Introduction to Management Accounting
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Introduction to Management Accounting
Chapter 4
Cost Management Systems
and Activity-Based Costing
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Learning
Objective 1
Cost Management System
A cost management system (CMS) is
a collection of tools and techniques
that identifies how management’s
decisions affect costs.
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Cost Management System
The primary purposes of a cost
management system are to provide...
cost information for strategic
management decisions,
cost information for
operational control, and
measure of inventory value and cost
of goods sold for financial reporting.
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Cost Accounting Systems
Cost accounting is that part of the cost
management system that measures
costs for the purposes of management
decision making and financial reporting.
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Objective 2
Cost Accounting System
Cost
accumulation:
Collecting costs by some
“natural” classification
such as materials or labor
Cost
assignment:
Tracing costs to one or
more cost objectives
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Cost Accounting System
Cost
accumulation
Material costs
(metals)
Cost assignment
to cost objects
1. Departments
2. Activities
Machining Department
Activity Activity
Activity Activity
Cabinets
3. Products
Finishing Department
Activity Activity
Activity Activity
Cabinets
Desks
Desks
Tables
Tables
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Cost
A cost is a sacrifice or giving up of
resources for a particular purpose.
Costs are frequently measured by
the monetary units that must be
paid for goods and services.
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Cost Object
A cost object (objective) is anything for which
A separate measurement of costs is desired.
Customers
Departments
Service
Processing orders
Product
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Learning
Objective 3
Direct, Indirect, and Unallocated Costs
Direct costs can be identified specifically and exclusively
with a given cost objective in an economically feasible way.
Indirect costs cannot be identified specifically and exclusively
With a given cost objective in an economically feasible way.
Unallocated costs are recorded but
not assigned to any cost object.
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Learning
Objective 4
Cost Allocation
Cost allocation is used to assign indirect costs to cost objects, in proportion
to the cost object’s use of a particular cost-allocation base.
A cost-allocation base is some measure of input or output that
determines the amount of cost to be allocated to a particular cost object.
An ideal cost-allocation base would measure how much
of the particular cost is caused by the cost objective.
Note the similarity of this definition to that of a cost driver—an output
measure that causes costs. Therefore, most allocation bases are cost drivers.
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Cost Allocation
Cost allocations support a company’s CMS—the system
providing cost measurements for strategic decision making,
operational control, and external reporting.
Four purposes of cost allocation:

Predict the economic effects of strategic and operational control decisions.
 Provide desired motivation and to give feedback for performance evaluation.
 Compute income and asset valuations for financial reporting.
 Justify costs or obtain reimbursement.
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Cost Pool
A cost pool is a group of individual costs that a company
allocates to cost objects using a single cost-allocation base.
1.
2.
3.
4.
5.
Accumulate indirect costs for a period of time.
Select an allocation base for each cost pool, preferably a cost driver,
that is, a measure that causes the costs in the cost pool.
Measure the units of the cost-allocation base used for each cost
object and compute the total units used for all cost objects.
Determine the percentage of total cost-allocation base units
used for each cost object.
Multiply the percentage by the total costs in the cost pool to
determine the cost allocated to each cost object.
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Cost Allocation
Direct costs are physically traced to a cost object.
Indirect costs are allocated using a cost-allocation base.
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Direct,
Indirect,
Unallocated
Costs
Statement
of and
Operating
Income
Li Company’s Statement of Operating Income
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Learning
Objective 5
Direct Material Costs
Direct materials include the acquisition costs
of all materials that a company identifies
as a part of the manufactured goods.
These costs are identified in
an economically feasible way.
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Direct Labor Costs
Direct Labor costs include the
wages of all labor that can be
traced specifically and exclusively
to the manufactured goods in an
economically feasible way.
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Indirect Production Costs (Manufacturing Overhead)
Manufacturing overhead includes all costs
associated with the production process
that the company cannot be traced to
the manufactured goods in an
economically feasible way.
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Product Costs
Product costs are costs identified with goods
produced or purchased for resale.
These costs first become part of the inventory
on hand, sometimes called inventoriable costs.
Inventoriable costs become expenses in the form of
cost of goods sold only when the inventory is sold.
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Period Costs
Period costs are deducted as expenses
during the current period without
going through an inventory stage.
