1. Basic Management Accounting Concepts
CHAPTER
Basic Management Accounting Concepts

2. 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:

3. 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”?

4. 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.

5. 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.

6. 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.

7. 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.

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

9. 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

10. 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

11. 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.

12. Design
Service
Develop
Produce
Distribute
Market

13. 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

14. 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

15. 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

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

17. 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)

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

19. External Financial Statements

20. 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 , ,400,000
Gross margin $1,400,000
Less operating expenses:
Selling expenses $ 600,000
Administrative expenses , ,000
Income before taxes $ 500,000

21. 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 ,000
Materials available $650,000
Less: Ending inventory ,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 , ,000
Total manufacturing costs added $1,400,000
continued on next slide

22. Total manufacturing costs added $1,400,000
Add: Beginning work in process ,000
Total manufacturing costs $1,600,000
Less: Ending work in process ,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.

23. 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
Total $225,000
Less: Ending work in process , ,000
Gross margin $ 85,000
Less operating expenses:
Selling expenses $ 8,000
Administrative expenses , ,000
Income before income taxes $ 55,000

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

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

26. 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

27. Chapter Two
The End