10 Flashcards
(10 cards)
- What are some differences between financial
and managerial accounting?
Financial accounting deals with regulated, historical, financial information that pertains to the whole company and is designed primarily to meet the information needs of outsiders. Managerial accounting is concerned with unregulated financial, economic as well as physical data, which pertains more to the sub-units of the organization, that is current and future oriented, and that is designed primarily to meet the information needs of insiders.
- What does the statement “costs can be assets
or expenses” mean?
A cost that has the future economic potential to increase assets is recorded as an asset (e.g. product cost of products purchased). A cost that is used in the process of earning revenue is recorded as an expense (e.g. administrative salaries, and product cost associated with products sold).
- Why are the salaries of production workers
accumulated in an inventory account
instead of being directly expensed on the
income statement?
The cash paid to production workers is not used to produce revenue but to produce inventory. The revenue is earned when the inventory is sold at which time the cost of salaries associated with those products sold should be expensed.
6. How do product costs affect the financial statements? How does the classification of product cost (as an asset vs. an expense) affect net income?
Product costs associated with goods that have not been sold are recorded in the account called inventory. Inventory cost is shown on the balance sheet as an asset. The amount of total assets and net income will be higher if a product cost is classified as an asset. Product cost associated with goods that have been sold should be recorded in the account called cost of goods sold. Cost of goods sold is an expense shown on the income statement. The amount of total assets and net income will be lower if a product cost is classified as an expense as opposed to being classified as an asset.
- What is an indirect cost? Provide examples
of product costs that would be classified as
indirect.
An indirect product cost is a cost that cannot be easily or economically traced to a specific product. Product costs that would be considered indirect include costs such as production supplies, salaries of production supervisors, and depreciation, rent, and utilities on factory facilities.
- How does a product cost differ from a general,
selling, and administrative cost? Give
examples of each.
Product costs are all costs incurred to obtain a product or provide a service. These costs are treated as assets, recorded in inventory, and expensed when the associated products are sold. Period costs are all costs not associated with a product. They are associated with the general, selling, and administrative functions of the business and are generally expensed in the period in which the associated economic sacrifices are made. A product cost would be the cost of direct materials used in the production of a product. A period cost would be rent on administrative facilities.
- Why is cost classification important to
managers?
The effects of cost classification on the financial statements can have important implications for managers with respect to the following:
(1) Availability of financing - Investors and creditors use financial statement data to predict businesses’ future earnings. Favorable financial statements provide evidence of favorable future performance whereas unfavorable financial statements are an indication of possible poor future financial performance. A company with favorable financial performance is more likely to generate sufficient cash flows to make interest payments, to repay the principal balance of its liabilities, and to pay dividends. Hence, investors and creditors believe they have a greater probability of receiving interest payments, the return of principal, and return on investment when companies show favorable financial statements. Since expenses reduce profit and financial performance, classifying a cost as an expense will inhibit the company’s ability to obtain financing. Classifying a cost as an asset, which will increase profit, total assets, and equity, enhances businesses’ ability to obtain financing.
(2) Management motivation - Executive compensation may be affected by financial statement data. Many managers’ bonuses are based on a percentage of net income. If costs are classified as expenses, net income will be reduced which in turn affects managerial income. Managers may even be tempted to misclassify costs in order to manipulate financial statement data to their advantage.
(3) Income tax considerations - With respect to taxes, managers prefer to classify costs as expenses rather than assets. Classifying a cost as an expense reduces net income and in turn reduces income taxes, which are determined by taking a designated percentage of taxable income.
- What is cost allocation? Give an example
of a cost that needs to be allocated.
Cost allocation is the process of dividing a total cost into parts and assigning the parts to relevant cost objects. A production manager is usually in charge of the manufacturing operation of multiple products. The manager’s salary needs to be allocated among the products for the computation of product costs.
- What costs should be considered in determining the sales price of a product?
A pricing decision must include all costs associated with the product. The manufacturing product cost as well as all upstream costs (costs that occur before the manufacturing process begins, e.g., research and development costs) and downstream costs (costs that are incurred after the manufacturing process, e.g., sales commissions) must be covered by the product’s revenues in order for the company to be profitable.
- What is a just-in-time (JIT) inventory
system? Name some inventory costs that
can be eliminated or reduced by its use.
JIT inventory system is a reengineering principle where inventory is made available for customer consumption at the time of customer demand. A JIT inventory system is designed to eliminate the storage of large amounts of inventory. By eliminating the storage of inventory, costs related to inventory such as financing, warehouse space, security and maintenance, theft, damage and obsolescence can be reduced or eliminated.
