2-1 Basic Cost Management Concepts Prepared by Douglas Cloud Pepperdine University Prepared by Douglas Cloud Pepperdine University.

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Basic Cost Basic Cost Management Management

ConceptsConceptsPrepared by

Douglas Cloud Pepperdine University

Prepared by Douglas Cloud

Pepperdine University

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1. Describe a cost management information system, its objectives, and its major subsystems, and indicate how it relates 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.

ObjectivesObjectivesObjectivesObjectives

After studying this After studying this chapter, you should chapter, you should

be able to:be able to:

After studying this After studying this chapter, you should chapter, you should

be able to:be able to:

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4. Prepare income statements for manufacturing and service organizations.

5. Explain the differences between traditional and contemporary cost management systems.

ObjectivesObjectivesObjectivesObjectives

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A Systems FrameworkA Systems FrameworkA Systems FrameworkA 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

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Output:Output:

Cooled AirCooled Air

Operational Model of an Air Conditioning SystemOperational Model of an Air Conditioning System

Cooling Process

Inputs:Inputs:

FreonFreon

Warm AirWarm Air

ElectricityElectricity

Delivery Process

Inputs:Inputs:

Cooled AirCooled Air

ElectricityElectricity

DuctsDucts

Output:Output:

Delivered Cooled AirDelivered Cooled Air

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Accounting Information SystemAccounting Information SystemAccounting Information SystemAccounting 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.

Like any system, an accounting information system consists of: (1) objectives, (2) interrelated

parts, (3) processes, and (4) outputs.

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ProcessesProcesses

Operational Model for an Operational Model for an Accounting Information SystemAccounting Information System

Operational Model for an Operational Model for an Accounting Information SystemAccounting Information System

Economic Events

CollectingClassifyingSummarizingAnalyzingManaging

Special ReportsFinancial StatementsBudgetsPerformance ReportsPersonal Communication

InputsInputs OutputsOutputs

UsersUsers

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Accounting Information SystemsAccounting 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.

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Accounting Information SystemsAccounting 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

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An Integrated Cost An Integrated Cost Management SystemManagement SystemAn Integrated Cost An Integrated Cost

Management SystemManagement System

Design andDevelopment

System

CustomerCustomerServicingServicingSystemSystem

Marketing andMarketing andDistributionDistribution

SystemSystem

CostManagement

System

ProductionProductionSystemSystem

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The Subsystems of the Accounting Information System

The Subsystems of the Accounting Information System

Financial AccountingFinancial AccountingInformation SystemInformation System

Accounting Information SystemAccounting Information System

Cost ManagementCost ManagementInformation SystemInformation System

OperationalControl System

Cost AccountingCost AccountingInformation SystemInformation System

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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.

Basic Cost ConceptsBasic Cost Concepts

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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.

Basic Cost ConceptsBasic Cost Concepts

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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 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.

Basic Cost ConceptsBasic Cost Concepts

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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.

Basic Cost ConceptsBasic Cost Concepts

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Cost Assignment MethodsCost Assignment MethodsCost Assignment MethodsCost Assignment Methods

Cost of ResourcesCost of Resources

DirectDirectTracingTracing

DriverDriverTracingTracing

AllocationAllocation

Resource Drivers

Cost ObjectsCost Objects

ActivityDrivers

ConvenienceAssumedLinkage

PhysicalObservation

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Product Cost Definitions

Pricing DecisionsProduct Mix DecisionsStrategic Profitability Analysis

Strategic Design DecisionsTactical Profitability Analysis

External FinancialReporting

Research andResearch andDevelopmentDevelopment

Research andResearch andDevelopmentDevelopment

ProductionProductionProductionProduction

MarketingMarketingMarketingMarketing

Customer ServiceCustomer ServiceCustomer ServiceCustomer Service

Value-Chain Product Costs

ProductionProductionProductionProduction

MarketingMarketingMarketingMarketing

Customer ServiceCustomer ServiceCustomer ServiceCustomer Service

Operating Product Costs

Traditional Product Costs

ProductionProductionProductionProduction

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Manufacturing CostsManufacturing CostsManufacturing CostsManufacturing 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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Marketing (selling) costs are the costs necessary to market, distribute, and service a product or service.

Example: Advertising, storage costs, and freight out.

Nonproduction CostsNonproduction CostsNonproduction CostsNonproduction Costs

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.

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Nonproduction CostsNonproduction CostsNonproduction CostsNonproduction Costs

For external financial reporting, marketing and

administrative costs are not inventoried. They are

referred to as period costs.

For external financial reporting, marketing and

administrative costs are not inventoried. They are

referred to as period costs.

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Production or Production or Manufacturing Manufacturing

CostsCosts

Nonproduction Nonproduction or Operating or Operating

CostsCosts

Direct Materials

Direct Labor

Overhead

Prime Cost

Conversion Cost

Marketing ExpenseMarketing ExpenseOrder-Getting CostsOrder-Getting CostsOrder-Filling CostsOrder-Filling Costs

Administrative Expense

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Manufacturing OrganizationManufacturing OrganizationIncome StatementIncome Statement

For the Year Ended December 31, 2004For the Year Ended December 31, 2004

Sales $2,800,000

Less: Cost of goods sold 1,300,000

Gross margin $ 700,000

Less operating expenses:

Selling expenses $300,000

Administrative expenses 150,000 450,000

Operating income $ 250,000

From the Cost of Goods Sold

Schedule

From the Cost of Goods Sold

Schedule

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Direct materials:Beginning inventory $200,000Add: Purchases 450,000Materials available $650,000Less: Ending inventory 50,000Direct materials used in production $ 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 ManufacturedStatement of Cost of Goods ManufacturedFor the Year Ended December 31, 2004For the Year Ended December 31, 2004

continuedcontinued

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Total manufacturing costs added $1,400,000Add: Beginning work in process 200,000Less: Ending work in process 400,000Cost of goods manufactured $1,200,000

Work in process consists of all partially completed units found in

production at a given point in time.

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Cost of Goods Sold ScheduleCost of Goods Sold Schedule For the Year Ended December 31, 2004For the Year Ended December 31, 2004

Cost of goods manufactured $1,200,000

Add: Beginning inventory finished goods 250,000

Cost of goods available for sale $1,450,000

Less: Ending inventory finished goods 150,000

Cost of goods sold $1,300,000

From the Statement of

Cost of Goods Manufactured

From the Statement of

Cost of Goods Manufactured

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Activity-Based Management ModelCost View

Driver Analysis

Process View

Performance Performance AnalysisAnalysisActivitiesActivities

Products and Products and CustomersCustomers

Why? What? How well?

ResourcesResources

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Functional-Based and Activity-Based Cost Management SystemsFunctional-Based and Activity-

Based Cost Management Systems

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

Functional-Based

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Functional-Based and Activity-Based Cost Management SystemsFunctional-Based and Activity-

Based Cost Management Systems

Activity-Based1. 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

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Low Accuracy

High Accuracy

Optimal Level

Measurement Cost

Cost

Error Cost

Total Cost

Trade-Off Between Measurement and Error CostsTrade-Off Between Measurement and Error CostsTrade-Off Between Measurement and Error CostsTrade-Off Between Measurement and Error Costs

2-30 Low High Accuracy

New Measurement Cost

Cost

Old Error Cost

Shifting CostsShifting CostsShifting CostsShifting Costs

Old Optimum

Old Measurement Cost

New Error Cost

New Optimum

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Chapter

End ofEnd of

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