1. Basic Cost Management Concepts
Prepared by
Douglas Cloud Pepperdine University

2. After studying this chapter, you should be able to:
Objectives
1. Describe a cost management information system, its objectives, and its major subsystems, and indicate how it relates to other operating and information systems.
2. Explain the cost assignment process.
3. Define tangible and intangible products, and explain why there are different product cost definitions.
After studying this chapter, you should be able to:

3. Objectives
4. Prepare income statements for manufacturing and service organizations.
5. Explain the differences between traditional and contemporary cost management systems.

4. A Systems Framework
A system is a set of interrelated parts that performs one or more processes to accomplish specific objectives.
Example: An air conditioning system for a home

5. Operational Model of an Air Conditioning System
Cooling Process
Delivery Process
Inputs:
Cooled Air
Electricity
Ducts
Inputs:
Freon
Warm Air
Electricity
Output:
Cooled Air
Output:
Delivered Cooled Air

6. Accounting Information System
An accounting information system is a system consisting of interrelated manual and computer parts, using processes such as collecting, recording, summarizing, analyzing, and managing data to provide information to users.
Like any system, an accounting information system consists of: (1) objectives, (2) interrelated parts, (3) processes, and (4) outputs.

7. Operational Model for an Accounting Information System
Collecting
Classifying
Summarizing
Analyzing
Managing
Special Reports
Financial Statements
Budgets
Performance Reports
Personal Communication
Economic Events
Inputs
Processes
Outputs
Users

8. Accounting Information Systems
The financial accounting information system is an accounting information subsystem that is primarily concerned with producing outputs for external users.
The cost management information system is an accounting information subsystem that is primarily concerned with producing outputs for internal users using inputs and processes needed to satisfy management objectives.

9. Accounting Information Systems
The cost management information system has three broad objectives that provide information for--
1) Costing out services, products, and other objects of interest to management
2) Planning and control
3) Decision making

10. An Integrated Cost Management System
Design and
Development
System
Production
System
Cost
Management
System
Customer
Servicing
System
Marketing and
Distribution
System

11. The Subsystems of the Accounting Information System
Financial Accounting
Information System
Cost Management
Information System
Operational
Control System
Cost Accounting
Information System

12. Basic Cost Concepts
Cost is the cash or cash equivalent value sacrificed for goods and services that are expected to bring a current or future benefit to the organization.
Costs are incurred to produce future benefits.
Expired costs are called expenses.
Unexpired costs are classified as assets and appear on the balance sheet.
Assigning cost accurately to cost objects is crucial.

13. Basic Cost Concepts
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.

14. Basic Cost Concepts
Traceability is the ability to assign a cost to a cost object in an economically feasible way by means of a causal relationship.
Direct costs are those costs that can be easily and accurately traced to a cost object.
Example: The salary of a supervisor of a department, where the department is defined as the cost object.

15. Basic Cost Concepts
Indirect costs are those costs that cannot be traced easily and accurately to a cost object.
Example: The cost of heating and cooling a plant that manufactures five products.

16. Cost Assignment Methods
Cost of Resources
Direct
Tracing
Driver
Allocation
Resource Drivers
Cost Objects
Activity
Drivers
Convenience
Assumed
Linkage
Physical
Observation

17. Product Cost Definitions
Value-Chain Product Costs
Operating Product Costs
Traditional Product Costs
Research and
Development
Production
Marketing
Customer Service
Production
Marketing
Customer Service
Production
Pricing Decisions
Product Mix Decisions
Strategic Profitability
Analysis
Strategic Design
Decisions
Tactical Profitability
Analysis
External Financial
Reporting

18. Manufacturing Costs
Direct materials are those materials that are directly traceable to the goods or services being produced.
Example: The cost of wood in furniture.
Direct labor is the labor that is directly traceable to the goods or services being produced.
Example: Wages of assembly-line workers.
Overhead are all other manufacturing costs.
Example: Plant depreciation, utilities, property taxes, indirect materials, indirect labor, etc.

19. Nonproduction Costs
Marketing (selling) costs are the costs necessary to market, distribute, and service a product or service.
Example: Advertising, storage costs, and freight out.
Administrative costs are the costs associated with research, development, and general administration of the organization that cannot reasonably be assigned to either marketing or production.
Example: Legal fees, salary of the chief executive officer.

20. Nonproduction Costs
For external financial reporting, marketing and administrative costs are not inventoried. They are referred to as period costs.

21. Administrative Expense
Production or Manufacturing Costs
Nonproduction or Operating Costs
Direct Materials
Direct Labor
Overhead
Prime Cost
Marketing Expense
Order-Getting Costs
Order-Filling Costs
Conversion Cost
Administrative Expense

22. From the Cost of Goods Sold Schedule
Manufacturing Organization Income Statement For the Year Ended December 31, 2004
Sales $2,800,000
Less: Cost of goods sold 1,300,000
Gross margin $ 700,000
Less operating expenses:
Selling expenses $300,000
Administrative expenses 150, ,000
Operating income $ 250,000
From the Cost of Goods Sold Schedule

23. Statement of Cost of Goods Manufactured For the Year Ended December 31, 2004
Direct materials:
Beginning inventory $200,000
Add: Purchases ,000
Materials available $650,000
Less: Ending inventory ,000
Direct materials used in production $ 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

24. Total manufacturing costs added $1,400,000
Add: Beginning work in process ,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.

25. Cost of Goods Sold Schedule For the Year Ended December 31, 2004
Cost of goods manufactured $1,200,000
Add: Beginning inventory finished goods ,000
Cost of goods available for sale $1,450,000
Less: Ending inventory finished goods ,000
Cost of goods sold $1,300,000
From the Statement of Cost of Goods Manufactured

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

27. Functional-Based and Activity-Based Cost Management Systems
1. Unit-based drivers
2. Allocation-intensive
3. Narrow and rigid product costing
4. Focus on managing costs
5. Sparse activity information
6. Maximization of individual unit performance
7. Uses financial measures of performance

28. Functional-Based and Activity-Based Cost Management Systems
1. Unit- and nonunit-based drivers
2. Tracing intensive
3. Broad, flexible product costing
4. Focus on managing activities
5. Detailed activity information
6. Systemwide performance maximization
7. Uses both financial and nonfinancial measures of performance

29. Trade-Off Between Measurement and Error Costs
Total Cost
Measurement Cost
Error Cost
High Accuracy
Low Accuracy
Optimal Level

30. Shifting Costs Cost Old Optimum New Optimum Low Accuracy High
Old Measurement Cost
New Measurement Cost
New Error Cost
Old Error Cost
Old Optimum
New Optimum
Low
Accuracy
High

31. End of
Chapter