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Building Blocks of Managerial Accounting

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Building Blocks of Managerial Accounting 2 Chapter CXXXX 41137 9/10/07 4:33 PM Page 1 2 Building Blocks of Managerial Accounting n 1999, Nissan Motor Company had a problem. With no cash div- 2 Chapter Cxxxx 41137 page 1 09/07/07—mp I idends and a net loss of over ¥684 billion yen (approximately $4.1 bil- lion), CEO Carlos Ghosn knew he had to do something. In his words: “The lack of profit is like a fever. When your business is not profitable, that’s a serious signal that something is wrong. Either the products are not right, or marketing is inefficient, or the cost base is too high—some- thing is wrong. If you ignore a fever, you can get very sick. If you ignore unprofitability, the situation can only worsen.” Ghosn launched the Nissan Revival Plan that turned the company around by designing and marketing new models, investing in new plant technologies, slashing supply costs, and emphasizing the company’s most profitable products. Five years later, Nissan’s annual operating income tops ¥861 billion yen (approximately $7.6 billion). 2 Chapter CXXXX 41137 9/10/07 4:33 PM Page 2 2 Chapter 2 Nissan’s operating margin is now the highest in the automotive industry, and it is paying its shareholders cash dividends at record levels. Before Nissan could attack its problems, it had to know where its costs were incurred, and whether it could control those costs by making different decisions. Was the company spending too much in production, using outdated equipment and technologies? Was it spending enough on designing new products that better met customers’ needs and desires? Was it targeting the right audiences in its television advertis- ing? In this chapter, we talk about many costs: Costs that both man- agers and management accountants must understand to successfully 2 Chapter Cxxxx 41137 page 3 09/07/07—mp run a business. Sources: NissanUSA.com; Nissan-Global.com; and Nissan Motor Co., Ltd., Annual Reports 2002, 2003, 2004. ᭿ Learning Objectives 1 Distinguish among service, merchandising, and manufacturing companies 2 Describe the value chain and its elements 3 Distinguish between direct and indirect costs Identify the inventoriable product costs and period costs of 4 2 Chapter Cxxxx 41137 page 2 09/07/07—mp merchandising and manufacturing firms 5 Prepare the financial statements for service, merchandising, and manufacturing companies 6 Describe costs that are relevant and irrelevant for decision making 7 Classify costs as fixed or variable and calculate total and average costs at different volumes So far, we have seen how managerial accounting provides information that managers use to run their businesses more efficiently. Managers must understand basic managerial accounting terms and concepts before they can use the information to make good decisions. This terminology provides the “common ground” through which managers and accountants communicate. Without a common understanding of these concepts, managers may ask for, and accountants may provide, the wrong information for making decisions. As you will see, different types of costs are useful for different purposes. Both managers and accountants must have a clear understanding of the situation and the types of costs that are relevant to the decision at hand. 2 Chapter CXXXX 41137 9/10/07 4:33 PM Page 3 Building Blocks of Managerial Accounting 3 Three Business Sectors and the Value Chain Before we talk about specific types of costs, let’s consider the three most common types of companies and the business activities in which they incur costs. Service, Merchandising, and Manufacturing 1 Distinguish among service, merchandising, Companies and manufacturing Organizations other than not-for-profits and governmental agencies are in business companies to generate profits for their owners. The primary means of generating that profit generally fall into one of three categories: 2 Chapter Cxxxx 41137 page 3 09/07/07—mp Service Companies Service companies are in business to sell intangible services—such as health care, insurance, and consulting—rather than tangible products. Recall from the last chapter that service firms now make up the largest sector of the U.S. economy, providing jobs to over 55% of the workforce. For service companies, such as eBay (online auc- tion), H&R Block (tax return preparation), and Accountemps (temporary personnel services), salaries and wages often make up over 70% of their costs. Because service companies sell services, they generally don’t have Inventory or Cost of Goods Sold accounts. Some service providers carry a minimal amount of supplies inventory; however, this inventory is used for internal operations—not sold for profit. In addi- tion to labor costs, service companies incur costs to develop new services, advertise, and provide customer service. Merchandising Companies Merchandising companies, such as Amazon.com, Wal-Mart, and Foot Locker, resell 2 Chapter Cxxxx 41137 page 2 09/07/07—mp tangible products they buy from suppliers. Amazon.com, for example, buys books, CDs, and DVDs and resells them to customers at higher prices than what it pays its own suppliers