COST MANAGEMENT

Guan Hansen Mowen

COPYRIGHT 2009 South-Western Publishing, a division of Cengage Learning.
Cengage Learning and South-Western are trademarks used herein under license.
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Chapter 2
Basic Cost Management
Concepts
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Study Objectives
1. Explain the cost assignment process.
2. Define tangible and intangible products, and
explain why there are different product cost
definitions.
3. Prepare income statements for manufacturing
and service organizations.
4. Explain the differences between traditional and
contemporary cost management systems.
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Cost Assignment: Direct Tracing,
Driver Tracing and Allocation
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.
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Cost Assignment: Direct Tracing,
Driver Tracing and Allocation
Traceability means that costs can be assigned
easily and accurately, using a causal
relationship.

Methods of tracing:
Direct tracing: relies on physical observance of
causal relationships to assign costs to cost objects.
Driver tracing: relies on drivers as causal factors to
assign costs to cost objects.
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Cost Assignment Methods
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Examples of Product Cost
Definitions
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Product Costs
Direct materials: those materials directly
traceable to the goods or services being
produced.
Example: The cost of wood in furniture.
Direct labor: labor that is directly traceable to
the goods or services being produced.
Example: Wages of assembly-line workers.
Overhead: all other manufacturing costs.
Example: Plant depreciation, utilities, property
taxes, indirect materials, indirect labor, etc.
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Prime and Conversion Costs
Direct Direct Prime
+ =
Materials Labor Costs
Direct Overhead Conversion
+ =
Materials Costs Costs
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Nonproduction Costs
Amount and timing of benefit cannot be
reasonably estimated
Period costs
Not inventoried
Expensed as incurred
Examples
Research and development
Marketing costs
Administrative costs
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Production and Nonproduction
Costs
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External Financial Statements
Income Statement ~ Manufacturing Firm
Functional categories of expense
Cost of goods sold
Operating expenses
Supporting schedules
Cost of goods manufactured
Cost of goods sold
Income Statement ~ Service Organization
No finished goods inventory
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Income Statement: Manufacturing Firm
Sales 2,000,000 $
Less: Cost of Goods Sold 1,300,000
Gross margin 700,000 $
Less operating expenses:
Research and development 100,000 $
Selling 300,000
Administrative 150,000 550,000
Operating income 150,000 $
Manufacturing Organization
Income Statement
For the Year Ended December 31, 2009
From the Cost of
Goods Sold Schedule
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Statement of Cost of Goods
Manufactured
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Cost of Goods Sold Schedule
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Cost Management Systems
Functional-Based
Assumes a linear production cost behavior
Assigns costs to organizational units

Activity-Based
Emphasizes tracing over allocation
Identifies non-unit-based activity drivers
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Functional-Based
Cost Management
Unit-based drivers
Allocation-intensive
Narrow and rigid product costing
Focus on managing costs
Sparse activity information
Maximization of individual unit
performance
Uses financial measures of performance
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Activity-Based
Cost Management
Unit- and non-unit-based drivers
Tracing intensive
Broad, flexible product costing
Focus on managing activities
Detailed activity information
System-wide performance maximization
Uses both financial and nonfinancial
measures of performance

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Trade-Off between Measurement
Costs and Error Costs
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Shifting Costs
COST MANAGEMENT

Guan Hansen Mowen
COPYRIGHT 2009 South-Western Publishing, a division of Cengage Learning.
Cengage Learning and South-Western are trademarks used herein under license.
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End Chapter 2