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Accounting Accounting for for Management Management and and decision decision Making Making

Prof. Prof. Ahmed Ahmed Farghally Farghally

Professor Professor of of Accounting, Accounting, Cairo Cairo University University McGraw-Hill/Irwin

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Part (1) Introducing Accounting

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The accounting process

Economic activities

Actions (decisions) McGraw-Hill/Irwin

Accounting “links” decision makers with economic activities ⎯ and with the results of their decisions.

Accounting information

Decision makers © The McGraw-Hill Companies, Inc., 2005

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Types Types of of Accounting Accounting Information Information

Financial

Tax

Managerial

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Information Information System System

Information Information Users Users yInvestors yInvestors yCreditors yCreditors yManagers yManagers yOwners yOwners yCustomers yCustomers yEmployees yEmployees yRegulators yRegulators -SEC -SEC -IRS -IRS -EPA -EPA

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Financial Financial Information Information Provided Provided yProfitability yProfitability yFinancial yFinancial position position yCash yCashflows flows

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Decisions Decisions Supported Supported yPerformance yPerformance evaluations evaluations yStock yStock investments investments yTax yTaxstrategies strategies yLabor yLaborrelations relations yResource yResource allocations allocations yLending yLending decisions decisions yBorrowing yBorrowing © The McGraw-Hill Companies, Inc., 2005

Basic Basic Functions Functions of of an an Accounting Accounting System System

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n Interpret and record business transactions. Payment

Car McGraw-Hill/Irwin

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Basic Basic Functions Functions of of an an Accounting Accounting System System n Interpret and record business transactions.

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o Classify similar transactions into useful reports.

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p Summarize and communicate information to decision makers.

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External External Users Users of of Accounting Accounting Information Information

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•Owners •Creditors •Labor unions •Governmental agencies •Suppliers •Customers •Trade associations •General public McGraw-Hill/Irwin

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(Specific)

Provide information about economic resources, claims to resources, and changes in resources and claims.

Objectives of Financial Reporting

Provide information useful in assessing amount, timing and uncertainty of future cash flows.

Provide information useful in making investment and credit decisions. (General) McGraw-Hill/Irwin

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Objectives Objectives of of External External Financial Financial Reporting Reporting

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Balance Sheet Income Statement Statement of Cash Flows

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The primary financial statements.

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Characteristics Characteristics of of Externally Externally Reported Reported Information Information

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AAMeans Meansto to an anEnd End Usefulness Usefulness Enhanced Enhancedvia via Explanation Explanation

Broader Broaderthan than Financial Financial Statements Statements

Based Basedon on General-Purpose General-Purpose Assumption Assumption

Historical Historicalin in Nature Nature

Results Resultsfrom fromInexact Inexactand and Approximate ApproximateMeasures Measures McGraw-Hill/Irwin

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Users Users of of Internal Internal Accounting Accounting Information Information

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z Board of directors z Chief executive officer (CEO) z Chief financial officer (CFO) z Vice presidents z Business unit managers z Plant managers z Store managers z Line supervisors

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Typical Simple Organization Chart

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Board of Directors (Owners) Chief Executive Officer (CEO) Business Unit Manager Plant Manager

Plant Manager

Plant Accountant

Plant Accountant

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V.P. Human Resources

V.P. Information Services

Chief Financial Officer (CFO)

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Objectives Objectives of of Management Management Accounting Accounting Information Information

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To Tohelp helpachieve achieve goals goalsand andmissions missions

To Tohelp helpevaluate evaluate and andreward reward decision decisionmakers makers

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Characteristics Characteristics of of Management Management Accounting Accounting Information Information

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Timeliness Timeliness AAMeans Meansto to an anEnd End

Identify Identify Decision Decision Maker Maker

Measures Measuresof of Efficiency Efficiencyand and Effectiveness Effectiveness

Oriented Oriented Toward Toward Future Future

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Integrity Integrity of of Accounting Accounting Information Information Institutional Features yGenerally Accepted Accounting Principles (GAAP) yFinancial Accounting Standards Board ySecurities and Exchange Commission yInternal Control Structure yAudits yLegislation

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Integrity Integrity of of Accounting Accounting Information Information Professional Organizations yAmerican Institute of Certified Public Accountants yInstitute of Management Accountants yInstitute of Internal Auditors yAmerican Accounting Association

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Integrity Integrity of of Accounting Accounting Information Information Competence, Judgment and Ethical Behavior yCertified Public Accountants (CPAs) yCertificate in Management Accounting (CMA) yCertificate in Internal Auditing (CIA) yCode of Professional Conduct

CPA McGraw-Hill/Irwin

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Integrity Integrity of of Accounting Accounting Information Information Careers in Accounting yPublic Accounting yManagement Accounting yGovernmental Accounting yAccounting Education

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End End of of Part Part (1) (1)

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Part (2) FINANCIAL STATEMENTS

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Introduction Introduction to to Financial Financial Statements Statements Balance Sheet Income Statement Statement of Cash Flows

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Three primary financial statements. We will use a corporation to describe these statements.

