Chapter 4

4 - 1©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton

Chapter 4

Cost Management Systems

and Activity-Based Costing

4 - 2

©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton

Learning Objective 1

Describe the purposes of

cost management systems.

4 - 3


Cost Management System

A cost-management system (CMS) is a collection of tools and techniques thatidentifies how management’s decisions affect costs.

4 - 4


What is Cost Accounting?

Cost accounting is that part of theaccounting system that measures costsfor the purposes of management decisionmaking and financial reporting.

4 - 5



Explain the relationships

among cost, cost objective,

cost accumulation, and

cost allocation.

4 - 6


Cost Accounting System

CostAccumulation

Collecting costs by some“natural” classificationsuch as materials or labor

CostAllocation

Tracing costs to one or more cost objectives

4 - 7


Cost Accounting System

MACHININGDEPARTMENT

ACTIVITY ACTIVITY

FINISHINGDEPARTMENT

ACTIVITY ACTIVITY

RAW MATERIALCOSTS (METALS

CABINETS CABINETS

DESKS DESKS

TABLESTABLES

Cost Accumulation

Cost Allocationto Cost Objects:

1. Departments

2. Activities

3. Products

4 - 8


Cost

A cost may be defined as a sacrifice or giving up of resources for a particular purpose.

Costs are frequently measured by the monetary units that must be paid for goods and services.

4 - 9


Cost Objective

What is a cost object or cost objective?

It is anything for which a separate measurementof costs is desired.

4 - 10



Distinguish among direct,

indirect, and unallocated costs.

4 - 11


Direct Costs

Direct costs can be identified specifically and exclusively with a given costobjective in an economicallyfeasible way.

What are direct costs?

4 - 12


Indirect Costs

Indirect costs cannot be identifiedspecifically and exclusively with agiven cost objective in an economicallyfeasible way.

What are indirect costs?

4 - 13


What Distinguishes Direct and Indirect Costs?

Managers prefer to classify costs as direct rather than indirect whenever it is “economically feasible” or “cost effective.”

Other factors also influence whether a cost is considered direct or indirect.

The key is the particular cost objective.

4 - 14


Categories of Manufacturing Costs

Any raw material, labor, or other inputused by any organization could,in theory, be identified as adirect or indirect costdepending on thecost objective.

4 - 15


Categories of Manufacturing Costs

All costs which are eventually allocated to products are classified as either…

1 direct materials,2 direct labor, or3 indirect manufacturing.

4 - 16


Direct Material Costs...

– include the acquisition costs of all materials that are physically identified as a part of the manufactured goods and that may be traced to the manufactured goods in an economically feasible way.

4 - 17


Direct Labor Costs...

– include the wages of all labor that can be traced specifically and exclusively to the manufactured goods in an economically feasible way.

4 - 18


Indirect Manufacturing Costs...

– or factory overhead, include all costs associated with the manufacturing process that cannot be traced to the manufactured goods in an economically feasible way.

4 - 19


Product Costs...

– are costs identified with goods produced or purchased for resale.

Product costs are initially identified as part of the inventory on hand.

These costs, inventoriable costs, become expenses (in the form of cost of goods sold) only when the inventory is sold.

4 - 20


Period Costs...

– are costs that are deducted as expenses during the current period without going through an inventory stage.

1 2 3

4 5 6 7 8 9 10

11 12 13 14 15 16 17

18 19 20 21 22 23 24

25 26 28 29 30 3127

4 - 21


Period or Product Costs

In merchandising accounting, insurance, depreciation, and wages are period costs (expenses of the current period).

In manufacturing accounting, many of these items are related to production activities and thus, as indirect manufacturing, are product costs.

4 - 22


Period Costs – Merchandising and Manufacturing

In both merchandising and manufacturing accounting, selling and general administrative costs are period costs.

4 - 23



Explain how the financial

statements of merchandisers

and manufacturers differ

because of the types of goods

they sell.

