d. e. f. g.
produce their own inventory. typically have a single category of inventory. do not have tangible products intended for sale. resell products they previously purchased ready-made from suppliers' use their workforce and equipment to transform raw materials into new finished products. sell to consumers. Swaim, a company based in North Carolina, makes furniture. Partially completed sofas are Completed sofas that remain unsold in the warehouse Fabric and wood are -. are -. For Kellogg's, corn, cardboard boxes, and waxed paper liners are classified as - . buy in bulk from manufacturers and sell to retailers -
h. i.
85
E2-2O Cfassify costs along the value chain for a retailer (LearningObjectiue 2) Suppose RadioShack incurredthe following costsat its Charleston, SouthCarolina,store:
t nl
Requirements 1. Usethe following format to classifyeachcost accordingto its placein the valuechain.
2. Compute the total costs for each value-chain category. 3. How much are the total inventoriable product costs?
E2-21 Classifycosts afongthe valuechainfor a manufacturer (LeamingObiectiues 3) 2, Suppose cellphone the manufacturer Samsung Electronics provides following the
information for its costs last month (in hundreds of thousands):
Requirements
L Use the following format to classify each cost according to its place in the value chain. (Hint: You should have at least one cost in each value-chain function.)
2. Compute the total costs for each value-chain category. 3. How much are the total inventoriable product costs? 4, How much are the total prime costs? 5. How much are the total conversion costs? 86 Chapter2
C. Wages of checkout clerks h. Cost of grocery store's advertisementflyer placed in the weekly newspaper i. j. k. l. Store manager'ssalary Cost of equipment used to peel and core pineapples at the store Free grocery delivery serviceprovided to senior citizens Depreciation on self-checkoutmachines
a. b. c. d. e. f. g. h. i. j. k. l.
can be traced to cost obiects. are expensedwhen incurred. are the combination of direct materials and direct labor. Compensation includes wages' salaries,and -. until sold' are treated as include costs from only the production or purchaseselement of the value chain. are allocatedto cost objects. Both direct and indirect costs are to -' include costs from every element of the value chain. are the combination of direct labor and manufacturing overhead. are expensedas when sold. of production.
a7
E2-24
Classify and calculate a manufacturer's costs (LearningObjectiues 4) 3, An airline manufacturerincurred the followins costs last month (in thousands of dollars):
Requirements L. If the cost object is an airplane, classifyeach cost as one of the following: direct material (DM), direct labor (DL), indirect labor (IL), indirect materials (IM), other manufacturing overhead (other MOH), or period cost. (Hint: Set up a column for eachtype of cost.) What is the total for each type of cost? 2, Calculate total manufacturing overhead costs. 3, Calculate total inventoriable product costs. 4. Calculate total prime costs. 5. Calculatetotal conversioncosts. 6. Total period costs. E2-25 Prepare the current assest section of the balance sheet (Leaming Objectiue 5) Consider the following selectedamounts and account balancesof Lords:
Show how Lords reports current assetson the balance sheet. Not alI data are used. Is Lords a service company, a merchandiser, or a manufacturer? How do you know?
88
Chapter 2
E2-26
Prepare a retailer's income statement (Learning Obiectiue5) in specializing an Pets, e-tailbusiness RobbieRobertsis the soleproprietorof Precious Pets'salestotaled $987,000 Precious high-endp.t giftt and accessories. the saleof relating to during 2007. During the year,the companyspent $56,000 on expenses 'Web maintenanci; and $25,000on wrapping,boxing,and on marketing; site $22,000 Petsalsospent$642,000on inventorypurPrecious shippingthe goodsto customers. The on freight-incharges. companystartedthe year chases an additional$21,000 and on hand and endedthe year with $15,000 of inventory' with $17,000 of inventory Pets'2007incomestatement. Precious Prepare Compute direct materials used and cost of goods manufactured (Learning Obiectiue 5) at Danielle'sDie-cutsis preparingits Cost of GoodsManufacturedSchedule year-end. recordsshow the following: The Raw MaterialsInventoryaccount Danielle's accounting of of balance $13,000andan endingbalance $17,000.Duringtheyear, had a beginning Danielle purchased$58,000 of direct materials.Direct labor for the year totaled 'Workin Process The to amounted $152,000. overhead manufacturing $123,000;while of balance $15,000' andan ending of balance $21,000 had Invenrory account a beginning Computethe Cost of GoodsManufacturedfor the year.(Hint: The first stepis to calcuusedduringthe year.Model your answerafter Exhibit 2-15.) latethe directmaterials Compute cost of goods manufactured and cost of goods sold (Learning Objectiue 5) and cost of goodssold for Strike Compute the 2007 cost of goodsmanufactured that raw materials below Assume Marine Companyusingthe amountsdescribed inventorycontainsonly directmaterials.