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Introduction Introduction to to Financial Financial Statements Statements Balance Sheet Income Statement Statement of Cash Flows

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Describes where the enterprise stands at a specific date.

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Introduction Introduction to to Financial Financial Statements Statements Balance Sheet Income Statement Statement of Cash Flows

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Depicts the revenue and expenses for a designated period of time.

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Introduction Introduction to to Financial Financial Statements Statements

Revenues result in positive cash flow.

Expenses result in negative cash flow.

Either in the past, present, or future. McGraw-Hill/Irwin

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Introduction Introduction to to Financial Financial Statements Statements Balance Sheet Income Statement Statement of Cash Flows

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Net income (or net loss) is simply the difference between revenues and expenses.

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Introduction Introduction to to Financial Financial Statements Statements Balance Sheet Income Statement Statement of Cash Flows

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Depicts the ways cash has changed during a designated period of time.

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A A Starting Starting Point: Point: Statement Statement of of Financial Financial Position Position

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Vagabond Travel Agency Balance Sheet December 31, 2005 Assets Liabilities & Owners' Equity Cash $ 22,500 Liabilities: Notes receivable 10,000 Notes payable $ 41,000 Accounts receivable 60,500 Accounts payable 36,000 Supplies 2,000 Salaries payable 3,000 Land 100,000 Total liabilities $ 80,000 Building 90,000 Owners' Equity: Office equipment 15,000 Capital stock 150,000 Retained earnings 70,000 Total $ 300,000 Total $ 300,000 McGraw-Hill/Irwin

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The The Concept Concept of of the the Business Business Entity Entity

Vagabond Travel Agency

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A business entity is separate from the personal affairs of its owner. © The McGraw-Hill Companies, Inc., 2005

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Assets Assets Vagabond Travel Agency Balance Sheet December 31, 2005 Assets Liabilities & Owners' Equity Cash $ 22,500 Liabilities: Notes receivable 10,000 Notes payable $ 41,000 Accounts receivable 60,500 Accounts payable 36,000 Supplies 2,000 Salaries payable 3,000 Land 100,000 Total liabilities $ 80,000 Building 90,000 Owners' Equity: Office equipment 15,000 Capital stock 150,000 Retained earnings 70,000 Total $ 300,000 Total $ 300,000

Assets are economic resources that are owned by the business and are expected to provide positive future cash flows.

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Assets Assets Cost Principle These accounting Stable-Dollar principles support Going-Concern cost as the basis Assumption Assumption for asset valuation.

Objectivity Principle McGraw-Hill/Irwin

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Liabilities Liabilities Vagabond Travel Agency Balance Sheet December 31, 2005 Assets Liabilities & Owners' Equity Cash $ 22,500 Liabilities: Notes receivable 10,000 Notes payable $ 41,000 Accounts receivable 60,500 Accounts payable 36,000 Supplies 2,000 Salaries payable 3,000 Land 100,000 Total liabilities $ 80,000 Building 90,000 Owners' Equity: Office equipment 15,000 Capital stock 150,000 Retained earnings 70,000 Total $ 300,000 Total $ 300,000

Liabilities are debts that represent negative future cash flows for the enterprise.

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Owners’ Owners’ Equity Equity Vagabond Travel Agency Balance Sheet December 31, 2005 Assets Liabilities & Owners' Equity Cash $ 22,500 Liabilities: Notes receivable 10,000 Notes payable $ 41,000 Accounts receivable 60,500 Accounts payable 36,000 Supplies 2,000 Salaries payable 3,000 Land 100,000 Total liabilities $ 80,000 Building 90,000 Owners' Equity: Office equipment 15,000 Capital stock 150,000 Retained earnings 70,000 Total $ 300,000 Total $ 300,000

Owners’ equity represents the owners’ claims to the assets of the business.

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Owners’ Owners’ Equity Equity

Changes in Owners’ Equity •Owners’ Investments

•Payments to Owners

•Business Earnings

•Business Losses

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The The Accounting Accounting Equation Equation Travel Assets Liabilities ++ Agency Owners’ Assets ==Vagabond Liabilities Owners’ Equity Equity

Balance Sheet December 31, 2005 $300,000 $220,000 $300,000 = $80,000 $80,000 +Liabilities + $220,000 Assets= & Owners' Equity Cash $ 22,500 Liabilities: Notes receivable 10,000 Notes payable $ 41,000 Accounts receivable 60,500 Accounts payable 36,000 Supplies 2,000 Salaries payable 3,000 Land 100,000 Total liabilities $ 80,000 Building 90,000 Owners' Equity Office equipment 15,000 Capital stock 150,000 Retained earnings 70,000 Total $ 300,000 Total $ 300,000 McGraw-Hill/Irwin

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Let’s analyze some transactions for JJ’s Lawn Care Service.

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On May 1, 2005, Jill Jones and her family invested $8,000 in JJ’s Lawn Care Service and received 800 shares of stock.

