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Introduction to Management Accounting

2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton
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Introduction to Management
Accounting
Chapter 4

Cost Management Systems


and Activity-Based Costing

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Learning
Objective 1

Cost Management System

AAcost
costmanagement
managementsystem
system(CMS)
(CMS)isis
aacollection
collectionof
oftools
toolsand
andtechniques
techniques
that
thatidentifies
identifieshow
howmanagements
managements
decisions
decisionsaffect
affectcosts.
costs.

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Cost Management System


The primary purposes of a cost
management system are to provide...
cost information for strategic
management decisions,
cost information for
operational control, and
measure of inventory value and cost
of goods sold for financial reporting.

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Cost Accounting Systems


Cost accounting is that part of the cost
management system that measures
costs for the purposes of management
decision making and financial reporting.

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Learning
Objective 2

Cost Accounting System

Cost
accumulation:

Collecting costs by some


natural classification
such as materials or labor

Cost
assignment:

Tracing costs to one or


more cost objectives

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Cost Accounting System


Cost
accumulation

Material costs
(metals)

Cost assignment
to cost objects
Machining Department Finishing Department
1. Departments
Activity Activity
Activity Activity
Activity Activity
Activity Activity
2. Activities
Cabinets
3. Products

Cabinets

Desks
Tables

Desks
Tables

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Cost
A cost is a sacrifice or giving up of
resources for a particular purpose.
Costs are frequently measured by
the monetary units that must be
paid for goods and services.

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Cost Object
A cost object (objective) is anything for which
A separate measurement of costs is desired.
Customers

Departments
Service

Processing orders

Product

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Learning
Objective 3

Direct, Indirect, and Unallocated


Costs

Direct costs can be identified specifically and exclusively


with a given cost objective in an economically feasible way.

ndirect costs cannot be identified specifically and exclusively


With a given cost objective in an economically feasible way.

Unallocated costs are recorded but


not assigned to any cost object.

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Learning
Objective 4

Cost Allocation

ost allocation is used to assign indirect costs to cost objects, in proportio


to the cost objects use of a particular cost-allocation base.
A cost-allocation base is some measure of input or output that

determines the amount of cost to be allocated to a particular cost object


An ideal cost-allocation base would measure how much
of the particular cost is caused by the cost objective.
Note the similarity of this definition to that of a cost driver
an output
measure that causes costs. Therefore, most allocation
bases are cost drivers.

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Cost Allocation
Cost allocations support a companys CMSthe system
providing cost measurements for strategic decision making,
operational control, and external reporting.

Four purposes of cost allocation:

Predict the economic effects of strategic and operational control

Provide desired motivation and to give feedback for performance


Compute income and asset valuations for financial reporting.
Justify costs or obtain reimbursement.

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Cost Pool
A cost pool is a group of individual costs that a company
allocates to cost objects using a single cost-allocation base.

1. Accumulate indirect costs for a period of time.


2. Select an allocation base for each cost pool, preferably a cos
that is, a measure that causes the costs in the cost pool.
3. Measure the units of the cost-allocation base used for each c
object and compute the total units used for all cost objects.
4. Determine the percentage of total cost-allocation base units
used for each cost object.
5. Multiply the percentage by the total costs in the cost pool to
determine the cost allocated to each cost object.

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Cost Allocation
Direct costs are physically traced to a cost object.
Indirect costs are allocated using a cost-allocation base.

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Direct, Indirect, and Unallocated


Statement ofCosts
Operating Income
Li Companys Statement of Operating Income

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Learning
Objective 5

Direct Material Costs

Direct materials include the acquisition costs


of all materials that a company identifies
as a part of the manufactured goods.
These costs are identified in
an economically feasible way.

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Direct Labor Costs

Direct Labor costs include the


wages of all labor that can be
traced specifically and exclusively
to the manufactured goods in an
economically feasible way.

