Basic Management Accounting Concepts

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CHAPTER

Basic Management Accounting Concepts

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Objectives Objectives 1. Describe the cost assignment process. After After studying studying this this 2. Define tangible and intangible products and chapter, you should chapter, you should explain why there are different product cost be able to: be able to: definitions. 3. Prepare income statements for manufacturing and service organizations. 4. Outline the differences between functional-based and activity-based management accounting systems.

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Exactly Exactlywhat whatisismeant meant by by“cost”? “cost”?

IIsee… see… It’s It’saa dollar dollarmeasure measureof of the theresources resourcesused used totoachieve achieveaagiven given benefit. benefit.

Cost Costisisthe thecash cashor orcashcashequivalent value sacrificed equivalent value sacrificedfor for goods goodsand andservices servicesthat thatisis expected expectedto tobring bringaacurrent currentor or future benefit to the organization. future benefit to the organization.

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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: 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.

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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 cause-and-effect relationship. Direct costs are 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.

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Indirect costs are 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.

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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 tracing is the process of identifying and assigning costs that are exclusively and 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.

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Cost Cost Assignment Assignment Methods Methods Cost of Resources

Direct Tracing

Driver Tracing

Allocation

Physical Observation

Causal Relationship

Assumed Relationship

Cost Objects

Interface of Services with Management Accounting

1.

2. 3. 4.

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

Interface of Services with Management Accounting

1.

2. 3. 4.

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No No inventories. inventories. Strong Strong ethical ethical code. code. Price Intangibility Price difficult difficult to to set. set. Demand for more accurate No inventories. Demand for more accurate No inventories. Costs often accounted Costs often accounted cost assignments. Perishability Need for standards and cost assignments. Need for standardstype. and for by customer for by customer type. consistent high quality. consistent high quality. Demand for measureProductivity and quality Demand for measureProductivity and quality Inseparability ment measurement and ment and and control control of measurement andof quality to maintain control must be quality to maintain control must be Heterogeneity consistency. ongoing. consistency. ongoing. Total quality manageTotal quality manageImpact on Management Impact on Management ment critical. ment critical. Accounting Accounting

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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.

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Design

Service

Develop

Distribute

Produce

Market

Product Costing Definitions Operating Product Costs

Traditional Product Costs

Production

Production

Production

Marketing

Marketing

Customer Service

Customer Service

Value-Chain Product Costs

Managerial objectives served

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Research and Development

Pricing Decisions Strategic Design Decisions Product-Mix Decisions Tactical Profitability Strategic Profitability Analysis Analysis

External Financial Reporting

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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

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Direct labor is 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

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Overhead are all other production costs.  Depreciation on building and equipment  Maintenance  Supplies  Supervision  Power  Property taxes

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Noninventoriable Noninventoriable (period) (period) costs costs are are expensed expensed in in the the period period in in which which they they are are incurred. incurred.  Salaries and commissions of sales personnel (marketing)  Advertising (marketing)  Legal fees (administrative)  Printing the annual report (administrative)

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Prime Cost : Direct Materials Costs + Direct Labor Costs

Conversion Cost: Direct Labor Costs + Overhead Costs

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External Financial Statements

Manufacturing Organization Income Statement For the Year Ended December 31, 2004 Sales

$2,800,000

Less cost of goods sold: Beginning finished goods inventory Add: Cost of goods manufactured Cost of goods available for sale Less: Ending finished goods inventory

$ 500,000 1,200,000 $1,700,000 300,000 1,400,000

Gross margin

$1,400,000

Less operating expenses: Selling expenses Administrative expenses Income before taxes

$ 600,000 300,000

900,000 $ 500,000

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Statement of Cost of Goods Manufactured For the Year Ended December 31, 2004 Direct materials: Beginning inventory Add: Purchases Materials available Less: Ending inventory Direct materials used Direct labor Manufacturing overhead: Indirect labor Depreciation Rent Utilities Property taxes Maintenance Total manufacturing costs added

$200,000 450,000 $650,000 50,000

$122,500 177,500 50,000 37,500 12,500 50,000

continued continuedon onnext nextslide slide

$ 600,000 350,000

450,000 $1,400,000

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Total manufacturing costs added Add: Beginning work in process Total manufacturing costs Less: Ending work in process Cost of goods manufactured

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

$1,400,000 200,000 $1,600,000 400,000 $1,200,000

Service Organization Income Statement For the Year Ended December 31, 2004 Sales Less expenses: Cost of services sold: Beginning work in process Service costs added: Direct materials Direct labor Overhead Total Less: Ending work in process Gross margin Less operating expenses: Selling expenses Administrative expenses Income before income taxes

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$300,000

$ 5,000 $ 40,000 80,000 100,000

220,000 $225,000 10,000

$

8,000 22,000

215,000 $ 85,000

30,000 $ 55,000

Functional-Based Functional-Based Management Management Model Model Cost View

Resources Operational View

Efficiency Analysis

Functions

Products

Performance Analysis

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Activity-Based Activity-Based Management Management Model Model

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Cost View

Resources Process View

Driver Analysis

Activities

Performance Analysis

Why?

What?

How Well?

Products and Customers

Functional-Based 1. Unit-based drivers

Activity-Based

2. Allocation-intensive

1. Unit- and nonunit-based drivers 2. Tracing intensive

3. Narrow and rigid product costing

3. Broad, flexible product costing

4. Focus on managing cost

4. Focus on managing activities 5. Detailed activity information

5. Sparse activity information 6. Maximization of individual unit performance

6. Systematic performance maximization

7. Use of financial measures of performance

7. Use of both financial and nonfinancial measures of performance

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Chapter Two

The The End End

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