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1 AN INTRODUCTION TO THE PRINCIPLES OF MANAGERIAL ACCOUNTING Assessment Questions AS-1 ( 1 ) What is managerial accounting? Managerial accounting relies on financial information to help managers and employees make informed business decisions. AS-2 ( 1 ) What is financial accounting? Financial accounting is the branch of accounting concerned with formal financial statement preparation by classifying, measuring and recording the transactions of a business. AS-3 ( 1 ) Briefly describe five differences between managerial and financial accounting. Refer to page

2 An Introduction to the Principles of Managerial Accounting AS-4 ( 1 ) What is cost accounting? Cost accounting studies the relationship between costs, volume and profit to provide management with better information to make planning decisions. AS-5 ( 2 ) What are the two main stages in making decisions? Making decisions require planning and controlling. The planning stage involves creating objectives and developing strategies to achieve those objectives. The controlling stage involves implementing the objective, reviewing the results and applying corrective action. AS-6 ( 3 ) Describe the three main types of businesses. Manufacturing businesses purchase raw materials and convert them into finished goods. Merchandise businesses purchase and re-sell tangible products to their customers. Service businesses provide services to their customers. AS-7 ( 3 ) Provide three real world companies for each type of business. Answers will vary. Some companies may fall into more than one category. 268

3 An Introduction to the Principles of Managerial Accounting Chapter 19 AS-8 ( 3 ) Provide an example of a profession or occupation that will benefit from an understanding of management accounting, and explain how it might be helpful. Answers may vary. Possible answer: A sales professional should understand management accounting. If there are any changes in the costs of the product or service, the sales professional can properly adjust his/her sales strategy and sale price to compensate for the increased/decreased costs. AS-9 ( 5 ) How are costs classified based on their behavior at different activity levels? Costs can be classified as variable, fixed or mixed. AS-10 ( 5 ) What is a variable cost? Provide an example. A variable cost is a cost that will vary with the amount of product manufactured or service provided. Examples will vary. AS-11 ( 5 ) What is a fixed cost? Provide an example. A fixed cost is a cost that will remain constant for a certain level of production. Examples will vary. 269

4 An Introduction to the Principles of Managerial Accounting AS-12 ( 5 ) Explain the difference between variable costs and fixed costs. Variable costs change depending on the amount of products manufactured or services provided. The higher the volume, the higher the variable costs. Fixed costs, however, will remain relatively the same as long as the volume of production is within a relevant range. AS-13 ( 6 ) What is the purpose of a formal income statement? A formal income statement will provide summarized information on revenue and expenses useful to external users. AS-14 ( 6 ) What is the purpose of a contribution margin statement? A contribution margin statement will provide detailed information to internal users and separates variable costs from fixed costs. AS-15 ( 6 ) What is the difference between the formal income statement and the contribution margin statement? The contribution margin statement focuses on grouping items based on cost behavior (i.e. variable versus fixed costs); whereas the formal income statement separates costs based on whether they are related to the product (product costs) or not (operating expenses). AS-16 ( 7 ) What is the break-even point? It is the level of sales at which the company s operating profit is equal to zero. 270

5 An Introduction to the Principles of Managerial Accounting Chapter 19 AS-17 ( 7 ) Why is the break-even point important? The break-even point can be used to answer sales questions such as by how much sales can drop before the company begins to lose money. AS-18 ( 8 ) Define relevant range. Relevant range refers to the range where certain cost behavior remains the same. AS-19 ( 9 ) What is the balanced scorecard (BSC) used for? The balanced scorecard (BSC) is a strategic performance management framework that helps implement the company s strategy. AS-20 ( 10 ) Based on the Institute of Management Accountants (IMA), briefly indicate the standards that a member must comply with. A member must maintain a high level of competence, keep all private information about their clients confidential, maintain integrity by avoiding conflicts of interest and report information objectively. AS-21 ( 10 ) Why is it important for managerial accountants to follow the code of ethics? Failure to abide by the code of ethics will result in disciplinary measures against the offending member. 271

