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2 -1
Basic Basic Management Management Accounting Accounting ConceptsConcepts
CHAPTERCHAPTER
2 -2
1. Describe the cost assignment process.2. Define tangible and intangible products and
explain why there are different product cost definitions.
3. Prepare income statements for manufacturing and service organizations.
4. Outline the differences between functional-based and activity-based management accounting systems.
ObjectivesObjectivesObjectivesObjectives
After studying this After studying this chapter, you should chapter, you should
be able to:be able to:
After studying this After studying this chapter, you should chapter, you should
be able to:be able to:
2 -3
Exactly what is meant by “cost”?
Exactly what is meant by “cost”?
Cost is the cash or cash-equivalent value sacrificed for goods and services
that is expected to bring a current or future benefit to the organization.
Cost is the cash or cash-equivalent value sacrificed for goods and services
that is expected to bring a current or future benefit to the organization.
I see… It’s a dollar measure of the
resources used to achieve a given
benefit.
I see… It’s a dollar measure of the
resources used to achieve a given
benefit.
2 -4
A cost objectcost object is any item such as products, customers, departments, projects, activities, and so on, for which costs are measured and assigned.
ExampleExample: A bicycle is a cost object when you are determining the cost to produce a bicycle.
An activityactivity is a basic unit of work performed within an organization.
Example:Example: Setting up equipment, moving materials, maintaining equipment, designing products, etc.
2 -5
Traceability Traceability is the ability to assign a cost to a cost object in an economically feasible way by means of a cause-and-effect relationship.Direct costsDirect costs are those costs that can be easily and accurately traced to a cost object.
Example:Example: If a hospital is the cost object,the cost of heating andcooling the hospital is a direct cost.
2 -6
Indirect costsIndirect costs are those costs that cannot be easily and accurately traced to a cost object.
Example:Example: The salary of a plant manager, where departments within the plant are defined as the cost objects.
2 -7
Tracing Tracing is the actual assignment of costs to a cost object using an observable measure of the resources consumed by the cost object. Tracing costs to cost objects can occur in the following two ways:
Direct tracingDirect tracing is the process of identifying and assigning costs that are exclusively and physically associated with a cost object to that cost object. Eq. Equipment maintaining needs physical parts or tools. Bicycle product needs material and labor cost.
Driver tracingDriver tracing is the use of drivers to assign costs to cost objects. DriversDrivers are observable causal factors that measure a cost object’s resource consumption. Driver tracing comprises of two types: resources drivers and activity drivers.
2 -8
Driver tracing
1. Resource drivers is measured by resources demand in an activity. Eq. equipment maintaining needs tools or parts that can be directly traced to the activity. Power and indirect labor can not be traced directly. So that it needs a resource driver. Machine hour can be a driver for power and labor hour can be a driver for indirect labor.
2. Activity driver is measured by activity needed in a cost object. Eq. equipment maintaining uses number of maintenance hours worked as a driver. Table below presents potential activities.
2 -9
Activity Potential activity driver
Setting equipment Number of setups
Ordering material Number of moves
Drilling holes Number of machine hours
Redesigning product Number of engineering orders
Paying bills Number of invoices
Inspecting finished goods Number of bathes produced
Maintaining equipment Number of maintenance hours
Providing power Number of kilowatt-hours
Packing goods Number of boxes
Scheduling production Number of different products
2 -10
Cost Assignment MethodsCost Assignment Methods
Cost of ResourcesCost of Resources
DirectDirectTracingTracing
DriverDriverTracingTracing
AllocationAllocation
PhysicalPhysicalObservationObservation
CausalCausalRelationshipRelationship
AssumedAssumedRelationshipRelationship
Cost ObjectsCost Objects
2 -11 Dimensions of Services withManagement Accounting
1. Intangibility
2. Perishability (easily
damaged)
3. Inseparability (hardly
separated)
4. Heterogeneity
Buyers can not see, feel, hear or taste the service before it is bought
Buyers can not see, feel, hear or taste the service before it is bought
Derived PropertiesDerived PropertiesDerived PropertiesDerived Properties
Services cannot be stored.No patent protection.
Cannot display or communicate services.Price difficult to set.
Services cannot be stored.No patent protection.
Cannot display or communicate services.Price difficult to set.
Customer directly involved with production of service (a doctor and a patient).
Centralized mass production of services difficult.
Customer directly involved with production of service (a doctor and a patient).
Centralized mass production of services difficult.
Wide variation in service products possible.
Wide variation in service products possible.
2 -12 Interface of Services withManagement Accounting
No inventories.Strong ethical code.Price difficult to set.Demand for more accurate
cost assignments.
No inventories.Strong ethical code.Price difficult to set.Demand for more accurate
cost assignments.
Impact on Management Impact on Management AccountingAccounting
Impact on Management Impact on Management AccountingAccounting
No inventories.Need for standards and
consistent high quality.
No inventories.Need for standards and
consistent high quality.
Costs often accounted for by customer type.
Demand for measure-ment and control of quality to maintain consistency.
Costs often accounted for by customer type.
Demand for measure-ment and control of quality to maintain consistency.
Productivity and quality measurement and control must be ongoing.
