Chapter 1. Accounting for Engineers. Eng. Osama Aljarrah, MBA Hashemite University

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1 Chapter 1 Accounting for Engineers Eng. Osama Aljarrah, MBA Hashemite University osamaiemba@gmail.com

2 Intended learning outcomes Introduction to accounting Financial Accounting versus Management Accounting Introduction in Financial Accounting Introduction in Management Accounting Cost accounting in manufacturing companies Inventories in manufacturing companies Budgeting Use cost accounting for decision making

3 Objective of accounting To provide information Economic useful for decision maker

4 Introduction to accounting Accounting Financial Accounting Management Accounting

5 Financial Accounting Objectives 1- Economic resources & obligations on these resources (قائمة الميزانية) Balance Sheet (األصول) Economic resources Assets Obligations Liability and owner equity (االلتزامات وحقوق الملكية)

6 Financial Accounting Objectives 2- Earning Generation Power (قائمة الدخل) Income statement (اإليرادات) Revenues (تكلفة البضاعة المباعة) - Cost of Goods Sold (الربح اإلجمالي) Gross Profit (المصاريف األخرى) - Other Expenses (الربح الصافي) Net Profit

7 Financial Accounting Objectives 3- Cash sources and uses Cash flow statement Cash in Cash out

8 Financial Statement Balance Sheet: (At any moment of time) 1- Assets األصول 2- Liabilities االلتزامات 3- Owner Equity حقوق الملكية

9 Balance Sheet 1- Assets: 1-1 Current Assets (Converted to cash before one year) Cash and Cash Equivalent Accounts Receivables Inventory Prepaid Expenses

10 Financial Statement Balance Sheet Assets (continue..) 1-2 Long terms assets (Normally don t convert to cash within one year) Property, plant, and equipment Intangible assets (Goodwill, Trade name)

11 Balance Sheet 2- Liabilities 2-1 Current Liabilities (Paid within one year) Accounts Payable Accrued Payroll Tax Payable Advanced payments Others

12 Balance Sheet Liabilities (Continue ) 2-2 Long terms liabilities (Normally paid after one year) Long terms notes payable Long terms debt

13 Balance Sheet 3- Owner Equity 3-1 Capital 3-2 Reserves 3-3 Common stock 3-4 Retained Earnings

14 Balance Sheet Assets = Liabilities + Owner Equity

15 Financial statement Income statement (Profit and Loss statement) (within specific period) Sales - Cost of Goods Sold Gross Profit - Operating Expenses Operating Income - Non Operating gains and losses Net Income

16 Accounting cycle

17 Accounting Cycle Each financial event affects two accounts. Nature of accounts: 1- Assets: Debit 2- Liabilities: Credit 3- Owner Equity: Credit 4- Sales: Credit 5- Cost of goods sold: Debit 6- Expenses: Debit

18 Accounting Cycle Each account increases by it s nature and decreases by the opposite of it s nature. Examples: 1- Increase cash increase assets debit 2- Decrease payables decrease liability debit 3- Increase sales credit 4- Increase expense debit

20 Accounting Cycle - Exercise Example 1.1- Open new trading company: You have 5000 JOD and you borrow 5000 JOD. You deposited these in a new bank account: Dr/ Cr/ Cr/

21 Accounting Cycle - Exercise Example 1.2- Purchasing goods for resale: You purchased 10 smart phones for resale by credit for 30 days. Purchase price is 500 JOD/ unit: Dr/ Cr/

22 Accounting Cycle - Exercise Example 1.3- Selling Goods to customers in credit You sold 5 smart phones in credit for 15 days. Selling price 600 JOD / unit: Dr/ Cr/ Dr/ Cr/

23 Accounting Cycle - Exercise Example 1.4- Collect cash from customer You collected from the customer 3000 JOD: Dr/ Cr/

24 Accounting Cycle - Exercise Example 1.5- Vendor Payment You paid to vendor 5000 JOD Dr/ Cr/

25 Accounting Cycle - Exercise Example 1.6- Period Expenses: You paid electrical invoice for 100 JOD by cash: Dr/ Cr/

26 Accounting Cycle - Exercise Example 1.7- Period expenses You paid 500 JOD by cash for office rent: Dr/ Cr/

27 Accounting Cycle - Exercise Example 1.8- Payroll calculation You calculated payroll expense of 500 JOD at the end of the year but not paid at the current year Dr/ Cr/

28 Accounting Cycle Exercise Example 1.9- Year End Closing Only previous transaction occurred during the year. You decided to retain all of the profit to next year operations Dr/ Cr/

29 Accounting Cycle - Exercise Prepare balance sheet. Prepare income statement. Prepare cash flow statement

30 Financial Ratios Make comparisons through: 1- Single Company 2- Other companies in the same industry 3- Management Expectations

