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CHAPTER

Basic Management Accounting Concepts

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

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Cost is the cash or cash-equivalent value I see Its a dollar sacrificed for goods measure of the and services that is expected to bring future what is Exactly resources used a tocurrent or benefit a to the organization. meant by cost? achieve given benefit.

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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.

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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.

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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.

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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 objects resource consumption.

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Cost Assignment Methods

Cost of Resources

Direct Tracing

Driver Tracing

Allocation

Physical Observation

Causal Relationship

Assumed Relationship

Cost Objects

Interface of Services with Management Accounting

1. Intangibility

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2. Perishability
3. Inseparability 4. Heterogeneity

Services cannot be stored. No patent protection. Cannot display or Services benefits expire communicate services. quickly. directly Customer Price difficult to set. Services may be repeated involved with often for one customer. production of service. Centralized mass production of in services Wide variation service difficult. products possible.

Derived Properties

1.

2.
3. 4.

No inventories. Strong ethical code. Intangibility Price difficult to set. Demand for more accurate No inventories. Costs often accounted Perishability cost for assignments. Need standards and for by customer type. consistent high quality. Demand for and measureProductivity quality Inseparability ment and control measurement andof quality to maintain control must be Heterogeneity consistency. ongoing. Total quality manageImpact on Management Accounting ment critical.

Interface of Services with Management Accounting

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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.

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Design

Service

Develop

Distribute

Produce

Market

Product Costing Definitions

Value-Chain Product Costs Operating Product Costs

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Traditional Product Costs

Research and Development

Production Marketing
Customer Service

Production Marketing
Customer Service

Production

Pricing Decisions Strategic Design Decisions Product-Mix Decisions Tactical Profitability Strategic Profitability Analysis Analysis

External Financial Reporting

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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

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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

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Overhead are all other production costs. Depreciation on building and equipment Maintenance Supplies Supervision

Power
Property taxes

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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)

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Prime Cost :
Direct Materials Costs + Direct Labor Costs

Conversion Cost:
Direct Labor Costs + Overhead Costs

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External Financial Statements

Manufacturing Organization Income Statement For the Year Ended December 31, 2004
Sales Less cost of goods sold: Beginning finished goods inventory Add: Cost of goods manufactured Cost of goods available for sale $ 500,000 1,200,000 $1,700,000 $2,800,000

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Less: Ending finished goods inventory

Gross margin Less operating expenses: Selling expenses Administrative expenses Income before taxes

300,000

1,400,000
$1,400,000

$ 600,000 300,000 900,000 $ 500,000

Statement of Cost of Goods Manufactured For the Year Ended December 31, 2004
Direct materials: Beginning inventory Add: Purchases Materials available Less: Ending inventory Direct materials used Direct labor Manufacturing overhead: Indirect labor Depreciation Rent Utilities Property taxes Maintenance Total manufacturing costs added $200,000 450,000 $650,000 50,000 $ 600,000 350,000

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$122,500 177,500 50,000 37,500 12,500 50,000

450,000 $1,400,000

continued on next slide

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Total manufacturing costs added Add: Beginning work in process Total manufacturing costs Less: Ending work in process Cost of goods manufactured

$1,400,000 200,000 $1,600,000 400,000 $1,200,000

Work in process consists of all partially completed units found in production at a given point in time.

Service Organization Income Statement For the Year Ended December 31, 2004
Sales Less expenses: Cost of services sold: Beginning work in process Service costs added: Direct materials Direct labor Overhead Total Less: Ending work in process Gross margin Less operating expenses: Selling expenses Administrative expenses Income before income taxes

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$300,000

$ 5,000 $ 40,000 80,000 100,000

220,000 $225,000 10,000

215,000 $ 85,000

8,000 22,000

30,000 $ 55,000

Functional-Based Management Model

Cost View

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Resources
Operational View

Efficiency Analysis

Functions

Performance Analysis

Products

Activity-Based Management Model

Cost View

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Resources
Process View

Driver Analysis
Why?

Activities
What?

Performance Analysis
How Well?

Products and Customers

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Functional-Based
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

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. Systematic performance maximization 7. Use of both financial and nonfinancial measures of performance

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Chapter Two

The End

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