Total quality manage-ment critical.
Productivity and quality measurement and control must be ongoing.
Total quality manage-ment critical.
1. Intangibility
2. Perishability
3. Inseparability
4. Heterogeneity
2 -13
Product cost is a cost assignment that supports a well-specified managerial
object. Thus, what product cost means depends on the managerial
objective being served.
2 -14
DesignDesign
ProduceProduce
MarketMarket
DistributeDistribute
ServiceService DevelopDevelop
2 -15 Product Costing Definitions
Pricing DecisionsProduct-Mix DecisionsStrategic Profitability
Analysis
Strategic Design DecisionsTactical Profitability
Analysis
External FinancialReporting
Research andResearch andDevelopmentDevelopment
ProductionProduction
MarketingMarketing
Customer Customer ServiceService
Value-Chain Product Costs
ProductionProduction
MarketingMarketing
Customer Customer ServiceService
Operating Product Costs
Traditional Product Costs
ProductionProduction
Man
ager
ial o
bjec
tive
s se
rved
2 -16
Direct materials are those materials that are directly traceable to the goods or services being produced.
Steel in an automobile
Wood in furniture
Alcohol in cologne
Denim in jeans
Braces for correcting teeth
2 -17
Direct labor is the labor that is directly traceable to the goods or services being produced.
Workers on an assembly line at Chrysler
A chef in a restaurant
A surgical nurse attending an open heart operation
Airline pilot
2 -18
Overhead are all other production costs.
Depreciation on building and equipment
Maintenance
Supplies
Supervision
Power
Property taxes
2 -19
Noninventoriable (period) costs are expensed in the period in
which they are incurred.
Noninventoriable (period) costs are expensed in the period in
which they are incurred.
Salaries and commissions of sales personnel (marketing)
Advertising (marketing) Legal fees (administrative) Printing the annual report
(administrative)
2 -20
Prime Cost :Direct Materials Costs + Direct Labor
Costs
Conversion Cost:Direct Labor Costs + Overhead Costs
2 -21
External Financial
Statements
2 -22 Manufacturing OrganizationManufacturing OrganizationIncome StatementIncome Statement
For the Year Ended December 31, 2004For the Year Ended December 31, 2004
Sales $2,800,000
Less cost of goods sold:
Beginning finished goods inventory $ 500,000
Add: Cost of goods manufactured 1,200,000
Cost of goods available for sale $1,700,000
Less: Ending finished goods inventory 300,000 1,400,000
Gross margin $1,400,000
Less operating expenses:
Selling expenses $ 600,000
Administrative expenses 300,000 900,000
Income before taxes $ 500,000
2-202-20
2 -23
Direct materials:Beginning inventory $200,000Add: Purchases 450,000Materials available $650,000Less: Ending inventory 50,000Direct materials used $ 600,000
Direct labor 350,000Manufacturing overhead:
Indirect labor $122,500Depreciation 177,500Rent 50,000Utilities 37,500Property taxes 12,500Maintenance 50,000 450,000
Total manufacturing costs added $1,400,000
Statement of Cost of Goods ManufacturedStatement of Cost of Goods ManufacturedFor the Year Ended December 31, 2004For the Year Ended December 31, 2004
2-212-21
continued on next slidecontinued on next slidecontinued on next slidecontinued on next slide
2 -24
Total manufacturing costs added $1,400,000Add: Beginning work in process 200,000Total manufacturing costs $1,600,000Less: Ending work in process 400,000Cost of goods manufactured $1,200,000
Work in process consists of all partially completed units found in
production at a given point in time.
2 -25 Service OrganizationService OrganizationIncome StatementIncome Statement
For the Year Ended December 31, 2004For the Year Ended December 31, 2004Sales
$300,000Less expenses:Cost of services sold:
Beginning work in process $ 5,000Service costs added:
Direct materials $ 40,000Direct labor 80,000Overhead 100,000 220,000
Total $225,000Less: Ending work in process 10,000
215,000Gross margin
$ 85,000Less operating expenses: Selling expenses $ 8,000 Administrative expenses 22,000
30,000Income before income taxes
$ 55,000
2-232-23
2 -26
Functional-Based Management ModelFunctional-Based
Management Model
Efficiency Efficiency AnalysisAnalysis
Performance Performance AnalysisAnalysis
Operational View
ResourcesResources
FunctionsFunctions
ProductsProducts
Cost View
2 -27
Activity-Based Management Model
Activity-Based Management Model
ResourcesResources
ActivitiesActivities
Products and Products and CustomersCustomers
Cost View
Driver Driver AnalysisAnalysis
Performance Performance AnalysisAnalysis
Process View
Why? What? How Well?
2 -28
1. Unit-based drivers
2. Allocation-intensive
3. Narrow and rigid product costing
4. Focus on managing cost
5. Sparse activity information
6. Maximization of individual unit performance
7. Use of financial measures of performance
1. Unit- and nonunit-based drivers
2. Tracing intensive
3. Broad, flexible product costing
4. Focus on managing activities
5. Detailed activity information
6. Systematic performance maximization
7. Use of both financial and nonfinancial measures of performance
Functional-Based Activity-BasedFunctional-Based Activity-Based