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
26
27
28
29
30
31
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Learning
Objective 6
Financial Statement Presentation
– Merchandising Companies
Merchandising Company
(Retailer or Wholesaler)
Sales
Minus
Product
(Inventoriable)
Costs
Merchandise
Purchases
Merchandise Expiration
Inventory
Cost of
Goods Sold
(Expenses)
Equals Gross Margin
Minus
Period
Costs
Selling Expenses and
Administrative
Expenses
Equals Operating
Income
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Financial Statement Presentation
– Manufacturing Companies
Manufacturing Company
Product
(Inventoriable)
Costs
Direct
Material
Purchases
Direct Labor
Indirect
Manufacturing
Direct
Material
Inventory
Finished
Goods
Inventory
Work-inProcess
Inventory
Sales
Minus
Expiration
Period
Costs
Cost of
Goods Sold
(Expenses)
Equals Gross Margin
Minus
Selling Expenses and
Administrative
Expenses
Equals Operating
Income
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Current Asset Sections
of Balance Sheets
Manufacturer
Cash
$ 4,000
Receivables
25,000
Subtotal
$29,000
Finished goods 32,000
Work in process 22,000
Direct material 23,000
Total inventories
$77,000
Other current assets
1,000
Total current assets
$107,000
Retailer or Wholesaler
Cash
Receivables
$
4,000
25,000
Merchandise inventories
Other current assets
Total current assets
77,000
1,000
$107,000
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Income Statement Presentation
of Costs for a Manufacturer
The manufacturer’s cost of goods produced
and then sold is usually composed of
the three major categories of cost:
Direct materials
Direct labor
Indirect manufacturing
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Income Statement Presentation
of Costs for a Retailer
The merchandiser’s cost of goods sold
is usually composed of the purchase
cost of items, including freight-in,
that are acquired and then resold.
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Learning
Objective 7
Traditional Costing System
All
Indirect
Resources
$220,000
All Unallocated
Value Chain
Costs
$100,000
Cost Driver
[Direct Labor
Hours]
Direct
Materials
For Pen
Casings
$22,500
Sales $360,000
Direct
Labor
For Pen
Casings
$135,000
Direct
Materials For
Cell
Phone
Casings
$12,000
Sales $80,000
Direct
Labor For
Cell Phone
Casings
$15,000
Unallocated $00,000
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Traditional Costing System
Statement of Operating Income
Traditional Cost Allocation System
Pen
Casings
Sales
Direct materials
Direct labor
Indirect manufacturing
Gross profit
Corporate expenses
Operating loss
Gross profit margin
$440,000
34,500
150,000
220,000
$ 35,500
100,000
($ 64,500)
8.07%
Cell Phone
Casings
$360,000
22,500
135,000
198,000
$ 4,500
$80,000
12,000
15,000
22,000
$31,000
1.25%
38.75%
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ABC System
Plant and
Machinery
$180,000
Engineers and
CAD Equipment
$40,000
20%
75%
All Unallocated
Value Chain Costs
$100,000
80%
25%
Processing
Activity
$135,000
+ 8,000
$143,000
Production Support
Activity
$45,000
+32,000
$77,000
Cost Driver
[Direct Labor Hours]
Direct
Materials
For Pen
Casings
$22,500
Sales $360,000
Direct
Labor
For Pen
Casings
$135,000
Cost Driver
[Distinct Parts]
Direct
Materials For
Cell
Phone
Casings
$12,000
Sales $80,000
Direct
Labor For
Cell Phone
Casings
$15,000
Unallocated $00,000
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Activity-Based Cost Allocation System
External
Reporting
Sales
Direct materials
Direct labor
Processing activity
Production support activity
Gross profit
Corporate expenses
Operating loss
Gross profit margin
$440,000
34,500
150,000
143,000
77,000
$ 35,500
100,000
($ 64,500)
8.07%
Internal Purposes
Cell
Pen
Phone
Casings
Casings
$360,000
22,500
135,000
128,700
15,400
$ 58,400
16.22%
$80,000
12,000
15,000
14,300
61,600
($22,900)
(28.63%)
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Learning
Objective 8
Activity-Based Management
ABM is using the output of an activity-based
cost accounting system to aid strategic decision
making and to improve operational control.
A value-added cost is the cost of an activity
that cannot be eliminated without affecting
a product’s value to the customer.
In contrast, nonvalue-added costs are costs
that can be eliminated without affecting
a product’s value to the customer.
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Activity-Based Management
Benchmarking is the continuous process of
comparing products, services, and activities
to the best industry standards.
Benchmarking is a tool to help an organization measure
its competitive posture. Benchmarks can come from
within the organization, from competing organizations,
or from other organizations having similar processes.
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Benefits of Activity-Based Costing and
Management Systems
Companies adopt ABC systems to:








set an optimal product mix
to estimate profit margins of new products
determine consumption of company’s shared resources
keep pace with new product techniques
and technological changes
decrease the costs associated with bad decisions
take advantage of reduced cost of ABC
systems due to computer technology
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Design of a Traditional Costing System
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Learning
Objective 9
Design of an Activity-Based
Cost Accounting System
Determine the key
components of the
cost accounting
system.
Cost objectives
Key activities
Resources
Related cost drivers
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Design of an Activity-Based
Cost Accounting System
Key
Activity
Account billing
Bill verification
Account inquiry
Correspondence
Other activities
Cost
Driver
Number or printed pages
Number of accounts verified
Number of inquiries
Number of letters
Number of printed pages
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Design of an Activity-Based
Cost Accounting System
Determine the relationships among
cost objectives,activities, and resources.