31 Short term Liquidity Current Ratio = Current Assets Current Liabilities Quick Ratio = Current Assets -Inventory Current Liabilities Cash Ratio = Cash + Cash Equivalents Current Liabilities

32 Short term liquidity - Exercise For example company, calculate: 1- Current ratio 2- Quick ratio 3- Cash ratio

33 Inventory Ratios Inventory Turnover Ratio = Cost of Goods Sold Average Inventory Days of Sales in Inventory = 365 Inventory Turnover

34 Inventory Ratios - Exercise For example company, calculate: 1- Inventory turnover ratio 2- Days of sales in inventory

35 Receivables Ratios Accounts Receivable Turnover Ratio = Sales Average Accounts Receivable Days of Sales in Receivables = 365 Receivables Turnover

36 Receivable Ratios - Exercise For example company, calculate: 1- Accounts receivable turnover ratio 2- Days of sales in receivable

37 Solvency Ratios Financial Leverage Ratio = Total Assets Owner Equity Total Debt to Total Assets = Total liabilities Total Assets

38 Solvency Ratios - Exercise For example company, calculate: 1- Financial leverage ratio 2- Total debt to total assets

39 Return on Investment Return on Invested Net Income Capital = Average Invested Capital Return on Assets = Net Income Total Assets

40 Return on Investment - Exercise For example company, calculate: 1- Return on Invested capital 2- ROA

41 Profitability Ratio Gross Profit Margin = Sales Cost of Goods Sold Sales

42 Profitability ratio - Exercise For example company, calculate: Gross Profit Margin

43 Objectives of Management Accounting Product Costing (for income determination and inventory valuation.) Performance evaluation: (Compare actual figures with estimated figures; Cost Control.) Short term decision (make or buy, pricing, cost volume profit analysis.) Long term decision (Capital budgeting system.)

44 Classification of costs Fixed Costs: Total amount costs does not change with a change in production. Cost per unit decrease as production increase. Variable Costs: Total costs increases as production increases. Cost per unit will remain unchanged. (at relevant range of production) Mixed Costs Semi-variable: utilizations, salesperson Semi-fixed: some machines

45 Product costs versus Period costs Product costs (Inventoriable costs) Without it the product could not be made Period costs Not involved in the production of the product

46 Product costs Direct materials Direct labor Manufacturing overheads: Includes: Indirect labor Indirect materials

47 Grouping of Product Costs Prime Costs Conversion Costs Includes: Direct Labor Overheads

48 Exercise Cost Fixed or variable? Product or period cost? DM, DL, or OH Conversion Costs? Packaging materials Production manager Screws Labor Office building Factory Cafeteria Overtime QC R&D

49 Other Cost Classification Opportunity Costs: Income lost by not using alternatives Carrying Costs: Costs incurred by carrying inventory Sunk Costs: Costs incurred and cannot be recovered Committed Costs: Not be spent but committed to be spent Discretionary Costs: May or may not be spent at the decision of the manager Marginal Costs: Costs necessary to produce one more unit

50 Types of Pharmaceutical Inventories 1- Raw materials inventory (مخزون مواد أولية) 2- Packaging materials inventory (مخزون مواد تعبئة وتغليف ( 3- Work in process inventory (مخزون بضاعة تحت التصنيع ) 4- Finished products inventory (مخزون مواد جاهزة)

51 Types of inventories Raw materials Direct labor- Bulk Overheads- Bulk Work in process FP

52 Types of inventory Raw materials inventory Beginning Inventory + Purchasing - Used in production = Ending Inventory

53 Types of inventory Work in process inventory Beginning Inventory { + Direct materials Direct Labor Factory Overheads - Cost of Goods Manufactured = Ending Inventory

54 Types of inventory Finished products inventory Beginning Inventory + Cost of goods manufactured - Cost of goods sold = Ending Inventory

55 Product Costs Finished Product Cost Direct Materials Direct Labor Manufacturing Overheads Formula Route Depend on the method of allocation

56 Direct materials Bulk: 1101, Pharmadol 5 mg Tablets Qty: 1tablet Bulk Pharmadol 5 mg Tablets RAC001 Paracetamol RIN001 Filler Qty: 0.5 Qty: 0.5 Unit Cost = 20 JOD Unit Cost = 1 JOD

57 Direct labor Opr. No. Operation Run time (hr) Next Labor hour rate (JOD) 10 Dispensing Mixing Compression

58 Overhead Annual expected manufacturing of FP:1101 = 2000 pcs Annual expected electricity expenses = 5000 JOD Annual expected depreciation expenses = JOD Annual sales forecast for Bulk:1101 = 100 pcs Annual marketing expenses for Bulk:1101=500 JOD

59 Calculate unit cost of Bulk:1101

60 Life-Cycle Costing 1- Upstream Costs (before production) R&D, Quality Development 2- Manufacturing Costs Materials, Labor, OH 3- Downstream Costs (after production) Marketing and Distribution Services and warranties

