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Chapter 4

Chapter 4. Cost Management Systems and Activity-Based Costing. Describe the purposes of cost management systems. Learning Objective 1. Cost Management System. A cost- management system (CMS) is a collection of tools and techniques that identifies how management’s decisions

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Chapter 4

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  1. Chapter 4 Cost Management Systems and Activity-Based Costing

  2. Describe the purposes of cost management systems. Learning Objective 1

  3. Cost Management System A cost-management system(CMS) is a collection of tools and techniques that identifies how management’s decisions affect costs.

  4. What is Cost Accounting? Costaccounting is that part of the accounting system that measures costs for the purposes of management decision making and financial reporting.

  5. Explain the relationships among cost, cost objective, cost accumulation, and cost allocation. Learning Objective 2

  6. Cost Accounting System Collecting costs by some “natural” classification such as materials or labor Cost Accumulation Cost Allocation Tracing costs to one or more cost objectives

  7. Cost Accounting System RAW MATERIAL COSTS (METALS Cost Accumulation Cost Allocation to Cost Objects: 1. Departments 2. Activities 3. Products MACHINING DEPARTMENT ACTIVITYACTIVITY FINISHING DEPARTMENT ACTIVITYACTIVITY CABINETS CABINETS DESKS DESKS TABLES TABLES

  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.

  9. Cost Objective What is a cost object or cost objective? It is anything for which a separate measurement of costs is desired.

  10. Distinguish among direct, indirect, and unallocated costs. Learning Objective 3

  11. Direct Costs What are direct costs? Direct costs can be identified specifically and exclusively with a given cost objective in an economically feasible way.

  12. Indirect Costs What are indirect costs? Indirect costs cannot be identified specifically and exclusively with a given cost objective in an economically feasible way.

  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.

  14. Categories of Manufacturing Costs Any raw material, labor, or other input used by any organization could, in theory, be identified as a direct or indirect cost depending on the cost objective.

  15. Categories of Manufacturing Costs • All costs which are eventually allocated to products are classified as either… • direct materials, • direct labor, or • indirect manufacturing.

  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.

  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.

  18. Indirect Manufacturing Costs... • or factoryoverhead, include all costs associated with the manufacturing process that cannot be traced to the manufactured goods in an economically feasible way.

  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.

  20. Period Costs... • are costs that are deducted as expenses during the current period without going through an inventory stage.

  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.

  22. Period Costs – Merchandising and Manufacturing • In both merchandising and manufacturing accounting, selling and general administrative costs are period costs.

  23. Explain how the financial statements of merchandisers and manufacturers differ because of the types of goods they sell. Learning Objective 4

  24. Financial Statement Presentation– Merchandising Companies Income Statement Balance Sheet Sales – Expiration Merchandise Inventory Cost of Goods Sold (an expense) Equals Gross Margin – Selling and Administrative Expenses Period Costs Equals Operating Income

  25. Financial Statement Presentation– Manufacturing Companies Income Statement Balance Sheet Sales – Direct Material Inventory Expiration Cost of Goods Sold (an expense) Equals Gross Margin – Work-in- Process Inventory Finished Goods Inventory Selling and Administrative Expenses Period Costs Equals Operating Income

  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 ofgoods sold is different.

  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: • Direct materials • Direct labor • Indirect manufacturing

  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.

  29. Understand the main differences between traditional and activity-based costing systems and why ABC systems provide value to managers. Learning Objective 5

  30. Traditional Cost System Direct Material Resource Direct Labor Resource All Indirect Resources All Unallocated Value Chain Costs Direct Trace Direct Trace Cost Driver Products Unallocated

  31. Two-Stage Activity-BasedCost System Direct Material Resource Direct Labor Resource Other Direct Resources Indirect Resource A Indirect Resource Z All Unallocated Value Chain Costs % % % % Direct Trace Direct Trace Activity 1 Activity 10 Cost Driver Cost Driver Products Unallocated

  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.

  33. Activity-Based Costing Example of Activities and Cost Drivers: Activities: Account billing Bill verification Account iniquity Correspondence Cost Drivers: No. of lines No. of accounts No. of labor hours No. of letters

  34. Learning Objective 6 Identify the steps involved in the design and implementation of an activity-based costing system.

  35. Designing and Implementing an Activity-Based Costing System Step 1 Step 2 Determine cost of activities, resources, and related cost drivers. Develop a process-based map representing the flow of activities, resources, and their interrelationships.

  36. Designing and Implementing an Activity-Based Costing System Step 3 Collect relevant data concerning costs and the physical flow of the cost-driver units among resources and activities.

  37. Designing and Implementing an Activity-Based Costing System Step 4 Calculate and interpret the new activity-based information. Using an activity-based costing system to improve the operations of an organization is activity-basedmanagement(ABM).

  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.

  39. Activity-Based Management • A value-added costis the cost of an activity that cannot be eliminated without affecting a product’s value to the customer. • In contrast, non-value-added costsare costs that can be eliminated without affecting a product’s value to the customer.

  40. Use activity-based cost information to improve the operations of an organization. Learning Objective 7

  41. Using ABC Information Activity-based management… provides costs of value-added and non-value-added activities. improves managers’ understanding of operations.

  42. Understand cost accounting’s role in a company’s improvement efforts across the value chain. Learning Objective 8

  43. Cost Accounting andthe Value Chain A good cost accounting system is critical to all value-chain functions from research and development through customer service.

  44. End of Chapter 4

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