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2 -1

CHAPTER

Basic
Management
Accounting
Concepts

2 -2

Objectives
Objectives
1. Describe the cost assignment process.
2.

After
studying
this
After
studying
this
Define tangible and intangible products and
chapter,
you
should
chapter,
you
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.

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Cost
the
cash-equivalent
II is
see
Its
Cost
is
the cash
cash
cash-equivalent value
value
see
Itsaor
aordollar
dollar
sacrificed
for
measure
of
sacrificed
for goods
goods
and services
services that
that isis
measure
ofthe
theand
expected
to
future
resources
used
expected
to bring
bring
atocurrent
current or
orExactly
future what
Exactly
what isis
resources
usedato
benefit
the
meant
achieve
benefitato
the organization.
organization.
meant by
by cost?
cost?
achieve
atogiven
given
benefit.
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:
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
Cost Assignment
Assignment Methods
Methods
Cost of Resources

Direct
Tracing

Driver
Tracing

Allocation

Physical
Observation

Causal
Relationship

Assumed
Relationship

Cost Objects

Interface of Services with


Management Accounting
1.

2.
3.
4.

2 -9

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

Interface of Services with


Management Accounting
1.

2.
3.
4.

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


Operating Product
Costs

Traditional Product
Costs

Production

Production

Production

Marketing

Marketing

Customer
Service

Customer
Service

Value-Chain
Product Costs

Managerial objectives served

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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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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
Noninventoriable (period)
(period) costs
costs
are
are expensed
expensed in
in 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)

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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 1,400,000

Gross margin

$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
$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
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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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$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
Functional-Based
Management
Management Model
Model
Cost View

Resources
Operational View

Efficiency
Analysis

Functions

Products

Performance
Analysis

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Activity-Based
Activity-Based
Management
Management Model
Model

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Cost View

Resources
Process View

Driver
Analysis

Activities

Performance
Analysis

Why?

What?

How Well?

Products and
Customers

Functional-Based
1. Unit-based drivers

Activity-Based

2. Allocation-intensive

1. Unit- and nonunit-based


drivers
2. Tracing intensive

3. Narrow and rigid product


costing

3. Broad, flexible product


costing

4. Focus on managing cost

4. Focus on managing
activities
5. Detailed activity
information

5. Sparse activity information


6. Maximization of individual
unit performance

6. Systematic performance
maximization

7. Use of financial measures of


performance

7. Use of both financial and


nonfinancial measures of
performance

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Chapter Two

The
The End
End

2 -28

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