61 Budgeting Planning versus Budgeting: Planning is essentially the process of determining answers to : 1- Who? 2- What? 3- When? 4- Where? 5- How? Questions of business operations

62 Types of planning Strategic Planning Tactical Planning Operational Planning Time Frame Long Term (more than five years) Medium (One to five years) Short (One week to one year) Focus Strategies, objectives and goals of the company Implement specific parts of the strategic plan Day-to-day operations Done by Top Management Upper and Middle managers Lower Level of Management Examples Vision, Mission, Capital budgeting Budgeting MPS, MRP, and Capacity Planning

63 Budgeting Budgeting: the process of creating a formal plan and translating goals into a quantitative format.

64 Budgeting Advantages Help in Strategic Planning Provides Motivation Provides frame of reference evaluation For communications between different departments

65 Master budget A summarized set of budgeted financial statements (sometimes called pro forma financial statements), including budgeted income statement, budgeted balance sheet, and budgeted cash flow.

66 Budgeted Income Statement (Operating Budget) Sales budget Based on sales forecast First budget to be prepared Most difficult to produce

67 Operating Budget Production budget Based on: 1- Sales Budget 2- Production Capacity 3- Inventory Objectives Provide information for: 1- Direct Materials Budget 2- Direct Labor Budget 3- OH Budget

68 Operating Budget Cost of Goods Sold Budget Beginning Inventory + Expected Budgeted Production - Desired Ending Inventory = Budgeted Cost of Goods Sold

69 Operating Budget Other Budgets: R&D Budget Selling and Marketing Budget Admin. and general Expense Budget Other Revenues and Expenses Budget

70 Capital Budget The budget of long-term capital expenditures Only expenditure that are to be made in the budget year will be included in the master budget

71 Cash Budget Called Working Capital Budget Last budget created Tracks the inflows and outflows of a month-by-month (possibly week-by-week or day-by-day basis)

72 Static Budget versus Flexible Budget Static budget is prepared for only one level of sales Static budget not used for control and evaluation purposes

73 Static Budget versus Flexible Budget Flexible budget includes what the budget should be for different levels of sales To prepare flexible budget the company needs to use standard cost system The difference between actual amount and flexible budget is called flexible budget variance Flexible budget variances is used for control and performance evaluation

74 Exercise (Flexible Budget) Level of sales 100,000 90, ,000 Sales ( $ 9 per unit) 900,000 Variable costs ($ 5 per unit) (500,000) Contribution Margin 400,000 Fixed Costs (380,000) Operating Income 20,000

75 Other types of Budgeting Zero-Based Budgeting Life Cycle Budgeting Activity Based Budgeting Kaizen Budgeting Continuous Budgeting Project Budgeting

76 Budget Reports 1- Establish the budget 2- Measure the actual performance 3- Analyze and compare actual with budget 4- Investigate unexpected variances 5- Devise and implement corrective actions 6- Review and revise the standards

77 Exercise (Operation Budget) Budgeted amounts: 1- DM: $5 per Kg = $10 per unit 2- DL: $6 per unit = $24 per unit 3- VOH: $3 per hr = $12 per unit 4- FOH: $ Selling price = $100 per unit 6- Expected sales: 1000 units 7- Variable selling expenses = $2 per unit 8- Fixed S&A = $5000

78 Exercise (Operation Budget) 7- Inventory Balances: Beginning Balance FG per unit DM 1000 $5 per Kg Target Balance 300 units 1200 $5 per Kg 8- Assume no WIP inventories

79 Exercise (Operation Budget) Prepare Operation Budget (Net Income Budget). What is purchase budget of DM? Expected Net Income = $39000

80 Successful Budgeting Starts with the company s short term and long term plans Must have support of management at all levels People should believe in budgeting Must be flexible

81 Make or Buy Decisions Relevant Costs: Costs differ among alternatives (incremental costs) (Variable costs and avoidable fixed costs) Highest purchase price = relevant costs

82 Special order decision Operating at less than full capacity: Avoidable Costs Operating at full capacity: Unit selling price

83 Pricing Short Term Price: Minimum price must be higher than unit variable costs. Long Term Price: Minimum price must be higher than all unit costs.

84 Cost Volume-Profit Analysis Unit Contribution Margin = Unit Selling Price Unit Variable Costs Breakeven Point in units = Total Fixed Costs Unit Contribution Margin

MID TERM EXAMINATION Spring 2010 MGT402- Cost and Management Accounting (Session - 2) Time: 60 min Marks: 47

MID TERM EXAMINATION Spring 2010 MGT402- Cost and Management Accounting (Session - 2) Time: 60 min Marks: 47 Question No: 1 ( Marks: 1 ) - Please choose one Which of the following product cost is Included