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Individual Project Introduction to the Subject of the Project

Prepare income statements for a merchandising company using the traditional and contribution formats.

Learning objective number 5 is to prepare income statements for a merchandising company using the traditional and contribution formats.

Contribution Approach Income Statement

The contribution approach income statement organizes costs by behavior, first deducting variable expenses to obtain contribution margin, and then deducting fixed expenses to obtain net operating income.

The traditional approach organizes costs by function, such as production, selling, and administration. Within a functional area, fixed and variable costs are intermingled.

The contribution margin is total sales revenue less total variable expenses.

The Traditional and Contribution Formats

Used primarily for external reporting.

Used primarily by management.

The contribution format allocates costs based on cost behavior. The contribution approach differs from the traditional approach illustrated in an earlier chapter.

The traditional approach organizes costs in a functional format. Costs relating to production, administration, and sales are grouped together without regard to their cost behavior.

The traditional approach is used primarily for external reporting purposes.

Uses of the Contribution Format

The contribution income statement format is used as an internal planning and decision-making tool. We will use this approach for:

Cost-volume-profit analysis

Budgeting

Segmented reporting of profit data

Special decisions such as pricing and make-or-buy analysis

This approach is used as an internal planning and decision-making tool. For example, this approach is useful for and discussed further in Cost-volume-profit analysis (Chapter 5), Budgeting (Chapter 8), Segmented reporting of profit data (Chapter 6), Special decisions such as pricing and make or buy analysis (Chapter 12).

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1. Traditional format income statements are prepared primarily for external reporting purposes.

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True

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2. In a contribution format income statement, sales minus cost of goods sold equals the gross margin.

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False

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3. In a traditional format income statement for a merchandising company, the cost of goods sold reports the product costs attached to the merchandise sold during the period.

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True

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4.Contribution format income statement is useful for external reporting purposes, it has serious limitations when used for internal purposes because it does not distinguish between fixed and variable costs.

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False

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5. In a contribution format income statement for a merchandising company, cost of goods sold is a variable cost that gets included in the "Variable expenses" portion of the income statement.

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True

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6. The traditional format income statement is used as an internal planning and decision-making tool. Its emphasis on cost behavior aids cost-volume-profit analysis, management performance appraisals, and budgeting.

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False

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7.When finished goods are sold, there is an increase in which of the following accounts?

A- Finished Goods Inventory

B- Cost of Goods Sold

C- Work-in-Process Inventory

D- Cost of Goods Manufactured

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B

Explaining the Individual Project

Part 1: Summarize what a contribution format income statement depicts, as compared to the traditional format.

Please discuss

Explaining the Individual Project

Part 2: Using the following company data, show how the two income statement formats would look side by side.

Traditional- versus contribution-format statements are as follows:

Explaining the Individual Project

Explaining the Individual Project

Part 3: Explain why the contribution approach is more useful to project profits. As an example, show your calculations when using a projected sales increase of 20%.

Please discuss and make the following calculation

Explaining the Individual Project

Part 4: Using the following data, show how expected profits would be different if there was a sales increase of 10% and she used variable COGS of 50% vs. 60%. As an offset, this implies an increase in fixed COGS of $1,000,000.

WEEK 1 LECTURE

Cost Accounting and Cost Concepts

Learning Objectives

1-Identify and give examples of each of the three basic manufacturing cost categories.

2-Distinguish between product costs and period costs and give examples of each.

3-Understand cost behavior patterns including variable costs, fixed costs, and mixed costs.

4-Analyze a mixed cost using a scattergraph plot and the high-low method.

5- Prepare income statements for a merchandising company using the traditional and contribution formats.

Learning Objective

6-Understand the differences between direct and indirect costs.

7-Understand cost classifications used in making decisions: differential costs, opportunity costs, and sunk costs.

The Product

Direct Materials

Direct Labor

Manufacturing Overhead

Classifications of Manufacturing Costs

Manufacturing costs are usually grouped into three main categories: direct materials, direct labor, and manufacturing overhead. These costs are incurred to make a product.

Manufacturing Costs

Direct materials are an integral part of a finished product and their costs can be conveniently traced to it.

Indirect materials are generally small items of material such as glue and nails. They may be an integral part of a finished product but their costs can be traced to the product only at great cost or inconvenience.

Direct labor consists of labor costs that can be easily traced to particular products. Direct labor is also called “touch labor.”