Cash

Total

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JJ's Lawn Care Service Balance Sheet May 1, 2005 Owners' Equity Assets $ 8,000 Capital Stock $

$

8,000 Total

$

8,000

8,000

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On May 2, JJ’s purchased a riding lawn mower for $2,500 cash. JJ's Lawn Care Service Balance Sheet May 2, 2005 Owners' Equity Assets Cash $ 5,500 Capital Stock $ Tools & Equipment 2,500

Total

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$

8,000 Total

$

8,000

8,000

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On May 8, JJ’s purchased a $15,000 truck. JJ’s paid $2,000 down in cash and issued a note payable for the remaining $13,000. JJ's Lawn Care Service Balance Sheet May 8, 2005 Liabilities and Owners' Equity Assets Cash $ 3,500 Liabilities: Tools & Equipment 2,500 Notes Payable $ 13,000 Truck 15,000 Owners' Equity: Capital Stock 8,000

Total

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$ 21,000 Total

$ 21,000

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On May 11, JJ’s purchased some repair parts for $300 on account. JJ's Lawn Care Service Balance Sheet May 11, 2005 Liabilities and Owners' Equity Assets Cash $ 3,500 Liabilities: Tools & Equipment 2,800 Notes Payable $ 13,000 Truck 15,000 Accounts Payable 300 Total Liabilities $ 13,300 Owners' Equity: Capital Stock 8,000 Total

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$ 21,300 Total

$ 21,300

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End End of of Part Part (2) (2)

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Part (3) ACCOUNTING REPORTING of FINANCIAL RESULTS

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JJ's Lawn Care Service Adjusted Trial Balance May 31, 2005 Cash $ 3,925 Accounts receivable 75 Tools & equipment 2,650 Accum. depreciation: tools & eq. $ 50 Truck 15,000 Accum. depreciation: truck 250 Notes payable 13,000 Accounts payable 150 Capital stock 8,000 Dividends 200 Sales revenue 750 Gasoline expense 50 Depreciation exp.: tools & eq. 50 Depreciation exp.: truck 250 Total $ 22,200 $ 22,200

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This This is is the the Adjusted Adjusted Trial Trial Balance Balance for for JJ’s. JJ’s. 1-43

Now, Now, let’s let’s prepare prepare the the financial financial statements statements for for JJ’s JJ’s Lawn Lawn Care Care Service Service for for May. May. © The McGraw-Hill Companies, Inc., 2005

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JJ's Lawn Care Service Income Statement For the month ending May 31, 2005 Sales revenue Operating expenses: Gasoline expense $ 50 Depr. exp.: tools & eq. 50 Depr. exp.: truck 250 Net income

$ 750

350 $ 400

Net Net income income also also appears appears on on the the Statement of Retained Earnings. Statement of Retained Earnings. © The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin

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Statement Statement of of Retained Retained Earnings Earnings This statement summarizes the increases and decreases in Retained Earnings during the period. •Business Earnings

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•Dividends •Business Losses

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JJ's Lawn Care Service Statement of Retained Earnings For the Month Ended May 31, 2005 Retained earnings, May 1 Add: Net income Subtotal Less: Dividends Retained earnings, May 31

$

400 $ 400 200 $ 200

Now, let’s prepare the Balance Sheet. McGraw-Hill/Irwin

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JJ's Lawn Care Service Balance Sheet May 31, 2005

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Assets Cash Accounts receivable Tools & equipment $ 2,650 Less: Accum. depr.: tools & eq. 50 Truck $ 15,000 Less: Accum. depr.: truck 250 Total assets Liabilities & Stockholders' Equity Liabilities: Notes payable Accounts payable Total liabilities Stockholders' equity: Capital stock $ 8,000 Retained earnings 200 Total stockholders' equity Total liabilities & stockholders' equity

McGraw-Hill/Irwin

$

3,925 75 2,600

14,750 $ 21,350

$ 13,000 150 $ 13,150

8,200 $ 21,350

Next, Next, let’s let’s prepare prepare the the Statement Statement of of Cash Cash Flows Flows for for JJ’s JJ’s Lawn Lawn Care Care Service Service for for May. May.

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JJ's Lawn Care Service Statement of Cash Flows For the Month Ended May 31, 2005 Cash flows from operating activities: Cash received from revenue transactions $ 750 Cash paid for expenses (50) Net cash provided by operating activities $ 700 Cash flows from investing activities: Purchase of lawn mower $ (2,500) Purchase of truck (2,000) Collection for sale of repair parts 75 Payment for repair parts (150) Net cash used by investing activities (4,575) Cash flows from financing activities: Investment by owners $ 8,000 Dividends (200) Net cash provided by financing activities 7,800 Increase in cash for month $ 3,925 Cash balance, May 1, 2005 Cash balance, May 31, 2005 $ 3,925 McGraw-Hill/Irwin

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Drafting Drafting Notes Notes to to the the Financial Financial Statements Statements

Notes to the Financial Statements

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Examples Examplesof ofItems ItemsDisclosed Disclosed yLawsuits yLawsuitspending pending yScheduled yScheduledplant plantclosings closings yGovernmental yGovernmentalinvestigations investigations ySignificant ySignificantevents eventsoccurring occurring after afterthe thebalance balancesheet sheetdate date ySpecific ySpecificcustomers customersthat that account accountfor foraalarge largeportion portionof of revenue revenue yUnusual yUnusualtransactions transactionsand and related relatedparty partytransactions transactions

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Closing Closing the the Temporary Temporary Equity Equity Accounts Accounts nClose Revenue accounts to Income Summary.

oClose Expense accounts to Income Summary.

