Chapter 2 Basic Cost Management Concepts COPYRIGHT © 2009 South-Western Publishing, a division of Cengage Learning. Cengage Learning and South-Western are trademarks used herein under license.

Study Objectives Explain the cost assignment process. Define tangible and intangible products, and explain why there are different product cost definitions. Prepare income statements for manufacturing and service organizations. Explain the differences between traditional and contemporary cost management systems.

Cost Assignment: Direct Tracing, Driver Tracing and Allocation 1. 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.

Cost Assignment: Direct Tracing, Driver Tracing and Allocation 1. Traceability means that costs can be assigned easily and accurately, using a causal relationship. Methods of tracing: Direct tracing: relies on physical observance of causal relationships to assign costs to cost objects. Driver tracing: relies on drivers as causal factors to assign costs to cost objects.

Cost Assignment Methods 1.

Examples of Product Cost Definitions 2.

Product Costs 2. Direct materials: those materials directly traceable to the goods or services being produced. Example: The cost of wood in furniture. Direct labor: labor that is directly traceable to the goods or services being produced. Example: Wages of assembly-line workers. Overhead: all other manufacturing costs. Example: Plant depreciation, utilities, property taxes, indirect materials, indirect labor, etc.

Prime and Conversion Costs 2.

Nonproduction Costs 2. Amount and timing of benefit cannot be reasonably estimated Period costs Not inventoried Expensed as incurred Examples Research and development Marketing costs Administrative costs

Production and Nonproduction Costs 2.

External Financial Statements Income Statement ~ Manufacturing Firm Functional categories of expense Cost of goods sold Operating expenses Supporting schedules Cost of goods manufactured Income Statement ~ Service Organization No finished goods inventory

Income Statement: Manufacturing Firm 3. From the Cost of Goods Sold Schedule

Statement of Cost of Goods Manufactured 3.

Cost of Goods Sold Schedule 3.

Cost Management Systems 4. Functional-Based Assumes a linear production cost behavior Assigns costs to organizational units Activity-Based Emphasizes tracing over allocation Identifies non-unit-based activity drivers

Functional-Based Cost Management 4. Unit-based drivers Allocation-intensive Narrow and rigid product costing Focus on managing costs Sparse activity information Maximization of individual unit performance Uses financial measures of performance

Activity-Based Cost Management 4. Unit- and non-unit-based drivers Tracing intensive Broad, flexible product costing Focus on managing activities Detailed activity information System-wide performance maximization Uses both financial and nonfinancial measures of performance

Trade-Off between Measurement Costs and Error Costs 4.

Shifting Costs 4.

End Chapter 2 COPYRIGHT © 2009 South-Western Publishing, a division of Cengage Learning. Cengage Learning and South-Western are trademarks used herein under license.