Manufacturing Costs

Indirect labor consists of the labor costs of janitors, supervisors, materials handlers, and other factory workers that cannot be conveniently traced to particular products. These labor costs are incurred to support production, but the workers involved do not directly work on the product.

Manufacturing overhead includes all manufacturing costs except direct materials and direct labor.

Consequently, manufacturing overhead includes indirect materials and indirect labor as well as other manufacturing costs.

Learning Objective 1

Identify and give examples of each of the three basic manufacturing cost categories.

Learning objective number 1 is to identify and give examples of each of the three basic manufacturing cost categories.

Example of Direct Materials

Raw materials that become an integral part of the product and that can be conveniently traced directly to it.

Example: A radio installed in an automobile

Direct materials are raw materials that become an integral part of the finished product and whose costs can be conveniently traced to it. Examples include the aircraft engines on a Boeing 777, the Intel processing chip in a personal computer, the blank video cassette in a pre-recorded video, and a radio in an automobile.

Example of Direct Labor

Those labor costs that can be easily traced to individual units of product.

Example: Wages paid to automobile assembly workers

Direct labor consists of that portion of labor cost that can be easily traced to a product. Direct labor is sometimes referred to as “touch labor,” since it consists of the costs of workers who “touch” the product as it is being made.

Example of Manufacturing Overhead

Manufacturing costs that cannot be easily traced directly to specific units produced.

Examples: Indirect materials and indirect labor

Wages paid to employees who are not directly involved in production work. Examples: maintenance workers, janitors, and security guards.

Materials used to support the production process. Examples: lubricants and cleaning supplies used in the automobile assembly plant.

Manufacturing overhead includes all manufacturing costs except direct materials and direct labor. These costs cannot be easily traced to specific units produced (also called indirect manufacturing cost, factory overhead, and factory burden).

Manufacturing overhead includes indirect materials that are part of the finished product, but that cannot be easily traced to it. It includes indirect labor costs that cannot be conveniently traced to the creation of products.

Other examples of manufacturing overhead include: maintenance and repairs on production equipment, heat and light, property taxes, depreciation and insurance on manufacturing facilities, etc.

Example of Nonmanufacturing Costs

Selling Costs

Costs necessary to secure the order and deliver the product.

Administrative Costs

All executive, organizational, and clerical costs.

A manufacturing company incurs many other costs in addition to manufacturing costs. For financial reporting purposes, most of these other costs are typically classified as selling costs and administrative costs. These costs are also called selling, general and administrative costs, or SG&A. Selling and administrative costs are incurred in both manufacturing and merchandising firms.

Selling costs include all costs necessary to secure customer orders and get the finished product into the hands of the customer. These costs are also referred to as order-getting and order-filling costs. Examples of selling costs include advertising, shipping, sales travel, sales commissions, sales salaries, and costs of finished goods warehouses.

Administrative costs include all executive, organizational, and clerical costs associated with the general management of an organization. Examples of administrative costs include executive compensation, general accounting, secretarial, public relations, and similar costs involved in the overall general administration of the organization as a whole.

Review Questions T/F

1. Managerial accounting is primarily concerned with the organization as a whole rather than with segments of the organization.

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False

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2. Managerial accounting places less emphasis on nonmonetary data than financial accounting.

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False

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3. Direct labor is a part of both prime cost and conversion cost.

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True

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4. Direct material cost combined with manufacturing overhead cost is known as conversion cost.

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False

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5. Wages paid to production supervisors would be considered direct labor.

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False

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6. Advertising is a product cost as long as it promotes specific products.

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False

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7. For a lamp manufacturing company, the cost of the insurance on its vehicles that deliver lamps to customers is best described as a: A. prime cost. B. manufacturing overhead cost. C. period cost. D. differential (incremental) cost of a lamp.

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C. period cost

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8. Manufacturing overhead consists of: A. all manufacturing costs. B. indirect materials but not indirect labor. C. all manufacturing costs, except direct materials and direct labor. D. indirect labor but not indirect materials.

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C. all manufacturing costs, except direct materials and direct labor.

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9. Which of the following costs would not be included as part of manufacturing overhead? A. Insurance on sales vehicles. B. Depreciation of production equipment. C. Lubricants for production equipment. D. Direct labor overtime premium.

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A. Insurance on sales vehicles.

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10. Conversion cost consists of which of the following? A. Manufacturing overhead cost. B. Direct materials and direct labor cost. C. Direct labor cost. D. Direct labor and manufacturing overhead cost.