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The closing process gets the temporary accounts ready for the next accounting period.

pClose Income Summary account to Retained Earnings.

qClose Dividends to Retained Earnings.

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Closing Closing the the Temporary Temporary Equity Equity Accounts Accounts JJ's Lawn Care Service Adjusted Trial Balance May 31, 2005 Cash $ 3,925 Accounts receivable 75 Tools & equipment 2,650 Accum. depreciation: tools & eq. $ 50 Truck 15,000 Accum. depreciation: truck 250 Notes payable 13,000 Accounts payable 150 Capital stock 8,000 Dividends 200 Sales revenue 750 Gasoline expense 50 Depreciation exp.: tools & eq. 50 Depreciation exp.: truck 250 Total $ 22,200 $ 22,200 McGraw-Hill/Irwin

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Let’s Let’s prepare prepare the the closing closing entries entries for for JJ’s JJ’s Lawn Lawn Care Care Service. Service.

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Closing Closing Entries Entries for for Revenue Revenue Accounts Accounts Since Since Sales Sales Revenue Revenue has has aa credit credit balance, balance, the the closing closing entry entry requires requires aa debit debit to to the the Sales Sales Revenue Revenue account. account. GENERAL JOURNAL Date

Account Titles and Explanation

May 31 Sales Reveune Income Summary

Debit

Credit

750 750

To close the revenue account.

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Closing Closing Entries Entries for for Revenue Revenue Accounts Accounts

Income Summary 750

Sales Revenue 750 750

-

750

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Closing Closing Entries Entries for for Expense Expense Accounts Accounts Since Since expense expense accounts accounts have have aa debit debit balance, balance, the the closing closing entry entry requires requires aa credit credit to to the the expense expense accounts. accounts. GENERAL JOURNAL Date

Account Titles and Explanation

Debit

May 31 Income Summary

350

Gasoline Expense

50

Depreciation Exp.: Tools & Equipment

50

Depreciation Exp.: Truck To close the expense accounts.

McGraw-Hill/Irwin

Credit

250 © The McGraw-Hill Companies, Inc., 2005

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Closing Closing Entries Entries for for Expense Expense Accounts Accounts Gasoline Exp. 50 50 Depr. Exp.: Tools & Equipment 50 50 -

Depr. Exp.: Truck 250 250 McGraw-Hill/Irwin

Income Summary 350 750

400 Net Income © The McGraw-Hill Companies, Inc., 2005

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Closing Closing the the Income Income Summary Summary Account Account Since Since Income Income Summary Summary has has aa $400 $400 credit credit balance, balance, the the closing closing entry entry requires requires aa debit debit to to Income Income Summary. Summary. GENERAL JOURNAL Date

Account Titles and Explanation

May 31 Income Summary Retained Earnings

Debit Credit 400 400

To close Income Summary.

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Closing Closing the the Income Income Summary Summary Account Account

Retained Earnings 400

Income Summary 350 750 400

-

400

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The balance in Income Summary is now zero. © The McGraw-Hill Companies, Inc., 2005

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Closing Closing the the Dividends Dividends Account Account Since Since the the Dividends Dividends account account has has aa debit debit balance, balance, the the closing closing entry entry requires requires aa credit credit to to the the Dividends Dividends account. account. GENERAL JOURNAL Date

Account Titles and Explanation

May 31 Retained Earnings Dividends

Debit Credit 200 200

To close the Dividends account.

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Closing Closing the the Dividends Dividends Account Account Dividends 200 200

-

McGraw-Hill/Irwin

Retained Earnings 200 400

200

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JJ's Lawn Care Service After-Closing Trial Balance May 31, 2005 Cash $ 3,925 Accounts receivable 75 Tools & equipment 2,650 Accum. depreciation: tools & eq. $ 50 Truck 15,000 Accum. depreciation: truck 250 Notes payable 13,000 Accounts payable 150 Capital stock 8,000 Retained earnings 200 Total $ 21,650 $ 21,650

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After After all all closing closing entries entries are are made, made, JJ’s JJ’s After-Closing After-Closing Trial Trial Balance Balance looks looks like like this. this. 1-60

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Evaluating Evaluating the the Business Business Evaluating Evaluating Profitability Profitability

Evaluating Evaluating Liquidity Liquidity

Did the business earn a profit or loss in the current period?

Does the business have assets available to pay debts as they become due?

