AGRIB-112 Lesson 2 Management Accounting Concepts and Techniques for Planning and Control PDF

AGRIB-112: MANAGERIAL ACCOUNTING Lesson 2- Management Accounting Concepts and Techniques for Planning and Control After studying the lesson, the student be able to: 1. Describe the elements of good business planning. 2. Explain and identify the various classifications of costs...

AGRIB-112: MANAGERIAL ACCOUNTING Lesson 2- Management Accounting Concepts and Techniques for Planning and Control After studying the lesson, the student be able to: 1. Describe the elements of good business planning. 2. Explain and identify the various classifications of costs. 3. Recall the process of journalizing and posting. Financial and cost information is used in management accounting to give managers an idea of planning and controlling their organizations or businesses. The management accountants yield reports to assist the needs of decision-makers. The past and recent activities are stated that guided the management to make a strategy for the forthcoming. Business Planning As mentioned in Lesson 1, the main objective of any business organization is the maximization of profits. According to Eric Dickmann (https://fiveechelon.com), profit planning is the process of creating a financial plan that outlines the expected revenues and expenses of a business for a given period, typically a year. He also added that the primary objective of profit planning is to ensure that the company generates a profit that meets its financial goals and objectives. As stated in the book entitled Managerial Accounting: An Integrated Approach by Ma. Elenita B. Cabrera, et al., profit planning is a big part of most management control systems. When administered wisely it: a. Compels strategic planning and implementation of plans b. Provides a framework for judging performance c. Motivates managers and employees d. Promotes coordination and communicates among sub-units within the company Business planning (https://www.simplilearn.com), is developing a company's mission or goals and defining the strategies that will be used to achieve those goals or tasks. The process can be extensive, encompassing all aspects of the operation, or it can be concrete, focusing on specific functions within the overall corporate structure. Business planning is forecasting developments for a specific period to formulate a course of action. The course of action is spelled out in a document called a business plan. Effective planning enables the organization to control its direction and stabilize it. Planning is an effective way of guiding the organization through a changing environment. Planning enables the company to achieve results on a broader scale rather than constantly reacting to events on a day-to-day basis. (Managerial Accounting: An Integrated Approach by Ma. Elenita B. Cabrera, et al.) The planning process is a process used to develop objectives, develop tasks to meet objectives, determine needed resources, create a timeline, determine tracking and assessment, finalize the plan, and distribute the plan to the team. The process can be used by large organizations, management teams, or individual staff to develop and complete a plan. (https://study.com)  BuemzJenfiles24 Page 1 of 23 AGRIB-112: MANAGERIAL ACCOUNTING Lesson 2- Management Accounting Concepts and Techniques for Planning and Control Planning is the first primary function of management that precedes all other functions. The planning function involves the decision of what to do and how it is to be done. The managers focus a lot of their attention on planning and the planning process. (https://www.toppr.com) According to https://www.toppr.com, the eight (8) important steps of the planning process are: 1. Recognizing Need for Action An important part of the planning process is to be aware of the business opportunities in the firm’s external environment as well as within the firm. Once such opportunities get recognized the managers can recognize the actions that need to be taken to realize them. A realistic look must be taken at the prospect of these new opportunities and a Strengths, Weaknesses, Opportunities, and Threats (SWOT) analysis should be done. Say for example the government plans on promoting cottage industries in semi-urban areas. A firm can look to explore this opportunity. 2. Setting Objectives This is the second and perhaps the most important step of the planning process. In this step, establish the objectives for the whole organization and also individual departments. Organizational objectives provide a general direction, objectives of departments will be more planned and detailed. Objectives can be long-term and short-term as well. They indicate the result the company wishes to achieve. The objectives will percolate down from the managers and will also guide and push the employees in the correct direction. 3. Developing Premises Planning is always done keeping the future in mind, however, the future is always uncertain. In the function of management, certain assumptions will have to be made. These assumptions are the premises. Such assumptions are made in the form of forecasts, existing plans, past policies, etc. These planning premises are also of two (2) types – internal and external. External assumptions deal with factors such as the political environment, social environment, the advancement of technology, competition, government policies, etc. Internal assumptions deal with policies, availability of resources, quality of management, etc. These assumptions being made should be uniform across the organization. All managers should be aware of these premises and should agree with them.  4. Identifying Alternatives The fourth step of the planning process is to identify the alternatives available to the managers. There is no one way to achieve the objectives of the firm, there is a multitude of choices. All of these alternative courses should be identified. There must be options available to the manager. Maybe the manager chooses an innovative alternative hoping for more efficient results. If the manager does not want to experiment should stick to the more routine course of action. The problem with this step is not finding the alternatives but narrowing them down to a reasonable amount of choices so all of them can be thoroughly evaluated. 