6 An Introduction to the Principles of Managerial Accounting Application Questions AP-1 ( 1 ) Indicate whether the following statements describe financial accounting (FA) or managerial accounting (MA). FA MA FA MA FA MA a) Must follow Generally Accepted Accounting Principles (GAAP) or International Financial Reporting Standards (IFRS) set by professional bodies. b) Largely based on forecasting future sales and cash flows, calculating costs and preparing budgets. c) Is concerned with collecting data of historical nature. d) Does not require independent examination. e) Primarily prepared for external users such as creditors and stockholders so that they can make sound financial or investment decisions. f) Reports are very detailed and provide a wealth of information. AP-2 ( 1 ) Owen s Office Supply sells office supplies, office furniture and equipment from four stores in a major metropolitan city. The accountant for Owen s Office Supply is preparing the yearend financial statements for 2014 and also creating forecasted financial statements. Indicate whether the items listed would use historical information or forecast information. Sales for 2014 Cost of goods sold for next year Budgeted income statement Actual operating income Expected gross profit Historical Forecast Forecast Historical Forecast AP-3 ( 2 ) Match the appropriate management activity to the following scenarios. Activity: A) Setting objectives B) Implementing the objective C) Reviewing and monitoring results D) Applying corrective action 272

7 An Introduction to the Principles of Managerial Accounting Chapter 19 A D B The manager of the power tools department at a local hardware store would like to increase power tool sales by 6% for the next year. The factory manager at a car seat manufacturer discovers that the new work flow that was implemented is not keeping up with production requirements and the manager begins designing a new work flow. The company requires all employees to know how to use the new inventory tracking software. As a result, the store manager has scheduled a training workshop for next week. C The sales manager finds that sales have exceeded the projected increase of 4%. AP-4 ( 4, 5 ) Titans Plumbing Inc. provides a general line of plumbing as well as a septic tank emptying and cleaning service. Consider the following facts: Helpers and registered plumbers earn their salaries based on their hourly rate times the number of hours worked on the job Supplies and materials are used as each job requires them Advertising and general administrative expenses are not charged directly to each job Insurance and pensions are paid regardless of the hours worked The following costs have been taken from the accounting records for the month of June: (in thousands) Supplies for helpers and plumber $160 Helpers salaries 75 General office salaries 43 Job supervisors salaries 175 Registered plumbers salaries 14 Advertising 3 Medical and life insurance of helpers and plumbers 5 Pension costs of helpers and plumbers 14 Medical and life insurance of general office staff 1.5 Utilities (divided between operations and general office)

8 An Introduction to the Principles of Managerial Accounting Required: Identify each cost as variable or fixed. Show the total dollar amounts for each category. Variable costs: (in thousand dollars) Fixed Cost (in thousand dollars) Supplies for helpers and plumber $160 General office salaries $43 Helpers salaries 75 Job supervisors salaries 175 Registered plumbers salaries 14 Advertising 3 Medical and life insurance of general office staff 1.5 Medical and life insurance of helpers and plumbers 5 Pension costs of helpers and plumbers 14 Utilities 16 Total Variable costs $249 Total Fixed costs $258 AP-5 ( 2, 3, 4, 5 ) Massive Video Store (MVS) operates a large store in Toronto. The store sells movies and TV series in the form of DVDs. The following is a list of expenses that the company has incurred over the year: Required: I. Electricity costs of the MVS store single bill for the entire store II. Annual fee paid to DVD distributor (same amount each year) III. Costs of DVDs purchased for sale to customers IV. Fire insurance policy for MVS V. Shipping costs of DVDs purchased VI. Rent paid on a monthly basis (rent fees are based on the square footage of store) a) As discussed at the beginning of the chapter, organizations fall into three main categories with respect to the type of business they are in. What type of business is MVS in? Why is it important for the owner of MVS to understand managerial accounting? MVS is an example of a merchandising business, because it purchases DVDs and re-sells them to its customers. Understanding managerial accounting is extremely important because it allows the owner of MVS to make informed business decisions. For example, if the DVD distributer decides to increase the annual fee, the owner can consider adjusting his operations (e.g. sales strategy and sales price) to compensate for the increase in costs. 274

