CHAPTER

Basic
Management
Accounting
Concepts
 Objectives
Objectives
1. Describe theAfter
cost studying
assignment process.
this
After studying this
2. Define tangible and intangible
chapter, you should products and
chapter, you should
explain why there be are different
able to: product cost
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.
Cost
Cost isis the
the cash
cash oror cash-equivalent
cash-equivalent value
value
sacrificed
sacrificed forfor goods
goods andand services
services that
that isis
expected
expected to to bring
bring aa current
current or
or future
future
benefit
benefit to to the organization.Exactly
the organization. Exactly what
what isis
meant
meant by by “cost”?
“cost”?

II see…
see… It’s
It’s aa dollar
dollar
measure
measure ofof the
the
resources
resources used
used toto
achieve
achieve aa given
given
benefit.
benefit.
Product Cost vs Period Cost
Manager should also understand opportunity cost
An opportunity cost is the benefit given up or
sacrificed when one alternative is chosen over
another.
Example: A firm may invest $100,000 in inventory for a
year instead of investing in investment that
yield 12% rate of return.
the opportunity cost of capital tied up in
inventory is $12,000 (12% x $100,000)
Expired cost are called expenses.
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.
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.
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.
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.

See
See pizza’s
pizza’s example
example
 Pizza’s Case
Ryan Chesser and Shana Parker go to lunch together.

Shana and Ryan agree to share the cost of the lunch.

They order a medium pizza (divided into 10 slices) for $9

a pitcher of root beer for $2 (five glasses of content),

Shana orders a small salad for $1.

How much cost should be Assume that Ryan eats 7 slices of pizza and drinks 3
glasses of root beer, with Shana consuming the
assigned to each person? remainder
Direct and Driver Tracing

Salad Pizza Root-beer

direct tracing: $1 to driver tracing: slices of driver tracing: glasses
Shana and $0 to Ryan pizza of root beer

Assume that Ryan eats 7 slices of pizza and drinks 3 glasses of

root beer, with Shana consuming the remainder
 Cost
Cost Assignment
Assignment Methods
Methods
Cost of Resources

Direct Driver
Allocation
Tracing Tracing

Physical Causal Assumed

Observation Relationship Relationship

Cost Objects
 Exercise: Cost Assignment Methods
(direct, driver or allocation.)
Cost object: manufacturing cell of small motors for lawn mower
a. Salary of cell supervisor,
b. Power of heat and cool for plant.
c. Material used to produce the motors,
d. Maintenance for the cell equipment (by maintenance dept.);
e. Labor used to produce motors,
f. Cafeteria that service the plant’s employees;
g. Depreciation of the plant.
h. Depreciation on equipment to produce motors,
i. Ordering cost for material used in production;
j. Engineering support (provided by Engineering dept.);
k. Cost of maintaining the plant and ground.
l. Cost of the plant’s personnel office;
m. Property tax on the plant and land.
 Relationship of Services with
Management Accounting
Services
Services cannot
cannot be
be stored.
stored.
No
No patent
patent protection.
protection.
1. Intangibility Cannot
Cannot display
display or
or expire
Services
Services benefits
benefits expire
communicate
communicate services.
services.
quickly.
Customer
quickly.
Customer directly
directly
2. Perishability Price
Price difficult
difficult to
to set.
set.
Services
involved with repeated
involved
Services may
may be
withbe repeated
often
often for
production
for
productionone
one ofcustomer.
of service.
customer.
service.
3. Inseparability
Centralized
Centralized mass
mass
production
Wide variation
production
Wide variationof services
ofin
in service
services
service
4. Heterogeneity
difficult.
products
products possible.
difficult. possible.
Properties
Properties
 Relationship of Services with
Management Accounting
No
No inventories.
inventories.
Strong
Strong ethical
ethical code.
code.
1. Intangibility Price
Price difficult
difficult to
to set.
set.
Demand
No
Demand
No for
for more
inventories.more
inventories. accurate
accurate
Costs
Costs often
often accounted
accounted
2. Perishability cost
Need
cost
Need assignments.
for standards
assignments.
for and
standardstype.
and
for by customer
for by customer type.
consistent
consistent high
high quality.
quality.
3. Inseparability Demand
Productivityfor
Demand for and
Productivity measure-
and quality
measure-
quality
ment
ment and
and control
measurement
measurement andof
and
control of
4. Heterogeneity quality
quality to
control
control to maintain
must be
maintain
must be
consistency.
ongoing.
consistency.
ongoing.
Impact on Total
Total
Management quality
quality manage-
manage-
Impact on Management
Accounting ment
ment critical.
critical.
Accounting
Internal value chain Activities
Design

