2 -1

CHAPTER

Basic
Management
Accounting
Concepts

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Objectives
1. Describe theAfter
cost assignment
studying thisprocess.
2. Define tangible
and intangible
chapter,
you shouldproducts and
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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CostI see
is the cash
cash-equivalent value
Its aordollar
sacrificed
for goods
measure
of the and services that is
expected
to bring
future what is
resources
used atocurrent orExactly
benefit atogiven
the organization.
meant by cost?
achieve
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

2. Perishability
3. Inseparability
4. Heterogeneity

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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 oneofcustomer.
production
service.
Centralized mass
production
of in
services
Wide
variation
service
difficult.
products possible.

Derived Properties

Interface of Services with

Management Accounting

1.

2.
3.
4.

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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.

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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

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Operating Product
Costs

Traditional Product
Costs

Production

Production

Production

Marketing

Marketing

Customer
Service

Customer
Service

Value-Chain
Product Costs

Research and
Development

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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Page

Manufacturing Costs
Direct
Materials

Direct
Labor

The Product

Manufacturing
Overhead

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Click
Here

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Page

Direct Materials
Those materials that become
an integral part of the product and
that can be conveniently traced directly to it.

Example: A radio installed in an automobile

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Click
Here

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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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Page

Direct Labor

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Click

Those labor costs that can be easily traced to

individual units of product.

Example: Wages paid to automobile assembly workers

Here

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Manufacturing Overhead

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Click

Manufacturing costs that cannot be traced directly to

specific units produced.
Examples: Indirect labor and indirect materials
Wages paid to employees
who are not directly
involved in production.
Examples:
maintenance workers,
janitors and security guards.

Materials used to support

the production process.
Examples:
lubricants and cleaning
supplies used in the
automobile assembly plant.

Here

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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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Page

Manufacturing Cost Flows

Costs

Balance Sheet
Inventories

Material Purchases

Raw Materials

Direct Labor

Work in
Process

Manufacturing
Overhead

Selling and
Administrative

Finished
Goods

Period
Costs

Income
Statement
Expenses

Cost of
Goods
Sold
Selling and
Administrative
Expenses

2 -22
Click
Here

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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

$2,800,000

Less cost of goods sold:

Beginning finished goods inventory
Add: Cost of goods manufactured
Cost of goods available for sale

Less: Ending finished goods inventory

$ 500,000
1,200,000
$1,700,000

300,000

Gross margin

1,400,000
$1,400,000

Less operating expenses:

Selling expenses
Administrative expenses
Income before taxes

$ 600,000
300,000

900,000
$ 500,000

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2-20

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

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

continued on next slide

450,000
$1,400,000

2 -26
2-21

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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

Work in process consists of all

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

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

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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2-23

$300,000

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

220,000
$225,000
10,000

8,000
22,000

215,000
$ 85,000

30,000
$ 55,000

Functional-Based
Management Model

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Cost View

Resources
Operational View

Efficiency
Analysis

Functions

Products

Performance
Analysis

Activity-Based
Management Model

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Cost View

Resources
Process View

Driver
Analysis

Activities

Performance
Analysis

Why?

What?

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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