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Indirect Production Costs (Manufacturing


Overhead)
Manufacturing overhead includes all costs
associated with the production process
that the company cannot be traced to
the manufactured goods in an
economically feasible way.

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Product Costs
Product costs are costs identified with goods
produced or purchased for resale.

These costs first become part of the


inventory on hand, sometimes called
inventoriable costs.
Inventoriable costs become expenses in
the form of cost of goods sold only when
the inventory is sold.

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Period Costs
Period costs are deducted as expenses
during the current period without
going through an inventory stage.

10

11

12

13

14

15

16

17

18

19

20

21

22

23

24

25

26

27

28

29

30

31

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Learning
Objective 6

Financial Statement Presentation


Merchandising Companies

Merchandising
Company (Retailer
or Wholesaler)
Product

Merchandi
se
(Inventoriab
Purchases
le)

Sales
Sales
Minus
Cost
Cost of
of
Expiratio
Merchandi
Merchandi
Goods
Goods Sold
Sold
n
se
se
(Expenses)
(Expenses)
Inventory
Inventory

Equals Gross
Margin Minus

Costs
Period
Costs

Selling
Selling Expenses
Expenses
and
and
Administrative
Administrative
Expenses
Expenses
Equals
Operating
Income

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Financial Statement Presentation


Manufacturing Companies
Manufacturing
Company
Direct
Product
Material
Purchases
(Inventoriab
Direct
le)
Labor
Indirect
Costs
Manufactur
ing

Direct
Direct
Material
Material
Inventory
Inventory
Finished
Finished
Goods
Goods
Inventory
Inventory

Sales
Sales
Minus

Cost
Cost of
of
Expiratio
Goods
Work-inGoods Sold
Sold
Work-inn
(Expenses)
(Expenses)
Process
Process
Equals Gross
Inventory
Inventory
Margin Minus
Selling
Selling Expenses
Expenses
Period
and
and
Costs
Administrative
Administrative
Expenses
Expenses
Equals
Operating
2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton
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Current Asset Sections


of Balance Sheets
Manufacturer

Retailer or Wholesaler

Cash
$ 4,000
Cash
$ 4,000
Receivables
25,000
Receivables
25,0
Subtotal
$29,000
Finished goods
32,000
Work in process 22,000
Direct material 23,000
Merchandise inventories
7
Total inventories
$77,000
Other current assets
Other current assets
1,000
Total current assets
$10
Total current assets
$107,000

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Income Statement Presentation


of Costs for a Manufacturer
The manufacturers cost of goods produced
and then sold is usually composed of
the three major categories of cost:
Direct materials
Direct labor
Indirect manufacturing

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Income Statement Presentation


of Costs for a Retailer
The merchandisers cost of goods sold
is usually composed of the purchase
cost of items, including freight-in,
that are acquired and then resold.

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ce Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgst

Learning
Objective 7

Traditional Costing System


All
All
Indirect
Indirect
Resources
Resources
$220,000
$220,000

All
AllUnallocated
Unallocated
Value
ValueChain
Chain
Costs
Costs
$100,000
$100,000

Cost Driver
[Direct Labor
Hours]

Direct
Direct
Materials
Materials
For
ForPen
Pen
Casings
Casings
$22,500
$22,500

Direct
Direct
Direct
Direct Materials
MaterialsFor
For
Labor
Cell
Labor
Cell
For
Phone
ForPen
Pen
Phone
Casings
Casings
Casings
Casings
$135,000
$12,000
$135,000$12,000

Sales
Sales $360,000
$360,000

Sales
Sales $80,000
$80,000

Direct
Direct
Labor
LaborFor
For
Cell
CellPhone
Phone
Casings
Casings
$15,000
$15,000

Unallocated
Unallocated $00,000
$00,000

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Traditional Costing System


Statement of Operating Income
Traditional Cost Allocation System
Pen
Casings

Cell Phone
Casings

Sales
$440,000 $360,000 $80,000
Direct materials
34,500
22,500
12,000
Direct labor
150,000
135,000
15,000
Indirect manufacturing 220,000
198,000
22,000
Gross profit
$ 35,500 $ 4,500 $31,000
Corporate expenses
100,000
Operating loss
($ 64,500)
Gross profit margin
8.07%
1.25%
38.