Service Develop

Distribute Produce

Market
 Cost of product and service
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.
 Product Costing Definitions
Value-Chain Operating Product Traditional Product
Product Costs Costs Costs
Research and
Development
Managerial objectives served

Production Production Production

Marketing Marketing

Customer Customer
Service Service
Pricing Decisions Strategic Design Decisions External Financial
Product-Mix Decisions Tactical Profitability Reporting
Strategic Profitability Analysis
Analysis
 Exercise 2-5
Three a. Setting the price for a new product,
possible
product cost b. Valuation of finished goods inventories for external reporting.
definitions
c. Choosing among different products in order to maintain a product
were mix that will provide the company with a long-term sustainable
introduced: competitive advantage,
value-chain,
operating;
and d. Choosing among competing product designs;
traditional.
Identify e. Calculating cost of goods sold for external reporting.
which of the f. Deciding whether to increase the price of an existing product;
three best
fits the
g. Deciding whether to accept or reject a special order, where the
following price offered is lower than the normal selling price;
situations
(justify your h. Determining which of several potential new products should be
choice): developed, produced, and sold,
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
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
Overhead are all other production costs.
 Depreciation on building
and equipment
 Maintenance
 Supplies
 Supervision
 Power
 Property taxes
Noninventoriable
Noninventoriable (period)
(period) costs
costs
are
are expensed
expensed inin 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)
Prime Cost :
Direct Materials Costs + Direct Labor Costs

Conversion Cost:
Direct Labor Costs + Overhead Costs

See
See exercise
exercise 2-13
2-13
 External
Financial
Statements
Flow of Cost in Manufacturing Co.
 Manufacturing Organization 2-20

Income Statement
For the Year Ended December 31, 2019
Sales $2,800,000
Less cost of goods sold:
Beginning finished goods inventory $ 500,000
Add: Cost of goods manufactured 1,200,000
Cost of goods available for sale$1,700,000
Less: Ending finished goods inventory 300,000 1,400,000
Gross margin $1,400,000
Less operating expenses:
Selling expenses $ 600,000
Administrative expenses 300,000 900,000
Income before taxes $ 500,000
 Statement of Cost of Goods Manufactured 2-21

For the Year Ended December 31, 2019

Direct materials:
Beginning inventory $200,000
Add: Purchases 450,000
Materials available $650,000
Less: Ending inventory 50,000
Direct materials used $ 600,000
Direct labor 350,000
Manufacturing overhead:
Indirect labor $122,500
Depreciation 177,500
Rent 50,000
Utilities 37,500
Property taxes 12,500
Maintenance 50,000 450,000
Total manufacturing costs added $1,400,000
continued
continuedon
onnext
nextslide
slide
Total manufacturing costs added $1,400,000
Add: Beginning work in process 200,000
Total manufacturing costs $1,600,000
Less: Ending work in process 400,000
Cost of goods manufactured $1,200,000

Work in process consists of all

partially completed units found in
production at a given point in time.
 Service Organization 2-23

Income Statement
For the Year Ended December 31, 2019
Sales $300,000
Less expenses:
Cost of services sold:
Beginning work in process $ 5,000
Service costs added:
Direct materials $ 40,000
Direct labor 80,000
Overhead 100,000 220,000
Total $225,000
Less: Ending work in process 10,000 215,000
Gross margin $ 85,000
Less operating expenses:
Selling expenses $ 8,000
Administrative expenses 22,000 30,000
Income before income taxes $ 55,000
 Functional-Based
Functional-Based
Management
Management Model
Model
Cost View

Resources

Operational View

Efficiency Performance
Functions
Analysis Analysis

Products
 Activity-Based
Activity-Based
Management
Management Model
Model
Cost View

Resources

Process View

Driver Performance
Activities
Analysis Analysis
Why? What? How Well?

Products and
Customers
 Functional-Based
1. Unit-based drivers
2. Allocation-intensive
3. Narrow and rigid product
costing
4. Focus on managing cost
5. Sparse activity information
6. Maximization of individual
unit performance
7. Use of financial measures of
performance
See
See problem
problem 2-20
2-20
Activity-Based
1. Unit- and nonunit-based
drivers
2. Tracing intensive
3. Broad, flexible product
costing
4. Focus on managing
activities
5. Detailed activity
information
6. Systematic performance
maximization
7. Use of both financial and
nonfinancial measures of
performance
Chapter Two

The
The End
End
Never leave for
tomorrow what
you can do
today (Benyamin
Franklin)