Financial management
Chapter 2
Managers use information about operating costs to plan, perform, evaluate, and
communicate the results of operating activities.
All organizations use cost information to determine profits and selling prices and to
value inventories. Ultimately, a company is profitable only when its revenues from
sales or services cover and bridge the costs. But different types of organizations
have different types of products or services costs.
The figure above provides an overview of commonly used cost classifications. These
classifications enable managers to do the following:
1. Cost traceability: Control costs by determining which are traceable to a
particular cost object; service or product.
Direct costs: Costs that can be easily and economically traced to a cost
object. e.g. wages of workers can be traced by their time cards and pay-roll records. Or
the costs of the main ingredients used for a chocolate bar
Indirect costs: Costs that cannot be easily and economically traced to a
cost object. e.g. the salt used in candy. However these indirect costs must be
included in the cost of a product or service. Due to the fact that these are
difficult to trace or that it is a meaningless amount, management uses a
formula to assign them to cost objects.
2. Cost behaviour: Calculate the number of units that must be sold to achieve
a certain level of profit.
Variable cost: Costs that changes in direct proportion to a change in
productive output.
Fixed cost: Costs that remains constant within a defined range of activity
or time period, like rental costs.
3. Value-adding attributes: Identify the costs of activities that do and do not
add value to product or service.
Value-adding cost: Cost of an activity that increases the market value of
the product or service.
Nonvalue-adding cost: Cost of an activity that adds cost to a product or
service but does not increase its market value. (costs of administrative
activities)
4. Financial reporting: Classify costs for the preparation of financial
statements.
Product costs/inventoriable costs: costs assigned to an inventory; they
include direct materials, direct labor and overhead. These costs appear
1
, on the income statement as cost of sold goods and on the balance sheet
as inventory.
Period costs/noninventoriable costs: costs of resources used during the
accounting period that are not assigned to products. They appear as
operating expenses on the income statement.
The key to preparing an income statement or a balance sheet in any kind of
organization is determining its cost of goods or services sold and the value of its
inventories, if any. All organizations use the following income statement format:
Sales - cost of sales or cost of goods sold = gross margin.
Gross margin-operating expenses = operating income.
Product costs or inventoriable costs, appear as inventory on the balance sheet and as
cost of goods sold on the income statement. Period costs or noninventoriable costs,
are reflected in the operating expenses on the income statement. The cost of sales for
UPS would include the wages and salaries of personnel plus the expense of the
trucks, planes,
supplies, and
anything else used
to deliver
packages.
The key to preparing an income statement for a manufacturing organization is
computing its cost of goods sold, which means that you must first determine the
cost of goods manufactured. This dollar amount is calculated on the statement of
cost of goods manufactured, a special report based on an analysis of the Work in
Process Inventory account. . At the end of an accounting period the flow of all
manufacturing costs incurred during the period is summarized in this statement. It
might be helpful to think of the statement of cost of goods manufactured to be
developed in three steps.
2
, 1) Compute the cost of direct materials used during the accounting period.
2) Calculate total manufacturing costs for the period.
3) Determine total cost of goods manufactured for the period.
The total amount of the cost of goods
manufactured during the period is carried
over to the income statement, where it is
used to compute the cost of goods sold.
the beginning balance of the finished
goods inventory account is added to the
cost of goods manufactured to arrive at
the total cost of goods available for sale
during the period. The cost of goods sold
is then computed by subtracting the
ending balance in finished goods
inventory (what is not sold) from the toal
cost of goods available for sale (what was
available for sale). The cost of goods sold
is considered as an expense in the period
in which the goods are sold.
Transforming materials into finished products ready for sale requires a number of
production and production-related activities. A manufacturing organization's
accounting system tracks these activities as products costs flowing through the
materials inventory, work in process inventory and finished goods inventory
accounts.
Materials inventory account - shows the balance of cost of unused materials.
Work in process inventory account - shows the manufacturing costs that have
been incurred and assigned to partially completed units of products.
Finished goods inventory account - shows the costs assigned to all completed
products that have not been sold.
Managers gather and report manufacturing costs based on documents related to
production and production-related activities. Looking at the relationship between
activities and documents provides insight into how costs flow through the three
inventory accounts and when an activity must be recorded in the accounting
records. As illustrated in the figure underneath.
