1. © 2007 Pearson Education Canada Slide 4-1 Cost Management Systems 4

2. © 2007 Pearson Education Canada Slide 4-2 Cost Management Systems Cost a sacrifice or giving up of resources for a particular purpose Cost Objective a department, service or product for which cost information is collected Direct Cost a cost which can be identified specifically and exclusively with a given cost objective in an economically feasible way examples: direct material and direct labour Indirect Cost a cost which cannot be identified specifically and exclusively with a given cost objective in an economically feasible way factory overhead cost (or factory burden) all factory costs other than direct material and direct labour power, supplies, indirect labor, supervisory salaries, property taxes, rent, insurance and depreciation

3. © 2007 Pearson Education Canada Slide 4-3 Cost Accumulation and Assignment Raw material costs (metals) Machining Department Finishing Department Product X-1 (Cabinets) Product X-1 (Cabinets) Product Y-1 (Desks) Product Y-1 (Desks) Product Z-1 (Tables) Product Z-1 (Tables) 1. Cost Accumulation 2.Cost charged to cost objectives a.To departments b.To products

4. © 2007 Pearson Education Canada Slide 4-4 Manufacturing Costs Prime Costs Direct material and direct labour costs in many companies direct labour has become so insignificant that it is simply lumped in with overhead Conversion Costs Direct labour and factory overhead costs cost of converting material into finished product Direct Materials Direct Labour Factory Overhead Prime Costs Conversion Costs

5. © 2007 Pearson Education Canada Slide 4-5 Classification of Labour-Related Costs Forklift truck operators (internal handling of materials) Maintenance Production setup Expediting (overseeing special and rush orders) Janitors Plant guards Rework labour Overtime premium (factory workers) Idle time Managers’ salaries Employee benefit costs (e.g. pension costs)

6. © 2007 Pearson Education Canada Slide 4-6 Product and Period Costs - Retailer Product Cost cost identified with goods purchased for resale are expensed only when product is sold Period Cost costs which are expensed during the current period without going through an inventory stage Merchandise Inventory Cost of Goods Sold Balance SheetIncome Statement Product Costs Selling & Administrative Expenses Period Costs

7. © 2007 Pearson Education Canada Slide 4-7 Product and Period Costs - Manufacturer Product Cost cost identified with goods produced are expensed only when product is sold Period Cost costs which are expensed during the current period without going through an inventory stage Direct Material Inventory Work in Process Inventory Finished Goods Inventory Cost of Goods Sold Balance SheetIncome Statement Product Costs Selling & Administrative Expenses Period Costs

8. © 2007 Pearson Education Canada Slide 4-8 Cost Behaviour and Income Statements Absorption Income Statement Sales$20,000 Cost of Goods Sold: Direct material$7,000 Direct labour4,000 Factory overhead4,00015,000 Gross margin5,000 Selling expenses3,000 Administrative expenses1,000 Total selling & administrative expenses4,000 Operating Income$1,000 Contribution Income Statement Sales$20,000 Variable expenses: Direct material$7,000 Direct labour4,000 Variable overhead1,000 Variable selling1,000 Variable administrative 100 Total variable expenses13,100 Contribution margin6,900 Fixed expenses: Manufacturing$3,000 Selling 2,000 Administrative 900 Total fixed expenses5,900 Operating Income$1,000

9. © 2007 Pearson Education Canada Slide 4-9 Period and Product Costs Absorption Costing Variable Selling & Administrative Fixed Selling & Administrative Fixed Manufacturing Overhead Variable Manufacturing Contribution Costing Variable Selling & Administrative Fixed Selling & Administrative Fixed Manufacturing Overhead Variable Manufacturing Period Costs Product Costs

10. © 2007 Pearson Education Canada Slide 4-10 Variable & Absorption Costing Variable Costing Income Statement Also called "direct" or "variable" Classify costs based on behaviour Inventory comprised of variable production costs only Net income is a function of sales Absorption Costing Income Statement Also called "full" costing Classify costs by function - selling & administration versus manufacturing Inventory comprised of variable and fixed production costs Net income is a function of sales and production Converting Between the Two Models of Income Difference in net income is equal to the dollar change in the value assigned to inventories on the two statements Revenue Variable Costs Contribution Margin Fixed Costs Net Income Revenue Cost of Goods Sold Gross Margin Sell & Admin Costs Net Income

11. © 2007 Pearson Education Canada Slide 4-11 Cost Flows: Variable Costing Costs to Account For Inventoried Costs on Balance Sheet Expense on Income Statement Become expenses immediately Initially applied to inventory as unexpired costs Direct material Direct labour Variable manufacturing overhead All selling & administrative costs Fixed manufacturing overhead As goods are sold Expires immediately Become expenses when inventory is sold

12. © 2007 Pearson Education Canada Slide 4-12 Cost Flows: Absorption Costing Costs to Account For Inventoried Costs on Balance Sheet Expense on Income Statement Direct material Direct labour Variable manufacturing overhead Fixed manufacturing overhead Become expenses when inventory is sold Become expenses immediately Initially applied to inventory as unexpired costs As goods are sold Expires immediately All selling & administrative costs

13. © 2007 Pearson Education Canada Slide 4-13 Fixed Manufacturing Overhead & Absorption Costing Firms use a fixed overhead rate to smooth the application of overhead to work in process and determine "full" product costs Fixed =Budgeted fixed manufacturing overhead overhead rateExpected volume of production Production Actual-Expectedxfixed-overhead volume=volumevolumerate variance

14. © 2007 Pearson Education Canada Slide 4-14 Flow of Fixed Manufacturing Costs - Variable Fixed Manufacturing Overhead Incurred Inventoried Costs on Balance Sheet Expense on Balance Sheet $150,000 None

15. © 2007 Pearson Education Canada Slide 4-15 Flow of Fixed Manufacturing Costs - Absorption Fixed Manufacturing Overhead Incurred Inventoried Costs on Balance Sheet Expense on Balance Sheet $150,000 Fixed-overhead costs in beginning inventory: $30,000 Costs added to product: $140,000 Fixed-overhead costs in ending inventory: $10,000 $140,000 Cost of goods sold: $30,000 + $140,000 - $10,000 = $160,000 $10,000 Unfavourable production volume variance: $10,000 Total expense = $170,000

16. © 2007 Pearson Education Canada Slide 4-16 Segment Reporting Reporting the contribution of a business unit or segment Any business unit this is important enough to warrant a segmented reporting Variable costing is better suited than absorption costing to evaluate segment i.e. allows us to evaluate the contributions to the company’s profitability of various product lines, divisions, departments, or business segments