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Basic Cost Basic Cost Management Management
ConceptsConceptsPrepared by
Douglas Cloud Pepperdine University
Prepared by Douglas Cloud
Pepperdine University
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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.
ObjectivesObjectivesObjectivesObjectives
After studying this After studying this chapter, you should chapter, you should
be able to:be able to:
After studying this After studying this chapter, you should chapter, you should
be able to:be able to:
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4. Prepare income statements for manufacturing and service organizations.
5. Explain the differences between traditional and contemporary cost management systems.
ObjectivesObjectivesObjectivesObjectives
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A Systems FrameworkA Systems FrameworkA Systems FrameworkA 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
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Output:Output:
Cooled AirCooled Air
Operational Model of an Air Conditioning SystemOperational Model of an Air Conditioning System
Cooling Process
Inputs:Inputs:
FreonFreon
Warm AirWarm Air
ElectricityElectricity
Delivery Process
Inputs:Inputs:
Cooled AirCooled Air
ElectricityElectricity
DuctsDucts
Output:Output:
Delivered Cooled AirDelivered Cooled Air
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Accounting Information SystemAccounting Information SystemAccounting Information SystemAccounting 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.
Like any system, an accounting information system consists of: (1) objectives, (2) interrelated
parts, (3) processes, and (4) outputs.
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ProcessesProcesses
Operational Model for an Operational Model for an Accounting Information SystemAccounting Information System
Operational Model for an Operational Model for an Accounting Information SystemAccounting Information System
Economic Events
CollectingClassifyingSummarizingAnalyzingManaging
Special ReportsFinancial StatementsBudgetsPerformance ReportsPersonal Communication
InputsInputs OutputsOutputs
UsersUsers
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Accounting Information SystemsAccounting 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.
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Accounting Information SystemsAccounting 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
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An Integrated Cost An Integrated Cost Management SystemManagement SystemAn Integrated Cost An Integrated Cost
Management SystemManagement System
Design andDevelopment
System
CustomerCustomerServicingServicingSystemSystem
Marketing andMarketing andDistributionDistribution
SystemSystem
CostManagement
System
ProductionProductionSystemSystem
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The Subsystems of the Accounting Information System
The Subsystems of the Accounting Information System
Financial AccountingFinancial AccountingInformation SystemInformation System
Accounting Information SystemAccounting Information System
Cost ManagementCost ManagementInformation SystemInformation System
OperationalControl System
Cost AccountingCost AccountingInformation SystemInformation System
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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.
Basic Cost ConceptsBasic Cost Concepts
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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.
Basic Cost ConceptsBasic Cost Concepts
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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.
Basic Cost ConceptsBasic Cost Concepts
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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.
Basic Cost ConceptsBasic Cost Concepts
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Cost Assignment MethodsCost Assignment MethodsCost Assignment MethodsCost Assignment Methods
Cost of ResourcesCost of Resources
DirectDirectTracingTracing
DriverDriverTracingTracing
AllocationAllocation
Resource Drivers
Cost ObjectsCost Objects
ActivityDrivers
ConvenienceAssumedLinkage
PhysicalObservation
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Product Cost Definitions
Pricing DecisionsProduct Mix DecisionsStrategic Profitability Analysis
Strategic Design DecisionsTactical Profitability Analysis
External FinancialReporting
Research andResearch andDevelopmentDevelopment
Research andResearch andDevelopmentDevelopment
ProductionProductionProductionProduction
MarketingMarketingMarketingMarketing
Customer ServiceCustomer ServiceCustomer ServiceCustomer Service
Value-Chain Product Costs
ProductionProductionProductionProduction
MarketingMarketingMarketingMarketing
Customer ServiceCustomer ServiceCustomer ServiceCustomer Service
Operating Product Costs
Traditional Product Costs
ProductionProductionProductionProduction
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Manufacturing CostsManufacturing CostsManufacturing CostsManufacturing 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.
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Marketing (selling) costs are the costs necessary to market, distribute, and service a product or service.
Example: Advertising, storage costs, and freight out.
Nonproduction CostsNonproduction CostsNonproduction CostsNonproduction Costs
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.
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Nonproduction CostsNonproduction CostsNonproduction CostsNonproduction Costs
For external financial reporting, marketing and
administrative costs are not inventoried. They are
referred to as period costs.
For external financial reporting, marketing and
administrative costs are not inventoried. They are
referred to as period costs.
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Production or Production or Manufacturing Manufacturing
CostsCosts
Nonproduction Nonproduction or Operating or Operating
CostsCosts
Direct Materials
Direct Labor
Overhead
Prime Cost
Conversion Cost
Marketing ExpenseMarketing ExpenseOrder-Getting CostsOrder-Getting CostsOrder-Filling CostsOrder-Filling Costs
Administrative Expense
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Manufacturing OrganizationManufacturing OrganizationIncome StatementIncome Statement
For the Year Ended December 31, 2004For 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 150,000 450,000
Operating income $ 250,000
From the Cost of Goods Sold
Schedule
From the Cost of Goods Sold
Schedule
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Direct materials:Beginning inventory $200,000Add: Purchases 450,000Materials available $650,000Less: Ending inventory 50,000Direct materials used in production $ 600,000
Direct labor 350,000Manufacturing overhead:
Indirect labor $122,500Depreciation 177,500Rent 50,000Utilities 37,500Property taxes 12,500Maintenance 50,000 450,000
Total manufacturing costs added $1,400,000
Statement of Cost of Goods ManufacturedStatement of Cost of Goods ManufacturedFor the Year Ended December 31, 2004For the Year Ended December 31, 2004
continuedcontinued
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Total manufacturing costs added $1,400,000Add: Beginning work in process 200,000Less: Ending work in process 400,000Cost of goods manufactured $1,200,000
Work in process consists of all partially completed units found in
production at a given point in time.
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Cost of Goods Sold ScheduleCost of Goods Sold Schedule For the Year Ended December 31, 2004For the Year Ended December 31, 2004
Cost of goods manufactured $1,200,000
Add: Beginning inventory finished goods 250,000
Cost of goods available for sale $1,450,000
Less: Ending inventory finished goods 150,000
Cost of goods sold $1,300,000
From the Statement of
Cost of Goods Manufactured
From the Statement of
Cost of Goods Manufactured
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Activity-Based Management ModelCost View
Driver Analysis
Process View
Performance Performance AnalysisAnalysisActivitiesActivities
Products and Products and CustomersCustomers
Why? What? How well?
ResourcesResources
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Functional-Based and Activity-Based Cost Management SystemsFunctional-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
Functional-Based
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Functional-Based and Activity-Based Cost Management SystemsFunctional-Based and Activity-
Based Cost Management Systems
Activity-Based1. 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
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Low Accuracy
High Accuracy
Optimal Level
Measurement Cost
Cost
Error Cost
Total Cost
Trade-Off Between Measurement and Error CostsTrade-Off Between Measurement and Error CostsTrade-Off Between Measurement and Error CostsTrade-Off Between Measurement and Error Costs
2-30 Low High Accuracy
New Measurement Cost
Cost
Old Error Cost
Shifting CostsShifting CostsShifting CostsShifting Costs
Old Optimum
Old Measurement Cost
New Error Cost
New Optimum
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