5. Examining Alternate Course of Action The next step of the planning process is to evaluate and closely examine each of the alternative plans. Every option will go through an examination where all their pros and cons will be weighed. The alternative plans need to be evaluated in light of the organizational objectives. For example, if it is a financial plan. Then in that case its risk-return evaluation will be done. Detailed calculations and analysis are done to ensure that the plan is capable of achieving the objectives in the best and most efficient manner possible. 6. Selecting the Alternative Finally, this step is the decision-making stage of the planning process. Now, the best and most feasible plan will be chosen to be implemented. The ideal plan is the most profitable one with the least amount of negative consequences and is also adaptable to dynamic situations. The choice is based on scientific analysis and mathematical equations. But a manager's intuition and experience should also play a big part in this decision. Sometimes a few different aspects of different plans are combined to come up with the one ideal plan. 7. Formulating a Supporting Plan Once the managers have chosen the plan to be implemented, they will have to come up with one or more supporting plans. These secondary plans help with the implementation of the main plan. For example, plans to hire more people, train personnel, expand the office, etc. are supporting plans for the main plan of launching a new product. All these secondary plans are part of the main plan. 8. Implementation of the Plan And finally, the last step of the planning process is the implementation of the plan. This is when all the other functions of management come into play and the plan is put into action to achieve the objectives of the organization. The tools required for such implementation involve the types of plans- procedures, policies, budgets, rules, standards, etc. A business plan can be defined as a guide for a company to operate and achieve its goals. One business plan can look entirely different from another one. A good business plan can be a game-changer for startups that are looking to raise funds to grow and scale. It convinces prospective investors that the venture will be profitable and provides a realistic outlook on how much profit is on the cards and by when it will be attained. (https://www.simplilearn.com) As published in https://www.simplilearn.com, the following are the four (4) types of business plans: 1. Operational Planning This type of planning typically describes the company's day-to-day operations. Single-use plans are developed for events and activities that occur only once (such as a single marketing campaign). Ongoing plans include problem-solving policies, rules for specific regulations, and procedures for a step-by-step process for achieving particular goals. 2. Strategic Planning Strategic plans are all about why things must occur. A high-level overview of the entire business is included in strategic planning. It is the organization's foundation and will dictate long term decisions. 3. Tactical Planning Tactical plans are about what will happen. Strategic planning is aided by tactical planning. It outlines the tactics the organization intends to employ to achieve the goals outlined in the strategic plan. 4. Contingency Planning When something unexpected occurs or something needs to be changed, contingency plans are created. In situations where a change is required, contingency planning can be beneficial. In the book entitled Managerial Accounting: An Integrated Approach by Ma. Elenita B. Cabrera, et al., the authors specified the importance of planning to an entrepreneurial firm. Moreover, elements of good business planning, the business plan, and the role of the consultant were also discussed and itemized below. Importance of Planning to an Entrepreneurial Firm 1. Planning helps smaller businesses to identify and allocate scarce resources to move the company in the desired direction. Without an explicit plan, resources may be used to meet immediate needs that may conflict with long-term objectives. 2. Smaller businesses cannot absorb mistakes as well as larger firms; therefore, risks must be continually identified. Planning helps small businesses to identify these potential hazards earlier and to prepare a contingency plan. 3. The flexibility common to many small firms enables easier implementation of plans. Small firms can make a major change in direction. Therefore, a smaller firm can often quickly capitalize on economic or market shifts if it has developed the appropriate business plans.  BuemzJenfiles24 Page 4 of 23 AGRIB-112: MANAGERIAL ACCOUNTING Lesson 2- Management Accounting Concepts and Techniques for Planning and Control Elements of Good Business Planning 1. The Business Plan 2. Common Characteristics 3. Role of the Consultant The Business Plan a. A brief description of the company’s present practices in all important areas, including products, purchasing, quality control, labor relations, channels of distribution, and production. b. A list of the principal external factors-government regulation, the economy, competition, the community environment, technology, and the labor markets. c. A list of changes expected in present practices and external factors over the next few years. d. An assessment of the strengths and weaknesses of the firm and its products. e. A forecast of expected financial results for the next two (2) years. f. A financial analysis identifying anticipated problems (cash shortage, low profits, etc.) or potential actions (investment of cash, expanded advertising, etc.) g. Performance projections under alternate assumptions such as a decline in sales, shortage of material, and increase in labor costs. h. Contingency plans for action under various scenarios. i. If the business plan is for starting a new venture or raising additional financing, it includes the following: 1. Financing requirements 2. Detailed marketing information 3. Relevant technical factors 4. Sensitivity analysis indicating the critical factors 5. Bank and investor relationships 6. Past and potential problem areas  Role of the Consultant 1. Develop the methods of planning Where a company does not have a formal planning approach and does not have the staff or the capability to develop an approach, the consultant can develop the features of a good planning system. 2. Evaluate the methods for long-range planning If the company is capable of developing plans with its planning function, then the consultant can evaluate the various aspects of the planning methods. 