Technische Universität München
Cost Accounting
Lecture 1:
An Introduction to Management Accounting,
Cost Terms and Purposes
Dr. Markus Brunner
Lehrstuhl für Controlling
Technische Universität München
Email: markus.brunner@tum.de
Technische Universität München
Overview
1. An Introduction to Management Accounting, Cost Terms and Purposes
2. Job Costing
3. Activity-Based Costing
4. Process Costing
5. Allocation of Support-Department Costs
6. Inventory Costing and Capacity Analysis
7. Determining How Costs Behave
8. Cost-Volume-Profit Analysis
9. Decision Making and Relevant Information
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Required readings
 Horngren, C./Datar, S./Rajan, M.: Cost Accounting. A Managerial Emphasis (Global
Edition), 15th ed., Pearson, 2015, chapter 1 and 2.
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Outline
1.1 Financial Accounting, Management Accounting,
and Cost Accounting
1.2 Strategic Decisions, Value-Chain and Supply-Chain
Analysis, and Key Success Factors
An Introduction to
Management
Accounting,
Cost Terms
and Purposes
1.3 Decision Making, Planning, and Control
1.4 Management Accounting Guidelines and
Organization Structure
1.5 Cost Terms
1.6 Inventoriable Costs and Period Costs
1.7 Measuring Costs Requires Judgment
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Accounting systems record economic events and transactions
 Data is processed into information helpful for internal and external users
 Collecting, categorizing, summarizing, analyzing
 Management accounting—measures, analyzes, and reports financial and
nonfinancial information to help managers make decisions to fulfill organizational
goals. Management accounting need not be GAAP compliant.
 Financial accounting—focuses on reporting to external users including investors,
creditors, banks, suppliers, and governmental agencies. Financial statements must
be based on GAAP.
 Cost accounting—measures, analyzes and reports financial and nonfinancial
information related to the costs of acquiring or using resources in an organization.
(most accounting professionals take the position that cost information is part of
management accounting)
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Major differences between management and financial accounting
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Outline
1.1 Financial Accounting, Management Accounting, and
Cost Accounting
1.2 Strategic Decisions, Value-Chain and SupplyChain Analysis, and Key Success Factors
An Introduction to
Management
Accounting,
Cost Terms
and Purposes
1.3 Decision Making, Planning, and Control
1.4 Management Accounting Guidelines and
Organization Structure
1.5 Cost Terms
1.6 Inventoriable Costs and Period Costs
1.7 Measuring Costs Requires Judgment
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A company’s strategy specifies how the organization matches its own
capabilities with the opportunities in the marketplace
 Cost leadership strategy vs. product differentiation strategy
 Management accounting provides information about the sources of competitive
advantage, such as
 company’s cost, productivity, or efficiency advantage relative to competitors
 premium prices a company can charge relative to costs of adding new features
 Management accounting helps answer important questions such as:
 Who are our most important customers, and how can we be competitive and
deliver value to them?
 What substitute products exist in the marketplace, and how do they differ from
our own?
 What is our most critical capability?
 Will adequate cash be available to fund the strategy or will additional funds need
to be raised?
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Management accounting and value
 Creating value is an important part of planning and implementing strategy.
 Value is the usefulness a customer gains from a company’s product or service.
The entire customer experience determines the value a customer derives from a
product.
 The Value chain is the sequence of business functions in which a product is made
progressively more useful to customers.
 The Value chain consists of:
1.
2.
3.
4.
5.
6.
Research & development
Design of Products and Processes
Production
Marketing
Distribution
Customer service
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Value-Chain Analysis
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Supply-Chain Analysis
 Production and Distribution are the parts of the value chain associated with
producing and delivering a product or service. These two functions together are
known as the Supply-Chain
 The supply chain describes the flow of goods, services and information from the
initial sources of materials, services, and information to their delivery regardless of
whether the activities occur in one organization or in multiple organizations.
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Key Success Factors
 Customers want companies to use the value chain and supply chain to deliver everimproving levels of performance when it comes to several (or even all) of the
following:
 Cost and efficiency
 Quality
 Time
 Innovation
 Sustainability
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Outline
1.1 Financial Accounting, Management Accounting, and
Cost Accounting
1.2 Strategic Decisions, Value-Chain and Supply-Chain
Analysis, and Key Success Factors
An Introduction to
Management
Accounting,
Cost Terms
and Purposes
1.3 Decision Making, Planning, and Control
1.4 Management Accounting Guidelines and
Organization Structure
1.5 Cost Terms
1.6 Inventoriable Costs and Period Costs
1.7 Measuring Costs Requires Judgment
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The Five-Step Decision-Making Process in Planning and Control
1.
2.
3.
4.
5.
Identify the problem and uncertainties.
Obtain information.
Make predictions about the future.
Make decisions by choosing between alternatives.
Implement the decision, evaluate performance, and learn.
 Planning (steps 1 through 4) selects goals and strategies, predicts results, decides
how to attain goals, and communicates this to the organization.
