Question

Mastery Problem: Introduction to Managerial Accounting

Able Baker Charlie Company

Charles Maxwell is starting a cheesecake bakery, Able Baker Charlie Company, to produce and sell different flavored cheesecakes to restaurants and the general public. He has just begun his study of accounting, and is a bit confused about the many types of reports he has read about and how they will help him run his business. He asks you to help him clarify what the differences between managerial accounting and financial accounting are. He’s also wondering how to set up his inventory, how to classify the costs of his business, and how to fill in some missing information.

Managerial vs. Financial

Select whether the following characteristics are most often associated with managerial accounting or financial accounting.

Primarily used for internal decision making
Generally Accepted Accounting Principles (GAAP) must be used
Prepared statements usually pertain to the company as a whole rather than individual departments or products
Information provided will often be subjective, such as estimated future results
Often prepared on an as-needed basis rather than at fixed intervals

Cost Classification

Charles has provided some of the costs he expects to incur as follows. Decide on the classifications that could be applied to each of these costs using the table provided. The cost object in each case is the cheesecake.

(Select "Yes" or "No" from the below dropdowns.)

Cost	Product Cost	Period Cost	Direct Materials	Direct Labor	Factory Overhead	Selling Expense	Administrative Expense	Direct Cost	Indirect Cost	Prime Cost	Conversion Cost
Eggs used to make cheesecakes
Baker’s wages
Delivery driver wages
Depreciation of office computers
Power to run the cheesecake ovens
President’s salary
Sales commissions
Factory supervisor salary

Financial Statements

Charles found some sample income statements and balance sheets on the Internet, and asked which of them might be most appropriate for a manufacturing business like his. Review income statements A and B, and balance sheets C and D. Determine which income statement and balance sheet would be most appropriate for a manufacturing business like Able Baker Charlie Company.

Income Statement A

Sample Company A Income Statement For the Year Ended December 31, 20Y8
Sales		$42,000
Finished goods inventory, January 1, 20Y8	$5,250
Cost of goods manufactured	6,400
Cost of finished goods available for sale	$11,650
Finished goods inventory, December 31, 20Y8	(400)
Cost of goods sold		(11,250)
Gross profit		$30,750
Operating expenses:
Selling expenses	$6,400
Administrative expenses	5,250
Total operating expenses		(11,650)
Net income		$19,100

Income Statement B

Sample Company B Income Statement For the Year Ended December 31, 20Y8
Sales		$42,000
Beginning inventory	$5,250
Net purchases	6,400
Inventory available for sale	$11,650
Ending inventory	(400)
Cost of goods sold		(11,250)
Gross profit		$30,750
Operating expenses:
Selling expenses	$6,400
Administrative expenses	5,250
Total operating expenses		(11,650)
Net income		$19,100

Balance Sheet C

Sample Company C Balance Sheet December 31, 20Y8
Assets
Cash		$20,800
Accounts receivable (net)		10,000
Inventory		6,000
Supplies		2,100
Land		17,000
Total assets		$55,900
Liabilities
Accounts payable		$17,800
Stockholders’ Equity
Common stock	$19,000
Retained earnings	19,100
Total stockholders’ equity		38,100
Total liabilities and stockholders’ equity		$55,900

Balance Sheet D

Sample Company D Balance Sheet December 31, 20Y8
Assets
Cash		$20,800
Accounts receivable (net)		10,000
Inventory:
Direct materials	$2,500
Work in process	1,500
Finished goods	2,000
Total inventory		6,000
Supplies		2,100
Land		17,000
Total assets		$55,900
Liabilities
Accounts payable		$17,800
Stockholders’ Equity
Common stock	$19,000
Retained earnings	19,100
Total stockholders’ equity		38,100
Total liabilities and stockholders’ equity		$55,900

Which income statement is most appropriate for a manufacturing business?

Which balance sheet is most appropriate for a manufacturing business?

Costs and Balances

At the end of February, after the second month of operations of Able Baker Charlie Company, Charles shows you the data he’s collected, but he was unable to figure out some of the amounts. Review the following data and fill in the missing amounts on the chart for Able Baker Charlie Company. Note: It may be helpful to use T accounts to map the flow of the amounts through the manufacturing accounts and solve for the missing dollar values. It may also be helpful to review the steps for determining the cost of materials used, total manufacturing cost incurred, and cost of goods manufactured.

Data for February
Decrease in materials inventory	$3,000
Materials inventory on Feb. 28	50% of materials inventory on Jan. 31
Direct materials purchased	$12,000
Direct materials used	3 times the direct labor incurred
Total manufacturing costs incurred in period	$29,400
Total manufacturing costs incurred in period	70% of Cost of Goods Manufactured
Total manufacturing costs incurred in period	$8,000 less than Cost of Goods Sold

	Account Balances
Account	Jan. 31	Feb. 28	Costs Incurred
Materials Inventory	$	$	Direct Materials Used	$
Work in Process Inventory	27,000		Direct Labor Incurred
Finished Goods Inventory		17,000	Factory Overhead Incurred
			Cost of Goods Sold

Answer 1

Financial accounting refers to the process of preparation of financial statements from the accounting records of a business during a defined accounting period, for the purpose of reporting the overall performance (profitability) of a business to various stakeholders, mainly external stakeholders like shareholders, creditors, statutory bodies. The object is to report the performance of the Company to its stakeholders.

Managerial accounting, on the other hand, is more inward-looking in terms of providing detailed data such as profitability of various product lines, processes, estimates, budgets to the management of the Company. The purpose is to enable better decision-making by the management and to chart future course of action for the Company.

