© 2007 Pearson Education Canada Slide 4-1

Cost ManagementSystems

4

© 2007 Pearson Education Canada Slide 4-2

Cost Management SystemsCost• 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

© 2007 Pearson Education Canada Slide 4-3

Cost Accumulation and Assignment

Raw material costs (metals)

Machining Department Finishing Department

ProductX-1

(Cabinets)

ProductX-1

(Cabinets)

ProductY-1

(Desks)

ProductY-1

(Desks)

ProductZ-1

(Tables)

ProductZ-1

(Tables)

1. CostAccumulation

2. Cost chargedto cost objectives

a. To departments

b. To products

© 2007 Pearson Education Canada Slide 4-4

Manufacturing CostsPrime 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

DirectMaterials

DirectLabour

FactoryOverhead

Prime Costs

Conversion Costs

© 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)

© 2007 Pearson Education Canada Slide 4-6

Product and Period Costs - RetailerProduct 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

MerchandiseInventory

Cost ofGoods Sold

Balance Sheet Income Statement

Product Costs

Selling &Administrative

ExpensesPeriodCosts

© 2007 Pearson Education Canada Slide 4-7

Product and Period Costs - ManufacturerProduct 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

DirectMaterial

Inventory

Work inProcess

Inventory

FinishedGoods

Inventory

Cost ofGoods Sold

Balance Sheet Income Statement

Product Costs Selling &Administrative

ExpensesPeriodCosts

© 2007 Pearson Education Canada Slide 4-8

Cost Behaviour and Income Statements

Absorption Income Statement

Sales $20,000Cost of Goods Sold:Direct material $7,000Direct labour 4,000Factory overhead 4,000 15,000

Gross margin 5,000

Selling expenses 3,000Administrative

expenses 1,000Total selling & administrative expenses 4,000

Operating Income $1,000

Contribution Income Statement

Sales $20,000Variable expenses:Direct material $7,000Direct labour 4,000Variable overhead 1,000Variable selling 1,000Variable administrative 100Total variable expenses 13,100Contribution margin 6,900Fixed expenses:Manufacturing $3,000Selling 2,000Administrative 900Total fixed expenses 5,900Operating Income $1,000

© 2007 Pearson Education Canada Slide 4-9

Period and Product Costs

AbsorptionCosting

Variable Selling& Administrative

Fixed Selling& Administrative

Fixed ManufacturingOverhead

Variable Manufacturing

Contribution

Costing

Variable Selling& Administrative

Fixed Selling& Administrative

Fixed ManufacturingOverhead

Variable Manufacturing

Period

Costs

Product

Costs

© 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

RevenueVariable Costs

Contribution MarginFixed CostsNet Income

RevenueCost of Goods Sold

Gross MarginSell & Admin Costs

Net Income

© 2007 Pearson Education Canada Slide 4-11

Cost Flows: Variable Costing

Costs to Account ForInventoried Costson Balance Sheet

Expense onIncome Statement

Becomeexpenses

immediately

Initially applied to

inventory asunexpired

costs

Direct material

Direct labour

Variable manufacturingoverhead

All selling & administrative costs

Fixed manufacturingoverhead

As goods

are sold

Expiresimmediately

Becomeexpenses

when inventoryis sold

© 2007 Pearson Education Canada Slide 4-12

Cost Flows: Absorption Costing

Costs to Account ForInventoried Costson Balance Sheet

Expense onIncome Statement

Direct material

Direct labour

Variable manufacturingoverhead

Fixed manufacturingoverhead

Becomeexpenses

when inventoryis sold

Becomeexpenses

immediately

Initially applied

toinventory

asunexpired

costs

As goods

are sold

Expires

immediately

All selling & administrative costs

© 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 overheadoverhead rate Expected volume of production

Production Actual - Expected x fixed-overheadvolume = volume volume ratevariance

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Flow of Fixed Manufacturing Costs - Variable

Fixed Manufacturing

Overhead Incurred

Inventoried Costson Balance Sheet

Expense onBalance Sheet

$150,000 $150,000None

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Flow of Fixed Manufacturing Costs - Absorption

Fixed Manufacturing

Overhead Incurred

Inventoried Costson Balance Sheet

Expense onBalance 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

$10,000Unfavourable

production volume variance: $10,000

Total expense = $170,000

© 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