Accounting 2. For Professor Howard J. Levine

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1 Accounting 2 Chapters 12 to 26 Class Handouts For Professor Howard J. Levine Note: This packet should be brought to class every week. If you forget or misplace it you can reprint the set by going to the Valley College web site and navigating to Howard Levine s instructor page:

2 BUSINESS COMBINATIONS Three methods are used to combine businesses, as follows: 1. Merger One company purchases the assets and liabilities of another company. The acquired company is dissolved. 2. Consolidation Two companies transfer their assets and liabilities to a new corporation. Both of the original companies are dissolved. 3. Parent-Subsidiary Relationship One company purchases a controlling interest in another company by acquiring shares of its voting stock. Neither company is dissolved. Page 2

3 AMORTIZATION OF A BOND DISCOUNT/PREMIUM Discount: Effect of Amortization Reason Bond is a Increases Discount represents debt instrument. interest expense. extra interest paid to bondholders to bring the bond's stated interest rate up to a Bond is an Increases higher market investment. interest income. interest rate. Premium: Bond is a Reduces Premium represents debt instrument. interest expense. a reduction in interest to bring the bond's stated interest rate down to Bond is an Reduces a lower market investment. interest income. interest rate. Page 4

4 TRADING SECURITIES/ AVAILABLE-FOR-SALE SECURITIES Unrealized gain/loss Trading Securities Unre alized gain/loss Available-for-Sale Securities Income Statement Stockholders Equity section of the Balance Sheet Page 5

5 Trading Securities Available-for-Sale Securities Held-to-Maturity Securities Valued at: Fair Value Fair Value Amortized Cost Changes in valuation are reported as: Reported on the balance sheet as: Classified on balance sheet as: Unrealized gain or loss is reported on income statement as Other revenue (loss). Cost of investments plus or minus valuation allowance. A current asset. Accumulated unrealized gain or loss is reported in stockholders equity on the balance sheet. Cost of investments plus or minus valuation allowance. Either as a current or noncurrent asset, depending on management s intent. Premium or discount amortization is reported as part of interest revenue on the income statement. Amortized cost of investment. Either as a current or noncurrent asset, depending on remaining term to maturity. Page 6

6 SECTIONS OF THE STATEMENT OF CASH FLOWS Cash Flows from Operating Activities Report cash received and paid in the daily operations of the business, including: 1. Cash received from customers 2. Cash paid to suppliers Cash Flows from Investing Activities Report cash received and paid as a result of the sale and purchase of investments. The investments reported in this section can be divided into two categories: 1. Investments in YOURSELF, for example: a. Purchase of fixed assets b. Sale of fixed assets 2. Investments in OTHERS, for example: a. Purchase of equity or debt securities of another corporation b. Sale of equity or debt securities held as investments c. Making of a loan to another company d. Collection of principal payments on a loan made to another company (Continued) Page 7

7 SECTIONS OF THE STATEMENT OF CASH FLOWS (Concluded) Cash Flows from Financing Activities Report cash received and paid as a result of the activities to obtain and repay funds used to finance the operations of a company. Financing activities can be divided into two categories: 1. EQUITY financing: a. Issuing shares of stock b. Retiring shares of stock c. Purchasing shares of treasury stock d. Selling shares of treasury stock e. Paying cash dividends on stock 2. DEBT financing: a. Borrowing cash b. Repaying principal on a loan Page 8

8 STATEMENT OF CASH FLOWS Schedule of Noncash Investing and Financing Activities Used to report transactions that are investing and/or financing activities but do not bring in or use up any cash. These transactions need to be reported because they will affect cash flows in the future. Examples include the following: 1. Purchasing fixed assets by signing a note payable 2. Purchasing a building through a mortgage loan 3. Exchanging stock for fixed assets 4. Issuing stock to retire debt 5. Converting preferred stock to common stock Page 9

9 STATEMENT OF CASH FLOWS Three Foolers The following transactions are reported in the Operating Activities section of the statement of cash flows: 1. Interest paid on debt Justification: The decision to finance the business through debt is a financing activity. Once that decision has been made, the cash to pay for the interest on debt must come from operating activities. 2. Interest received on investments 3. Dividends received on investments Justification: The decision to use cash to purchase equity or debt securities is an investment decision. Once that decision has been made, the cash received from interest or dividends is used to operate the business. Page 10

