These are the key points you should know for Chapter 1

1. Managerial accounting is designed for decision making within the company.

Managerial accounting uses more projections and estimates than seen in financial

accounting. The focus is within the company and is often applied to specific jobs,

process, products or departments.

2. Manufacturing Costs include:

● Direct Materials -- materials can be directly traced to a product or job

● Direct Labor -- labor can be directly traced to a product or job

● Overhead -- materials, labor, or other costs related to a product or job BUT

cannot be directly traced to a specific product or job (hint: look for keywords like

Indirect, Factory, or Manufacturing within the costs)

3. Prime Costs are all DIRECT manufacturing costs and include direct material and

direct labor.

4. Conversion Costs are defined as any cost used to convert a raw material to a

finished good and include direct labor and overhead

NOTE: Direct labor is considered BOTH a prime and a conversion cost

5. Direct Materials Used can be calculated using Raw Materials Inventory:

Beg. Raw Materials Inventory

+ Raw Material Purchases

- End. Raw Materials Inventory

= Raw Materials Used

- Indirect Materials (typically given in problems)

= DIRECT MATERIALS USED

6. Cost of Goods Manufactured is the cost of jobs, processes, or products that are

finished. We need to transfer this cost to finished goods inventory and OUT of work in

process inventory. We will use Direct Materials USED in this calculation which is

different from material purchases (see above formula for getting direct materials used) .

Cost of Goods Manufactured is calculated as:

+Direct Materials Used

+ Direct Labor

+ Overhead Applied

=Total Manufacturing Costs

 + Beg. Work in Process Inventory

- End. Work in Process Inventory

= COST OF GOODS MANUFACTURED

Example calculation of Cost of Goods Manufactured (COGM)

This can be more clearly seen in a T-account. For example, let’s say that a company that manufactures furniture
incurs the following costs:

Direct Materials: $100,000

Direct Labor: $50,000

Manufacturing Overhead: $60,000

Beginning WIP Inventory: $10,000

Ending WIP Inventory: $30,000

Work in Process (WIP) Inventory

Beginning Balance                                     10,000

Direct Materials                                         100,000

  190,000*                      COGM
Direct Labor                                                50,000

Manufacturing Overhead                         60,000

Ending Balance                                           30,000

COGM = 10,000 + 100,000 + 50,000 + 60,000 – 30,000 = $190,000*

7. Cost of Goods Sold represents the TOTAL COST of a finished product, job, or

process and is recorded as an expense ONLY when it is sold. Cost of goods sold is

calculated as:

Beg. Finished Goods Inventory

+ Cost of Goods Manufactured

- End. Finished Goods Inventory

= COST OF GOODS SOLD

8. Gross Profit (or Gross Margin) is calculated as Sales - Cost of Goods Sold and does not

include any selling, general or administrative costs. Net Income includes ALL expenses and is

calculated as Sales - cost of goods sold, selling, general and administrative costs.
TERMS
 Administrative costs Costs of managing the organization, including the costs of top administrative functions and
various staff departments such as accounting, data processing, and personnel.
 Cost A financial measure of the resources used or given up to achieve a stated purpose.
 Cost driver Activity or transaction that causes costs to be incurred. Machine-hours can be a cost driver for costs
of energy to run machines, for example.
 Cost of goods manufactured Consists of the total costs of all goods completed during the period; includes cost
to manufacture plus beginning work in process inventory minus ending work in process inventory
 Cost of goods sold Cost of goods manufactured plus the beginning finished goods inventory minus the ending
finished goods inventory.
 Cost to manufacture (or manufacturing costs) Includes the direct materials, direct labor, and manufacturing
overhead incurred during the period.
 Direct labor Labor costs of all employees actually working on materials to convert them to finished goods. Direct
labor costs are directly traced to particular products in contrast to indirect labor costs.
 Direct materials Materials that are used only in making the product and are clearly and easily traceable to a
particular product.
 Finished goods Completed manufactured products ready to be sold. Finished Goods Inventory is the title of an
inventory account maintained for such products.
 Indirect labor The cost of labor that cannot, or will not for practical reasons, be traced to the goods being
produced or the services being provided.
 Indirect materials Materials used in making a product that cannot, or will not for practical reasons, be traced
directly to particular products.
 Managerial accounting Managerial accounting information is intended for internal use. The purpose is to
generate information managers can use to make good decisions.
 Manufacturing overhead All manufacturing costs except for those costs accounted for as direct materials and
direct labor.
 Materials Unprocessed items used in the manufacturing process typically stored in Raw Materials Inventory.
 Overhead All costs of making goods or providing services except for those costs classified as direct materials and
direct labor. See manufacturing overhead for overhead in manufacturing companies.
 Period costs Costs related more closely to periods of time than to products produced. Period costs cannot be
traced directly to the manufacture of a specific product; they are expensed in the period in which they are
incurred.
 Predetermined overhead rate Calculated by dividing estimated total overhead costs for a period by the
expected level of activity, such as total expected machine-hours or total expected direct labor-hours for the
period.
 Product costs Costs a company assigns to units produced. In manufacturing companies, these costs are direct
materials, direct labor, and manufacturing overhead. In service companies that have no materials, these costs
are direct labor and overhead.
 Selling costs Costs incurred to obtain customer orders and distribute the finished product to the customer.
 Statement of cost of goods manufactured An accounting report showing the cost to manufacture and the cost
of goods manufactured.
 Work in process Partially manufactured products; a Work in Process Inventory account is maintained for such
products.
The Statement of Cost of Goods Manufactured
The statement of cost of goods manufactured supports the cost of goods sold figure on the income
statement.  The two most important numbers on this statement are the total manufacturing cost and the cost of
goods manufactured. Be careful not to confuse the terms total manufacturing cost and cost of goods
manufactured with each other or with the cost of goods sold.

