Basic Cost

Management
Concepts

2-1

Objectives
Objectives
1. Describe a cost
management
information
After
studying
this
After studying this
system, its objectives,
and
its major
chapter,
you
should
chapter, you should
subsystems, andbe
indicate
how it relates to
able
to:
be able to:
other operating and information systems.
2. Explain the cost assignment process.
3. Define tangible and intangible products, and
explain why there are different product cost
definitions.
2-2

Objectives
Objectives
4. Prepare income statements for manufacturing
and service organizations.
5. Explain the differences between traditional
and contemporary cost management systems.

2-3

A
A Systems
Systems Framework
Framework
A system is a set of interrelated parts
that performs one or more processes to
accomplish specific objectives.
Example: An air conditioning system
for a home

2-4

Operational
Operational Model
Model of
of an
an
Air
Air Conditioning
Conditioning System
System
Cooling Process
Inputs:
Freon
Warm Air
Electricity

Output:
Cooled Air

Delivery Process
Inputs:
Cooled Air
Electricity
Ducts

Output:
Delivered Cooled Air
2-5

Accounting
Accounting Information
Information System
System
An accounting information system is a system
consisting of interrelated manual and computer parts,
using processes such as collecting, recording,
summarizing, analyzing, and managing data to provide
information to users.
Like
Like any
any system,
system, an
an accounting
accounting information
information
system
systemconsists
consists of:
of: (1)
(1) objectives,
objectives, (2)
(2) interrelated
interrelated
parts,
parts, (3)
(3) processes,
processes, and
and (4)
(4) outputs.
outputs.

2-6

Operational
Operational Model
Model for
for an
an
Accounting
Accounting Information
Information System
System

Economic Events

Collecting
Classifying
Summarizing
Analyzing
Managing

Special Reports
Financial Statements
Budgets
Performance Reports
Personal Communication

Inputs

Processes

Outputs

Users

2-7

Accounting Information Systems

The financial accounting information system is an
accounting information subsystem that is primarily
concerned with producing outputs for external users.
The cost management information system is an
accounting information subsystem that is primarily
concerned with producing outputs for internal users
using inputs and processes needed to satisfy
management objectives.

2-8

Accounting Information Systems

The cost management information system has three
broad objectives that provide information for-1) Costing out services, products, and other
objects of interest to management
2) Planning and control
3) Decision making

2-9

An
An Integrated
Integrated Cost
Cost
Management
Management System
System
Design and
Development
System

Production
System
Cost
Management
System

Marketing and
Distribution
System

Customer
Servicing
System
2-10

The
The Subsystems
Subsystems of
of the
the Accounting
Accounting
Information
Information System
System
Accounting Information System

Financial Accounting
Information System

Cost Management
Information System

Cost Accounting
Information System

Operational
Control System
2-11

Basic
Basic Cost
Cost Concepts
Concepts
Cost is the cash or cash equivalent value sacrificed

for goods and services that are expected to bring a

current or future benefit to the organization.
Costs are incurred to produce future benefits.
Expired costs are called expenses.
Unexpired costs are classified as assets and appear

on the balance sheet.

Assigning cost accurately to cost objects is crucial.

2-12

Basic
Basic Cost
Cost Concepts
Concepts
A cost object is any item, such as products, customers,
departments, projects, activities, and so on, for which
costs are measured and assigned.
Example: A bicycle is a cost object when you are
determining the cost to produce a bicycle.

An activity is a basic unit of work performed within an

organization.
Example: Setting up equipment, moving materials,
maintaining equipment, designing products, etc.

2-13

Basic
Basic Cost
Cost Concepts
Concepts
Traceability is the ability to assign a cost to a
cost object in an economically feasible way by
means of a causal relationship.
Direct costs are those costs that can be easily
and accurately traced to a cost object.
Example: The salary of a supervisor of a department,
where the department is defined as the cost
object.

2-14

Basic
Basic Cost
Cost Concepts
Concepts
Indirect costs are those costs that cannot be traced
easily and accurately to a cost object.
Example: The cost of heating and cooling a plant that
manufactures five products.

2-15

Cost
Cost Assignment
Assignment Methods
Methods
Cost of Resources
Resource Drivers

Direct
Tracing

Physical
Observation

Driver
Tracing

Allocation

Activity
Drivers

Convenience
Assumed
Linkage

Cost Objects
2-16

Product Cost Definitions

Value-Chain
Product Costs

Operating
Product Costs

Traditional
Product Costs

Research
Researchand
and
Development
Development

Production
Production
Marketing
Marketing

Production
Production
Marketing
Marketing

Customer
CustomerService
Service

Customer
CustomerService
Service

Pricing Decisions
Product Mix Decisions
Strategic Profitability
Analysis

Strategic Design
Decisions
Tactical Profitability
Analysis

Production
Production

External Financial
Reporting

2-17

Manufacturing
Manufacturing Costs
Costs
Direct materials are those materials that are directly
traceable to the goods or services being produced.
Example: The cost of wood in furniture.