4 - 24


Financial Statement Presentation– Merchandising Companies

MerchandiseInventory

MerchandiseInventory

SalesSales

Cost of Goods Sold(an expense)


Selling andAdministrative

Expenses


Expenses

Balance Sheet Income Statement

–

Equals Gross Margin

Equals Operating Income

–

Expiration

PeriodCosts

4 - 25


Financial Statement Presentation– Manufacturing Companies

FinishedGoods

Inventory

FinishedGoods

Inventory

SalesSales




Expenses


Expenses

Balance Sheet Income Statement

–

Equals Gross Margin

Equals Operating Income

–

Expiration

PeriodCosts

DirectMaterial

Inventory

DirectMaterial

Inventory

Work-in-Process

Inventory

Work-in-Process

Inventory

4 - 26


Costs and Income Statements

On income statements, the detailed reporting of selling and administrative expenses is typically the same for manufacturing and merchandising organizations, but the cost of goods sold is different.

4 - 27


Cost of Goods Sold for a Manufacturer

The manufacturer’s cost of goods produced and then sold is usually composed of the three major categories of cost:

1 Direct materials2 Direct labor3 Indirect manufacturing

4 - 28


Cost of Goods Soldfor a Retailer or Wholesaler

The merchandiser’s cost of goods sold is usually composed of the purchase cost of items, including freight-in, that are acquired and then resold.

4 - 29



Understand the main

differences between traditional

and activity-based costing

systems and why ABC systems

provide value to managers.

4 - 30


Traditional Cost SystemAll

UnallocatedValue Chain

Costs

DirectMaterialResource

DirectLabor

Resource

AllIndirect

Resources

Products

DirectTrace

DirectTrace Cost

Driver

Unallocated

4 - 31


Two-Stage Activity-BasedCost System

AllUnallocatedValue Chain

Costs

DirectMaterialResource

DirectLabor

Resource

IndirectResource

A

Products

DirectTrace

DirectTrace Activity

1

Unallocated

OtherDirect

Resources

IndirectResource

Z

Activity10

% % % %

CostDriver

CostDriver

4 - 32


Activity-Based Costing

Understanding the relationships among activities, resources, costs, and cost drivers is the key to understanding ABC and how ABC facilitates managers’ understanding of operations.

4 - 33


Example of Activities and Cost Drivers:

Activities:Account billingBill verificationAccount iniquityCorrespondence

Cost Drivers:No. of lines No. of accountsNo. of labor hoursNo. of letters

Activity-Based Costing

4 - 34



Identify the steps involved in the

design and implementation

of an activity-based

costing system.

4 - 35


Designing and Implementing an Activity-Based Costing System

Determine cost ofactivities, resources,and related costdrivers.

Develop a process-basedmap representing the flowof activities, resources, andtheir interrelationships.

Step 1 Step 2

4 - 36



Collect relevant data concerning costsand the physical flow of the cost-driverunits among resources and activities.

Step 3

4 - 37



Calculate and interpret the new activity-based information.

Using an activity-based costing system toimprove the operations of an organizationis activity-based management (ABM).

Step 4

4 - 38


Activity-Based Management

Activity-based management aims to improve the value received by customers and to improve profits by identifying opportunities for improvements in strategy and operations.

4 - 39


Activity-Based Management

A value-added cost is the cost of an activity that cannot be eliminated without affecting a product’s value to the customer.

In contrast, non-value-added costs are costs that can be eliminated without affecting a product’s value to the customer.

4 - 40



Use activity-based cost

information to improve the

operations of an organization.

4 - 41


Using ABC Information

Activity-based management…

provides costs of value-added andnon-value-added activities.

improves managers’ understanding of operations.

4 - 42



Understand cost accounting’s

role in a company’s

improvement efforts across

the value chain.

4 - 43


Cost Accounting andthe Value Chain

A good cost accounting system is critical toall value-chain functions from research anddevelopment through customer service.

4 - 44©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton

End of Chapter 4

Documents

Chapter 4