E2-27
E2-29
5) Obiectiue Prepareincome statement (Learning E2-29 Continues E2-28':, inE2-28. Assume for statement StrikeMarineCompany Prepare 2007income the 2007. during at unitsof its product a priceof $12each sold thai thecompany 32,000 5) obiectiue E2-30 Work backwardsto find missingamounts(Learning
Smooth Sounds manufactures and sells a new line of MP3 players. Unfortunately, Smooth Soundssuffered seriousfire damageat its home office. As a result, the accounting records for October were partially destroyed-and completely jumbled. Smooth Sounds has hired you to help figure out the missing pieces of the accounting ptzzle. Assume that Smooth Sounds' raw materials inventory contains only direct materials. continued. . . Accounting Blocksof Managerial Building 89
'::,9 , , ooo,
Work in process inventory, October 1 Rgvenues October in ...............,........,.....:.....-. Grossprofit in October.. Directrnaterials usedin October,,...,...., 1,..,......... Raw materials inventory, October3 1....;.......,.. Manufacturingoverhead October in
Requirement F i n d th e fo l l o w i n g a mounrs: a. b. c. Cost of goods sold in October Beginning raw materials inventory Ending finished goods inventory (Hint: You may find Exhibits 2-15 and 2-16 helpful.)
$.'t1,5-00,,., ,4,300' .', : '3;9$6,.,, 0 ' 27,000', 12,000 9,000 3,000 6,300
E2'31
Determine whether information is relevant (Learning objectiue 6) Classify each of the following costs as relevant or irrelevant to the decision at hand and briefly explain your reason. a. b. c. d. e. Cost of operating automated production machinery versus the cost of direct labor when deciding whether to automare production Cost of computers purchased six months ago when deciding whether to upgrade to computers with a faster processingspeed Cost of purchasing packaging materials from an outside vendor when deciding whether to continue manufacturing the packaging materials in-house The property tax rates in different locales when deciding where to locate the company's headquarters The type of gas (regular or premium) used by delivery vans when deciding which make and model of van to Durchasefor the company's delivery van fleet Depreciation expenseon old manufacturing equipment when deciding whether to replaceit with newer equipment The fair market value of old manufacturing equipment when deciding whether to replaceit with new equipment The interest rate paid on invesredfunds when deciding how much inventory to keep on hand The cost of land purchased rhree years ago when deciding whether to build on th e l a n d n o w o r w ai t tw o more years The total amount of the restaurant's fixed costs when deciding whether to add additional items to the menu
f. g. h. i. f.
90
Chapter 2
E2-32
6, Describe other cost terms (Learning Obiecti'ues 7) with one of the termslisted here.You may usea Completethe following statements term more than once.and sometermsmay not be usedat all.
1 aosfR
a.
when production volume decreases. decrease b. Total c. For decision-making purposes, costs that do not differ between alternatives are d. e. f. g. h. Costs that have already been incurred are called Total stay constant over a wide range of production volumes. is the difference in cost between two alternative coursesof action. The is the cost of making one more unit. The product's not the product's and -, A product's at different production volumes. to forecast total costs should be used
Requirements a. b. c. d. e. f. g. \fhat is the current total product cost (for the 20 million units), including fixed and variable costs? What is the current averageproduct cost per unit? \What is the current fixed cost per unit? what is the forecastedtotal product cost next year (for the 25 million units)? \ffhat is the forecastedaverageproduct cost next year? \7hat is the forecastedfixed cost per unit? Why does the averageproduct cost decreaseas production increases?