3
Chapter 2
Managers use information about operating costs to plan, perform, evaluate, and
communicate the results of operating activities.
All organizations use cost information to determine profits and selling prices and to
value inventories. Ultimately, a company is profitable only when its revenues from
sales or services cover and bridge the costs. But different types of organizations
have different types of products or services costs.
The figure above provides an overview of commonly used cost classifications. These
classifications enable managers to do the following:
1. Cost traceability: Control costs by determining which are traceable to a
particular cost object; service or product.
Direct costs: Costs that can be easily and economically traced to a cost
object. e.g. wages of workers can be traced by their time cards and pay-roll records. Or
the costs of the main ingredients used for a chocolate bar
Indirect costs: Costs that cannot be easily and economically traced to a
cost object. e.g. the salt used in candy. However these indirect costs must be
included in the cost of a product or service. Due to the fact that these are
difficult to trace or that it is a meaningless amount, management uses a
formula to assign them to cost objects.
2. Cost behaviour: Calculate the number of units that must be sold to achieve
a certain level of profit.
Variable cost: Costs that changes in direct proportion to a change in
productive output.
Fixed cost: Costs that remains constant within a defined range of activity
or time period, like rental costs.
3. Value-adding attributes: Identify the costs of activities that do and do not
add value to product or service.
Value-adding cost: Cost of an activity that increases the market value of
the product or service.
Nonvalue-adding cost: Cost of an activity that adds cost to a product or
service but does not increase its market value. (costs of administrative
activities)
4. Financial reporting: Classify costs for the preparation of financial
statements.
Product costs/inventoriable costs: costs assigned to an inventory; they
include direct materials, direct labor and overhead. These costs appear
1
, on the income statement as cost of sold goods and on the balance sheet
as inventory.
Period costs/noninventoriable costs: costs of resources used during the
accounting period that are not assigned to products. They appear as
operating expenses on the income statement.
The key to preparing an income statement or a balance sheet in any kind of
organization is determining its cost of goods or services sold and the value of its
inventories, if any. All organizations use the following income statement format:
Sales - cost of sales or cost of goods sold = gross margin.
Gross margin-operating expenses = operating income.
Product costs or inventoriable costs, appear as inventory on the balance sheet and as
cost of goods sold on the income statement. Period costs or noninventoriable costs,
are reflected in the operating expenses on the income statement. The cost of sales for
UPS would include the wages and salaries of personnel plus the expense of the
trucks, planes,
supplies, and
anything else used
to deliver
packages.
The key to preparing an income statement for a manufacturing organization is
computing its cost of goods sold, which means that you must first determine the
cost of goods manufactured. This dollar amount is calculated on the statement of
cost of goods manufactured, a special report based on an analysis of the Work in
Process Inventory account. . At the end of an accounting period the flow of all
manufacturing costs incurred during the period is summarized in this statement. It
might be helpful to think of the statement of cost of goods manufactured to be
developed in three steps.
2
, 1) Compute the cost of direct materials used during the accounting period.
2) Calculate total manufacturing costs for the period.
3) Determine total cost of goods manufactured for the period.
The total amount of the cost of goods
manufactured during the period is carried
over to the income statement, where it is
used to compute the cost of goods sold.
the beginning balance of the finished
goods inventory account is added to the
cost of goods manufactured to arrive at
the total cost of goods available for sale
during the period. The cost of goods sold
is then computed by subtracting the
ending balance in finished goods
inventory (what is not sold) from the toal
cost of goods available for sale (what was
available for sale). The cost of goods sold
is considered as an expense in the period
in which the goods are sold.
Transforming materials into finished products ready for sale requires a number of
production and production-related activities. A manufacturing organization's
accounting system tracks these activities as products costs flowing through the
materials inventory, work in process inventory and finished goods inventory
accounts.
Materials inventory account - shows the balance of cost of unused materials.
Work in process inventory account - shows the manufacturing costs that have
been incurred and assigned to partially completed units of products.
Finished goods inventory account - shows the costs assigned to all completed
products that have not been sold.
Managers gather and report manufacturing costs based on documents related to
production and production-related activities. Looking at the relationship between
activities and documents provides insight into how costs flow through the three
inventory accounts and when an activity must be recorded in the accounting
records. As illustrated in the figure underneath.
3