3. Instruct members of management about planning While a company may have a planning capability, the chances are the resources will be limited. One of the tenets of planning is to have the individuals who will be responsible for the fulfillment of the plans prepare the plans themselves. Planning staff should be small and should not be charged with preparing the plans. Outside assistance can instruct the members of top and middle management in proper planning techniques. 4. Suggest techniques to be used in the planning process Consultants should be familiar with techniques that could be utilized to implement the goals and objectives of the planning process. Financial reporting systems, financial projection systems, and other subsystems of the planning process can be suggested. The purpose of these subsystems is to mechanize the process of capturing data to provide feedback to management. Effective reporting systems can improve the quality of the planning process. 5. Play the “devil’s advocate Perhaps the most effective role for the consultant would be playing devil’s advocate about the goals and objectives of the company. The consultant can suggest additional factors to be considered in the development of goals and objectives. 6. Conduct sessions to determine the cause of variances As a follow-up to the development of an instruction in planning methodology, the consultant can conduct a series of sessions aimed at exploring the causes of variances from the plans. This activity takes place after the fact rather than before. As a result of this interaction, the company should be able to reset its goals and objectives and explore additional alternatives. Basic Cost Management Concepts In the book, Managerial Accounting: An Integrated Approach by Ma. Elenita B. Cabrera, et al., the nature of Cost, Cost Pools, Cost Objectives, Cost Drivers; Cost Assignment and Classification; and Classification of Costs have been defined and analyzed. Nature of Cost, Cost Pools, Cost Objectives, and Cost Drivers  Cost At the most level, a cost may be defined as the value foregone or sacrifice of resources to achieve some economic benefit that will promote the profit-making ability of the firm. A cost is incurred when a resource is used for some purpose. It is also an outlay expenditure of money to acquire goods and services that assist in performing operations. In managerial accounting, the term cost may be used in different ways because many types of costs may be classified differently according to the immediate needs of management. For instance, external financial reporting requires the use of historical cost data whereas decision making may require current cost data. Accounting costs are classified in numerous ways. To prepare financial statements, accountants must associate costs with specific periods. The classification of costs into product and period costs allows accountants to do that. Costs are classified differently depending on the type of organization involved, that is, merchandising, service, or manufacturing. Cost data that are classified and recorded in a particular way for one purpose may be inappropriate for another use. Cost Pools Cost pools are costs collected into meaningful groups. Cost pools may be classified as: 1. By type of cost (labor cost in one pool, materials cost in another) 2. By source (department 1, department 2, and so on) 3. By responsibility (manager 1, manager 2, and so on) and many more Cost object A cost object is any product, service, or organizational unit to which costs are assigned for some management purpose. Products and services are generally cost objects, while manufacturing departments are considered either cost pools or cost objects, depending on whether management’s main focus is on the cost of the products or the production department. Any item where costs can be traced and that has a key role in management strategy can be considered a cost object. Cost Drivers A critical first step in achieving a competitive advantage is to identify the key cost drivers in a firm or organization. A cost driver is any factor that has the effect of changing the level of total cost. The management of the key cost drivers is essential for a firm that competes based on cost leadership. For example, to achieve its low-cost leadership in manufacturing electronic products, Sony Manufacturing watches carefully the design and manufacturing factors that drive the costs of its products. For firms that are not cost leaders, the management of cost drivers may not be as critical but focusing attention on the key cost drivers contributes directly to the success of the firm. For example, an important cost driver for retailers is loss and damage to merchandise so most retailers have careful procedures for handling, displaying, and storing merchandise.  Cost Assignment and Classification Cost assignment is the process of assigning costs to cost pools or from cost pools to cost objects. Cost allocation is the assignment of indirect costs to cost pools. Allocation bases are cost drivers used to allocate. Classification of Costs Cost classifications are necessary for the development of cost information to serve the needs of management. Understanding these concepts and classifications enables the managerial accountant to provide appropriate cost data to the managers who need it. 1. Nature or Management Function a. Manufacturing Costs b. Non-manufacturing Costs 2. Timing of Recognition as Expense a. Product (Inventoriable) Costs b. Period Costs 3. Financial Statements a. Statement of Financial Position (Inventory Costs) b. Income Statement (Cost of Sales/Other Operating Costs) 4. Cost Behavior a. Variable Costs b. Fixed Costs c. Semi variable Costs 5. Types of Inventory a. Raw Materials Inventory b. Work in process Inventory c. Finished Goods Inventory 6. Traceability to Cost Objective a. Direct Costs b. Indirect Costs 7. Managerial Influence a. Controllable Costs b. Noncontrollable Costs 8. Planning and Control a. Standard Costs b. Budgeted Costs c. Absorption Costing/Full Costing d. Direct Costing/Variable Costing e. Information Costs f. Ordering Costs g. Out-of-Pocket Costs 9. Time Frame/Commitment to Cost Expenditure a. Committed Costs b. Discretionary Costs 10. Period of Incurrence  a. Historical Costs b. Future Costs 11. Decision Making and Other Analytical Purposes a. Relevant Costs (Future/Differential) b. Sunk Costs c. Opportunity Costs d. Marginal Costs e. Value Added Costs Source: Managerial Accounting: An Integrated Approach by Ma. Elenita B. Cabrera, et al.  