2-1 Copyright © 2004 by Nelson, a division of Thomson Canada Limited. Basic Management Accounting Concepts 2 PowerPresentation® prepared by David J. McConomy, Queen’s University

2-2 Copyright © 2004 by Nelson, a division of Thomson Canada Limited. Learning Objectives Explain the cost assignment process. Define tangible and intangible products and explain why there are different product cost definitions.

2-3 Copyright © 2004 by Nelson, a division of Thomson Canada Limited. Learning Objectives l Prepare income statements for manufacturing and service organizations. l Outline the differences between functional-based and activity-based management accounting systems.

2-4 Copyright © 2004 by Nelson, a division of Thomson Canada Limited. 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. Opportunity cost is the benefit given up or sacrificed when one alternative is chosen over another. An expense is an expired cost or a cost used up in the production of revenues.

2-5 Copyright © 2004 by Nelson, a division of Thomson Canada Limited. l A cost object is any item for which costs are measured and assigned. l An activity is a basic unit of work performed within an organization. Costs and Activities

2-6 Copyright © 2004 by Nelson, a division of Thomson Canada Limited. Cost 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 are those costs that can be easily and accurately traced to a cost object. Indirect costs are those costs that cannot be easily and accurately traced to a cost object.

2-7 Copyright © 2004 by Nelson, a division of Thomson Canada Limited. Methods Of Tracing Tracing is the actual assignment of costs to a cost object using an observable measure of the resources consumed by the cost object. Direct tracing is the process of identifying and assigning costs that are specifically or 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 Copyright © 2004 by Nelson, a division of Thomson Canada Limited. Assigning Indirect Costs Indirect Costs l Cannot be assigned directly l No causal relationship exists l Must assume a linkage

2-9 Copyright © 2004 by Nelson, a division of Thomson Canada Limited. Cost Assignment Methods Cost of Resources Direct Tracing Driver Tracing Allocation Physical Observation Causal Relationship Assumed Relationship Cost Objects

2-10 Copyright © 2004 by Nelson, a division of Thomson Canada Limited. Interface of Services with Management Accounting 1. Intangibility 2. Perishability 3. Inseparability 4. Heterogeneity

2-11 Copyright © 2004 by Nelson, a division of Thomson Canada Limited. Intangibility Derived Properties Impact on Management Accounting *Many of these effects are also true of tangible products. Services cannot be stored.No inventories. No patent protection.Strong ethical code.* Cannot display or communicate services. Price difficult to set.Demand for more accurate cost assignment.*

2-12 Copyright © 2004 by Nelson, a division of Thomson Canada Limited. Perishability Derived Properties Impact on Management Accounting *Many of these effects are also true of tangible products. Service benefits expire quickly.No inventories. Services may be repeated oftenNeed for standards and for one customer.consistent high quality.*

2-13 Copyright © 2004 by Nelson, a division of Thomson Canada Limited. Inseparability Derived Properties Impact on Management Accounting *Many of these effects are also true of tangible products. Customer directly involvedCosts often accounted for by with production of service.customer type.* Centralized mass production Demand for measurement and of services difficult.control of quality to maintain consistency.*

2-14 Copyright © 2004 by Nelson, a division of Thomson Canada Limited. Heterogeneity Derived Properties Impact on Management Accounting *Many of these effects are also true of tangible products. Wide variation in service Productivity and quality product possible. measurement and control must be ongoing.* Total quality management critical*

2-15 Copyright © 2004 by Nelson, a division of Thomson Canada Limited. Product Costing Definitions Research and Development Production Marketing Production Marketing Production Pricing Decisions Product-Mix Decisions Strategic Profitability Analysis Strategic Design Decisions Tactical Profitability Analysis External Financial Reporting Value-Chain Operating Traditional Product Costs Product Costs Product costs Customer Service

2-16 Copyright © 2004 by Nelson, a division of Thomson Canada Limited. Production Costs Direct materials are those materials that are directly traceable to the goods or services being produced. Direct labour is the labour that is directly traceable to the goods or services being produced. Overhead are all other production costs.

2-17 Copyright © 2004 by Nelson, a division of Thomson Canada Limited. Nonproduction Costs Marketing (selling) costs are the costs necessary to market, distribute, and service a product or service. 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.

2-18 Copyright © 2004 by Nelson, a division of Thomson Canada Limited. Further Distinction of Costs Prime Cost = Direct Materials Costs + Direct Labour Costs Conversion Cost = Direct Labour Costs + Overhead Costs

2-19 Copyright © 2004 by Nelson, a division of Thomson Canada Limited. Statement of COGM Direct Materials Used: Beginning inventory$200,000 Add: Purchases 450,000 Materials available$650,000 Less: Ending inventory 50,000$ 600,000 Direct Labour350,000 Manufacturing overhead: Indirect labour$122,500 Amortization177,500 Rent50,000 Utilities37,500 Property taxes12,500 Maintenance 50, ,000 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 ========

2-20 Copyright © 2004 by Nelson, a division of Thomson Canada Limited. Income Statement for a Manufacturing Organization 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 Income before taxes$ 500,000 ========

2-21 Copyright © 2004 by Nelson, a division of Thomson Canada Limited. Income Statement for a Service Organization Sales$300,000 Less expenses: Cost of services sold: Beginning work in process$ 5,000 Service costs added: Direct materials$ 40,000 Direct labour80,000 Overhead 100, ,000 Total$225,000 Less: Ending work in process 10, ,000 Gross margin$ 85,000 Less operating expenses: Selling expenses$ 8,000 Administrative expenses 22,000 30,000 Income before taxes$ 55,000 =======

2-22 Copyright © 2004 by Nelson, a division of Thomson Canada Limited. Comparison of FBM and ABM Accounting Systems Functional-Based Activity-Based 1.Unit-level drivers 1.Unit- and nonunit-level drivers 2.Allocation-intensive2.Tracing-intensive 3.Narrow, rigid product costing3.Broad, flexible product costing 4.Focus on managing cost4.Focus on managing activities 5.Sparse activity information5.Detailed activity information 6.Maximization of individual unit 6.Systemwide performance performancemaximization 7.Use of financial measures of 7.Use of both financial and performancenonfinancial measures of performance

2-23 Copyright © 2004 by Nelson, a division of Thomson Canada Limited. Functional-Based Management Model Cost View Operational View Efficiency AnalysisFunctionsPerformance Analysis Resources Products

2-24 Copyright © 2004 by Nelson, a division of Thomson Canada Limited. Activity-Based Management Model Cost View Process View Driver Analysis Activities Performance Analysis Resources Products and Customers Why? What? How Well?