Question

One aspect of managerial accounting focuses on calculating a manufacturer's product costs as data inputs for the firm's external financial statements. For example, the manufacturer's income statement must report the actual cost of the products sold, and its balance sheet must report the actual costs in its ending inventories.

The managerial accounting costs needed to support these calculations include direct labor, direct materials, non-direct materials, job order costing, process costing, allocation of manufacturing overhead (utilities and real estate taxes), and costing of joint products.

Based on the managerial accounting costs provided above, select two (2) costs and explain why you believe they are the most important / impactful to preparing the firm’s external financial statements.

Answer 1

Managerial accounting costs include direct material, direct labour, allocation of direct manufacturing overhead, job order costing, process costing etc. These costs impact the various accounts which reflect on the financial statements ( Both Income Statement and Balance Sheet)

Direct materials is of the important managerial accounting costs. This forms the major components of a finsihed goods and takes the major portion of Variable cost of goods. We have to account these expenses carefully because the wrong allocation or wrong accounting may lead to misreporting of financials. The direct materials related to those finished goods that stayed in the godown/branches at end of year need not be accounted as expense for the year, for that we value finished goods at the end of year and reduce from material costs for the year. In next they are treated as opening inventory and are taken to expenses that year. This allows us to follow matching concept (matching revenues and expenses). We also have a major decision of selecting the method of valuation between FIFO (First In First Out), LIFO (Last In First Out), Weighted Average Cost method. Correct method has to be adopted based on the type of inventory and the type of industry the entity is in. These decisions also affect the financials.

Direct labour is also an important cost. These costs occupy major portion of Variable costs and thus affecting the expenses recognition and finished goods accounting. At the year all the goods will not be sold, some will stay in aa finished goods and some other will be still in Work in Progress. The labour costs needs to be allocated to such inventory as well. These are treated as product costs and not period costs. For valuation of Work In Progress (WIP) we have to find the equivalent units and then allocate the direct labour expenses based on such equivalent units. Unless these costs are allocated to WIP and Finished goods, all the direct labour costs will be treated as current year expenses leading to Under reporting of profit in current year and also lower accounting of assets in the balance sheet.

In brief, for these product costs we have to take to expense in the current only such costs which belong to the finished goods sold during the year and not for the entire produced finished goods.