Cost data helps the management accountant estimate the costs of resources such as personnel, supplies, and equipment associated with implementing a project, product, service, or other activity. An example of these is rent, insurance, or payroll. With variable costs, these scale with sales volume. A good example of these is raw material, shipping costs, and packaging costs. 1. Costs classified by Nature or Management Function Manufacturing Costs Manufacturing costs are all the costs associated with the production of goods. They are frequently classified as direct materials, direct labor, and factory overhead. Since costs attach to the product or groups of products as they are manufactured, expenditures, regardless of their nature, usually are capitalized as inventory assets and do not become “expired costs” or “expenses” until the goods are sold. a. Direct materials All raw material costs become an integral part of the finished product and that can be conveniently and economically assigned to specific units manufactured. Materials cost includes the invoice price plus other costs paid to the vendor, shipping costs, sales taxes, duty, cost of delivery containers and pallets (less net of return refunds), and royalty payment based on direct materials quantities. Trade discounts and cash discounts (if they exceed reasonable interest rates) should reduce material costs. Materials cost should also include scrap, waste, and normally anticipated defective units that occur in the ordinary course of the production process. Unanticipated quantities of scrap, shrinkage, waste, or defective units should be included in manufacturing overhead or expensed in the period incurred. Also, routine quality assurance samples are destroyed as part of testing and should be classified as materials. However, nonroutine quality assurance samples are taken due to manufacturing problems and the cost of marketing samples should not be added to materials costs. b. Direct labor All labor costs are related to time spent on products that can be conveniently and economically assigned to specific units manufactured. Estimates of direct labor quantities and unit prices may be sufficiently accurate to be considered “specifically identified” with a cost object. c. Manufacturing Overhead Manufacturing overhead, the third element of manufacturing cost, includes all costs of manufacturing except direct materials and direct labor. Indirect materials, indirect labor, property taxes, insurance, supervisor’s salaries, depreciation of factory building and factory equipment, and power are examples of factory overhead. Costs of operating services are also part of overhead. Service departments are those that do not work directly on manufacturing products but are necessary for the manufacturing process to occur. An example is equipment in equipment maintenance departments. Indirect materials Indirect materials include materials and supplies used in the manufacturing operation that do not become part of the product, such as oil for the machinery and cleaning fluids for the custodian. Indirect labor Labor costs that cannot be identified or traced to specific units manufactured. Examples include supervision, inspection, maintenance, personnel, and material handling. Other Manufacturing Overhead To summarize, manufacturing costs include direct materials, direct labor, and manufacturing overhead. Direct labor and overhead are often called conversion costs since they are the cost of “converting or transforming” raw material into finished products. Direct materials and direct labor are often referred to as prime costs. Other manufacturing overhead costs include overtime premiums and the cost of idle time. An overtime premium is the extra compensation paid to an employee who works beyond the time normally scheduled. Non-Manufacturing Costs Non-manufacturing costs generally include costs related to selling and other activities not related to the production of goods. a. Marketing Costs Marketing or selling costs include all costs associated with marketing or selling a product or all costs incurred by the marketing division from the time the manufacturing process is completed until the product is delivered to the customer or all costs necessary to secure customer orders and get the finished product or service into the hands of the customers. These costs are also called order-getting and order-filing costs. Examples of marketing costs are advertising, shipping, sales commissions, and storage costs. b. General and administrative costs General and administrative costs include all executive, organizational, and clerical costs associated with the general management of the organization rather than with manufacturing, marketing, or selling. Production Costs in Service Industry Firms and Nonprofit Organizations Service industry firms such as schools, hotels, banks, airlines, accounting firms, automotive repair shops, and many nonprofit organizations are also engaged in production. What distinguishes these enterprises from manufacturers is that a service is consumed as it is produced, whereas a manufactured product can be stored in inventory while less commonly applied in service firms, the same cost applications used in manufacturing companies can be applied. For example, an automotive repair shop produces repair services. Direct materials include such costs as new parts installed to replace the worn-out parts, paint, and other materials used. Direct labor includes the wages [aid to the service crew. Overhead costs include depreciation of equipment and other tools used and rental expenses. Recording and classifying costs is important not only for manufacturing firms but for service industry firms and nonprofit organizations as well. Cost analysis is necessary in pricing, banking and insurance services, hotel, and travel rental agencies, setting tuition fees in schools, and many more. As these organizations grow in the number and scope of business operations, applying managerial accounting to their activities takes an even greater importance. 