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D. Direct labor and manufacturing overhead cost.

Learning Objective 2

Distinguish between product costs and period costs and give examples of each.

Learning objective number 2 is to distinguish between product costs and period costs and give examples of each.

Product Costs

The three major elements of product costs in a manufacturing company are

1.direct materials,

2.direct labor, and

3.manufacturing overhead.

A product cost is any cost involved in purchasing or manufacturing goods.

In the case of manufactured goods, these costs consist of direct materials, direct labor, and manufacturing overhead.

A period cost is a cost that is taken directly to the income statement as an expense in the period in which it is incurred.

Examples of Product Costs Versus Period Costs

Product costs include direct materials, direct labor, and manufacturing overhead.

Period costs include all selling costs and administrative costs.

Inventory

Cost of Good Sold

Balance Sheet

Income Statement

Sale

Expense

Income Statement

Costs can also be classified as product or period costs.

Product costs include all the costs that are involved in acquiring or making a product. More specifically, it includes direct materials, direct labor, and manufacturing overhead. Consistent with the matching principle, product costs are recognized as expenses when the products are sold. This can result in a delay of one or more periods between the time in which the cost is incurred and when it appears as an expense on the income statement. Product costs are also known as inventoriable costs. The discussion in the chapter follows the usual interpretation of GAAP in which all manufacturing costs are treated as product costs.

Period costs include all selling costs and administrative costs. These costs are expensed on the income statement in the period incurred. All selling and administrative costs are typically considered to be period costs. The usual rules of accrual accounting apply to period costs. For example, administrative salary costs are “incurred” when they are earned by the employees and not necessarily when they are paid to employees.

Classifications of Costs

Manufacturing costs are often classified as follows:

Direct Material

Direct Labor

Manufacturing Overhead

Prime Cost

Conversion Cost

Two more cost categories are often used in discussions of manufacturing costs—prime cost and conversion cost. Prime cost is the sum of direct materials cost and direct labor cost. Conversion cost is the sum of direct labor cost and manufacturing overhead cost. The term conversion cost is used to describe direct labor and manufacturing overhead because these costs are incurred to convert materials into the finished product.

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11. Although depreciation is always a period cost in a merchandising firm, it can be a product cost in a manufacturing firm.

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True

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12. In a manufacturing firm, all costs are product costs.

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False

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13. The cost of shipping parts from a supplier is considered a product cost.

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True

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14.The costs of acquiring inventory are reported on the balance sheet as an asset labeled “inventory” and are expensed only when products are sold.

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True

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15.The cost of selling goods and administrative costs are reported on the income statement as expenses when inventory is sold.

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False – The cost of selling goods and administrative costs are reported on the income statement as expenses when they are incurred.

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16.Product costs are the costs related to inventory and period costs are the costs related to the selling and administrative functions.

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True

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17. Product costs are any costs that a company incurs to acquire raw materials and convert them to finished goods ready for sale.

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True

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18. The advertising costs that Pepsi incurred to air its commercials during the Super Bowl can best be described as a: A. variable cost. B. fixed cost. C. product cost. D. prime cost.

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B. fixed cost.

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19. Each of the following would be a period cost except: A. the salary of the company president's secretary. B. the cost of a general accounting office. C. depreciation of a machine used in manufacturing. D. sales commissions.

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C. depreciation of a machine used in manufacturing.

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20. Which of the following costs is an example of a period rather than a product cost? A. Depreciation on production equipment. B. Wages of salespersons. C. Wages of production machine operators. D. Insurance on production equipment.

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B. Wages of salespersons.

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21. Which of the following would be considered a product cost for external financial reporting purposes? A. Cost of a warehouse used to store finished goods. B. Cost of guided public tours through the company's facilities. C. Cost of travel necessary to sell the manufactured product. D. Cost of sand spread on the factory floor to absorb oil from manufacturing machines.

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D. Cost of sand spread on the factory floor to absorb oil from manufacturing machines.

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22. Which of the following would NOT be treated as a product cost for external financial reporting purposes? A. Depreciation on a factory building. B. Salaries of factory workers. C. Indirect labor in the factory. D. Advertising expenses.

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D. Advertising expenses.

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23. The salary of the president of a manufacturing company would be classified as which of the following? A. Product cost B. Period cost C. Manufacturing overhead D. Direct labor

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B. Period cost

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24. Conversion costs do NOT include: A. depreciation. B. direct materials. C. indirect labor. D. indirect materials.