Libby, Libby and Short

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CHAPTER
Basic Management Accounting Concepts
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Objectives

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.

After studying this chapter, you should be able
to
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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 Its a dollar measure of the resources
used to achieve a given benefit.
Cost Assignment
Exactly what is meant by cost?
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Cost Assignment
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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Cost Assignment

• 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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Cost Assignment
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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Cost Assignment

• 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
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Interface of Services withManagement Accounting
Services cannot be stored. No patent
protection. Cannot display or communicate
services. Price difficult to set.

• 1. Intangibility
• 2. Perishability
• 3. Inseparability
• 4. Heterogeneity

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.
Derived Properties
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Interface of Services withManagement Accounting
No inventories. Strong ethical code. Price
difficult to set. Demand for more accurate cost
assignments.
1. Intangibility 2. Perishability 3.
Inseparability 4. Heterogeneity
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.
Impact on Management 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
Produce
Distribute
Market
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Product Costing Definitions
Pricing Decisions Product-Mix Decisions Strategic
Profitability Analysis
Strategic Design Decisions Tactical Profitability
Analysis
External Financial Reporting
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Production Costs

• 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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Production Costs
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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Production Costs
Overhead are all other production costs.

• Depreciation on building and equipment
• Maintenance
• Supplies
• Supervision
• Power
• Property taxes

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Nonproduction Costs
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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Production Costs
Prime Cost Direct Materials Costs Direct
Labor Costs Conversion Cost Direct Labor
Costs Overhead Costs
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External Financial Statements
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Manufacturing OrganizationIncome StatementFor
the Year Ended December 31, 2004
2-20

• 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

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Statement of Cost of Goods ManufacturedFor the
Year Ended December 31, 2004
2-21

• 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 on next slide
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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
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Service OrganizationIncome StatementFor the
Year Ended December 31, 2004
2-23
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
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Functional-Based Management Model
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Activity-Based Management Model
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Functional-Based Activity-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
1. Unit- and nonunit-based drivers 2. Tracing
intensive 3. Broad, flexible product
costing 4. Focus on managing activities 5. Detail
ed 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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