2. Costs classified according to the Timing of Recognition as Expense An expense is defined as the cost incurred when an asset is used up or sold to generate revenue. The terms product cost and period cost are used to describe the timing with which various expenses are recognized. a. Product Costs Product costs include all the costs that are involved in acquiring or making a product. Also called inventory costs, they are costs that “attach” or cling to the units that are produced and are reported as assets until the goods are sold. In the case of manufactured goods, these costs consist of direct materials, direct labor, and manufacturing overhead. So initially, product costs are assigned to an inventory account on the statement of financial position. When the goods are sold, the costs are released from inventory as expenses (typically called cost of goods sold) and matched against sales revenue. This means that a product cost such as direct materials or direct labor might be incurred during one period but not treated as an expense until the following period when the completed product is sold. b. Period Costs Period costs are all the costs that are identified with accounting periods and not included in product costs. These costs are expensed on the income statement in the period in which they are incurred. Period costs are not included as part of the cost of either purchased or manufactured goods. Examples of period costs include selling and administrative expenses such as sales commissions, office rent, and transportation expenses. 3. Costs classification on Financial Statements The financial statements prepared by a manufacturing company are more complex than the statements prepared by a merchandising company. Manufacturing companies are more complex business firms than merchandising companies because the manufacturing company must produce its goods as well as market them. The production process gives rise to many costs that do not exist in a merchandising company. The manufacturing company’s product costs include not only the cost of purchasing but also the cost of converting materials into saleable products. These product costs are counted as assets until the product is sold and the revenue from the sales is recorded on the income statement. a. The Statement of Financial Position The statement of financial position of a manufacturing company is similar to that of a merchandising company. However, the inventory accounts differ between the two (2) types of companies. A merchandising company has only one (1) class of inventory called merchandise inventory. These are goods purchased from suppliers that are awaiting resale to customers. In contrast, manufacturing companies have three (3) classes of inventories, namely, raw materials; work in process, and finished goods. Raw materials are materials that are used to make a product. Work in process consists of units of product that are only partially complete and will require further work before they are ready for sale to a customer. Finished goods consist of units of product that have been completed but have not yet been sold to customers. The overall inventory figure is usually broken down into these three (3) classes of inventory footnote to the financial statements. b. The Income Statement At first glance, the income statements of merchandising and manufacturing firms are very similar. The only apparent difference is in the captions of some of the entries in the computation of the cost of goods sold. The cost of goods sold by a merchandising company is determined as follows: Beginning merchandise inventory Add: Purchases Total available for sale Less: Ending merchandise inventory Cost of goods sold The cost of goods sold by a manufacturing company is determined as follows: Beginning merchandise inventory Add: Cost of goods manufactured Total available for sale Less: Ending merchandise inventory Cost of goods sold  The cost of goods manufactured contains the three (3) elements of product costs namely direct materials, direct labor, and manufacturing overhead. 4. Cost classification for Predicting Cost Behavior Cost behavior refers to how a cost will react or respond to changes in the business activity. As the activity level rises and falls as well – or it may remain constant. For planning purposes, a manager must be able to anticipate which of these will happen; and if a cost is expected to change, the manager must know by how much it will change. To help make such a distinction, costs are often categorized as variable, fixed, or semi-variable. a. Variable Costs Costs that change directly in proportion to changes in activity (volume). Direct labor and direct materials are examples of variable costs. b. Fixed Costs Costs that remain unchanged for a given period regardless of change in activity (volume). Rent, insurance on property, maintenance, and repairs of buildings, and depreciation of factory equipment are examples of fixed costs. c. Semi-variable costs Costs that contain both fixed and variable elements. Examples of social security taxes, materials handling, personnel services, heat, light, and power. These cost elements must be divided into their proper elements. 5. Costs classified by Types of Inventory a. Raw Materials Inventory The cost of all raw materials and production supplies that have been purchased but not used at the end of the period. b. Work-in-Process Inventory The cost associated with goods is partially completed at the end of the period. c. Finished Goods Inventory Cost of completed goods that have not been sold at the end of the period. 6. Cost classification according to Traceability to Cost Objective a. Direct costs (traceable; separable) Costs that can be economically traced to a single cost object (i.e. product, department, or unit)  b. Indirect costs Costs that are not directly traceable to the cost object (i.e. product, department, etc.) 7. Cost classification according to Managerial Influence a. Controllable Cost Cost that is subject to significant influence by a particular manager within the period under consideration. b. Noncontrollable Cost Cost over which a given manager does not have a significant influence. 