Basic Management Accounting Concepts CHAPTER Basic Management Accounting Concepts

After studying this chapter, you should be able to: Objectives Describe 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. Outline the differences between functional-based and activity-based management accounting systems. After studying this chapter, you should be able to:

Exactly what is meant by “cost”? Cost is the cash or cash-equivalent value sacrificed for goods and services that is expected to bring a current or future benefit to the organization. I see… It’s a dollar measure of the resources used to achieve a given benefit. Cost Assignment Exactly what is meant by “cost”?

Cost Assignment 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 Traceability is the ability to assign a cost to a cost object in an economically feasible way by means of a cause-and-effect relationship. Direct costs are those costs that can be easily and accurately traced to a cost object. Example: If a hospital is the cost object, the cost of heating and cooling the hospital is a direct cost.

Cost Assignment Indirect costs are those costs that cannot be easily and accurately traced to a cost object. Example: The salary of a plant manager, where departments within the plant are defined as the cost objects.

Cost Assignment Tracing is the actual assignment of costs to a cost object using an observable measure of the resources consumed by the cost object. Tracing costs to cost objects can occur in the following two ways: Direct tracing is the process of identifying and assigning costs that are exclusively and physically associated with a cost object to that cost object. Driver tracing is the use of drivers to assign costs to cost objects. Drivers are observable causal factors that measure a cost object’s resource consumption.

Cost Assignment Methods Cost of Resources Direct Tracing Driver Allocation Physical Observation Causal Relationship Assumed Cost Objects

Interface of Services with Management Accounting Services cannot be stored. No patent protection. Cannot display or communicate services. Price difficult to set. 1. Intangibility 2. Perishability 3. Inseparability 4. Heterogeneity Services benefits expire quickly. Services may be repeated often for one customer. Customer directly involved with production of service. Centralized mass production of services difficult. Wide variation in service products possible. Derived Properties

Interface of Services with Management Accounting No inventories. Strong ethical code. Price difficult to set. Demand for more accurate cost assignments. 1. Intangibility 2. Perishability 3. Inseparability 4. Heterogeneity No inventories. Need for standards and consistent high quality. Costs often accounted for by customer type. Demand for measure-ment and control of quality to maintain consistency. Productivity and quality measurement and control must be ongoing. Total quality manage-ment critical. Impact on Management Accounting

Product cost is a cost assignment that supports a well-specified managerial object. Thus, what product cost means depends on the managerial objective being served.

Design Service Develop Produce Distribute Market

Product Costing Definitions Research and Development Production Marketing Customer Service Value-Chain Product Costs Production Marketing Customer Service Operating Product Costs Traditional Product Costs Production Managerial objectives served Pricing Decisions Product-Mix Decisions Strategic Profitability Analysis Strategic Design Decisions Tactical Profitability Analysis External Financial Reporting

Production Costs Direct materials are those materials that are directly traceable to the goods or services being produced. Steel in an automobile Wood in furniture Alcohol in cologne Denim in jeans Braces for correcting teeth

Production Costs Direct labor is the labor that is directly traceable to the goods or services being produced. Workers on an assembly line at Chrysler A chef in a restaurant A surgical nurse attending an open heart operation Airline pilot

Production Costs Overhead are all other production costs. Depreciation on building and equipment Maintenance Supplies Supervision Power Property taxes

Nonproduction Costs Noninventoriable (period) costs are expensed in the period in which they are incurred. Salaries and commissions of sales personnel (marketing) Advertising (marketing) Legal fees (administrative) Printing the annual report (administrative)

Production Costs Prime Cost : Direct Materials Costs + Direct Labor Costs Conversion Cost: Direct Labor Costs + Overhead Costs

External Financial Statements

Manufacturing Organization Income Statement For the Year Ended December 31, 2004 2-20 Sales $2,800,000 Less cost of goods sold: Beginning finished goods inventory $ 500,000 Add: Cost of goods manufactured 1,200,000 Cost of goods available for sale $1,700,000 Less: Ending finished goods inventory 300,000 1,400,000 Gross margin $1,400,000 Less operating expenses: Selling expenses $ 600,000 Administrative expenses 300,000 900,000 Income before taxes $ 500,000

continued on next slide Statement of Cost of Goods Manufactured For the Year Ended December 31, 2004 2-21 Direct materials: Beginning inventory $200,000 Add: Purchases 450,000 Materials available $650,000 Less: Ending inventory 50,000 Direct materials used $ 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 added $1,400,000 continued on next slide

Total manufacturing costs added $1,400,000 Add: Beginning work in process 200,000 Total manufacturing costs $1,600,000 Less: Ending work in process 400,000 Cost of goods manufactured $1,200,000 Work in process consists of all partially completed units found in production at a given point in time.

Service Organization Income Statement For the Year Ended December 31, 2004 2-23 Sales $300,000 Less expenses: Cost of services sold: Beginning work in process $ 5,000 Service costs added: Direct materials $ 40,000 Direct labor 80,000 Overhead 100,000 220,000 Total $225,000 Less: Ending work in process 10,000 215,000 Gross margin $ 85,000 Less operating expenses: Selling expenses $ 8,000 Administrative expenses 22,000 30,000 Income before income taxes $ 55,000

Functional-Based Management Model Resources Functions Products Cost View Efficiency Analysis Performance Analysis Operational View

Activity-Based Management Model Resources Activities Products and Customers Cost View Driver Analysis Performance Analysis Process View Why? What? How Well?

Functional-Based Activity-Based 1. Unit-based drivers 2. Allocation-intensive 3. Narrow and rigid product costing 4. Focus on managing cost 5. Sparse activity information 6. Maximization of individual unit performance 7. Use of financial measures of performance 1. Unit- and nonunit-based drivers 2. Tracing intensive 3. Broad, flexible product costing 4. Focus on managing activities 5. Detailed activity information 6. Systematic performance maximization 7. Use of both financial and nonfinancial measures of performance

Chapter Two The End