2 -1

Basic

Management

Accounting

Concepts

CHAPTER

2 -2

1. Describe the cost assignment process.

2. Define tangible and intangible products and

explain why there are different product cost

definitions.

3. Prepare income statements for manufacturing

and service organizations.

4. Outline the differences between functional-

based and activity-based management

accounting systems.

Objectives

After studying this

chapter, you should

be able to:

2 -3

Exactly what is

meant by “cost”?

Cost is the cash or cash-equivalent value

sacrificed for goods and services that is

expected to bring a current or future

benefit to the organization.

I see… It’s a dollar

measure of the

resources used to

achieve a given

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: 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 object’s resource consumption.

2 -8

Cost Assignment Methods

Cost of Resources

Direct

Tracing

Driver

TracingAllocation

Physical

Observation

Causal

Relationship

Assumed

Relationship

Cost Objects

2 -9Interface of Services with

Management Accounting

1. Intangibility

2. Perishability

3. Inseparability

4. Heterogeneity

Services cannot be stored.

No patent protection.

Cannot display or

communicate services.

Price difficult to set.

Derived Properties

Services benefits expire

quickly.

Services may be repeated

often for one customer.

Customer directly

involved with

production of service.

Centralized mass

production of services

difficult.

Wide variation in service

products possible.

2 -10Interface of Services with

Management AccountingNo inventories.

Strong ethical code.

Price difficult to set.

Demand for more accurate

cost assignments.

Impact on Management

Accounting

No inventories.

Need for standards and

consistent high quality.

Costs often accounted

for by customer type.

Demand for measure-

ment and control of

quality to maintain

consistency.

Productivity and quality

measurement and

control must be

ongoing.

Total quality manage-

ment critical.

1. Intangibility

2. Perishability

3. Inseparability

4. Heterogeneity

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

Produce

Market

Distribute

Service Develop

2 -13

Product Costing Definitions

Pricing Decisions

Product-Mix Decisions

Strategic Profitability

Analysis

Strategic Design Decisions

Tactical Profitability

Analysis

External Financial

Reporting

Research andDevelopment

Production

Marketing

Customer

Service

Value-Chain

Product Costs

Production

Marketing

Customer

Service

Operating Product

Costs

Traditional Product

Costs

Production

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

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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

2 -19

External

Financial

Statements

2 -20Manufacturing Organization

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

2-20

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Direct materials:Beginning inventory $200,000Add: Purchases 450,000Materials available $650,000Less: Ending inventory 50,000Direct materials used $ 600,000

Direct labor 350,000Manufacturing overhead:

Indirect labor $122,500Depreciation 177,500Rent 50,000Utilities 37,500Property taxes 12,500Maintenance 50,000 450,000

Total manufacturing costs added $1,400,000

Statement of Cost of Goods Manufactured

For the Year Ended December 31, 2004

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continued on next 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.

2 -23Service Organization

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

2-23

2 -24Functional-Based

Management Model

Efficiency

Analysis

Performance

Analysis

Operational View

Resources

Functions

Products

Cost View

2 -25Activity-Based

Management Model

Resources

Activities

Products and

Customers

Cost View

Driver

Analysis

Performance

Analysis

Process View

Why? What? How Well?

2 -26

1. Unit-based drivers

2. Allocation-intensive3. Narrow and rigid product

costing4. Focus on managing cost

5. Sparse activity information

6. Maximization of individual unit performance

7. Use of financial measures of performance

1. Unit- and nonunit-based drivers

2. Tracing intensive3. 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

Functional-Based Activity-Based

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The End

Chapter Two

2 -28