8. Cost Terminologies Used for Planning and Control a. Standard Costs A predetermined cost estimate that should be attained; is usually expressed in terms of costs per unit. b. Budgeted Cost Used to represent the expected/planned cost for a given period. For example, a company that plans to manufacture 1,000 units of product X, which has a standard cost per unit of P4.00, would have a budgeted cost for the period of P4,000.00 for product X. c. Absorption Costing A costing method that includes all manufacturing costs – direct materials, direct labor, and both variable and fixed manufacturing overhead – in the cost of a unit of product. It is also referred to as full cost method. d. Direct Costing A type of product costing where fixed costs are charged against revenue as incurred and are not assigned to specific units of product manufactured. Also referred to as variable costing. e. Information Costs Costs of obtaining information f. Ordering Costs Costs that increase with the number of orders placed for inventory. g. Out-of-pocket Costs Costs that must be met with a current expenditure or cash outlay.  9. Cost classification according to a Time-Frame Perspective a. Committed Cost The cost is an inevitable consequence of a previous commitment. b. Discretionary Cost (programmed; managed cost) Cost for which size or the time of incurrence is a matter of choice. 10. Cost classified according to the Time Period for Which the Cost is Incurred a. Historical Costs (Past Costs) Costs that were incurred in a past period. b. Future Costs Budgeted costs that are expected to be incurred in a future period. 11. Costs classifications for Decision-making and other Analytical Purposes a. Relevant Costs Future costs are different under one decision alternative than under another decision alternative. b. Incremental Costs The difference between two or more alternatives. In evaluating a given alternative, the incremental cost is the additional revenue to determine the feasibility of this particular alternative. To be an incremental cost, the cost must be a future cost and be different under various alternatives. c. Sunk Costs Past costs that have been incurred are irrelevant to a future decision. d. Opportunity Costs The value of the best alternative is foregone as the result of selecting a different use of a resource or choosing a particular strategy. e. Marginal Costs Costs associated with the next unit or the next project or incremental costs associated with an additional project as opposed to the next discrete unit.  f. Value-Added Costs Costs that add value to the product. These costs result from activities that are necessary to satisfy the requirements of the consumer. Efforts should be made to eliminate those costs that do not add value to the product, such as storage and materials handling. Illustrative Problem on Cost Classifications Bettina Cabrera is the production manager of a ready-to-wear manufacturing outfit. A decision needs to be made about the type of clothing material or fabric to be used to make a shirt. The fabric that has been used in the previous production cost P40.00 per yard but it is not available currently. Similar material from another supplier will cost P50.00 per yard. The cost of the fabric can be classified as follows: 1. Time Period P40.00 – historical cost P50.00 – future cost 2. Management function The cost of fabric is a manufacturing cost 3. Accounting treatment Whatever is paid for the fabric will be capitalized as a product cost and carried in inventory until it is sold. 4. Traceability to product The fabric is a direct cost because it represents a significant portion of the cost of the product and can be traced to a specific unit of the finished product. 5. Cost behavior Both the P40.00 and P50.00 cost per yard are variable costs. As the number of yard purchases increases, the total fabric cost increases proportionately. 6. Decision significance The P50.00 cost is relevant because it can be compared with the price of other fabrics of similar quality to select the best alternative. The P40.00 is irrelevant. 7. Managerial influence The cost of the fabric to be acquired is controllable since Ms. Cabrera has the authority to make production decisions. 8. Others The fabric is an out-of-pocket cost associated with producing additional skirts which will involve cash outlay in its acquisition. B  Review on Journalizing and Posting Recording It is concerned with the recording of financial transactions in an orderly manner, soon after their occurrence in the proper books of accounts. In every business, there are three (3) basic steps in the recording process: 1. Analyze each transaction for its effects on the accounts. 2. Enter the transaction information in a journal. 3. Transfer the journal information to the appropriate accounts in the ledger. Journal and Journalizing A journal is a historical record of business transactions or events. The word journal comes from the French word "Jour" meaning "day". It is a book of original or prime entries written up from various source documents. A journal is a primary book for recording the day-to-day transactions in chronological order i.e. in the order in which they occur. The journal is a form of diary for business transactions. General Journal is sometimes called the book of original entry (or day book, primary book or primary entry and book of first entry) because all transactions are recorded in it in chronological order as they occur. When a transaction is entered in the journal, it becomes a journal entry. The process of entering transactions in the journal is referred to as journalizing. Advantages of General Journal 1. The General Journal shows all information about a transaction as it takes place and also provides an explanation of the transaction. 2. It helps in locating errors. 3. It provides a chronological record of all transactions which is helpful to locate a transaction relating to a particular date. 4. There is no possibility of omitting a transaction as each transaction is recorded immediately. 5. As dual aspects of a transaction are recorded in the Journal so there is no chance of committing any mistake in writing to the ledger. 6. While preparing Journal each transaction gives detailed information so it is helpful in posting entries into ledger. There are various types of journals. This may include cash journal, purchases journal, sales journal and general journal. The simplest form of journal is the general journal.  BuemzJenfiles24 Page 18 of 23 AGRIB-112: MANAGERIAL ACCOUNTING Lesson 2- Management Accounting Concepts and Techniques for Planning and Control The general journal provides column spaces for the following information: 1. Date Column. It is used to record the dates of the transaction. 2. Explanation Column. It is used to record the affected accounts and brief statement about the transaction. 