9 An Introduction to the Principles of Managerial Accounting Chapter 19 b) Classify each of the above cost items as either variable or fixed with respect to the number of DVDs purchased and resold. Cost Item I. Electricity costs of the MVS store single bill for the entire store Variable or Fixed Cost Fixed Cost II. Annual fee paid to DVD distributor Fixed Cost III. Costs of DVDs purchased for sale to customers Variable Cost IV. Fire insurance policy for MVS Fixed Cost V. Shipping costs of DVDs purchased Variable Cost VI. Rent paid on a monthly basis Fixed Cost AP-6 ( 10 ) Taylor Accountants LLP recently hired a university student for the summer. With little knowledge on accounting and lack of work experience, the student continued to perform various tasks without any supervision. These tasks include analyzing financial statements and providing recommendations to clients. Required: According to the IMA standards, which of the four standards did the company violate and why? Competence The company should ensure all staff members have the appropriate level of professional expertise. Since the student has minimal exposure to accounting, this can put in to question their ability to analyze financial statements and providing recommendations to clients. As a result, the company needs to provide the student with the technical training and proper supervision. AP-7 ( 10 ) Gordon & Morgan LLP (G&M) is an accounting firm. The firm compiles financial statements and also provides managerial consulting to their clients. Two days ago, Y&E Company approached Gordon, the controlling partner of G&M, for managerial accounting assistance. The client has been experiencing significant losses for the past few years, and for the very first time, the board 275

10 An Introduction to the Principles of Managerial Accounting of directors of Y&E Company demanded a particular set of financial reports. The CEO of Y&E made a personal agreement with Gordon. He will pay Gordon an additional 20% if Gordon ensures the report on income to be prepared for Y&E s board of directors will not present a net loss. Required: Which of the four IMA standards did Gordon violate and why? Integrity Maintaining objectivity is one of IMA s overarching ethical principles. Objectivity is the ability of a member in professional practice to hold themselves free of any influence, interest or relationship that impairs the member s professional judgment. The agreement between Gordon and the CEO of Y&E can impair Gordon's objectivity for this client since he will be personally benefited by accepting the bonus. As a result, Gordon did not fulfill the responsibility to mitigate all conflicts of interest. AP-8 ( 10 ) After a meeting with M&T Accountant LLP, the CEO of Bill Jonny Corporation decided to have lunch in the cafeteria (which was located in the same building as M&T). As he was about to leave, he noticed that all of Bill Jonny Corporation s financial records were scattered on the ground. At this point, the CEO was extremely upset with M&T, since these records were meant for internal use only. Two days after the incident, Bill Jonny Corporation filed a lawsuit against its accounting firm, M&T Accountants LLP. Required: Which of the four IMA standards did Bill Jonny Corporation sue M&T Accountants LLP for breaching and why? Confidentiality Knowing that M&T s internal financial records cannot be disclosed to the public, M&T Accountants LLP should have taken extra care with Bill Jonny Corporation s information. M&T also should not have brought the client s information to the cafeteria. All clients financial records should be kept in a safeguarded, private area. As a result, M&T failed to ensure Bill Jonny Corporation s financial records are kept confidential. 276

11 An Introduction to the Principles of Managerial Accounting Chapter 19 AP-9 ( 10 ) At year end, the accounting department of QRT Limited is required to provide a set of financial statements. For the past two years, QRT has been experiencing financial difficulties and 70% of its long-term assets have been used as collateral for a bank loan. To make QRT s stockholders confident about the company s operations, the accounting department decided to withhold information regarding the collateral. Required: According to the IMA standards, which of the four standards did the company violate and why? Credibility Having 70% of QRT s long-term assets used as collateral is significant and can definitely affect the stockholders investment decisions. As a result, the accounting department failed to disclose all relevant information that can reasonably affect the user s (stockholder s) understanding of the reports, analyses or recommendations. 277

