ACCOUNTING
AND FINANCIAL
STATEMENT ANALYSIS
Cost for management decisions
Learning Objectives
In this chapter you will be introduced
to:
Some types of cost
The differences between a merchandising
and a manufacturing financial statements
which arise from cost term.
Manufacturing costs
Manufacturing costs are associated with
converting raw materials into finished
goods
Major manufacturing cost classifications
are:
1. direct materials
2. direct labour
3. manufacturing overheads
3
Manufacturing costs continued
1. Direct materials
Direct materials can be economically
and physically traced to finished goods
e.g. flour for bread, steel for cars, cloth for
shirts, plastic for toys
Indirect materials
Do not physically become part of finished
product
Not directly traceable to specific goods
e.g. oil for lubricating machines
Treated as manufacturing overhead
4
Manufacturing costs continued
2. Direct labour
Direct labour can be economically
and physically traced to finished
goods
e.g. bakers in a bakery, typesetters in a
printery
Indirect labour
Cannot directly trace to specific goods
e.g. maintenance crew, supervisors
Treated as manufacturing overhead
5
Manufacturing costs continued
3. Manufacturing Overhead
Indirect costs associated with
manufacturing products
e.g. indirect materials, indirect labour,
depreciation, insurance, maintenance
Also called factory overhead, indirect
manufacturing costs
6
4. PRODUCT VS. PERIOD
COSTS
Product costs
Relate directly to finished products
Expensed as Cost of sales when
finished products are sold
Period costs
Not directly part of manufacturing
process
Expensed according to time (financial
period costs), not specific goods
e.g. selling and administration costs
7
Product vs. period costs
continued
Prime costs
Consists of direct materials plus direct
labour
Directly associated with manufacture of
finished products
Conversion costs
Consists of direct labour plus
manufacturing overhead
Incurred in converting raw materials into
finished products
8
Product vs. period costs
continued
9
5. DIFFERENCE BETWEEN
MERCHANDISING & MANUFACTURING
INCOME STATEMENT
Income Statement
Cost of Sales
Merchandising entity uses cost of goods purchased
Manufacturing entity calculates cost of goods
manufactured
10
DIFFERENCE BETWEEN MERCHANDISING &
MANUFACTURING INCOME STATEMENT
continued
11
INCOME STATEMENT
MERCHANDISING ENTITY MANUFACTURING ENTITY
Income Statement (partial) Income Statement (partial)
For the year ended 31 December For the year ended 31 December
Cost of sales Cost of sales
Inventory, 1 Jan $ 70 000 FG inventory, 1 Jan $ 90
COG purchased 650 000 000
COGAS 720 000 COG manufactured 370 000
Inventory, 31 Dec 400 000 COGAS 460 000
Cost of sales $320 FG inventory, 31 Dec 80
000 000
Cost of sales $380
000
12
6. DIFFERENCE BETWEEN
MERCHANDISING & MANUFACTURING
STATEMENT OF FINANCIAL POSITION
Statement of Financial Position
Inventory
Merchandisers only use one account
Manufacturers use several accounts, to reflect
various stages of production
13
STATEMENT OF
FINANCIAL POSITION
MERCHANDISING ENTITY MANUFACTURING ENTITY
Balance Sheet (partial) Balance Sheet (partial)
As at 31 December As at 31 December
Current assets Current assets
Cash $100 Cash $180
000 000
Receivables (net) 210 000 Receivables (net) 210 000
Inventory 400 000 Inventories:
Prepaid expenses 22 000 Finished good $80 000
Total current assets $732 000 Work in process 25 200
Raw materials 22 800 128 000
Prepaid expenses 18 000
Total current assets $536 000
14
DETERMINING THE COST OF GOODS
MANUFACTURED AND COST OF
SALES
15
Managerial Cost Concepts
Variable cost
Fixed cost
Mixed cost
Variable Costs
Costs that vary in total directly and
proportionately with changes in the activity
level.
Example: direct materials and direct labour
Variable costs remain the same per unit at
every level of activity.
SO 1 Distinguish between variable and fixed costs.
Fixed Costs
Costs that remain the same in total regardless of
changes in the activity level.
Per unit cost varies inversely with activity: As
volume increases, unit cost declines, and vice
versa.
Examples: the cost of a leased building,
depreciation on buildings and equipment
SO 1 Distinguish between variable and fixed costs.
Mixed costs (semi-variable
costs)
many costs are neither fully fixed nor fully
variable they contain elements of both
for example the cost of equipment repairs
fixed - is the cost of maintenance staff
variable is the increased cost of repairs caused by
increased usage
they are not strictly variable - they are not
zero when activity is zero
Mixed Costs - High-Low
Method
Mixed costs must be classified into their
fixed and variable elements.
High-Low Method uses the total costs incurred
at both the high and the low levels of
activity to analyse mixed costs.
SO 3 Explain the concept of mixed costs.
High-low method
Month Equivalent full Maintenance
units of cost
production
1 7,200 4,790
2 7,000 4,700
3 7,700 5,100
4 8,400 5,430
5 9,000 5,700
6 8,600 5,600
High-low method
Equivalent full Maintenance
units of production cost ($)
Highest level 9,000 5,700
Lowest level 7,000 4,700
Changes 2,000 1,000
High-low method
Variable cost = $ 1,000/2,000 = $0.5/unit
Fixed cost = Total cost – Total variable cost
= $ 5,700 - $ 0.5 * 9, 000
= $ 5,700 - $ 4,500 = $1,200
Contribution margin
Contribution margin per unit:
P-Vc : the amount of unit price in excess of
variable cost per unit
Total contribution margin:
(P-Vc)*Q
Contribution margin ratio:
= Contribution margin per unit
Sales price per unit