3. Folio Reference Column. It is used to record the account number in the account ledger to which the entry will be later transferred. 4. Debit Column. It is used to record the debited amounts. 5. Credit Column. It is used to record the credited amounts. Some entries involve only two (2) accounts, one debit and one credit. An entry like these is considered a simple entry. Some transactions, however, require more than two (2) accounts in journalizing. An entry that requires three (3) or more accounts is a compound entry. Formal Recording of Transactions in Journal Recording transactions in the journal requires appropriate transaction analysis. The affected accounts to be debited or credited must be properly identified. Any error in transaction analysis and recording of the effects of transactions in the journal will subsequently result to errors of financial information summary. The process of recording financial transactions in the general journal involves the following procedures: 1. The specific year of the accounting period is written on the first line of the left sub column below the Date column heading. 2. The specific month of the first business transaction is written on the next line under the Date column heading just below the year entry. In writing the month of the transaction, take note of the following: a. The name of the month is not written repeatedly on the same page of the journal. For transactions occurring within the same months, only the specific day is entered for the succeeding transactions. b. If the succeeding transactions occur on a new month, the name of the new month is written. c. The name of month under date column is written on every page of the journal for every first transaction recorded in the page. 3. The specific date or day of transaction is written on the right sub-column of the Date column heading. The specific date or day is repeated for transactions occurring on the same day. 4. The DEBITED Account Title of particular transaction is written on the Explanation column at the same line as the day entry and it is not indented. The corresponding amount is written on the Debit money column at the same line as the debited account title entry. BuemzJenfiles24 Page 19 of 23 AGRIB-112: MANAGERIAL ACCOUNTING Lesson 2- Management Accounting Concepts and Techniques for Planning and Control 5. The CREDITED Account Title of the particular transaction is written on the following line and it is indented. The corresponding amount is written on the Credit money column. 6. A brief explanation about the transaction is written on the next line after the last CREDITED Account Title entry and it is double-indented from the extreme left of the Explanation column. 7. A single line space between entries must be provided. 8. The Folio Reference Column is used when journal entries are posted to account ledgers. This will be discussed in the topic of recording in the account ledger. Ledger and Posting After journal entries are made, the next step in the accounting cycle is to post the journal entries into the ledger. The entire group of accounts maintained by a company is the ledger. The ledger keeps in one place all the information about changes in specific account balances. While the journal is referred to as Books of Original Entry, the ledger is known as Books of Final Entry. Ledger is a principal book of accounts of the enterprise. It is rightly called as the 'King of Books'. Ledger is a set of accounts. Ledger contains the various personal, real and nominal accounts in which all business transactions of the entity are recorded. The main function of the ledger is to classify and summarise all the items appearing in Journal and other books of original entry under appropriate head/set of accounts so that at the end of the accounting period, each account contains the complete information of all transaction relating to it. A ledger, therefore, is a collection of accounts and may be defined as a summary statement of all the transactions relating to a person, asset, expense or income which have taken place during a given period of time and shows their net effect. Posting refers to the process of transferring entries in the journal into the accounts in the ledger. Posting to the ledger is the classifying phase of accounting. An accounting ledger refers to a book that consists of all accounts used by the company, the debits and credits under each account, and the resulting balances. The pro-forma general ledger has eight (8) columns. The ledger is divided into halves by a vertical red line. The left-side is referred to as the debit-side of the ledger while the right side is referred to as the credit-side of the ledger. The debit journal account entries are posted in the debit side of the ledger. The credit journal account entries are posted in the credit side of the ledger. The column headings are the same in both sides of the ledger except that the right- most column of the debit side contains the DEBIT column heading while the right-most column of the credit side contains the CREDIT column heading. The top heading of the account ledger indicates the name of the business entity and the account title. The account number is also indicated at the right-most side of the ledger just below BuemzJenfiles24 Page 20 of 23 AGRIB-112: MANAGERIAL ACCOUNTING Lesson 2- Management Accounting Concepts and Techniques for Planning and Control the account title and above the column headings. The ledger has columnar spaces for entering column headings for DATE, PARTICULARS, FOLIO, DEBIT and CREDIT. Utility of a Ledger (a) It provides complete information about all accounts in one book. (b) It enables the ascertainment of the main items of revenues and expenses (c) It enables the ascertainment of the value of assets and liabilities. (d) It facilitates the preparation of Final Accounts. The Relationship Between Journal and Ledger Journal and Ledger are the most useful books kept by a business entity. The points of distinction between the two (2) are given below: 1. The journal is a book of original entry where as the ledger is the main book of account. 2. In the journal business transactions are recorded as and when they occur i.e. date-wise. However posting from the journal is done periodically, may be weekly, fortnightly as per the convenience of the business. 