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ABC System
Plant
Plantand
and
Machinery
Machinery
$180,000
$180,000

Engineers
Engineersand
and
CAD
Equipment
CAD Equipment
$40,000
$40,000

20%
75%

Processing
Activity
$135,000
+ 8,000
$143,000

Direct
Direct
Materials
Materials
For
ForPen
Pen
Casings
Casings
$22,500
$22,500

All
AllUnallocated
Unallocated
Value
ValueChain
ChainCosts
Costs
$100,000
$100,000

80%
25%

Production Support
Activity
$45,000
+32,000
$77,000
Cost Driver
Cost Driver

[Direct Labor Hours]

[Distinct Parts]

Direct
Direct
Direct
Materials
Direct
MaterialsFor
For
Labor
Cell
Labor
Cell
For
Pen
Phone
For Pen
Phone
Casings
Casings
Casings
Casings
$135,000
$12,000
$135,000 $12,000

Sales
Sales $360,000
$360,000

Sales
Sales $80,000
$80,000

Direct
Direct
Labor
LaborFor
For
Cell
Phone
Cell Phone
Casings
Casings
$15,000
$15,000

Unallocated
Unallocated $00,000
$00,000

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Activity-Based Cost Allocation


System

Internal Purposes
Cell
Pen
Reportin
Phone
g
Casing
Casin
s
gs
Sales
$440,000
$360,000
$80,000
Direct materials
34,500
22,500
12,
Direct labor
150,000
135,000
15,000
Processing activity
143,000
128,700
14,
14
Production support activity
77,000
15,400
Gross profit
$ 35,500
$ 58,400
($22,
Corporate expenses
100,000
Operating loss
($ 64,500)
Gross profit margin
8.07%
16.22%
External

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ce Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgst

Learning
Objective 8

Activity-Based Management

ABM is using the output of an activity-based


cost accounting system to aid strategic decision
making and to improve operational control.
A value-added cost is the cost of an activity
that cannot be eliminated without affecting
a products value to the customer.
In contrast, nonvalue-added costs are costs
that can be eliminated without affecting
a products value to the customer.

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Activity-Based Management

Benchmarking is the continuous


process of comparing products,
services, and activities to the
best industry standards.
Benchmarking is a tool to help an organization measure
its competitive posture. Benchmarks can come from
within the organization, from competing organizations,
or from other organizations having similar processes.

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Benefits of Activity-Based Costing and


Management Systems
Companies adopt ABC systems to:

set an optimal product mix


to estimate profit margins of new products
determine consumption of companys shared resou
keep pace with new product techniques
and technological changes
decrease the costs associated with bad decisions
take advantage of reduced cost of ABC
systems due to computer technology

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Design of a Traditional Costing


System

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ce Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgst

Learning
Objective 9

Design of an Activity-Based
Cost Accounting System

Determine the key


components of the
cost accounting
system.

Cost objectives
Key activities
Resources
Related cost drivers

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Design of an Activity-Based
Cost Accounting System
Key
Activity
Account billing
Bill verification
Account inquiry
Correspondence
Other activities

Cost
Driver

Number or printed pages


Number of accounts verified
Number of inquiries
Number of letters
Number of printed pages

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Design of an Activity-Based
Cost Accounting System
Determine
Determine the
the relationships
relationships among
among
cost
cost objectives,activities,
objectives,activities, and
and resources.
resources.
Resource
Resource
Used
Usedto
to
Other
Other
Perform
PerformActivity
Activity
Activities
Activities Total
Total
Supervisor
Supervisor