Total Manufacturing Cost includes the costs of all resources put into production during the period (meaning,
the direct materials, direct labor and overhead applied).
Cost of goods manufactured consists of the cost of all goods completed during the period. It includes total
manufacturing costs plus the beginning work in process inventory minus the ending work in process inventory
Cost of goods sold are the costs of all goods SOLD during the period and includes the cost of goods
manufactured plus the beginning finished goods inventory minus the ending finished goods inventory. 
. Cost of goods sold is reported as an expense on the income statements and is the only time product
costs are expensed. 
This chart will summarize the formulas you will need:

Direct Materials Used

Beginning Raw Materials Inventory + Raw Material Purchases – Ending Raw Materials Inventory – Indirect
Materials Used

Total Manufacturing Cost

Direct Materials + Direct Labor + Overhead applied

Cost of Goods Manufactured

Total Manufacturing Cost (Direct Materials + Direct Labor + Overhead applied) + Beginning Work In Process
Inventory – Ending Work in Process Inventory

Cost of Goods Sold

Beginning Finished Goods Inventory + Cost of Goods Manufactured – Ending Finished Goods Inventory
 Farside Manufacturing Company

Statement of cost of goods manufactured

For the year ended December 31

Direct Materials Used:

Raw Materials inventory, January 1 40,000

Raw Materials purchases 480,000

Less: Raw Materials inventory, December 31 30,000

Raw Materials used 490,000

Less: Indirect Materials Used 0

Direct Materials Used 490,000

Direct labor 380,000

Manufacturing overhead:

Indirect labor 120,000

Maintenance and repairs expense 60,000

Factory utilities expense 10,000

Depreciation expense – factory building 20,000

Depreciation expense – factory equipment 30,000

Other expense – factory 20,000

Total manufacturing overhead 260,000

Total Manufacturing Cost 1,130,000

Add: Work in process inventory, January 1 30,000

Less: Work in process inventory, December 31 -60,000

Cost of goods manufactured 1,100,000

Note how the statement shows the costs incurred for direct materials, direct labor, and manufacturing overhead. The
statement totals these three costs for total manufacturing cost during the period. When adding beginning work in
process inventory and deducting ending work in process inventory from the total manufacturing cost, we obtain cost of
goods manufactured or completed. Cost of goods sold does not appear on the cost of goods manufactured statement
but on the income statement.

To make the manufacturer’s income statement more understandable to readers of the financial statements,
accountants do not show all of the details that appear in the cost of goods manufactured statement. Next, we show the
income statement for Farside Manufacturing Company. Notice the relationship of the statement of cost of goods
manufactured to the income statement.

The cost of goods manufactured appears in the cost of goods sold section of the income statement. The cost of goods
manufactured is in the same place that purchases would be presented on a merchandiser’s income statement. We add
cost of goods manufactured to beginning finished goods inventory to derive cost of goods available for sale. This is
similar to the merchandiser who presents purchases added to beginning merchandise to derive goods available for sale.
 Farside Manufacturing Company

Income statement

For the year ended December 31

Sales 1,800,000

Cost of goods sold:

Finished goods inventory, January 1 50,000

Cost of goods manufactured 1,100,000

Cost of goods available for sale$ 1,150,000

Less: Finished goods inventory, December 31 60,000

Cost of goods sold 1,090,000

Gross margin (Sales – Cost of goods sold) 710,000

Operating expenses:

Selling expenses 300,000

Administrative expenses 200,000

Total operating expenses 500,000

Income from operations 210,000