12 An Introduction to the Principles of Managerial Accounting Exercise Questions EX-1 ( 7 ) Complete the table below. 400 units sold 700 units sold 1,000 units sold Total Per unit Total Per unit Total Per unit Variable Cost $2,800 $7.00 $4,900 $7.00 $7,000 $7.00 Fixed Cost $3,500 $8.75 $3,500 $5.00 $3,500 $3.50 Total Cost $6,300 $8,400 $10,500 Analysis Component: If each unit is sold for $12, calculate the total revenue and profit (loss) in each scenario. What is the breakeven point? 400 units sold 700 units sold 1,000 units sold Total Revenue: $4,800 $8,400 $12,000 Total Cost: $6,300 $8,400 $10,500 Profit (Loss): ($1,500) $0 $1,500 The breakeven point is where profits are exactly equal to $0. Therefore, 700 units is the breakeven point EX-2 ( 5 ) Complete the table below. 3,000 hours worked 4,000 hours worked 5,000 hours worked 6,000 hours worked Variable Cost $15,000 $20,000 $25,000 $30,000 Fixed Cost $100,000 $100,000 $100,000 $100,000 Total Cost $115,000 $120,000 $125,000 $130,

13 An Introduction to the Principles of Managerial Accounting Chapter 19 EX-3 ( 5, 6 ) Herk Tools Inc. is a manufacturer of standard tools. The company purchases raw materials that are cut and formed by factory workers using a production machine. There are two supervisors earning equal salaries - one for the factory and one for the general office. Herk Tools Inc. stores inventory in an offshore facility that costs $1,000/month to rent. A second storage facility is available for $1,500/month if required. The following costs have been taken from the accounting records for the month of October: Supervisor Salaries $20,000 Rent Expense $4,000 Cost of Materials $35,000 Factory Wages $26,000 Inventory Storage Costs $2,500 Shipping of Materials $2,700 Depreciation on Production Machine $1,800 Herk Tools had sales of $110,000 during October a) Identify the above costs as either fixed or variable. Variable Cost of Materials Factory Wages Shipping of Materials Fixed Supervisor Salaries Rent Expense Inventory Storage Costs Depreciation on Production Machine b) Prepare a contribution margin statement for October Herk Tools Inc. Contribution Margin Statement For the month ended October 31, 2014 Sales $110,000 Less Variable Costs: Cost of Materials $35,000 Factory Wages 26,000 Shipping of Materials 2,700 63,700 Contribution Margin $46,300 Less Fixed Costs: Supervisor Salaries $20,000 Rent Expense 4,000 Inventory Storage Expense 2,500 Depreciation Expense 1,800 28,300 Operating Income $18,

14 An Introduction to the Principles of Managerial Accounting Analysis Component: Describe step costs. Does Herk Tools Inc. have any step costs? Step costs are fixed costs that change according to whether operations fall within the relevant range of the cost or not. The inventory storage cost at Herk Tools Inc. is a step cost because the cost remains the same over a wide range of production levels, but will increase once a certain level is reached. The supervisor salary cost may also be a step cost if an additional supervisor is needed once production reaches a certain amount. EX-4 ( 5, 7 ) Sprout Company is a manufacturer of gardening equipment. One particular product requires $45 in raw materials and 1 hour of direct labour to produce. Workers earn $15/hour to produce up to 4,000 units of this product, but they will earn $25/hour for overtime to make additional units. Sprout Company s annual fixed costs total $335,000. Calculate Sprout Company s total fixed and variable costs at the following levels of production activity: Units Produced 2,500 units 5,000 units 7,500 units Variable Costs $150,000 $310,000 $485,000 Fixed Costs $335,000 $335,000 $335,000 Total $485,000 $645,000 $820,000 Analysis Component: Suppose that Sprout Company sells the product for $129 each, and it is the only product the company sells. Also suppose that the company sells every unit that it produces. a) Calculate the company s total sales for each activity level from above. 2,500 units 5,000 units 7,500 units Total Sales $322,500 $645,000 $967,500 b) What is the company s breakeven point? At 5,000 units total sales equal total expenses, so the company s breakeven point is 5,000 units. Given that employees must work overtime just to break even, the company doesn t seem very healthy. 280