What is the business’s future potential for a profit? McGraw-Hill/Irwin

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Evaluating Evaluating the the Business Business Evaluating Evaluating Profitability Profitability

Evaluating Evaluating Liquidity Liquidity

Net Income Net Income = Percentage Total Revenue

Working Current Assets – = Capital Current Liabilities

Return on Equity

Current Current Assets = Ratio Current Liabilities

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=

Net Income Avg. Stockholders’ Equity

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Preparing Preparing Financial Financial Statements Statements Covering Covering Different Different Periods Periods of of Time Time

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Many Many companies companies prepare prepare financial financial statements statements at at various various points points throughout throughout the the year. year. Annually Interim Financial Statements

Quarterly Monthly

Jan. 1 McGraw-Hill/Irwin

Dec. 31 © The McGraw-Hill Companies, Inc., 2005

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End End of of Part Part (3) (3)

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Part (4) COST ACCOUNTING FOR MANAGEMENT

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Inventory Inventory Defined Defined

Inventory Inventory Goods Goods owned owned and and held held for for sale sale to to customers customers

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Current Current asset asset

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The The Flow Flow of of Inventory Inventory Costs Costs BALANCE SHEET As purchase cost (or manufacturing costs) are incurred

Current assets: Inventory $

$

INCOME STATEMENT Revenue Cost of goods sold Gross profit Expenses Net income McGraw-Hill/Irwin

as goods are sold $

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The The Flow Flow of of Inventory Inventory Costs Costs In a perpetual inventory system, inventory entries parallel the flow of costs. GE N E R AL JOU R N AL Da te

Account Title s a nd Ex pla na tion

De bit

Cre dit

Entry on P urcha se Da te Inve ntory

$$$$

Accounts P a ya ble

$$$$

Entry on S a le Da te Cost of Goods S old Inve ntory McGraw-Hill/Irwin

$$$$ $$$$ © The McGraw-Hill Companies, Inc., 2005

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Which Which Unit Unit Did Did We We Sell? Sell? When identical units of inventory have different unit costs, a question naturally arises as to which of these costs should be used in recording a sale of inventory. GENERAL JOURNAL Date

Account Titles and Explanation

Debit

Credit

Entry on Sale Date Cost of Goods Sold Inventory McGraw-Hill/Irwin

$$$$ $$$$ © The McGraw-Hill Companies, Inc., 2005

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Inventory Inventory Subsidiary Subsidiary Ledger Ledger AA separate separate subsidiary subsidiary account account is is maintained maintained for for each each item item in in inventory. inventory. Item LL002 Description Laser Light Location Storeroom 2 Purchased

Date Sept. 5 Sept. 9

Units 100 75

Sept. 10

Unit Cost $ 30 50

Total $ 3,000 3,750

Sold

Units

Unit Cost

10

?

Primary supplier Electronic City Secondary supplier Electric Company Inventory level: Min: 25 Max: 200 Balance Cost of Goods Unit Sold Units Cost Total 100 $ 30 $ 3,000 100 30 3,000 75 50 3,750 ? ? ? ? ? ? ?

How can we determine the unit cost for the Sept. 10 sale? McGraw-Hill/Irwin

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Inventory Inventory Cost Cost Flows Flows We use one of these inventory valuation methods to determine cost of inventory sold. Specific identification

Average cost

FIFO

LIFO

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Information Information for for the the Following Following Inventory Inventory Examples Examples

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The Bike Company (TBC) Cost Costof ofGoods GoodsAvailable Available for for Sale Sale Aug. Aug. 11 Beg. Beg. Inventory Inventory 10 10 units units@ @ Aug. 15 Aug. 33 Purchased Purchased 15 units units@ @ Aug. 20 Aug. 17 17 Purchased Purchased 20 units units@ @ Aug. 10 Aug. 28 28 Purchased Purchased 10 units units@ @

$$ 91 91 $$ 106 106 $$ 115 115 $$ 119 119

== == == ==

Retail Retail Sales Salesof ofGoods Goods Aug. Aug. 14 14 Sales Sales Aug. Aug. 31 31 Sales Sales

$$ 130 130 $$ 150 150

== $$ 2,600 2,600 == $$ 3,450 3,450

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20 20 units units@ @ 23 23 units units@ @

$$ $$ $$ $$

910 910 1,590 1,590 2,300 2,300 1,190 1,190

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Specific Specific Identification Identification

When When aa unit unit is is sold, sold, the the specific specific cost cost of of the the unit unit sold sold is is added added to to cost cost of of goods goods sold. sold.