10 1 Sale of equipment at a gain 2 Issue shares of common stock 3 Purchase land 4 Decrease in accounts payable 5 Increase in accounts receivable 6 Redeem long-term bonds payable 7 Decrease in salaries payable 8 Decrease in prepaid expenses 9 Decrease in accounts receivable 10 Purchase equipment 11 Increase in merchandise inventory Statement of Cash Flows Practice Worksheet Indirect Method 12 Acquire patent by issuing preferred stock 13 Decrease in supplies 14 Buy back shares of preferred stock 15 Borrow notes payable (due in 5 years) 16 Sell a new issue of bonds 17 Pay dividends to preferred stockholders 18 Acquire building by issuing common stock 19 Decrease in taxes payable 20 Purchase building 21 Sell long-term debt investments 22 Acquire land financed by a mortgage 23 Record depreciation on fixed assets 24 Increase vacation payable Cur Asset (CA) Cur Liab (CL) Other Asset (OA) Operating (O) Investing (I) L-T Liab (LTL) Financing (F) Increase (+)* S/H Equity (SHE) Non-Cash (N/C) Decrease (-)* * An increase (+) to an operating activity item means that the amount is added to net income and a decrease (-) means that the amount is deducted from net income. Page 11

11 MANUFACTURING COSTS Direct Materials materials and component parts that become an integral part of the final product. These materials can be traced directly to a finished unit of product. Direct Labor cost of wages paid to employees who work directly on the product. Factory Overhead all other costs incurred in making the product. These costs include the following: 1. General manufacturing costs that cannot be traced directly to the product: Utilities (heating, lighting) Depreciation on machines Property taxes Insurance 2. Indirect Labor wages/salaries paid to workers who are necessary to keep the factory running, but who do not work directly on the product: Maintenance workers Janitorial staff Factory personnel department Plant manager and supervisors 3. Indirect Materials materials used in the manufacturing process that do not end up in the final product: Materials used to test machines Lubrication used on machines NOTE: Direct materials and direct labor costs may be treated as factory overhead costs if they are insignificant. Page 13

12 Statement of Cost of Goods Manufactured Beginning work in process inventory Direct materials: Beginning materials inventory Purchases Cost of materials available for use Less ending materials inventory Cost of direct materials used Direct labor Factory overhead: Indirect labor Depreciation on factory equipment Factory supplies and utility costs Total factory overhead Total manufacturing costs incurred Total manufacturing costs Less ending work in process inventory Cost of goods manufactured $XXX XXX $XXX XX $XXX XXX XXX $XXX XXX XXX $XXX XXX $XXX XX $XXX Page 14

13 Income Statement Sales Cost of goods sold: Finished goods inventory, beginning Cost of goods manufactured Cost of finished goods available for sale Less finished goods inventory, ending Cost of goods sold $XXX Operating expenses: Selling expenses Administrative expenses Total operating expenses Net income $XXX $XXX XXX XXX XXX XXX Gross profit $XXX XXX XXX $XXX Page 15

14 JOURNAL ENTRIES IN A JOB ORDER COST ACCOUNTING SYSTEM Record the following entries for Jen Manufacturing. 1. Purchased materials costing $20,000 on account. 2. Materials costing $13,000 were requisitioned for use in making specific customer jobs. An additional $1,000 in materials was requisitioned for general factory use. 3. $7,800 was paid to direct laborers. An additional $9,500 was paid to factory employees who do not work directly on Jen's products. 4. Factory overhead expenses totaling $5,000 were paid in cash. 5. $3,700 in depreciation was recorded on factory machines. 6. Overhead was applied to production using a predetermined rate of $24.50 per direct labor hour. Jen used 780 direct labor hours during the period. 7. Jobs costing $38,000 were completed. 8. Jobs costing $32,000 were sold to credit customers for $55,000. Page 16

15 JOB ORDER COSTING IN A SERVICE BUSINESS John Meyer, CPA, does tax and audit work. He estimates his overhead costs for the current year will be: Wages paid to receptionist... $17,000 Supplies... 8,000 Depreciation on office equipment... 2,000 Advertising... 1,300 Rent and utilities... 4,000 $32,300 John uses direct labor hours to allocate overhead costs to jobs performed for clients. He estimates that he will work 1,900 hours conducting audits and preparing tax returns this year. John uses $25 per hour for his wage rate when computing the cost of any work performed for a client. John spent 12 hours preparing a tax return for Sharon Ward. What was the cost to prepare Sharon's return? Page 17

