2 -1

CHAPTER
Basic
Management
Accounting
Concepts
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Objectives
1. Describe theAfter
cost assignment
studying thisprocess.
2. Define tangible and intangible
chapter, you shouldproducts and
explain why therebeare different
able to: 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.
 2 -3

CostI see… It’s aordollar

is the cash cash-equivalent value
sacrificed for goods
measure of the and services that is
expected to bring
resources used atocurrent orExactly
future what is
benefit atogiven
achieve meant by “cost”?
the organization.
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: 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 Driver
Allocation
Tracing Tracing

Physical Causal Assumed

Observation Relationship Relationship

Cost Objects
 Interface of Services with 2 -9

Management Accounting
Services cannot be stored.
No patent protection.
1. Intangibility Cannot display or
Services benefits expire
communicate services.
2. Perishability quickly. directly
Customer
Price difficult to set.
Services
involvedmay be repeated
with
3. Inseparability often for oneofcustomer.
production service.
Centralized mass
4. Heterogeneity production
Wide of in
variation services
service
difficult.
products possible.
Derived Properties
 Interface of Services with 2 -10

Management Accounting
No inventories.
Strong ethical code.
1. Intangibility Price difficult to set.
Demand for more accurate
No inventories.
2. Perishability Costs often accounted
cost for
Need assignments.
standards and
for by customer type.
consistent high quality.
3. Inseparability Demand for and
Productivity measure-
quality
ment and control
measurement andof
4. Heterogeneity quality to
control maintain
must be
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.
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Design

Service Develop

Distribute Produce

Market
 Product Costing Definitions 2 -13

Value-Chain Operating Product Traditional Product

Product Costs Costs Costs
Research and
Development

Production Production Production

Marketing Marketing

Customer Customer
Service Service
Pricing Decisions Strategic Design Decisions External Financial
Product-Mix Decisions Tactical Profitability Reporting
Strategic Profitability Analysis
Analysis
 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
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Manufacturing Costs
Click
Here

Direct Direct Manufacturing

Materials Labor Overhead

The Product
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Direct Materials
Click
Here

Those materials that become

an integral part of the product and
that can be conveniently traced directly to it.

Example: A radio installed in an automobile

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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
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Direct Labor
Click
Here

Those labor costs that can be easily traced to

individual units of product.

Example: Wages paid to automobile assembly workers

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Manufacturing Overhead
Click
Here

Manufacturing costs that cannot be traced directly to

specific units produced.

Examples: Indirect labor and indirect materials

Wages paid to employees Materials used to support

who are not directly the production process.
involved in production.
Examples:
Examples: lubricants and cleaning
maintenance workers, supplies used in the
janitors and security guards. automobile assembly plant.
 2 -20

Overhead are all other production costs.

 Depreciation on building
and equipment
 Maintenance
 Supplies
 Supervision
 Power
 Property taxes
 2 -21

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)
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2 -22
Manufacturing Cost Flows
Click
Here

Income
Balance Sheet Statement
Costs Inventories Expenses
Material Purchases Raw Materials

Direct Labor Work in

Process
Manufacturing
Overhead Cost of
Finished
Goods
Goods
Sold

Selling and Selling and

Period
Administrative Administrative
Costs Expenses
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Prime Cost :
Direct Materials Costs + Direct Labor Costs

Conversion Cost:
Direct Labor Costs + Overhead Costs
 2 -24

External
Financial
Statements
 Manufacturing Organization 2 -25
2-20

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
 Statement of Cost of Goods Manufactured 2 -26
2-21

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 -27

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 2 -28
2-23

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 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 2 -29

Management Model
Cost View

Resources

Operational View

Efficiency Performance
Functions
Analysis Analysis

Products
 Activity-Based 2 -30

Management Model
Cost View

Resources

Process View

Driver Performance
Activities
Analysis 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
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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 -32

Chapter Two

The End
2 -33