(c) 2013 Cengage Learning 1

Basic Cost Management

Concepts

2
 Chapter 2 Objectives
1. Describe a cost management information system, its
objectives, and its major subsystems, and indicate how it
relates 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.
4. Prepare income statements for manufacturing and service
organizations.
5. Explain the difference between traditional and
contemporary cost management systems.

3
 A Systems Framework
System: a set of interrelated parts that performs
one or more processes to accomplish specific
objectives
• Works by using processes to transform inputs
into outputs that satisfy the system’s objectives

An information system is designed to provide

information to people in the company who might
need it.

Objective 1
A Systems Framework

Objective 1
 A Systems Framework
Financial Accounting Information System
• Inputs: well-specified economic events
• Processes: rules and conventions established by the SEC
and FASB
• Outputs: financial statements for external users

Cost Management Information System

• Inputs and processes: set by management; not
bound by externally imposed criteria
• Outputs: reports for internal users

Objective 1
 A Systems Framework
The cost management information system has three broad
objectives that provide information for:

1) Costing services, products, and other objects of

interest to management
2) Planning and control
3) Decision making
The value chain is the set of activities required to design,
develop, produce, market, deliver, and provide post-sales
service for the products and services sold to customers.

Objective 1
A Systems Framework

Objective 1
A Systems Framework

Objective 1
 Cost Assignment: Direct Tracing, 2
Driver Tracing and Allocation
• Costs are sacrifices made to obtain goods or services. As long
as they remain unexpired, they are on the balance sheet as an
asset.
• Expenses are expired costs which are deducted from
revenues on the income statement.
• Cost Objects are anything for which costs are measured and
assigned. Some cost objects are tangible, such as the product
we make; others are not such as activities we for which we
wish to accumulate cost information.

Objective 2
Cost Assignment: Direct Tracing,
Driver Tracing and Allocation
Traceability means that costs can be assigned easily and
accurately, using a causal relationship.
Methods of tracing:
1. Direct tracing: relies on physical observance of causal
relationships to assign costs to cost objects.
2. Driver tracing: relies on drivers as causal factors to assign
costs to cost objects.

Costs that cannot be traced are considered indirect costs and

are allocated products in some predetermined way.

Objective 2
Cost Assignment: Direct Tracing,
Driver Tracing and Allocation

Objective 2
 3
Product and Service Costs

• Tangible products are goods produced by converting raw

materials into finished products.
• Services are activities performed for a customer or by a
customer using the service provider’s products or
facilities. Services have three characteristics that
separate them from tangible products:
• Intangibility
• Perishability
• Inseparability

Objective 3
Product and Service Costs

Objective 3
 Product and Service Costs
Manufacturing Costs
(Production 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.
Objective 3
 Product and Service Costs
Prime and Conversion costs

• Prime Cost is the sum of direct materials and direct labor.

• Conversion Cost is the sum of direct labor and overhead.

•Hint: Never add prime cost and conversion cost or you will
have double counted labor because it is included in each
definition!

Objective 3
 Product and Service Costs
Nonproduction Costs
(Period 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.

Objective 3
Product and Service Costs

Objective 3
 External Financial Statements
• Income Statement: Manufacturing Firm
• Prepared for external parties
• Follows standard format
• Is referred to as an absorption-costing or full-costing income
statement because all manufacturing costs are absorbed into the cost
of goods.
• Cost of Goods Manufactured represents the total manufacturing cost
of goods completed during the period.
• Work in Process consists of all partially completed unites found in
production at a given point in time (usually the end of one
period/beginning of the next).
• Cost of Goods Sold is the manufacturing cost of all goods that were
sold during the period.

Objective 4
Traditional and Activity-Based Cost
Management Systems
• Traditional Cost Management Systems
• Traditional Cost Accounting
• Assumes all costs can be classified as fixed or
variable with respect to changes in units or
volume.
• Allocates costs that are not unit-based.
• Traditional Cost Control
• Assigns costs to organizational units and holds the
unit manager responsible for controlling the
assigned costs.
• Performance is measured by comparing actual
outcomes with standard or budgeted outcomes.
• Emphasis is on financial measures of performance.
Objective 5
Traditional and Activity-Based Cost
Management Systems
• Activity-Based Cost Management Systems
• Activity-Based Cost Accounting
• Emphasizes tracing over allocation
• Identifies non-unit-based activity drivers.
• Flexible system capable of producing cost
information for a variety of purposes.
• Activity-based Cost Control
• Seeks to understand and control activities rather
than costs.
• Activity-based management (ABM) focuses on
improving customer value.
• Looks at the process view and focuses
accountability on activities to maximize
systemwide performance. Objective 5
Traditional and Activity-Based Cost
Management Systems

Objective 5
Traditional and Activity-Based Cost
Management Systems
Comparison of Traditional and ABC Systems

Objective 5
Traditional and Activity-Based Cost
Management Systems
Trade-Off Between Measurement and Error Costs

Objective 5
Traditional and Activity-Based Cost
Management Systems
Shifting Measurement and Error Costs

Objective 5
End of Chapter 2
26