15 An Introduction to the Principles of Managerial Accounting Chapter 19 EX-5 ( 5 ) Stripe Company manufactures patio furniture. The company has three identical machines that it uses for production when needed. The following table illustrates the company s machine usage at different annual production levels: Machines Used Units Produced 1 below 2, ,000-4,000 3 above 4,000 Last year, Stripe Company produced 2,600 units and had fixed and variable costs of $241,000 and $390,000 respectively. Each machine incurs $41,000 in set-up and utility costs per year when in use and is depreciated at $5,000 per year whether used or not. Calculate the variable and fixed costs at the following production levels. Units Produced 1,500 units 2,500 units 3,500 units 4,500 units Variable Costs $225,000 $375,000 $525,000 $675,000 Fixed Costs $200,000 $241,000 $241,000 $282,000 Total $425,000 $616,000 $766,000 $957,000 Analysis Component: Suppose that Stripe Company sells each product for $300. The company budgets to produce and sell 1,900 units this year. However, a new retail store would like to order 200 additional units. Calculate the operating income under each scenario. 1,900 units 2,100 units Sales $570,000 $630,000 Less: Variable Costs $285,000 $315,000 Fixed Costs $200,000 $241,000 Operating Income $85,000 $74,

16 An Introduction to the Principles of Managerial Accounting EX-6 ( 6 ) Glass Manufacturing has prepared its income statement for the most recent month of operations below: Glass Manufacturing Income Statement For the month ended May 31, 2014 Sales $200,000 Cost of Goods Sold 64,000 Gross Profit 136,000 Operating Expenses: Salaries Expense 79,000 Depreciation Expense 4,000 Advertising Expense 8,000 Rent Expense 4,500 Net Income $40,500 Notes: 1) 70% of Salaries Expense was paid to workers to create the products that the company sells. 2) 80% of the building is used to manufacture products. The remainder is used for administrative duties. 3) Cost of Goods Sold includes raw materials of $55,000 and paint of $9,000. Prepare the contribution margin statement for Glass Manufacturing. Glass Manufacturing Income Statement For the month ended May 31, 2014 Sales $200,000 Variable Costs Raw Materials $55,000 Paint 9,000 Direct Labour 55, ,300 Contribution Margin 80,700 Fixed Costs Salaries 23,700 Depreciation 4,000 Advertising 8,000 Rent 4,500 40,200 Operating Income $40,

17 An Introduction to the Principles of Managerial Accounting Chapter 19 Analysis Component: a) Glass Manufacturing sells its product for $160. Calculate the following values: Number of units sold 1,250 Variable cost per unit $95.44 Contribution margin per unit $64.56 b) If Glass Manufacturing raises its selling price, it won t be able to sell as many units. What would happen to operating income if the company increased its selling price by $40, but sold 250 fewer units? Sales would remain at $200,000 ($200 * 1,000 units), but Glass Manufacturing would save on variable costs since it will sell fewer units. Variable costs would be $95,440 ($95.44 x 1,000 units) instead of $119,300. Therefore operating income would increase by $23,860 ($119,300 - $95,440) 283

18 An Introduction to the Principles of Managerial Accounting Notes 284

Weygandt, Kieso, Kimmel, Trenholm, Kinnear, Barlow, Atkins: Principles of Financial Accounting, Canadian Edition CHAPTER 1. Accounting in Action

Weygandt, Kieso, Kimmel, Trenholm, Kinnear, Barlow, Atkins: Principles of Financial Accounting, Canadian Edition CHAPTER 1. Accounting in Action CHAPTER 1 Accounting in Action ASSIGNMENT CLASSIFICATION TABLE Study Objectives Questions Brief Exercises Exercises Problems Set A 1. Identify the use and users of accounting and the objective of financial