for these goods. Merchandising companies include retailers (such as Home Depot) and wholesalers. Retailers sell to consumers, such as yourself. Wholesalers, often referred to as “middlemen,” buy products in bulk from manufac- turers, mark up the prices, and then sell those products to retailers. Because mer- chandising companies sell tangible products, they have inventory. Even merchandis- ing companies that use just-in-time (JIT) systems have inventory, they just have less inventory than their non-JIT competitors. The cost of merchandise inventory is the cost merchandisers pay for the goods plus all costs necessary to get the merchandise in place and ready to sell, including freight-in costs and any import duties or tariffs. Because the entire inventory is ready for sale, a merchandiser’s balance sheet usually reports just one inventory account called Inventory or Merchandise Inventory. Merchandisers also incur other costs to identify new products and locations for new stores, to advertise and sell their products, and to provide customer service. Manufacturing Companies Manufacturing companies use labor, plant, and equipment to convert raw mate- rials into new finished products. For example, Nissan’s production workers use the company’s factories (plant and equipment) to transform raw materials, such as steel and tires, into high-performance automobiles. Manufacturers sell their 2 Chapter CXXXX 41137 9/10/07 4:33 PM Page 4 4 Chapter 2 products to retailers or wholesalers at a price that is high enough to cover their costs and generate a profit. Because of their broader range of activities, manufacturers have three types of inventory (pictured in Exhibit 2-1): 1. Raw materials inventory: All raw materials used in manufacturing. Nissan’s raw materials include steel, glass, carpeting, tires, upholstery fabric, engines, and other automobile components. It also includes other physical materials used in the plant, such as machine lubricants and janitorial supplies. EXHIBIT 2-1 Manufacturers’ Three Types of Inventory Raw materials inventory Work in process inventory Finished goods inventory 2 Chapter Cxxxx 41137 page 5 09/07/07—mp GMC GMC GMC 2. Work in process inventory: Goods that are partway through the manufacturing process but not yet complete. At Nissan, the work in process inventory consists of partially completed vehicles. 3. Finished goods inventory: Completed goods that have not yet been sold. Nissan is in business to sell completed cars, not work in process. Manufacturers sell their finished goods inventory to merchandisers. Nissan, for example, sells its completed automobiles to retail dealerships. Some manufacturers, such as The Original Mattress Factory, sell their products directly to consumers. 2 Chapter Cxxxx 41137 page 4 09/07/07—mp Exhibit 2-2 summarizes the differences among service, merchandising, and manufacturing companies. EXHIBIT 2-2 Service, Merchandising, and Manufacturing Companies Service Companies Merchandising Companies Manufacturing Companies Examples Advertising agencies Amazon.com Procter & Gamble Banks Kroger DaimlerChrysler Law firms Wal-Mart Dell Computer Insurance Companies Wholesalers Nissan Primary Output Intangible services Tangible products purchased New tangible products made from suppliers as workers and equipment convert raw materials into new finished products Type(s) of Inventory None Inventory (or Merchandise Raw materials inventory Inventory) Work in process inventory Finished goods inventory 2 Chapter CXXXX 41137 9/10/07 4:33 PM Page 5 Building Blocks of Managerial Accounting 5 Stop & Think... What type of company is Outback Steakhouse, Inc.? Answer: Some companies don’t fit nicely into the three categories discussed previously. Outback has some elements of a service company (they serve hungry patrons), some elements of a manufacturing company (their chefs convert raw ingredients into finished meals), and some elements of a merchandising company (they sell ready-to-serve bottles of wine and beer). Outback is really a hybrid of the three types of companies we just discussed. As the “Stop & Think” shows, not all companies are strictly service, merchan- 2 Chapter Cxxxx 41137 page 5 09/07/07—mp dising, or manufacturing firms. Recall from Chapter 1 that the U.S. economy is shifting more towards service. Many traditional manufacturers, such as General Electric (GE), have developed profitable service segments that provide much of their company’s profits. General Motors now earns more from its financing and insur- ance operations than it does from car sales. Even merchandising firms are getting into the “service game” by selling extended warranty contracts on merchandise sold. Retailers offer extended warranties on products ranging from furniture and major appliances to sporting equipment and consumer electronics. While the mer- chandiser recognizes a liability for these warranties, the price charged to customers for the warranties greatly exceeds the company’s cost of fulfilling their warranty obligations. Which Business Activities Make Up the Value Chain? 2 Describe the value chain and its elements Many people describe Nissan, Dell Computer, and Coca-Cola as manufacturing companies.
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