Basic Management Accounting Concepts

1. CHAPTER Basic Management Accounting Concepts

2. Objectives • Describe the cost assignment process. • Define tangible and intangible products and explain why there are different product cost definitions. • Prepare income statements for manufacturing and service organizations. • Outline the differences between functional-based and activity-based management accounting systems. After studying this chapter, you should be able to:

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

4. Cost Assignment 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 activityis a basic unit of work performed within an organization. Example:Setting up equipment, moving materials, maintaining equipment, designing products, etc.

5. Cost Assignment • 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 costsare 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.

6. Cost Assignment Indirect costsare 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.

7. Cost Assignment • 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 tracingis the process of identifying and assigning costs that are exclusively and physically associated with a cost object to that cost object. • Driver tracingis the use of drivers to assign costs to cost objects. Driversare observable causal factors that measure a cost object’s resource consumption.

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

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

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

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.

12. Design Service Develop Produce Distribute Market

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

14. Production Costs • 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

15. Production Costs Direct laboris 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

16. Production Costs Overheadare all other production costs. • Depreciation on building and equipment • Maintenance • Supplies • Supervision • Power • Property taxes

17. Nonproduction Costs 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)

18. Production Costs Prime Cost : Direct Materials Costs + Direct Labor Costs Conversion Cost: Direct Labor Costs + Overhead Costs

19. External Financial Statements

20. Manufacturing OrganizationIncome StatementFor the Year Ended December 31, 2004 2-20 • 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

21. Statement of Cost of Goods ManufacturedFor the Year Ended December 31, 2004 2-21 • 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

22. Work in process consists of all partially completed units found in production at a given point in time. 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

23. Service OrganizationIncome StatementFor the Year Ended December 31, 2004 2-23 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

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

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

26. Functional-Based Activity-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 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

27. Chapter Two The End