3. The journal does not disclose the complete position of an account. On the other hand, the ledger indicates the position of each account debit wise or credit wise, as the case may be. In this way, the net position of each account is known immediately. 4. The record of transactions in the journal is in the form of journal entries whereas the record in the ledger is in the form of an account. Closing Entries At the end of the accounting period, all the temporary or nominal accounts are transferred to Capital account. This process is referred to as closing the nominal account ledger. The closing entries are also recorded in the general journal and posted to the general ledger just like any other financial transactions. In closing the nominal account ledgers, the Revenue and Expense Summary Account is used. The revenue and expense summary account is used to summarize the revenues and expenses. The net balance of the revenue accounts and expense accounts are then transferred to the owner’s capital account. The net balance of the revenue and expense accounts shows the net income or loss of the enterprise for the given accounting period. The procedures of closing the nominal accounts are as follows: Step 1. DEBIT Revenue and Expense Summary account and CREDIT all nominal accounts with debit balances. Step 2. CREDIT Revenue and Expense Summary account and DEBIT all nominal accounts with credit balances. BuemzJenfiles24 Page 21 of 23 AGRIB-112: MANAGERIAL ACCOUNTING Lesson 2- Management Accounting Concepts and Techniques for Planning and Control Step 3. Close to Capital Account the net balances of the Revenue Accounts and Expenses Accounts: a. If there is net income balance, DEBIT Revenue and Expense Summary account and CREDIT capital account. b. If there is a net loss balance, DEBIT capital account and CREDIT Revenue and Expense Summary account. The closing entries are recorded in the general journal and then posted to proper nominal account ledgers. After posting, all the individual nominal account ledgers have debit total equal to credit total. If a nominal account ledger has only one amount entry on each side, it is double ruled. If a nominal account ledger has more than one entry on either side, it is single-ruled on both sides. The totals of amount entries of both sides are written below the single ruling along the same line. The account ledger is then double-ruled on both sides along the same line. The revenue account is closed to income or loss statement. The closing entries require that revenue account is to be DEBITED since it has a nominal credit balance in the ledger while the Revenue and Expense Summary account is CREDITED. The expense account is closed to income or loss statement as a CREDITED account since it has a nominal DEBIT BALANCE in the ledger. On the other hand, the Revenue and Expense Summary account is DEBITED. The net income balance of revenues and expenses is closed or transferred to Proprietor’s Capital as a CREDITED account while the Revenue and Expense Summary account is DEBITED. A net income balance results to an increase in Proprietor’s Capital, hence, it is CREDITED. On the other hand, the net loss balance is closed to Proprietor’s Capital as a DEBITED account while the Revenue and Expense Summary account is CREDITED. A net loss balance reduces the Proprietor’s Capital, hence, it is DEBITED. Balancing of an Account  After transferring the entries from Journal to the ledger, the next stage is to ascertain the net effect of all the transactions posted to relevant account. When the posting is completed, most of the accounts may have entries on both sides of the accounts i.e. debit entries and credits entries. The process of finding out the difference between the totals of the two (2) sides of a Ledger account is known as balancing and the difference of the total debits and the total credits of accounts is known as balance. If the total of the credit side is bigger than the total of the debit side, the difference is known as credit balance. In the reverse case, it is called debit balance. Steps for Balancing Ledger Account Ledger accounts may be balanced as and when it is required. The balances of various accounts are ascertained as under: 1. Make the total of both sides of an account in a worksheet. BuemzJenfiles24 Page 22 of 23 AGRIB-112: MANAGERIAL ACCOUNTING Lesson 2- Management Accounting Concepts and Techniques for Planning and Control 2. Write down the higher amount on the side obtained e.g. if the total of the debit side is P6,000.00 and the credit side is P5,500.00, the amount P6,000.00 is first inserted in the total on the debit side. 3. Also write down the same total on the other side of the account i.e. the total of P6,000.00 is written against the total on the credit side also. 4. Find out the difference between the two sides of the account. In this example debit side is more than credit side; therefore, there is a debit balance of P500.00. 5. This debit balance of P500.00 is to be shown as "By Balance c/d" in the account on the credit side. 6. Finally, the amount of the closing balance should be brought down as the opening balance at the beginning of the next day. Remember that if the opening balance is not written on the next day, the balancing is incomplete. Balancing of different accounts Balancing is done either weekly, monthly, quarterly, biannually or annually, depending on the requirements of the business concern. Personal Accounts: Personal accounts are balanced regularly to know the amounts due to the persons or due from the persons. A debit balance of this account indicate that the person concerned is a debtor of the business concern and a credit balance indicates that he is a creditor of the business concern. If a personal account shows no balance at all, it means that the amount due to him or due from him is settled in full.  Real Accounts: Real accounts are generally balanced at the end of the accounting year when final accounts are prepared and always shows debit balances. But, bank account may show either a debit balance or a credit balance. Nominal Accounts: In fact, nominal accounts are not balanced, as they are to be closed by transferring them to the final accounts i.e. Profit and Loss Account. Reference: Module 4.2: Recording of Financial Transactions in the General Journal and Account Ledger (Prof. Daniel R. Sadia) Bicol University-Led Institutional Capability Enhancement Project for AFNR Courses in Bicol Region. A PCARRD-BU Project funded by DOST BuemzJenfiles24 Page 23 of 23