Basic Cost
Management
Concepts
Prepared by
Douglas Cloud
Pepperdine University
2-1
Objectives
1. Describe a cost
management
information
After
studying this
system, its objectives,
and
its
major
chapter, you should
subsystems, andbe
indicate
how it relates to
able to:
other operating and information systems.
2. Explain the cost assignment process.
3. Define tangible and intangible products, and
explain why there are different product cost
definitions.
2-2
Objectives
4. Prepare income statements for manufacturing
and service organizations.
5. Explain the differences between traditional
and contemporary cost management systems.
2-3
A Systems Framework
A system is a set of interrelated parts
that performs one or more processes to
accomplish specific objectives.
Example: An air conditioning system
for a home
2-4
Operational Model of an
Air Conditioning System
Cooling Process
Inputs:
Freon
Warm Air
Electricity
Output:
Cooled Air
Delivery Process
Inputs:
Cooled Air
Electricity
Ducts
Output:
Delivered Cooled Air
2-5
Accounting Information System
An accounting information system is a system
consisting of interrelated manual and computer parts,
using processes such as collecting, recording,
summarizing, analyzing, and managing data to provide
information to users.
Like any system, an accounting information
system consists of: (1) objectives, (2) interrelated
parts, (3) processes, and (4) outputs.
2-6
Operational Model for an
Accounting Information System
Economic Events
Collecting
Classifying
Summarizing
Analyzing
Managing
Special Reports
Financial Statements
Budgets
Performance Reports
Personal Communication
Inputs
Processes
Outputs
Users
2-7
Accounting Information Systems
The financial accounting information system is an
accounting information subsystem that is primarily
concerned with producing outputs for external users.
The cost management information system is an
accounting information subsystem that is primarily
concerned with producing outputs for internal users
using inputs and processes needed to satisfy
management objectives.
2-8
Accounting Information Systems
The cost management information system has three
broad objectives that provide information for-1) Costing out services, products, and other
objects of interest to management
2) Planning and control
3) Decision making
2-9
An Integrated Cost
Management System
Design and
Development
System
Production
System
Cost
Management
System
Marketing and
Distribution
System
Customer
Servicing
System
2-10
The Subsystems of the Accounting
Information System
Accounting Information System
Financial Accounting
Information System
Cost Management
Information System
Cost Accounting
Information System
Operational
Control System
2-11
Basic Cost Concepts
 Cost is the cash or cash equivalent value sacrificed
for goods and services that are expected to bring a
current or future benefit to the organization.
 Costs are incurred to produce future benefits.
 Expired costs are called expenses.
 Unexpired costs are classified as assets and appear
on the balance sheet.
 Assigning cost accurately to cost objects is crucial.
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Basic Cost Concepts
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.
2-13
Basic Cost Concepts
Traceability is the ability to assign a cost to a
cost object in an economically feasible way by
means of a causal relationship.
Direct costs are those costs that can be easily and
accurately traced to a cost object.
Example: The salary of a supervisor of a department,
where the department is defined as the cost
object.
2-14
Basic Cost Concepts
Indirect costs are those costs that cannot be traced
easily and accurately to a cost object.
Example: The cost of heating and cooling a plant that
manufactures five products.
2-15
Cost Assignment Methods
Cost of Resources
Resource Drivers
Direct
Tracing
Physical
Observation
Driver
Tracing
Allocation
Activity
Drivers
Convenience
Assumed
Linkage
Cost Objects
2-16
Product Cost Definitions
Value-Chain
Product Costs
Operating
Product Costs
Traditional
Product Costs
Production
Production
Production
Marketing
Marketing
Customer Service
Customer Service
Pricing Decisions
Product Mix Decisions
Strategic Profitability
Analysis
Strategic Design
Decisions
Tactical Profitability
Analysis
Research and
Development
External Financial
Reporting
2-17
Manufacturing Costs
Direct materials are those materials that are directly
traceable to the goods or services being produced.
Example: The cost of wood in furniture.
Direct labor is the labor that is directly traceable to the
goods or services being produced.
Example: Wages of assembly-line workers.
Overhead are all other manufacturing costs.
Example: Plant depreciation, utilities, property taxes,
indirect materials, indirect labor, etc.
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Nonproduction Costs
Marketing (selling) costs are the costs necessary to
market, distribute, and service a product or service.
Example: Advertising, storage costs, and freight out.
Administrative costs are the costs associated with
research, development, and general administration of
the organization that cannot reasonably be assigned to
either marketing or production.
Example: Legal fees, salary of the chief executive officer.
2-19
Nonproduction Costs
For external financial
reporting, marketing and
administrative costs are not
inventoried. They are
referred to as period costs.
2-20
Production or
Manufacturing
Costs
Direct Materials
Direct Labor
Overhead
Nonproduction
or Operating
Costs
Marketing Expense
Prime Cost Order-Getting Costs
Order-Filling Costs
Conversion
Cost
Administrative
Expense
2-21
Manufacturing Organization
Income Statement
For the Year Ended December 31, 2004
Sales
Less: Cost of goods sold
$2,800,000
1,300,000
Gross margin
Less operating expenses:
$ 700,000
Selling expenses
Administrative expenses
Operating income
$300,000
From the Cost
150,000of Goods
450,000
Sold
$Schedule
250,000
2-22
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 in production
$ 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 continued
added
$1,400,000
2-23
Total manufacturing costs added
Add: Beginning work in process
Less: Ending work in process
Cost of goods manufactured
$1,400,000
200,000
400,000
$1,200,000
Work in process consists of all
partially completed units found in
production at a given point in time.
2-24
Cost of Goods Sold Schedule
For the Year Ended December 31, 2004
Cost of goods manufactured
Add: Beginning inventory finished goods
Cost of goods available for sale
Less: Ending inventory finished goods
Cost of goods sold
$1,200,000
250,000
$1,450,000
150,000
$1,300,000
From the
Statement of
Cost of Goods
Manufactured
2-25
Activity-Based Management Model
Cost View
Resources
Process View
Driver
Analysis
Activities
Performance
Analysis
Why?
What?
How well?
Products and
Customers
2-26
Functional-Based and ActivityBased Cost Management Systems
Functional-Based
1. Unit-based drivers
2. Allocation-intensive
3. Narrow and rigid product costing
4. Focus on managing costs
5. Sparse activity information
6. Maximization of individual unit performance
7. Uses financial measures of performance
2-27
Functional-Based and ActivityBased Cost Management Systems
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. Systemwide performance maximization
7. Uses both financial and nonfinancial
measures of performance
2-28
Trade-Off Between Measurement and Error Costs
Cost
Total Cost
Measurement
Cost
Error Cost
Low
Accuracy
Optimal
Level
High
Accuracy
2-29
Shifting Costs
Cost
Old Measurement Cost
New
Measurement
Cost
New Error
Cost
Old Error
Cost
Low
Old Optimum
New Optimum
Accuracy
High
2-30
End of
Chapter
2-31
2-32