16 JOB ORDER VS. PROCESS COSTING Job Order Costing Used by manufacturers who make special orders, customized products, or standard products produced in batches. Process Costing Used by manufacturers who mass produce large quantities of identical units in a continuous flow. Page 18

17 SIMILARITIES IN JOB ORDER AND PROCESS COSTING Both systems record and summarize product costs. Both systems classify product costs as direct materials, direct labor, and factory overhead. Both systems allocate factory overhead. Both systems use a perpetual inventory system for materials, work in process, and finished goods. Both systems provide useful product cost information for decision making. Page 19

18 DIFFERENCES IN JOB ORDER AND PROCESS COSTING Job Order: Costs are accumulated by job. Cost to Make One Unit = Cost of the Job No. of Units in the Job Process Costing: Costs are accumulated by department for a time period (for example, one month). Department s Cost Cost to Make One Unit = for the Month in One Department No. of Units Produced during the Month To find the total unit cost, add the unit costs incurred in each department. Page 20

19 FLOW OF COSTS IN A PROCESS COST SYSTEM Assume that Advanced Technologies, a computer manufacturer, makes its product in three departments: Assembly, Testing, and Packing. Materials and component parts are added in the Assembly Department. Packing materials are added in the Packing Department. Stu Materials WIP Assembly Cost of materials purchased Costs from assembly Direct Labor Overhead (applied) Cost of completed units Materials used in assembly Materials used in packing WIP Testing Finished Goods Cost of units transferred to packing Cost of units sold Materials Direct Labor Overhead (applied) Cost of units transferred to testing WIP Packing Costs from Cost of testing completed Materials units Direct Labor Overhead (applied) Cost of Goods Sold Cost of units sold Page 21

20 MARGIN OF SAFETY RGF Manufacturing makes a product that currently sells for $20 each. The variable costs to make this product are $12 per unit. Fixed costs total $800,000 per year. 1. How many units must be sold to break even? 2. What will be the company's sales revenue at the break-even point? 3. Assume that the company's current sales are $2.6 million (130,000 units) per year. Calculate the company's margin of safety: a. in dollars b. in units c. as a percentage 4. Assume that one of RGF's major competitors has a margin of safety of 35%. Which company is more recession proof: RGF or its competitor? Page 23

21 QUICK QUESTION Pretorious Manufacturing has just hired a new controller, Diana Metcalf. During her first week on the job, Diana is asked to establish a budget for operating expenses in Since Diana is not yet familiar with the operations of Pretorious Manufacturing, she decides to budget these expenses using the same procedures as the prior controller. Therefore, in order to establish a budget for operating expenses, Diana starts with actual operating expenses incurred in 2013 and adds 4.3%. Diana bases this percentage on inflation as measured by the consumer price index. Comment on the effectiveness of Diana s budgeting strategy. Page 24

22 BUDGETING METHODS TWO MAJOR TYPES OF BUDGETS Static Budget Description: A budget that does not reflect potential changes in volume or activity level Strength: Simple all expenses are budgeted as fixed costs Weakness: Does not reflect changes in revenues and expenses that must occur as volumes change, making it difficult to interpret actual performance Typical Usage: Service organizations or administrative departments of retailers and manufacturers Flexible Budgets Description: A budget that shows revenues and expenses for a variety of volumes or activity levels Strength: Provides information needed to analyze the impact of volume changes on actual operating results Weakness: Requires greater research into costs must differentiate fixed and variable costs in the budgeting process Typical Usage: Operational departments of retailers and manufacturers whose costs change with sales and production Page 25

23 WHAT DO YOU THINK? Assume that you manage one store in a chain of sporting goods retailers. Each month, your store is evaluated by comparing actual operating results to budgeted results. During December of the current year, your store's sales were up 25% from sales projected on the budget. As a result of this increase in sales, would you expect any other items to come in over (or under) their budgeted amounts? If so, list the items and describe why they would vary from the budget. Page 26