Requirements L Usethe following format to classify eachof these costsaccording its placein the to valuechain.(Hint:You shouldhaveat leastonecostin eachvalue-chain function.)
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2.
3. How much are the total inventoriable product costs? 4. Supposethe managersof the RB{D and designfunctions receiveyear-endbonuses based on meeting their unit's target cost reductions. Sfhat are they likely to do? How might this affect costs incurred in other elements of the value chain? P2-36A Prepare income statements (Learning Obiectiue 5) Part One:In2007,Hannah Summit opened Hannah's Pets, a small retail shop selling pet supplies. On December 31,2007, her accounting records show the following:
Requirement for Pets,a merchandiser, the year ended for Preparean incomestatement Hannah'S December 31,2007. her to so Part Two: Hannah'sPetssucceeded well that Hannah decided manufacture 2008, own brand of pet toys-Best FriendsManufacturing.At the end of December her accounting recordsshow the following:
Requirements for Prepare schedule cost of goodsmanufactured BestFriends of a 31, Manufacturingfor the yearendedDecember 2008. for 2. Prepare incomestatement BestFriendsManufacturingfor the year ended an December 31.,2008. l.
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3. How does the format of the income statement for Best Friends Manufacturinq differ from the income statement of Hannah's Pets? Part Three: Show the ending inventories that would appear on these balance sheers: 1, Hannah's Petsat December 31.2007 2. BestFriendsManufacturing at December31, 2008 P2-37A Fill in missing amounts (Learning Objectiue 5) Certain item descriptions and amounts are missing from the monthly scheduleof cost of goods manufactured below and the income statement of Tretinik Manufacturing. F i l l i n th e mi s s i n si tems.
$ 21,ooo
Beginning raw materials inventory Pu r ch a s es di rect materi al s of En d in g r aw rnateri al s nventory i Dir e ct Dir e ct Manufacturing overhead Total Total Less:Ending costs costs
166,000 X (2s,000)
Grossprofit
exDenses: M a r ke tin g expense, Administrative expense, lncome
154,000
$x
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P2-38A fdentify relevant information (Learning Objectiue 6) You receive two job offers in the same big city. The first job is close to your parents' house, and they have offered to let you live at home for a year so you won't have to incur expensesfor housing, food, or cable TV. This job pays $30'000 per year. The secondjob is far from your parents' house, so you'll have to rent an apartment with parking ($6,000 per year), buy your own food ($2'400 per year), and pay for your per year). This job pays $35,000 per year. You still plan to do own cable TV ($eOO laundry at your parents' house once a week if you live in the citS and you plan to go into the city once a week to visit with friends if you live at home. Thus, the cost of operating your car will be about the same either way. In addition, your parents refuse to pay for your cell phone service($720 per year), and you can't function without it. Requirements a. b. c. d. Based on this information alone, what is the net difference between the two alternatives (salary,net of relevant costs)? '!7hy? 'S7hat information is irrelevant? \fhat qualitative information is relevant to your decision? Assume that you really want to take Job #2, but you also want to live at home to 'What new quantitative and qualitative information will you need to cut costs. incorporate into your decision?
P2-39A Calculate the total and average costs (Learning Obiectiue 7) The owner of Pizza-HouseRestaurant is disappointed becausethe restaurant has been averaging 3,000 pizza salesper month, but the restaurant and wait staff can make and serve 5,000 pizzas per month. The variable cost (for example, ingredients) of each pizza is $2.00. Monthly fixed costs (for example, depreciation, property taxes, businesslicense,and manager'ssalary) are $6,000 per month. The owner wants cost information about different volumes so that he can make some operating decisions.
,00
2. From a cost standpoint, why do companies such as Pizza-HouseRestaurant want to operate near or at full capacity? continued . - Accounting Building Blocksof Managerial 95
4. The owner's other idea is to advertise his restaurant on the local radio stations.
If he keeps the salesprice at $10 per pizza, the advertising agency sayshe'll have to spend $10,000 in advertising each month to increasemonthly salesto 5,000 pizzas.How much extra profit (above the current level) would he generateif he kept the salesprice at $10 per pizza but spent $10,000 per month on advertising? Which of the owner's ideas is most profitable?
