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
chapter,intangible
you products
should and
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.
 2 -3

Cost
II see…
Costsee…isis the
the cash
It’s
It’s or
or cash-equivalent
aa dollar
cash dollarcash-equivalent
value sacrificed
valuemeasure
sacrificed
measure offor
of thegoods
the
for goods and
and services
services
that isis expected
resources
that expected
resources used
used to bring
totobring aa current
to current or
Exactlyor what
Exactly what isis
future
achieve
future
achievebenefit to
to the
aa given
benefit given the organization.
meant
meant by
organization. by “cost”?
“cost”?
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
Servicescannot
cannotbe bestored.
stored.
No
Nopatent
patentprotection.
protection.
1. Intangibility
Services
Cannot
Services
Cannot benefits
display
display or expire
or
benefits expire
quickly.
communicate
Customer services.
quickly. directly
communicate
Customer services.
directly
2. Perishability Price difficult
Services may to set.
be
involved
Price difficult
Services
involvedmay with
to
withbe repeated
set. repeated
often
often for
for one
production
production customer.
oneof
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
Noinventories.
inventories.
Strong
Strongethical
ethicalcode.
code.
1. Intangibility
Price
Price difficult
difficult to
to set.
set.
No
No inventories.
Demandinventories.
for more accurate
Costs
Demand
Costs often
for accounted
more
often accurate
accounted
2. Perishability Need
Need
cost for
for standards and
standardstype.
assignments. and
for
cost by customer
assignments.
for by customer type.
consistent
consistent high
high quality.
quality.
Demand for
Productivity
Demand for and
Productivity measure-
and quality
measure-
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
 2 -25
Activity-Based
Activity-Based Management
Management
Model
Model
Cost View

Resources

Process View

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

Products and
Customers

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
2 -26
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
 2 -27

Chapter Two

The
The End
End
2 -28