Activity Performed
Resource
Used to
Perform Activity
Account
Inquiry
Activity
Supervisor
40%
Account inquiry labor
90
Billing labor
Verification labor
Paper
Computer
45
Telecommunications
90
Occupancy
65
Printing machines
All other department resources
Correspondence
Activity
10%
10
Billing
Activity
Verification
Activity
30%
30
5
100
35
5
15
90
All Other
Activities
20%
70
100
10
5
10
20
5
100
Total
100%
100%
100%
100%
100%
100%
100%
100%
100%
100%
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Design of an Activity-Based
Cost Accounting System
Collect relevant data concerning costs and the physical
flow of the cost-driver units among resources and activities.
Number of Cost Driver Units
Activity
Cost Driver Units
Account inquiry
Inquiries
Correspondence
Letters
Bill printing
Printed pages
Verification
Accounts verified
Other activities
Printed pages
Residential
Commercial
Total
20,000
5,000
25,000
1,800
1,000
2,800
120,000
40,000
160,000
20,000
20,000
40,000
160,000
120,000
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Design of an Activity-Based
Cost Accounting System
Calculate and interpret the new
activity-based information.
Determine the traceable costs for
each of the activity cost pools.
Determine the activity-based cost per
account for each customer class
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Design of an Activity-Based
Cost Accounting System
Total traceable costs for the 5 activity cost pools.
Activity Cost Pool
Cost (from Account
slide 4-33) Inquiry Correspondence Billing Verification
$ 33,600 $ 13,440*
$ 3,360** $ 10,080***
Resource
Supervisors
Account inquiry
labor
173,460 156,114
Billing labor
56,250
Verification labor
11,250
Paper
7,320
Computer
178,000
80,100
Telecommunication
58,520
52,668
Occupancy
47,000
30,550
Printers
55,000
Other resources
67,100
Total traceable
cost
$687,500 $332,872
Other
$ 6,720****
17,346
16,875
8,900
7,320
62,300
2,750
7,050
49,500
$32,356
$153,125
$39,375
11,250
17,800
8,900
5,852
9,400
2,750
67,100
$68,425 $100,722
*From slides 33 and 36, account inquiry activity uses 40% of the supervisor resource. So the allocation is 40% × $33,600 = $13,440.
**10% × $33,600
***30% × $33,600
****20% × $33,600
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Publishing,
Introduction
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Accounting Accounting
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Design of an Activity-Based
Cost Accounting System
Activity-based cost per account for each customer class
Activity (Driver Units)
Account inquiry (inquiries)
Correspondence (letters)
Account billing (printed pages)
Bill verification (accounts verified)
Other activities (printed pages)
Account inquiry
Correspondence
Account billing
Bill verification
Other activities
Total cost
Number of accounts
Cost per account
Cost per account, traditional
system from slide 33
Cost per
Driver Unit
$13.314880
$11.555714
$ 0.957031
$ 3.421250
$ 0.629513
Driver Costs
Total Number of
Traceable Costs Driver Units
(from Exhibit 4-12) (From Exhibit 4-11)
(1)
(2)
$332,872
25,000 Inquiries
32,356
2,800 Letters
153,125
160,000 Printed pages
68,425
20,000 Accounts verified
100,722
160,000 Printed pages
Cost per Customer Class
Residential
Commercial
Number of
Number of
Driver Units
Cost
Driver Units
20,000 Inquiries $266,298
5,000 Inquiries
1,800 Letters
20,800
1,000 Letters
120,000 Pages
114,844 40,000 Pages
20,000 Accts.
120,000 Pages
75,541 40,000 pages
$477,483
120,000
$ 3.98
$ 4.58
Cost per
Driver Unit
(1) ÷ (2)
$13,314880
$11.555714
$ 0.957031
$ 3.421250
$ 0.629513
Cost
$ 66,574
11,556
38,281
68,425
25,181
$210,017
20,000
$ 10.50
$ 6.88
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Hall Business
Publishing,
Introduction
to Management
13/e, Horngren/Sundem/Stratton
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©2008
Prentice
Hall Business
Publishing,
Introduction
to Management
Accounting Accounting
14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler
- 40
Strategic Decisions, Operational Cost
Control, and ABM
Outsourcing
Reducing operating costs
Identifying nonvalue-added activities
Improving both strategic
and operational decisions
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©2008
Prentice
Hall Business
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Introduction
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Accounting Accounting
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The End
End of Chapter 4
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Prentice
Hall Business
Publishing,
Introduction
to Management
13/e, Horngren/Sundem/Stratton
4 -4 42
©2008
Prentice
Hall Business
Publishing,
Introduction
to Management
Accounting Accounting
14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler
- 42