24 FLEXIBLE BUDGETS Mars Corporation incurs the following overhead costs to manufacture its product: Indirect materials... $2 per unit Indirect labor... $1.50 per unit Supervisory salaries... $84,000 per month Depreciation of plant and equipment... $58,000 per month Utilities... $3,000 per month + $0.25 per unit Prepare a flexible overhead cost budget for the following production levels: 6,000 units, 8,000 units, and 10,000 units. Page 27

25 COST OF GOODS SOLD BUDGET Beginning Finished Goods Inventory Beginning Work in Process Inventory Beginning Materials Inventory + Cost of Goods Manufactured + Total Manufacturing Costs + Materials Purchases Goods Available for Sale Total Work in Process during Period Materials Available for Use - Ending Finished Goods Inventory - Ending Work in Process - Ending Materials Inventory Cost of Goods Sold Cost of Goods Manufactured Cost of Materials Used + Direct Labor + Overhead Total Manufacturing Costs

26 CASH BUDGET Estimated Cash Receipts Estimated Cash Payments Cash Increase (or Decrease) + Cash Balance at the Beginning of Month Cash Balance at the End of Month Minimum Cash Balance Excess (or Deficiency) Page 29

27 ESTIMATING CASH RECEIPTS The sales budget of Carson Industries projects the following sales for January through May: January... $235,000 February ,000 March ,000 April ,000 May ,000 Carson sells 30% of its merchandise to cash customers. Of the sales on credit, 75% are collected in the month after the sale, and 25% are collected in the second month after the sale. Determine the amount of cash that Carson will collect from cash sales and accounts receivable during the months of March, April, and May. The following should help you complete your calculations. Cash sales... Collections on accounts receivable: (1) From last month's credit sales... (2) From credit sales 2 months ago... Total cash receipts... March April May Page 30

28 RESPONSIBILITY CENTERS The following is a list of divisions/departments within a chain of department stores. Assuming that you are part of the top management team for the department store chain, state whether you would treat each operating unit as a cost, profit, or investment center. Remember that your decision determines the level of authority and responsibility that will be given to the manager of each unit. 1. Each of the five stores in the chain 2. Accounting department 3. Ladies clothing department 4. Furniture department 5. Credit and collection department Page 33

29 PERFORMANCE MEASURES FOR INVESTMENT CENTERS ROI vs. Residual Income Rate of Return on Investment (ROI) Advantages: ROI allows management to assess both profitability and efficiency in using assets. Divisions of unequal size can be compared. Management is provided with information to make decisions on where to invest additional company funds. The company knows where it is getting the most bang for its buck. Disadvantage: If a manager is evaluated based on ROI, he or she will not invest in any project that will lower the division s ROI, even if it would increase the company s profitability. Residual Income Advantages: It considers a company s minimum rate of return. Any project that increases residual income will be pursued by division management. Disadvantage: The relative size of the divisions is not considered. Page 34

30 INTERCOMPANY TRANSFERS Benefits of Transfer Pricing 1. Divisions can be evaluated as profit or investment centers. 2. Divisions are forced to control costs and operate competitively. 3. If divisions are permitted to buy component parts wherever they can find the best price (either internally or externally), transfer pricing will allow a company to maximize its profits. Page 35

31 DIFFERENTIAL ANALYSIS Summer Job Offers You have been offered two different jobs for the upcoming summer. Since both are full-time positions, you must choose to work only one of the jobs. The first job is in an office. The pay will be $320 per week. The office is located 20 miles from your home, so you estimate that you will spend $25 per week on gas. You will also have to pay $25 per week for parking. Because you are required to dress professionally, you will need to purchase some new clothes. You estimate that you will spend $350 on new clothes for this job during the summer. The second job is at an amusement park. The pay will be $220 per week. The amusement park is also 20 miles from your home, but you can carpool with a friend. Your share of the gas will be $12.50 per week. There is no charge for parking. The amusement park will furnish you with a uniform, so you won't need to buy any special clothes. Assuming that your summer break will allow you to work 12 weeks, which job will provide you with more money? Page 36

32 DETERMINING A PRODUCT'S SELLING PRICE The following costs were incurred to make 10,000 units of a product: Variable manufacturing costs... $5 per unit Variable selling and administrative expenses... $2 per unit Fixed factory overhead costs... $80,000 Fixed selling and administrative expenses... $30,000 This company wishes to price its product so it will make a profit of $27,000 if all 10,000 units are sold. How much should it sell for to make management happy? Page 37

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