Basic Cost

Management Concepts

2
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A Systems Framework

Financial Accounting Information System

Inputs: well-specified economic events
Processes: rules and conventions established by the

SEC and FASB

Outputs: financial statements for external users

Cost Management Information System

Inputs and processes: set by management; not

bound by externally imposed criteria

Outputs: reports for internal users

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A Systems Framework

The cost management information system has three

broad objectives that provide information for:
1) Costing services, products, and other objects of
interest to management
2) Planning and control
3) Decision making
The value chain is the set of activities required to
design, develop, produce, market, deliver, and provide
post-sales service for the products and services sold to
customers.
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Cost Assignment: Direct Tracing,

Driver Tracing and Allocation

Costs are sacrifices made to obtain goods or

services. As long as they remain unexpired,

they are on the balance sheet as an asset.
Expenses are expired costs which are
deducted from revenues on the income
statement.
Cost Objects are anything for which costs are
measured and assigned. Some cost objects
are tangible, such as the product we make;
others are not such as activities we for which
we wish to accumulate cost information.
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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:
1. Direct tracing: relies on physical observance of
causal relationships to assign costs to cost objects.
2. Driver tracing: relies on drivers as causal factors to
assign costs to cost objects.
Costs that cannot be traced are considered indirect
costs and are allocated products in some
predetermined way.
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Product and Service Costs

Tangible products are goods produced by

converting raw materials into finished

products.
Services are activities performed for a
customer or by a customer using the service
providers products or facilities. Services have
three characteristics that separate them from
tangible products:

Intangibility
Perishability
Inseparability
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Product and Service Costs

Manufacturing
Manufacturing Costs
Costs
(Production
(Production Costs)
Costs)

Direct materials are those materials that are directly

traceable to the goods or services being produced.

Example: The cost of wood in furniture.

Direct labor is the labor that is directly traceable to the
goods or services being produced.

Example: Wages of assembly-line workers.

Overhead are all other manufacturing costs.

Example: Plant depreciation, utilities, property

taxes, indirect materials, indirect labor, etc.
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Product and Service Costs

Prime
Prime and
and Conversion
Conversion costs
costs
Prime Cost is the sum of direct materials and direct

labor.
Conversion Cost is the sum of direct labor and
overhead.
Hint: Never add prime cost and conversion cost or you

will have double counted labor because it is included in

each definition!

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Product and Service Costs

Nonproduction
Nonproduction Costs
Costs
(Period
(Period Costs)
Costs)
Marketing (selling) costs are the costs necessary to

market, distribute, and service a product or service.

Example: Advertising, storage costs, and freight

out.
Administrative costs are the costs associated with
research, development, and general administration of
the organization that cannot reasonably be assigned to
either marketing or production.

Example: Legal fees, salary of the chief executive

officer.
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External Financial Statements

Income Statement: Manufacturing Firm

Prepared for external parties

Follows standard format
Is referred to as an absorption-costing or fullcosting income statement because all manufacturing
costs are absorbed into the cost of goods.
Cost of Goods Manufactured represents the total
manufacturing cost of goods completed during the period.
Work in Process consists of all partially completed unites
found in production at a given point in time (usually the end
of one period/beginning of the next).
Cost of Goods Sold is the manufacturing cost of all goods
that were sold during the period.

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Traditional and Activity-Based Cost

Management Systems

Traditional Cost Management Systems

Traditional Cost Accounting

Assumes all costs can be classified as fixed or

variable with respect to changes in units or
volume.

Allocates costs that are not unit-based.

Traditional Cost Control

Assigns costs to organizational units and holds

the unit manager responsible for controlling the
assigned costs.

Performance is measured by comparing actual

outcomes with standard or budgeted outcomes.

Emphasis is on financial measures of

performance.
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Traditional and Activity-Based Cost

Management Systems

Activity-Based Cost Management Systems

Activity-Based Cost Accounting

Emphasizes tracing over allocation

Identifies non-unit-based activity drivers.

Flexible system capable of producing cost

information for a variety of purposes.
Activity-based Cost Control

Seeks to understand and control activities rather

than costs.

Activity-based management (ABM) focuses on

improving customer value.
Looks at the process view and focuses accountability
on activities to maximize systemwide performance.

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