 A budget—the most important planning tool—is the quantitative expression of a plan
of activity by management and is an aid to coordinating what needs to be done to
execute that plan.
 Control takes actions that implement the planning decision, evaluates performance,
and provides feedback and learning to the organization.
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How accounting aids decision making, planning, and control
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Outline
1.1 Financial Accounting, Management Accounting, and
Cost Accounting
1.2 Strategic Decisions, Value-Chain and Supply-Chain
Analysis, and Key Success Factors
An Introduction to
Management
Accounting,
Cost Terms
and Purposes
1.3 Decision Making, Planning, and Control
1.4 Management Accounting Guidelines and
Organization Structure
1.5 Cost Terms
1.6 Inventoriable Costs and Period Costs
1.7 Measuring Costs Requires Judgment
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Three guidelines help management accountants provide the most
value to the decision-making of their companies
 Cost–benefit approach: benefits of an action/purchase generally must exceed costs
as a basic decision rule.
 Behavioral and technical considerations: people are involved in decisions, not just
dollars and cents.
 Different Costs for Different Purposes: Managers use alternative ways to compute
costs in different decision-making situations.
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A typical organizational structure and the management accountant
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Outline
1.1 Financial Accounting, Management Accounting, and
Cost Accounting
1.2 Strategic Decisions, Value-Chain and Supply-Chain
Analysis, and Key Success Factors
An Introduction to
Management
Accounting,
Cost Terms
and Purposes
1.3 Decision Making, Planning, and Control
1.4 Management Accounting Guidelines and
Organization Structure
1.5 Cost Terms
1.6 Inventoriable Costs and Period Costs
1.7 Measuring Costs Requires Judgment
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Basic Cost Terminology
 Cost—a sacrificed or forgone resource to achieve a specific objective. A cost is
usually measured as the monetary amount that must be paid to acquire goods or
services
 Actual cost (a cost that has occurred) vs. budgeted cost (a predicted cost)
 Cost object—anything for which a cost measurement is desired.
Cost Object
Illustration
Product
A BMW X6 sports activity vehicle
Service
Telephone hotline providing information and assistance to BMW dealers
Project
R&D project on DVD system enhancement in BMW cars
Customer
Herb Chambers Motors, a dealer that purchases a broad range of BMW vehicles
Activity
Setting up machines for production or maintaining production equipment
Department
Environmental, Health and Safety department
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Two Stages of Determining the Costs of Various Cost Objects
1. Cost accumulation—the collection of cost data in an organized way by means of an
accounting system.
2. Cost assignment—a general term that encompasses the gathering of accumulated
costs to a cost object in two ways:
 Tracing accumulated costs with a direct relationship to the cost object and
 Allocating accumulated costs with an indirect relationship to a cost object.
 Use of cost information:
 Making decisions, e.g., how to price different models of cars or how much to invest
in R&D and marketing
 Implementing decisions, by influencing and motivating employees to act, e.g., by
providing bonuses for reducing costs
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Direct Costs vs. Indirect Costs
 Direct costs can be conveniently and economically traced (tracked) to a cost object.
 Parts (steel or tires for a car, as an exampe), assembly line wages
 Indirect costs cannot be conveniently or economically traced (tracked) to a cost
object. Instead of being traced, these costs are allocated to a cost object in a rational
and systematic manner.
 Electricity, rent, property taxes, plant administration expenses
 Several factors affect whether a cost is classified as direct or indirect:
 The materiality of the cost in question.
 The available information-gathering technology.
 Design of operations.
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Cost Assignment to a Cost Object
 Note: a specific cost may be both a direct cost of one cost object and an indirect cost
of another cost object.
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Cost Behavior Patterns: Variable Costs vs. Fixed Costs
 Variable costs—change in total in proportion to changes in the related level of activity
or volume of output produced.
 Variable costs are constant on a per-unit basis. If a product takes 5 pounds of
materials each, it stays the same per unit regardless if one, ten, or a thousand
units are produced.
 Fixed costs—remain unchanged in total, for a given time period, despite changes in
the related level of activity or volume of output produced.
 Fixed costs per unit change inversely with the level of production. As more units
are produced, the same fixed cost is spread over more and more units, reducing
the cost per unit.
 Costs are fixed or variable only with respect to a specific activity or a given time
period.
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Cost Behavior Patterns: Variable Costs vs. Fixed Costs
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Relationship Between Types of Costs
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Cost Drivers and Relevant Range
 Cost driver—a variable, such as the level of activity or volume, that causally affects
costs over a given time span.
 Relevant range—the band or range of normal activity level (or volume) in which there
is a specific relationship between the level of activity (or volume) and the cost in
question.
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Unit Costs vs. Total Costs
 A unit cost, also called an average cost, is calculated by dividing the total cost by
the related number of units produced
 Example:
 Total manufacturing costs of $40,000,000;
total production of 500,000 speaker systems
Total manufacturing costs
$40,000,000
=
= $80 per unit
Number of units manufactured 500,000 units
 480,000 units are sold and 20,000 units remain in ending inventory
Costs of goods sold in the income statement, 480,000 units x $80 per unit
Ending inventory in the balance sheet, 20,000 units x $80 per unit
Total manufacturing costs of 500,000 units
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$38,400,000
1,600,000
$40,000,000
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Use Unit Costs Cautiously
 Unit costs should be used cautiously. Because unit costs change with a different level
of output or volume, it may be more prudent to base decisions on a total cost basis.