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Specific Specific Identification Identification

Date Aug. 1 Aug. 3

Purchases

Cost of Goods Sold

10

@

$ 91

=

$

910

15

@

$ 106

=

$ 1,590

Inventory Balance $ 910 $ 2,500

On On August August 14, 14, TBC TBC sold sold 20 20 bikes bikes for for $130 $130 each. each. Nine Nine bikes bikes originally originally cost cost $91 $91 and and 11 11 bikes bikes originally originally cost cost $106. $106. Continue McGraw-Hill/Irwin

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Specific Specific Identification Identification

Date Purchases Aug. 1 10 @ $ 91 = $ 910 Aug. 3 15 @ $ 106 = $ 1,590 Aug. 14

Inventory Balance $ 910 $ 2,500

Cost of Goods Sold

9

@

$ 91

=

$

819

11

@

$ 106

=

$ 1,166

$

515

The The Cost Cost of of Goods Goods Sold Sold for for the the August August 14 14 sale sale is is $1,985, $1,985, leaving leaving $515 $515 and and 55 units units in in inventory. inventory. Continue McGraw-Hill/Irwin

Let’s look at the entries for the Aug. 14 sale. © The McGraw-Hill Companies, Inc., 2005

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Specific Specific Identification Identification GENERAL JOURNAL Date

Account Titles and Explanation

Aug. 14 Cash

Retail Retail

Debit 2,600

Sales 14 Cost of Goods Sold

2,600

Cost Cost

1,985

Inventory

A A similar similar entry entry is is made made after after each each sale. sale. McGraw-Hill/Irwin

Credit

1,985

Continue © The McGraw-Hill Companies, Inc., 2005

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Specific Specific Identification Identification

Date Purchases Aug. 1 10 @ $ 91 = $ 910 Aug. 3 15 @ $ 106 = $ 1,590 Aug. 14

Cost Cost of of Goods Goods Sold Sold for for August August 31 31 == 20 @ $ 115 = $ 2,300 $2,610 10 @ $2,610 $ 119 = $ 1,190

Inventory Balance $ 910 $ 2,500

Cost of Goods Sold

9

@

$ 91

=

$

819

11

@

$ 106

=

$ 1,166

$ 515 $ 2,815 $ 4,005

Aug. 17 Aug. 28 Aug. 31 Additional purchases were made 1 @ $August 91 = $ 91 Additional purchases were madeon on August17 17and and28. 28. 3 @ $ 106 = $ 318 Costs 31 were as follows: 1 @ $91, Costsassociated associatedwith withsales saleson onAugust August 15 @31$were 115 as = follows: $ 1,725 1 @ $91, 33@ & 4 @ $119. @$106, $106,15 15@ @$115, $115, $119. 4 @& 4$@ 119 = $ 476 $ 1,395

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Specific Specific Identification Identification Inventory Balance $ 910 $ 2,500

Cost of Goods Sold

Income Statement

COGS = $4,595

Balance Sheet

Inventory = $1,395 McGraw-Hill/Irwin

9

@

$ 91

=

$

11

@

$ 106

=

$ 1,166

1

@

$ 91

=

$

91

3

@

$ 106

=

$

318

15

@

$ 115

=

$ 1,725

4

@

$ 119

=

$

11 55 66

819

476

$ $ $

515 2,815 4,005

$

1,395

@ @ $$106 106 == $$ 106 106 @ 575 @ $$115 115 == 575 @ 714 @ $$119 119 == 714 End. End.Inv. Inv. © The$McGraw-Hill $1,395 1,395 Companies, Inc., 2005

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Since specific identification is so easy, can’t we use it all the time?

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Not really. Specific identification is hard to use when we sell a lot of inventory that has lots of different costs.

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Average-Cost Average-Cost Method Method When a unit is sold, the average cost of each unit in inventory is assigned to cost of goods sold. Cost of Goods Units on hand Available for ÷ on the date of Sale sale

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First-In, First-In, First-Out First-Out Method Method (FIFO) (FIFO)

Oldest Oldest Costs Costs

Costs Costs of of Goods Goods Sold Sold

Recent Recent Costs Costs

Ending Ending Inventory Inventory

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Last-In, Last-In, First-Out First-Out Method Method (LIFO) (LIFO)

Recent Recent Costs Costs

Costs Costs of of Goods Goods Sold Sold

Oldest Oldest Costs Costs

Ending Ending Inventory Inventory

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The The Principle Principle of of Consistency Consistency Once a company has adopted a particular accounting method, it should follow that method consistently, rather than switch methods from one year to the next. McGraw-Hill/Irwin

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Just-In-Time Just-In-Time (JIT) (JIT) Inventory Inventory Systems Systems This inventory arrived just in time for us to use it in the manufacturing process.

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Periodic Periodic Inventory Inventory Systems Systems In a periodic inventory system, inventory entries are as follows. GENERAL JOURNAL Date

Account Titles and Explanation

Debit

Credit

Entry on Purchase Date Purchases Accounts Payable

$$$$ $$$$

Note Note that that an an entry entry is is not not made made to to inventory. inventory. McGraw-Hill/Irwin

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Periodic Periodic Inventory Inventory Systems Systems In a periodic inventory system, inventory entries are as follows. GENERAL JOURNAL Date

Account Titles and Explanation

Debit

Credit

Entry on Sale Date No entry to inventory. Accounts Receivable Sales

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$$$$ $$$$ © The McGraw-Hill Companies, Inc., 2005

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Periodic Periodic Inventory Inventory Systems Systems

The inventory on hand and the cost of goods sold for the year are not determined until year-end. McGraw-Hill/Irwin

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Periodic Periodic Inventory Inventory Systems Systems We use one of these inventory valuation methods in a periodic inventory system. Specific identification

Average cost

FIFO

LIFO

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For interim f inancial statements, we may need to estimate e nding inventory an d cost of goods sold.

