2 1 CHAPTER Basic Management Accounting Concepts 2

2 -1 CHAPTER Basic Management Accounting Concepts

2 -2 Objectives 1. Describe the. After cost assignment studying thisprocess. 2. Define tangible and intangible chapter, you shouldproducts and explain why there different product cost beare able to: definitions. 3. Prepare income statements for manufacturing and service organizations. 4. Outline the differences between functionalbased and activity-based management accounting systems.

2 -3 Cost. I see… is the cash-equivalent value It’s aordollar sacrificed for goods measure of the and services that is expected to bring future what is resources used atocurrent or. Exactly benefit atogiven the organization. meant by “cost”? achieve benefit.

2 -4 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. An activity is a basic unit of work performed within an organization. Example: Setting up equipment, moving materials, maintaining equipment, designing products, etc.

2 -5 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.

2 -6 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.

2 -7 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.

2 -8 Cost Assignment Methods Cost of Resources Direct Tracing Driver Tracing Allocation Physical Observation Causal Relationship Assumed Relationship Cost Objects

Interface of Services with Management Accounting 1. Intangibility 2. Perishability 3. Inseparability 4. Heterogeneity 2 -9 Services cannot be stored. No patent protection. Cannot display or Services benefits expire communicate services. quickly. directly Customer Price difficult to set. Services may be repeated involved with often for oneofcustomer. production service. Centralized mass production of in services Wide variation service difficult. products possible. Derived Properties

Interface of Services with Management Accounting 1. 2. 3. 4. 2 -10 No inventories. Strong ethical code. Intangibility Price difficult to set. Demand for more accurate No inventories. Costs often accounted for Perishability cost for assignments. Need standards and by customer type. consistent high quality. Demand for and measure. Productivity quality Inseparability ment and control measurement andof quality to maintain control must be Heterogeneity consistency. ongoing. Total quality manage. Impact on Management Accounting ment critical.

2 -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.

2 -12 Design Service Develop Distribute Produce Market

Product Costing Definitions Operating Product Costs Traditional Product Costs Production Marketing Customer Service Value-Chain Product Costs Managerial objectives served 2 -13 Research and Development Pricing Decisions Strategic Design Decisions Product-Mix Decisions Tactical Profitability Strategic Profitability Analysis External Financial Reporting

2 -14 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

2 -15 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

2 -16 Overhead are all other production costs. Ø Depreciation on building and equipment Ø Maintenance Ø Supplies Ø Supervision Ø Power Ø Property taxes

2 -17 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)

2 -18 Prime Cost : Direct Materials Costs + Direct Labor Costs Conversion Cost: Direct Labor Costs + Overhead Costs

2 -19 External Financial Statements

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

Statement of Cost of Goods Manufactured For the Year Ended December 31, 2004 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 2 -21 2 -21

2 -22 Total manufacturing costs added Add: Beginning work in process Total manufacturing costs Less: Ending work in process Cost of goods manufactured Work in process consists of all partially completed units found in production at a given point in time. $1, 400, 000 200, 000 $1, 600, 000 400, 000 $1, 200, 000

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

Functional-Based Management Model 2 -24 Cost View Resources Operational View Efficiency Analysis Functions Products Performance Analysis

Activity-Based Management Model 2 -25 Cost View Resources Process View Driver Analysis Activities Performance Analysis Why? What? How Well? Products and Customers

Functional-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 Activity-Based 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 2 -26

2 -27 Chapter Two The End

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