 Example (continued):
 Total manufacturing costs of $40,000,000:
$10,000,000 of fixed costs and $30,000,000 of variable costs
 Total fixed costs and variable cost per speaker in 2015 expected to be unchanged
Units
Produced
Variable Cost
per Unit
Total Variable
Costs
Total Fixed
Costs
Total Costs
Unit Cost
(1)
(2)
(3) = (1) x (2)
(4)
(5) = (3) + (4)
(6) = (5) ÷ (1)
200,000
$60
$12,000,000
$10,000,000
$22,000,000
$110.00
500,000
$60
$30,000,000
$10,000,000
$40,000,000
$80.00
800,000
$60
$48,000,000
$10,000,000
$58,000,000
$72.50
 Unit costs that include fixed costs should always reference a given level of output or
activity.
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Outline
1.1 Financial Accounting, Management Accounting, and
Cost Accounting
1.2 Strategic Decisions, Value-Chain and Supply-Chain
Analysis, and Key Success Factors
An Introduction to
Management
Accounting,
Cost Terms
and Purposes
1.3 Decision Making, Planning, and Control
1.4 Management Accounting Guidelines and
Organization Structure
1.5 Cost Terms
1.6 Inventoriable Costs and Period Costs
1.7 Measuring Costs Requires Judgment
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Different Types of Firms and Types of Inventory
 Three important factors of the economy:
 Manufacturing-sector companies purchase materials and components and
convert them into finished products.
 Merchandising-sector companies purchase and then sell tangible products
without changing their basic form.
 Service-sector companies provide services (intangible products) like legal advice
or audits.
 Types of inventory for manufacturing-sector companies:
 Direct materials—resources in-stock and available for use
 Work-in-process (or progress)—products started but not yet completed, often
abbreviated as WIP
 Finished goods—products completed and ready for sale
 Merchandising-sector companies hold only one type of inventory: merchandise
inventory
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Inventoriable Costs vs. Period Costs
 Inventoriable costs are all costs of a product that are considered assets in a
company’s balance sheet when the costs are incurred and that are expensed as cost
of goods sold only when the product is sold. For manufacturing companies, all
manufacturing costs are inventoriable costs:
 Direct materials—acquisition costs of all materials that will become part of the cost
object.
 Direct labor—compensation of all manufacturing labor that can be traced to the
cost object.
 Indirect manufacturing—factory costs that are not traceable to the product in an
economically feasible way. Examples include lubricants, indirect manufacturing
labor, utilities, and supplies.
 Prime cost is a term referring to all direct manufacturing costs (materials and
labor), conversion cost is a term referring to direct labor and indirect manufacturing
costs.
 Period costs are all costs in the income statement other than cost of goods sold.
They are treated as expenses of the accounting period in which they are incurred.
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Examples of Period Costs
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Illustrating the Flow of Inventoriable Costs and Period Costs
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Illustrating the Flow of Inventoriable Costs and Period Costs
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Technische Universität München
Illustrating the Flow of Inventoriable Costs and Period Costs
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Illustrating the Flow of Inventoriable Costs and Period Costs:
Merchandising Company
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Technische Universität München
Outline
1.1 Financial Accounting, Management Accounting, and
Cost Accounting
1.2 Strategic Decisions, Value-Chain and Supply-Chain
Analysis, and Key Success Factors
An Introduction to
Management
Accounting,
Cost Terms
and Purposes
1.3 Decision Making, Planning, and Control
1.4 Management Accounting Guidelines and
Organization Structure
1.5 Cost Terms
1.6 Inventoriable Costs and Period Costs
1.7 Measuring Costs Requires Judgment
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There are alternative ways for managers to define and classify costs:
Overtime premium and idle time as an example
 Software programmer who writes software for multiple products
$40 per hour for straight-time, $60 per hour of overtime,
44 hours of work (including 4 overtime hours)
Direct programming labor: 44 hours x $40 per hour
Overtime premium: 4 hours x $20 per hour
Total compensation for 44 hours
$1,760
80
$1,840
 Should the overtime premium be considered an overhead or a direct cost?
 Furthermore, 3 hours of idle time while waiting to receive code from a colleague
Direct programming labor: 41 hours x $40 per hour
Idle time: 3 hours x $40 per hour
Overtime premium: 4 hours x $20 per hour
Total compensation for 44 hours
$1,640
120
80
$1,840
 Should the costs of idle time be considered an overhead or a direct cost?
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Different Product Costs for Different Purposes
 Pricing and product-mix decisions—decisions about pricing and maximizing profits
 Contracting with government agencies—very specific definitions of allowable costs for
“cost plus profit” contracts
 Preparing external-use financial statements—GAAP-driven product costs only
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