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The The Gross Gross Profit Profit Method Method nDetermine nDetermine cost cost of of goods goods available available for for sale. sale. oEstimate oEstimate cost cost of of goods goods sold sold by by multiplying multiplying the the net net sales sales by by the the cost cost ratio. ratio. pDeduct pDeduct cost cost of of goods goods sold sold from from cost cost of of goods goods available available for for sale sale to to determine determine ending ending inventory. inventory. McGraw-Hill/Irwin

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The The Gross Gross Profit Profit Method Method In In March March of of 2005, 2005, ChemCo’s ChemCo’s inventory inventory was was destroyed destroyed by by fire. fire. ChemCo’s ChemCo’s normal normal gross gross profit profit ratio ratio isis 30% 30% of of net net sales. sales. At At the the time time of of the the fire, fire, ChemCo ChemCo showed showed the the following following balances: balances:

Sales $ 31,500 Sales returns 1,500 Beginning Inventory 12,000 Net cost of goods purchased 20,500 McGraw-Hill/Irwin

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The The Retail Retail Method Method The The retail retail method method of of estimating estimating inventory inventory requires requires that that management management determine determine the the value value of of ending ending inventory inventory at at retail retail prices. prices. In In March March of of 2005, 2005, ChemCo’s ChemCo’s inventory inventory was was destroyed destroyed by by fire. fire. At At the the time time of of the the fire, fire, ChemCo’s ChemCo’s management management collected collected the the following following information: information: Information for ChemCo The Retail Method Goods available for sale at cost Goods available for sale at retail Physical count of ending inventory priced at retail McGraw-Hill/Irwin

$ 32,500 50,000 22,000 © The McGraw-Hill Companies, Inc., 2005

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Financial Financial Analysis Analysis Measures Measures how how quickly quickly aa company company sells sells its its merchandise merchandise inventory. inventory. Inventory Turnover Rate

=

Cost of Goods Sold Average Inventory

Average AverageInventory Inventory==(Beg. (Beg.Inv. Inv.++End. End.Inv.) Inv.)÷÷22

A A ratio ratio that that is is low low compared compared to to competitors competitors suggests suggests inefficient inefficient use use of of assets. assets. McGraw-Hill/Irwin

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Financial Financial Analysis Analysis Avg. Number of Days to Sell Inventory

=

Days in the Year Inventory Turnover

Measures Measures how how many many days days on on average average itit takes takes to to sell sell its its inventory. inventory.

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Accounting Accounting Methods Methods Can Can Affect Affect Financial Financial Ratios Ratios

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Remember that identical companies that use different inventory methods (e.g., FIFO and LIFO) will have different inventory turnover ratios.

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End End of of Part Part (4) (4)

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Part (5) MANAGEMENT ACCOUNTING

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Management Management Accounting: Accounting: Basic Basic Framework Framework

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Management accounting and assigning decision-making authority. Accounting systems help to identify who has authority over assets. Accounting information supports planning and decision-making. Accounting reports provide a means of monitoring, evaluating, and rewarding performance. McGraw-Hill/Irwin

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Management Management Accounting Accounting Systems Systems Framework Framework

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Top Top Management Management

Budget: Budget: Future Future Plans Plans

Assign Assign Decision-Making Decision-Making McGraw-Hill/Irwin

Actual Actual Results: Results: Current Current

Support Support Decision-Making Decision-Making

Performance Performance Evaluation: Evaluation: Past Past

Evaluate Evaluate Decision-Making Decision-Making © The McGraw-Hill Companies, Inc., 2005

Comparing Comparing Financial Financial Accounting Accounting and and Management Management Accounting Accounting Purpose Purpose Types Typesof of Reports Reports Standards Standards Reporting Reporting Entity Entity Time Time Periods Periods Users Users McGraw-Hill/Irwin

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Financial Management Financial Accounting Accounting ManagementAccounting Accounting Provide Provide Provideinformation informationabout about the the Provideinformation informationfor for financial planning, financialposition positionand and planning, evaluating, evaluating, and and performance rewarding performanceof ofthe thecompany. company. rewardingperformance. performance. Balance Balancesheet, sheet, income income statement, statement, and andstatement statement of of Various, Various, non-standard non-standardreports. reports. cash cashflows. flows. GAAP None GAAP None Usually, AA component Usually, the thecompany company taken taken component of ofthe the as company's as aawhole. whole. company's value valuechain. chain. Usually Usually aayear, year, quarter, quarter, or oraa Any Any period. period. month. month. Investors, Investors, creditors, creditors, and andother other Management, Management, customers, customers, and and external others externalparties. parties. others ininthe thevalue valuechain. chain. © The McGraw-Hill Companies, Inc., 2005

Accounting Accounting for for Manufacturing Manufacturing Operations Operations

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The The cost cost to to produce produce aa unit unit of of product product includes: includes: zzDirect Direct material material zzDirect Direct labor labor zzManufacturing Manufacturing overhead overhead McGraw-Hill/Irwin

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Direct Direct Materials Materials Raw materials & component parts that become an integral part of finished products.