Account
Account
Inquiry
Inquiry Correspondence
Correspondence
Activity
Activity

Activity
ActivityPerformed
Performed
Billing
Billing

Activity
Activity
40%
40%

Verification
Verification

All
All

Activity
Activity Activity
Activity
10%
10%

30%
30%

20%
20%

100%
100%
Account
inquiry
90
10
Account inquirylabor
labor
90
10
100%
100%
Billing
labor
30
70
Billing labor
30
70
100%
100%
Verification
labor
100
100%
Verification labor
100
100%
Paper
100
100%
Paper
100
100%
Computer
45
5
35
10
55
Computer
45
5
35
10
100%
100%
2005
Prentice
Hall
Business Publishing, Introduction
to Management Accounting 13/e, Horngren/Sundem/Stratton
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Business
Publishing,
Introduction to90
Management
Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgst
Telecommunications
90
10

Design of an Activity-Based
Cost Accounting System

Collect relevant data concerning costs and the physica


flow of the cost-driver units among resources and activ
Number
Numberof
ofCost
CostDriver
Driver

Units
Units
Activity
Cost
Residential
Activity
CostDriver
DriverUnits
Units
Residential
Commercial
Total
Commercial
Total
Account
20,000
Accountinquiry
inquiryInquiries
Inquiries
20,000
5,000
5,000 25,000
25,000
Correspondence
Correspondence
1,000
2,800
1,000
2,800

Letters
Letters

Bill
Billprinting
printing
160,000
160,000

Printed
Printedpages
pages

Verification

Accounts verified

1,800
1,800
120,000
120,000

40,000
40,000

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20,000

Design of an Activity-Based
Cost Accounting System

Calculate and interpret the new


activity-based information.
Determine the traceable
costs for
each of the activity cost
Determine the pools.
activity-based
cost per account for each
customer class

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Design of an Activity-Based
Cost Accounting System
Total traceable costs for the 5 activity
cost pools.
Activity Cost Pool

Cost (from Account


Resource
slide 4-33) Inquiry
Correspondence
Billing Verification
Other
Supervisors
$ 33,600
$ 13,440*
$ 3,360** $
10,080***
$ 6,720****
Account inquiry
labor
173,460
156,114
17,346
Billing labor
56,250
16,875
$39,375
Verification labor
11,250
11,250
Paper
7,320
7,320
Computer
178,000
80,100
8,900
62,300
17,800
8,900
Telecommunication
58,520
52,668
5,852
Occupancy
47,000
30,550
7,050
9,400
Printers
55,000
2,750
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ce Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgst
49,500
2,750

Design of an Activity-Based
Cost Accounting System
Activity-based cost per account for each customer class
Driver Costs
Total Number of
Traceable Costs
Driver Units Cost per
(from Exhibit 4-12) (From Exhibit 4-11)
Driver Unit
Activity (Driver Units)
(1) (2)
Account inquiry (inquiries)
Inquiries $13,314880
Correspondence (letters)
Letters
$11.555714
Account billing (printed pages)
0.957031
Bill verification (accounts verified)
Accounts verified
$ 3.421250
Other activities (printed pages)
Printed pages
$ 0.629513

(1)

153,125

(2)

$332,872

25,000

32,356

2,800

160,000 Printed pages


68,425

20,000

100,722

160,000

Cost per Customer Class


Residential
Commercial
Cost per Number of
Number of
Driver Unit
Driver Units
Cost
Cost
$13.314880
20,000 Inquiries
$266,298
5,000

Driver Units
Account inquiry
Inquiries $ 66,574
Correspondence
$11.555714
1,800 Letters
20,800
1,000
2005
Prentice Hall11,556
Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton
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Letters
ce Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgst

Strategic Decisions, Operational


Cost Control, and ABM
Outsourcing
Reducing operating costs
Identifying nonvalue-added activities
Improving both strategic
and operational decisions

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The End

End of Chapter 4

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