Direct labor is the labor that is directly traceable to the

goods or services being produced.
Example: Wages of assembly-line workers.

Overhead are all other manufacturing costs.

Example: Plant depreciation, utilities, property taxes,
indirect materials, indirect labor, etc.

2-18

Nonproduction
Nonproduction Costs
Costs
Marketing (selling) costs are the costs necessary to
market, distribute, and service a product or service.
Example: Advertising, storage costs, and freight out.

Administrative costs are the costs associated with

research, development, and general administration of
the organization that cannot reasonably be assigned to
either marketing or production.
Example: Legal fees, salary of the chief executive officer.

2-19

Nonproduction
Nonproduction Costs
Costs
For
For external
external financial
financial
reporting,
reporting, marketing
marketing and
and
administrative
administrative costs
costs are
are not
not
inventoried.
inventoried. They
They are
are
referred
referred to
to as
as period
period costs.
costs.

2-20

Production or
Manufacturing
Costs

Direct Materials
Direct Labor
Overhead

Nonproduction
or Operating
Costs

Marketing Expense
Prime Cost Order-Getting Costs
Order-Filling Costs
Conversion
Cost
Administrative
Expense
2-21

Manufacturing Organization
Income Statement
For the Year Ended December 31, 2004
Sales
Less: Cost of goods sold
Gross margin

$2,800,000
1,300,000
$ 700,000

Less operating expenses:

Selling expenses
Administrative expenses
Operating income

$300,000From the Cost

From the Cost
150,000of
450,000
Sold
ofGoods
Goods
Sold
$Schedule
250,000
Schedule

2-22

Statement of Cost of Goods Manufactured

For the Year Ended December 31, 2004
Direct materials:
Beginning inventory
$200,000
Add: Purchases
450,000
Materials available
$650,000
Less: Ending inventory
50,000
Direct materials used in production
$ 600,000
Direct labor
350,000
Manufacturing overhead:
Indirect labor
$122,500
Depreciation
177,500
Rent
50,000
Utilities
37,500
Property taxes
12,500
Maintenance
50,000
450,000
Total manufacturing costs continued
added
$1,400,000

2-23

Total manufacturing costs added

Add: Beginning work in process
Less: Ending work in process
Cost of goods manufactured

$1,400,000
200,000
400,000
$1,200,000

Work in process consists of all

partially completed units found in
production at a given point in time.

2-24

Cost of Goods Sold Schedule

For the Year Ended December 31, 2004
Cost of goods manufactured
Add: Beginning inventory finished goods
Cost of goods available for sale
Less: Ending inventory finished goods
Cost of goods sold

$1,200,000
250,000
$1,450,000
150,000
$1,300,000

From
Fromthe
the
Statement
Statementof
of
Cost
Costof
ofGoods
Goods
Manufactured
Manufactured
2-25

Activity-Based Management Model

Cost View
Resources
Process View
Driver
Analysis

Activities

Performance
Analysis

Why?

What?

How well?

Products and
Customers
2-26

Functional-Based
Functional-Based and
and ActivityActivityBased
Based Cost
Cost Management
Management Systems
Systems
Functional-Based
1. Unit-based drivers
2. Allocation-intensive
3. Narrow and rigid product costing
4. Focus on managing costs
5. Sparse activity information
6. Maximization of individual unit
performance
7. Uses financial measures of performance

2-27

Functional-Based
Functional-Based and
and ActivityActivityBased
Based Cost
Cost Management
Management Systems
Systems
Activity-Based
1. Unit- and nonunit-based drivers
2. Tracing intensive
3. Broad, flexible product costing
4. Focus on managing activities
5. Detailed activity information
6. Systemwide performance maximization
7. Uses both financial and nonfinancial
measures of performance

2-28

Trade-Off
Trade-Off Between
Between Measurement
Measurement and
and Error
Error Costs
Costs
Cost

Total Cost

Measurement
Cost

Error Cost

Low
Accuracy

Optimal
Level

High
Accuracy
2-29

Shifting
Shifting Costs
Costs
Cost

Old Measurement Cost

New
Measurement
Cost
New Error
Cost

Old Error
Cost

Low

Old Optimum
New Optimum
Accuracy

High
2-30

End of

Chapte
r
2-31

2-32