Management Accounting Department of Accounting Chapter 3 Cost Management Concepts and Cost Behavior

Management Accounting Department of Accounting Chapter 3 objectives: 1. To be able to explain why the appropriate derivation of a cost depends on how the cost will be used. 2.To be able to explain why management accountants have developed the notions of long-run and short-run costs and how these different costs are used in decision making. 3.To be able to state the difference between flexible costs and capacity-related costs and why the difference is important. 4.To be able to show why the concept of opportunity cost is used in short-run decision making and how opportunity cost relates to conventional accounting costs. 5.To be able to explain the notion of life-cycle cost and how that idea is used in new product and product purchasing decisions.

Management Accounting Department of Accounting What Does Cost Mean - When the purpose is to compute the cost of something: In Management Accounting terms there is no single definition of cost. It is ”different cost for different purposes” Definitions : A cost object :Something for which we want to compute a cost. A direct cost :A cost of a resource og activity that is acquired for or used by a single cost object. An indirect cost :The cost of a resource that was aquired to be used by more than one cost object.

Management Accounting Department of Accounting What Does Cost Mean - When organizing cost based on the way they are created Flexible resources Resources whose costs are proportional to the amount of the resource used. Flexible costs The cost of flexible resources. Capacity-related resources Resources acquired and paid for in advance of when the work is completed and whose costs depend upon the amount required rather than the amount used. Capacity-related costs The costs associated with capacity-related resources.

Management Accounting Department of Accounting How the Use of Cost Information Defines Its Focus and Form - Using cost information outside the organization GAAP = Generally Accepted Accounting Principles CostGAAP defines cost as ”the monetary value of goods and services expended to obtain current or future benefits. ExpensesThe cost of goods or services that have expired. Product costCost incurred to produce the volume and mix of products made during the period. Cost of goods Share of the product cost assigned to the products actually sold soldduring a specific period.

Management Accounting Department of Accounting How the Use of Cost Information Defines Its Focus and Form - Using cost information outside the organization, continued …..

Management Accounting Department of Accounting How the Use of Cost Information Defines Its Focus and Form - Using cost information inside the organization Two broad categories: Cost structured for planning purposes (example: Determining the selling price of a specific product). Cost structured for evaluation purposes (example: Evaluation of profitability of a certain product). In general: Costs are used by decision makers to make decisions and to control the processes they manage. Benefits from providing cost information should exceed the cost of developing them.

Management Accounting Department of Accounting How the Use of Cost Information Defines Its Focus and Form - Using cost information inside the organization, continued … From a Management Accounting perspective a valid statement is : Different costs for different purposes. Opportunity cost. The sacrifices incurred when using resources for one purpose instead of another. Opportunity cost perspectives are widely used in organizations as a base for decision making.

Management Accounting Department of Accounting How the Use of Cost Information Defines Its Focus and Form - Using cost information inside the organization, continued …

Management Accounting Department of Accounting How the Use of Cost Information Defines Its Focus and Form - Using cost information inside the organization, continued … How perspective determines the cost definition Short-run costs:The short-run is defined as the period over which a decision maker cannot adjust capacity. The only cost that vary in the short run are those that vary in proportion to production. Long-run costs:The long-run is defined as the period over which a decision maker can influence flexible and capacity-related cost. Long- run costs are the sum of flexible and capacity-related costs associated with a cost object.

Management Accounting Department of Accounting How Organizations Create Costs Starting up Early growth Reaching existing capacity Expanding capacity Redefining the business Continued growth

Management Accounting Department of Accounting Cost Structures Today - History History timeline > Primary focus on Higher focus measuring and on measuring controlling directand controlling labor and materialscapacity related costs

Management Accounting Department of Accounting Cost Structures Today - Types of production activities Unit related activitiesThose activities whose volume or level is proportional to the number of units produced or sold Batch related activitiesThose activities triggered by the number of batches produced rater than by the number of units manufac- tured. Product sustainingThose activities that support the production and sales of activities individual products but are independent of actual prodution volumes and batches. Customer sustainingThose activities that enable the company to sell to an activitiesindividual customer but are independent of the volume and mix of the products sold and delivered to the customer. Business sustainingThose activities required for the basic functioning of the activities business, independent of production or sales volumes and mix. Other Support activities

Management Accounting Department of Accounting Cost Structures Today - Types of production activities, continued ….

Management Accounting Department of Accounting Cost Structures Today - Understanding the underlying behavior of costs Exhibits 3-1, 3-13 Exhibits 3-8, 3-9, 3-10, 3-11

Management Accounting Department of Accounting Cost Structures Today - Life-cycle costs The product development and planning phase Introduction phase Growth phase Product maturity phase Product decline and abandonment phase