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Managerial Accounting (Chapter 1)

  • Used internally - no official rules - consists of whatever reports management finds useful
  • Objective: Provide management with decision relevant information to assist in
    • Planning
    • Evaluation
    • Control

Manufacturing, Merchandising and Service Companies

Managerial accounting is just as important in a service company as it is in a manufacturing company or a merchandising company (see the functions above). However, there is a significant difference in the cost determination between the different types of companies. A manufacturing company uses labor and other inputs to transforms raw materials into finished product and then sells the product, like a merchandising company. A service company, on the other hand, does not produce/sell products, instead it provides service. The major difference between the three types of companies can be found in the cost of goods sold (services provided) calculation.


Service Company

Merchandising Company

Manufacturing Company

Cost of services provided:

Primarily labor and overhead costs

Cost of goods sold:

Net purchase price

Cost of goods manufactured




All three types of companies need to determine the costs of product or services to

A final, very important function of managerial accounting is to develop plans and policies to ensure internal control and that company objectives are accomplished (control).

Standard Costing System

  • Product cost - costs that can be associated with manufacturing a product either directly or indirectly


  • Raw material; labor
  • Manufacturing equipment depreciation
  • Supervisor's salary
  • Period cost - costs that cannot be associated with specific products and are expensed in the period in which they are incurred


  • Corporate advertising
  • Depreciation of corporate headquarter
  • Selling expenses
  • Insurance
  • Direct (prime) Cost - costs that are directly related and identifiable with producing a specific product. Usually raw materials and labor.
    • Indirect Costs - (Overhead) - costs of materials or labor that are necessary for production but cannot easily be measured for each product item.

    Example of Direct Cost, Indirect Cost and Overhead Allocation

    XYZ manufactures two products: (A) and (B).

    Direct Costs

    Indirect Cost Examples:

    • Incidental materials (nails, screws, adhesives, etc.)
    • Incidental labor (equipment maintenance, supervisor)
    • Utilities
    • Joint costs (i.e., two products use the same indirect materials)
    • Depreciation on equipment used in the manufacturing process





    Total direct costs


    2 pounds @ $ 3

    3 hours @ $15/hour

    $ 51





    Total direct costs


    3 pounds @ $1.75

    5 hours @ $12/ hour


    Indirect Costs for A and B

    Overhead allocation


    Indirect Material: $ 5

    Indi. Labor: 1.5hours @ $9


    Indirect Material: $ 2

    Indirect labor: 1hour @ $10

    Overhead is allocated to products according to some system


    Overhead is allocated using direct labor hours:

    10,000 units of A and 4,000 units of B are produced with the same equipment. Total depreciation for the equipment for the period: $12,000

    Other overhead costs total $18,000.

    • Labor hours
    • Machine hours
    • Some other method designed to accomplish certain managerial objectives (i.e., as a motivational or control tool)

    Total hours (A) 30,000

    Overhead allocation/unit:

    30,000/50,000*3 = $1.80/unit

    Total hours (A): 20,000

    Overhead allocation/unit:

    30,000/50,000*5 = $3/unit

    Total costs per unit (A)

    Total costs per unit (B)

    Direct costs

    Indirect costs



    $ 51





    Direct costs

    Indirect costs








    Inventory Accounts for Manufacturing Companies

    Manufacturing companies use multiple inventory accounts. At a minimum the following:

    • Raw Materials Inventory
    • Work in Process
    • Finished Goods

    Raw Materials Inventory:

    Used to track and report raw materials. As production occurs, raw material balances are transferred to work in process account using the standard quantity per unit produced ----->

    Work in Process:

    During production all appropriate costs are recorded in this account using the standard rate per unit (materials, labor, indirect materials and labor, overhead)


    Finished Goods

    As units are completed, the standard cost per unit is recorded in this account. At the end of the reporting period


    Note that all unit costs are recorded/transferred at the standard rate (cost) per unit. In reality, actually quantity and rates (costs) will likely differ from the standard (planned) The reasons are due to

    Quantity Variances

    E.g., it took 3 hours and 15 minutes per unit (@ 15 per hour) to produce one unit, compared to the budgeted 3 hours per unit

    Price Variances

    E.g., the product did use (as planned) 2 pounds of raw materials, however, the price per pound has increased to $3.10 (from $3) per pound.

    What happens to variances?

    A. They are closed to work in process (finished goods) for financial reporting purposes

    B. They are carefully analyzed to assist in the planning and evaluation/control purposes.


    Income Statement Comparison Merchandising versus Manufacturing Company

    The income statement of a manufacturing company is identical to that of a merchandising company. The difference between the two types of companies lies in the

    Determination of cost of goods sold

    Merchandising Company

    Manufacturing Company

    Beginning Inventory

    Purchases (net)

    (Ending Inventory)

    Cost of Goods Sold

    A. Beginning work in Process

    Beginning Raw materials

    Raw materials purchases

    (Ending raw materials inventory)

    Raw materials used

    Direct labor


    Total manufacturing costs

    (ending work in process)

    Cost of Goods Manufactured

    B. Finished goods inventory (beginning)

    Plus cost of goods manufactured

    (Finished goods inventory - ending)

    Cost of Goods Sold


    Balance Sheet Statement Comparison Merchandising versus Manufacturing Company

    Merchandising Company

    Manufacturing Company


    Raw Materials Inventory

    Work in Process

    Finished Goods Inventory

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    prepared and maintained by Heidemarie.Lundblad@csun.edu