1. 2 -1 Basic Management Accounting Concepts CHAPTER

2. 2 -2 1.Describe the cost assignment process. 2.Define tangible and intangible products and explain why there are different product cost definitions. 3.Prepare income statements for manufacturing and service organizations. 4.Outline the differences between functional- based and activity-based management accounting systems. ObjectivesObjectives After studying this chapter, you should be able to:

3. 2 -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.

4. 2 -4 cost object A cost object is any item such as products, customers, departments, projects, activities, and so on, for which costs are measured and assigned. Example Example:A bicycle is a cost object when you are determining the cost to produce a bicycle. activity An activity is a basic unit of work performed within an organization. Example: Example: Setting up equipment, moving materials, maintaining equipment, designing products, etc.

5. 2 -5 Traceability 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 Direct costs are those costs that can be easily and accurately traced to a cost object. Example: Example: If a hospital is the cost object, the cost of heating and cooling the hospital is a direct cost.

6. 2 -6 Indirect costs Indirect costs are those costs that cannot be easily and accurately traced to a cost object. Example: Example:The salary of a plant manager, where departments within the plant are defined as the cost objects.

7. 2 -7 Tracing 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 Direct tracing is the process of identifying and assigning costs that are exclusively and physically associated with a cost object to that cost object. Eq. Equipment maintaining needs physical parts or tools. Bicycle product needs material and labor cost. Driver tracing Drivers 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. Driver tracing comprises of two types: resources drivers and activity drivers.

8. 2 -8 Driver tracing 1. Resource drivers is measured by resources demand in an activity. Eq. equipment maintaining needs tools or parts that can be directly traced to the activity. Power and indirect labor can not be traced directly. So that it needs a resource driver. Machine hour can be a driver for power and labor hour can be a driver for indirect labor. 2. Activity driver is measured by activity needed in a cost object. Eq. equipment maintaining uses number of maintenance hours worked as a driver. Table below presents potential activities.

9. 2 -9 ActivityPotential activity driver Setting equipmentNumber of setups Ordering materialNumber of moves Drilling holesNumber of machine hours Redesigning productNumber of engineering orders Paying billsNumber of invoices Inspecting finished goodsNumber of bathes produced Maintaining equipmentNumber of maintenance hours Providing powerNumber of kilowatt-hours Packing goodsNumber of boxes Scheduling productionNumber of different products

10. 2 -10 Cost Assignment Methods Cost of Resources DirectTracingDriverTracingAllocation PhysicalObservationCausalRelationshipAssumedRelationship Cost Objects

11. 2 -11 Dimensions of Services with Management Accounting 1. Intangibility 2. Perishability (easily damaged) 3. Inseparability (hardly separated) 4. Heterogeneity Buyers can not see, feel, hear or taste the service before it is bought Derived Properties Services cannot be stored. No patent protection. Cannot display or communicate services. Price difficult to set. Services cannot be stored. No patent protection. Cannot display or communicate services. Price difficult to set. Customer directly involved with production of service (a doctor and a patient). Centralized mass production of services difficult. Customer directly involved with production of service (a doctor and a patient). Centralized mass production of services difficult. Wide variation in service products possible.

12. 2 -12 Interface of Services with Management Accounting No inventories. Strong ethical code. Price difficult to set. Demand for more accurate cost assignments. No inventories. Strong ethical code. Price difficult to set. Demand for more accurate cost assignments. Impact on Management Accounting No inventories. Need for standards and consistent high quality. 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. 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. Productivity and quality measurement and control must be ongoing. Total quality manage- ment critical. 1. Intangibility 2. Perishability 3. Inseparability 4. Heterogeneity

13. 2 -13 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.

14. 2 -14 Design Produce Market Distribute ServiceDevelop

15. 2 -15 Product Costing Definitions Pricing Decisions Product-Mix Decisions Strategic Profitability Analysis Strategic Design Decisions Tactical Profitability Analysis External Financial Reporting Research and Development Production Marketing Customer Service Value-Chain Product Costs Production Marketing Customer Service Operating Product Costs Traditional Product CostsProduction Managerial objectives served

16. 2 -16 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

17. 2 -17 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

18. 2 -18 Overhead are all other production costs.  Depreciation on building and equipment  Maintenance  Supplies  Supervision  Power  Property taxes

19. 2 -19 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)

20. 2 -20 Prime Cost : Direct Materials Costs + Direct Labor Costs Conversion Cost: Direct Labor Costs + Overhead Costs

21. 2 -21 External Financial Statements

22. 2 -22 Manufacturing Organization Income Statement For the Year Ended December 31, 2004 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 2-20

23. 2 -23 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 labor350,000 Manufacturing overhead: Indirect labor$122,500 Depreciation177,500 Rent50,000 Utilities37,500 Property taxes12,500 Maintenance 50,000 450,000 Total manufacturing costs added$1,400,000 Statement of Cost of Goods Manufactured For the Year Ended December 31, 2004 2-21 continued on next slide

24. 2 -24 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.

25. 2 -25 Service Organization Income Statement For the Year Ended December 31, 2004 Sales$300,000 Less expenses: Cost of services sold: Beginning work in process$ 5,000 Service costs added: Direct materials$ 40,000 Direct labor80,000 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 2-23

26. 2 -26 Functional-Based Management Model Efficiency Analysis Performance Analysis Operational View Resources Functions Products Cost View

27. 2 -27 Activity-Based Management Model Resources Activities Products and Customers Cost View Driver Analysis Performance Analysis Process View Why?What?How Well?

28. 2 -28 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 Functional-Based Activity-Based