Can be traced directly and conveniently to products.

IfIfmaterials materialscannot cannotbe betraced traceddirectly directlyto toproducts, products, the andare arepart part thematerials materialsare areconsidered considered indirect indirectand of ofmanufacturing manufacturingoverhead. overhead. McGraw-Hill/Irwin

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Direct Direct Labor Labor Includes Includes the the payroll payroll cost cost of of direct direct workers. workers.

Direct labor × hours

Wage rate

Those Thoseemployees employees who whowork workdirectly directly on onthe thegoods goodsbeing being manufactured. manufactured.

The Thecost costof ofemployees employeeswho whodo donot notwork work directly directlyon onthe thegoods goodsis isconsidered consideredindirect indirect labor laborand andis ispart partof ofmanufacturing manufacturingoverhead. overhead. McGraw-Hill/Irwin

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Manufacturing Manufacturing Overhead Overhead All All manufacturing manufacturing costs costs other other than than direct direct materials materials and and direct direct labor. labor.

Includes: Includes: zz Indirect Indirect materials. materials. zz Indirect Indirect labor. labor. zz Machinery Machinery and and

equipment equipment costs. costs. zz Cost Cost of of regulatory regulatory compliance. compliance. McGraw-Hill/Irwin

Does Doesnot notinclude include selling sellingor orgeneral generaland and administrative administrative expenses. expenses. © The McGraw-Hill Companies, Inc., 2005

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Flow Flow of of Physical Physical Goods Goods in in Production Production Direct Direct Materials Materials Purchased Purchased

Direct Direct Materials Materials Used Used Finished Finished Goods Goods

Direct Direct Labor Labor

Manufacturing Manufacturing Overhead Overhead

Goods Goods Sold Sold MegaLoMart

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Accounting Accounting for for Manufacturing Manufacturing Operations Operations

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Manufacturing Manufacturing costs costs are are often often combined combined as as follows: follows: Direct Direct Materials Materials

Direct Direct Labor Labor

Prime Cost McGraw-Hill/Irwin

Manufacturing Manufacturing Overhead Overhead

Conversion Cost © The McGraw-Hill Companies, Inc., 2005

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Product Product Costs Costs Versus Versus Period Period Costs Costs Product Costs (manufacturing costs)

Period Costs (operating expenses and income taxes.) McGraw-Hill/Irwin

Balance BalanceSheet Sheet

as incurred

as incurred

Current Currentassets assets and andinventory inventory Income Income Statement Statement Revenue Revenue COGS COGS Gross Grossprofit profit Expenses Expenses Net Netincome. income.

When Whengoods goods are aresold. sold.

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Inventories Inventories of of aa Manufacturing Manufacturing Business Business

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Raw Rawmaterials materials-- inventory inventoryon on hand handand andavailable availablefor foruse. use.

Finished Finished goodsgoodscompleted completed goods goodsawaiting awaiting sale. sale. McGraw-Hill/Irwin

Work Workin in process process-partially partially completed completed goods. goods. © The McGraw-Hill Companies, Inc., 2005

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Flow Flow of of Costs Costs Associated Associated With With Production Production Direct materials purchased

Direct materials used

Materials Inventory $$$

$$$

Work in Process Inventory $$$

$$$

Direct labor & Manufacturing Overhead

Cost of goods manufactured

Finished Goods Inventory $$$

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$$$

Cost of Goods Sold $$$ © The McGraw-Hill Companies, Inc., 2005

Flow Flow of of Costs Costs Associated Associated With With Production Production

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Pure-Ice Pure-Ice Inc. Inc. had had $52,000 $52,000 of of inventory inventory in in direct direct materials materials inventory inventory on on January January 1, 1, 2005. 2005. During During the the year, year, Pure-Ice Pure-Ice purchased purchased $586,000 $586,000 of of additional additional direct direct materials. materials. At At December December 31, 31, 2005, 2005, $78,000 $78,000 of of the the direct direct materials materials were were still still on on hand. hand.

How How much much direct direct material material was was placed placed into into production production during during 2005? 2005? McGraw-Hill/Irwin

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Flow Flow of of Costs Costs Associated Associated With With Production Production

+ = – =

Beginning materials inventory Materials purchased Materials available to be placed into production Materials placed into production Ending materials inventory

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$

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52,000 586,000 638,000

?? $

78,000

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Flow Flow of of Costs Costs Associated Associated With With Production Production

+ = – =

Beginning materials inventory Materials purchased Materials available to be placed into production Materials placed into production Ending materials inventory

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$

52,000 586,000 638,000

!

560,000 $

78,000

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End End of of Part Part (5) (5)

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