Managerial vs Financial:

1. Primarily used for internal decision making – This feature is associated more with managerial accounting, since its primary function is to provide data to management of a Company for internal decision-making.
2. Generally Accepted Accounting Principles (GAAP) must be used – This characteristic is more relevant to financial accounting, since financial statements for the outside world must be prepared strictly in adherence with generally accepted accounting principles (GAAP) for the purpose of authenticity and comparability of financial statements.
3. Prepared statements usually pertain to the company as a whole rather than individual departments or products – This is a feature of financial accounting since financial accounting is concerned with reporting performance of Company as a whole and not individual departments or products.
4. Information provided will often be subjective, such as estimated future results – This is more relevant to managerial accounting since managerial accounting involves projections, estimates relating to various products and processes to aid in managerial decision-making. Financial accounting, on the other hand, is just recording the financial transactions as it is, in the financial statements, therefore, is fully objective.
5. Often prepared on an as-needed basis rather than at fixed intervals – This is a characteristic of managerial accounting since financial accounts are prepared at fixed intervals, usually one year, while managerial accounts may be prepared as needed, semi-annually, quarterly, monthly and even fortnightly reporting to monitor performance regularly, so that actuals can be aligned to budgets well in time.

Cost classification:

In order to understand how each of the items given below are classified into various costs, a brief on what is the meaning of each cost classification is provided as under:

1. Product costs vs period costs : Product costs are costs which are directly related to the product produced or purchased, for e.g., direct material, direct labour, direct expenses, factory overheads that can be directly allocated to production. These costs are incurred only when there is production or purchase. Period costs, on the other hand, are related to passage of time and cannot be allocated to production directly, for e.g., administrative expenses are period costs because they are to be incurred irrespective of production level.
2. Direct material cost, direct labour cost, factory overhead: Direct material refers to the raw materials used in production, for e.g. eggs used to make cheesecake. Direct labour refers to labour directly employed for production, for e.g., baker’s wages. Factory overheads are overhead costs in production such as factory rent, factory power, lighting.
3. Selling expenses and Administrative expenses: These are indirect costs incurred for selling the product. Administrative expenses too are indirect period costs associated with running the administrative office such as administrative staff salaries.
4. Direct costs vs indirect costs: Direct costs are costs directly associated with production such as direct materials, direct labour, direct expenses, factory overheads which can be allocated to production. Indirect costs are selling, administrative expenses, depreciation, office rent etc. not directly associated to production.

Thus, the classification of various costs is presented in table below:

Cost	Product	Period	Direct	Direct	Factory	Selling	Administrative	Direct	Indirect
	Cost	Cost	Materials	Labor	Overhead	Expense	Expense	Cost	Cost
Eggs used to make cheesecakes	Yes	No	Yes	No	No	No	No	Yes	No
Baker’s wages	Yes	No	No	Yes	No	No	No	Yes	No
Delivery driver wages	No	Yes	No	No	No	Yes	No	No	Yes
Depreciation of office computers	No	Yes	No	No	No	No	Yes	No	Yes
Power to run the cheesecake ovens	Yes	No	No	No	Yes	No	No	Yes	No
President’s salary	No	Yes	No	No	No	No	Yes	No	Yes
Sales commissions	No	Yes	No	No	No	Yes	No	Yes	No
Factory supervisor salary	Yes	No	No	No	Yes	No	No	No	Yes

Financial statements:

Income statement A is more suitable in the given case since income statement A is for a production-based company as it records inventory of finished goods, and the case in question being a cheesecake-producing company. Income statement B is for a trading company which purchases products from outside and sells same (as “Net purchases” can be seen from the income statement).

Based on same principle as above, balance sheet D is more suitable since it reflects inventory into three categories: raw materials, work-in-process and finishes goods. The cheesecake-producing factory is more likely to have two or all of these. On the contrary, balance sheet D is more relevant to a Company which just purchases from outside and does not have raw materials or work-in-progress inventories.

Cost and balances:

We have been provided that Feb. 28 material inventory is 50% of materials inventory on Jan. 31.

So, if Jan. 31 materials inventory is x, Feb. 28 materials inventory = 50% of x = 0.5 x

Decrease = x-0.5 x = 0.5x, which is given as $ 3,000

So, x = $ 3,000 / 0.5 = $ 6,000

So, materials Jan. 31 inventory (beginning inventory) = $,6000

Materials Feb. 28 inventory(ending inventory) = $ 3,000

Material purchased during Feb = $ 12,000

So, materials used in Feb. = Beginning inventory + Purchases – Ending inventory

= $ 6,000 + $ 12,000 - $ 3,000 = $ 15,000

Now, direct materials used = 3 times direct labour incurred

So, direct labour incurred = $ 15,000 / 3 = $ 5,000

Now, factory overhead = Total manufacturing costs – Direct materials used – direct labour used

= $ 29,400 - $ 15,000 - $ 5,000 = $ 9,400

Total manufacturing cost incurred in the period = $ 29,400, which is

70% of Cost of Goods manufactured (COGM), So, COGM = $ 29,400 * 100/70 = $ 42,000

And, $ 8,000 less than Cost of Goods Sold (COGS), so COGS = $ 29,400 + $ 8,000 = $ 37,400

COGM = Direct materials used + Direct labour used + manufacturing overhead + Beginning work in process inventory – ending work in process inventory

$ 42,000 = $ 15,000 + $ 5,000 + $ 9,400 + $ 27,000 – ending Work in progress inventory

Ending work in progress inventory = ($ 15,000 + $ 5,000 + $ 9,400 + $ 27,000) - $ 42,000

                                                  = $ 14,400

Further, COGS = Beginning finished goods inventory + COGM – Ending finished goods inventory

$ 37,400 = Beginning finished goods inventory + $ 42,000 - $ 17,000

So, beginning finished goods inventory = $ 12,400