2 -1

CHAPTER
Basic
Management
Accounting
Concepts
 2 -2

Objectives
Objectives
1. Describe the cost assignment process.
After
After studying
studying this
this
2. Define tangible and intangible products and
chapter,
chapter, you
you should
should
explain why there are different product cost
be
be able
able to:
to:
definitions.
3. Prepare income statements for manufacturing and
service organizations.
4. Outline the differences between functional-based
and activity-based management accounting
systems.
 2 -3

Cost
Costisisthe
thecash
cashor
orcash-
cash-
Exactly
Exactlywhat
whatisismeant
meant equivalent
equivalent value sacrificedfor
value sacrificed for
by goods
goodsandandservices
servicesthat
thatisis
by“cost”?
“cost”?
expected
expectedto tobring
bringaacurrent
currentor or
future benefit to the organization.
future benefit to the organization.

IIsee…
see… It’s
It’saa
dollar
dollarmeasure
measureof of
the
theresources
resourcesused
used
totoachieve
achieveaagiven
given
benefit.
benefit.
 2 -4

A cost object is any item such as products,

customers, departments, projects, activities, and
so on, for which costs are measured and assigned.
Example:
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 -5

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 costs are those costs that can be easily
and accurately traced to a cost object.

Example: If a hospital is the cost object,

the cost of heating and
cooling the hospital is
a direct cost.
 2 -6

Indirect costs are those costs that cannot be

easily and accurately traced to a cost object.
Example: The salary of a plant manager, where
departments within the plant are defined
as the cost objects.
 2 -7

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 tracing is the process of identifying and
assigning costs that are exclusively and physically
associated with a cost object to that cost object.
Driver tracing is the use of drivers to assign costs to
cost objects. Drivers are observable causal factors
that measure a cost object’s resource consumption.
 2 -8

Cost
Cost Assignment
Assignment Methods
Methods
Cost of Resources

Direct Driver
Allocation
Tracing Tracing

Physical Causal Assumed

Observation Relationship Relationship

Cost Objects
 Interface of Services with 2 -9

Management Accounting
Services
Services cannot
cannot be be stored.
stored.
No
No patent
patent protection.
protection.
1. Intangibility Cannot
Cannot display
display or
or expire
Services
Services benefits
benefits expire
communicate
communicate services.
services.
quickly.
Customer
quickly.
Customer directly
directly
2. Perishability Price
Price difficult
difficult to
to set.
set.
Services
involved
Services may
involvedmay be
withbe repeated
with repeated
often
often for
for one
production
productiononeof customer.
of service.
customer.
service.
3. Inseparability
Centralized
Centralized mass
mass
Wide
Wide variation
variation in
in
production
production of services
of services
4. Heterogeneity service products
service products
difficult.
difficult.
possible.
possible.
Derived
Derived Properties
Properties
 Interface of Services with 2 -10

Management Accounting
No
No inventories.
inventories.
Strong
Strong ethical
ethical code.
code.
1. Intangibility Price
Price difficult
difficult to to set.
set.
Demand
No
Demand
No for
inventories.
for more
inventories.more accurate
accurate
Costs
Costs often
often accounted
accounted
2. Perishability cost
Need
cost
Need assignments.
for standards
assignments.
for standardstype.and
and
for by customer
for by customer type.
consistent
consistent high
high quality.
quality.
Demand
Productivity
Demand
Productivityfor
for measure-
and quality
measure-
and quality
3. Inseparability
ment
ment and
and control
measurement
measurement andof
and
control of
quality
control
quality
control to
must
to maintain
be
maintain
must be
4. Heterogeneity
consistency.
ongoing.
consistency.
ongoing.
Impact on Total
Total
Management quality
quality manage-
manage-
Impact on Management
Accounting ment
ment critical.
critical.
Accounting
 2 -11

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 -12

Design

Service Develop

Distribute Produce

Market
 Product Costing Definitions 2 -13

Value-Chain Operating Product Traditional Product

Product Costs Costs Costs
Research and
Development
Managerial objectives served

Production Production Production

Marketing Marketing

Customer Customer
Service Service
Pricing Decisions Strategic Design Decisions External Financial
Product-Mix Decisions Tactical Profitability Reporting
Strategic Profitability Analysis
Analysis
 2 -14

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 -15

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 -16

Overhead are all other production costs.

 Depreciation on building
and equipment
 Maintenance
 Supplies
 Supervision
 Power
 Property taxes
 2 -17

Noninventoriable
Noninventoriable (period)
(period) costs
costs
are
are expensed
expensed inin the
the period
period in
in
which
which they
they are
are incurred.
incurred.

 Salaries and commissions of

sales personnel (marketing)
 Advertising (marketing)
 Legal fees (administrative)
 Printing the annual report
(administrative)
 2 -18

Prime Cost :
Direct Materials Costs + Direct Labor Costs

Conversion Cost:
Direct Labor Costs + Overhead Costs
 2 -19

External
Financial
Statements
 Manufacturing Organization 2 -20
2-20

Income Statement
For 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
 Statement of Cost of Goods Manufactured 2 -21
2-21

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 $ 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 added $1,400,000
continued
continuedon
onnext
nextslide
slide
 2 -22

Total manufacturing costs added $1,400,000

Add: Beginning work in process 200,000
Total manufacturing costs $1,600,000
Less: Ending work in process 400,000
Cost of goods manufactured $1,200,000

Work in process consists of all

partially completed units found in
production at a given point in time.
 Service Organization 2 -23
2-23

Income Statement
For the Year Ended December 31, 2004
Sales $300,000
Less expenses:
Cost of services sold:
Beginning work in process $ 5,000
Service costs added:
Direct materials $ 40,000
Direct labor 80,000
Overhead 100,000 220,000
Total $225,000
Less: Ending work in process 10,000 215,000
Gross margin $ 85,000
Less operating expenses:
Selling expenses $ 8,000
Administrative expenses 22,000 30,000
Income before income taxes $ 55,000
 Functional-Based
Functional-Based
2 -24

Management
Management Model
Model
Cost View

Resources

Operational View

Efficiency Performance
Functions
Analysis Analysis

Products
 Activity-Based
Activity-Based
2 -25

Management
Management Model
Model
Cost View

Resources

Process View

Driver Performance
Activities
Analysis Analysis
Why? What? How Well?

Products and
Customers
 2 -26

Functional-Based Activity-Based
1. Unit-based drivers 1. Unit- and nonunit-based
drivers
2. Allocation-intensive 2. Tracing intensive

3. Narrow and rigid product 3. Broad, flexible product

costing costing

4. Focus on managing cost 4. Focus on managing

activities
5. Sparse activity information 5. Detailed activity
information

6. Maximization of individual 6. Systematic performance

unit performance maximization

7. Use of financial measures of 7. Use of both financial and

performance nonfinancial measures of
performance
 2 -27

Chapter Two

The
The End
End
2 -28