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Requirements to eachof thesecostsaccording its placein the t. Usethe following format to classify (Hint:You shouldhaveat leastone costin eachvalue-chain function.) valuechain.
2. Compute the total costs for each category. 3 . How much are the total inventoriable product costs? 4 . Supposethe managers of the R&D and design departments receiveyear-end
bonuses based on meeting their department's target cost reductions. What are they likely to do? How might this affect costs incurred in other elementsof the value chain?
P2-418 Prepare income statements (Leaming Obiectiue5) Memories,a smallretail Terri ShawopenedPrecious Part One: On January'1.,,2007, art. On December 31,2007,her storededicated sellingpictureframes,crafts,and to recordsshow the following: accounting
Requirement Preparean income statementfor PreciousMemories, a merchandiser, for the year endedDecember 2007. 31.,
continwed . . .
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Part Ttuo: Precious Memories succeededso well that Shaw decided to manufacture her own special brand of picture frames, to be called Forever Manufacturing. At the end of December 2009,her accounting records show the following:
Requirements
1. Prepare schedule cost of goodsmanufactured Forever a of for Manufacturing for the yearendedDecember 31,,2009. 2. Prepare incomestatement Forever for an Manufacturingfor the yearended December 31,2009. 3. How doesthe format of the incomestatement ForeverManufacturingdiffer for from the incomestatement Precious of Memories? Part Three:Showthe endinginventories that would appearon thesebalance sheets: L. Precious Memories December at 3'1,,2007 2, Forever Manufacturingat December 31,2009 P2-428 Filf in missing amounts (LearningObiectiue5) Certainitem descriptions amountsare missingfrom the monthly schedule cost and of of goodsmanufactured incomestatement PacificManufacturingCompany. and of Fill in the missingitems.
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work in processinventory Add: Direct materials used: materials of direct materials materials
PACIFICMANUFACTURING COMPANY
April30,2007
revenue
$450,000
. ,. $
Be g in n in g
X X
X (57,000)
243,000
X ,, $64,000
$ 76,000
P2-438 ldentify relevant information (Learning Objectiue 6) You receive two job offers in the same big city. The first job is close to your parents' house, and they have offered to let you live at home for a year so you won't have to for housing, food, or cable TV. This job pays $45,000 per year. The incur expenses secondlob is far away from your parents' house, so you'll have to rent an apartment with parking ($10,000 per year), buy your own food ($3,000 per year), and pay for your own cable TV ($700 per year). This job pays $50,000 per year.You still plan to do laundry at your parents' house once a week if you live in the city, and you plan to go into the city once a week to visit with friends if you live at home. Thus, the cost of operating your car will be about the same either way. In addition, your parents refuse to pay for your cell phone service ($720 per year), and you can't function without it. conti nued.
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Requirements a. b. c. d. Based on this information alone. what is the net difference between the two alternatives (salary,net of relevant costs)? \fhat information is irrelevant? Why? 'S7hat qualitative information is relevant to your decision? Assume that you really want to take Job #2, but you also want to live at home to cut costs. lfhat new quantitative and qualitative information will you need to incorporate into your decision?
P2-448
Cafculate total and average costs (Learning Obiectiue 7) The owner of New York Deli restaurant is disappointed becausethe restaurant has been averaging 4,000 sandwich sales per month, but the restaurant can make and serve 6,000 sandwiches per month. The variable cost (for example, ingredients) of each sandwich is $1.25. Monthly fixed costs (for example, depreciation, property taxes, businesslicense,manager'ssalary) are $6,000 per month. The owner wants cost information about different volumes so that he can make some operating decisions. Requirements L. Fill in the chart below to provide the owner with the cost information he wants. Then use the completed chart to help you answer the remaining questions.
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4. The owner's other idea is to advertisehis restaurant on the local radio stations.
If he keeps the salesprice at $6 per sandwich, the advertising agency says he'll have to spend $4,000 in advertising each month to increasemonthly salesto 6,000 sandwiches.How much extra profit (above the current level) would he generateif he kept the salesprice at $6 per sandwich but spent $4,000 per 'sfhich of the owner's two ideas is most profitable? month on advertising?
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