Cost Management

ACCOUNTING AND CONTROL

HANSEN & MOWEN

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Basic Cost Management Concepts

2
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A Systems Framework
Operational Model for an Accounting Information System
Collecting Classifying Summarizing Analyzing Managing

Economic Events

Special Reports Financial Statements Budgets Performance Reports Personal Communication

Inputs

Processes

Outputs

Users
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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 out services, products, and other objects of interest to management

2) Planning and control

3) Decision making

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A Systems Framework
An Integrated Cost Management System
Design and Development System Cost Management System Marketing and Distribution System Customer Servicing System

Production System

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A Systems Framework
The Subsystems of the Accounting Information System Accounting Information System

Financial Accounting Information System

Cost Management Information System

Cost Accounting Information System

Assigns costs to products, services or objects

Operational Control System

Provides performance feedback
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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: 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.

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Cost Assignment: Direct Tracing, Driver Tracing and Allocation

Cost Assignment Methods Cost of Resources
Resource Drivers Direct Tracing Physical Observation Driver Tracing Activity Drivers

Allocation Convenience Assumed Linkage

Cost Objects
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Cost Assignment: Direct Tracing, Driver Tracing and Allocation

Cost Assignment Methods Cost of Resources
Resource Drivers Direct Tracing Physical Observation Driver Tracing Activity Drivers

Allocation Convenience Assumed Linkage

Cost Objects
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Product and Service Costs

Examples of Product Cost Definitions
Value-Chain Product Costs
Research and Development

Operating Product Costs

Traditional Product Costs

Production
Marketing Customer Service
Pricing Decisions Product Mix Decisions Strategic Profitability Analysis

Production

Production

Marketing
Customer Service
Strategic Design Decisions Tactical Profitability Analysis External Financial Reporting
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Product and Service Costs

Manufacturing Costs (Production 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

Manufacturing costs are assigned to products and carried in inventories until the products are sold.

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Product and Service Costs

Nonmanufacturing Costs (Nonproduction 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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Product and Service Costs

For external financial reporting, marketing and administrative costs are not inventoried. They are are expensed in the period incurred and referred to as period costs.

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Product and Service Costs

Production and Nonproduction Costs
Production or Manufacturin g Costs
Direct Materials Direct Labor Overhead Nonproduction or Operating Costs

Prime Cost

Marketing Expense Order-Getting Costs Order-Filling Costs

Conversion Cost
Administrative Expense
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External Financial Statements

Manufacturing Organization Income Statement For the Year Ended December 31, 2007 Sales $ 2,000,000 Less: Cost of goods sold 1,300,000 Gross margin $ 700,000 Less operating expenses: Selling expenses $ 300,000 From 450,000 the Cost Administrative expenses 150,000 of Goods Sold Operating income $ 250,000 Schedule

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External Financial Statements

Statement of Cost of Goods Manufactured For the Year Ended December 31, 2007 Direct materials: Beginning inventory $ 200,000 Add: Purchases 450,000 Materials available $ 650,000 Less: Ending inventory 50,000 Direct materials used in production $ 600,000 Direct labor 350,000 Manufacturing overhead: Indirect labor $ 122,500 Depreciation on building 177,500 Rental of equipment 50,000 Utilities 37,500 Property taxes 12,500 Maintenance 50,000 450,000 Total manufacturing costs added $ 1,400,000 continued

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External Financial Statements

Total manufacturing costs added Add: Beginning work in process Less: Ending work in process Cost of goods manufactured

$ 1,400,000 200,000 400,000 $ 1,200,000

Work in process consists of all partially completed units found in production at a given point in time.
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External Financial Statements

Cost of Goods Sold Schedule For the Year Ended December 31, 2007 Cost of goods manufactured $ 1,200,000 Add: Beginning inventory finished goods 250,000 Cost of goods available for sale $ 1,450,000 From finished goods Less: Ending inventory the 150,000 Statement of Cost of goods sold $ 1,300,000
Cost of Goods Manufactured

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Functional-Based and Activity-Based Cost Management Systems

Activity-Based Management Model Cost View

Resources Process View

Driver Analysis Why?

Activities

Performance Analysis How well?

What?
Products and Customers

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Functional-Based and Activity-Based Cost Management Systems

Functional-Based 1. Unit-based drivers

2. Allocation-intensive
3. Narrow and rigid product costing 4. Focus on managing costs 5. Sparse activity information 6. Maximization of individual unit performance

7. Uses financial measures of performance

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Functional-Based and Activity-Based Cost Management Systems

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. Systemwide performance maximization

7. Uses both financial and nonfinancial measures of performance

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Functional-Based and Activity-Based Cost Management Systems Trade-Off Between Measurement and Error Costs
Cost Total Cost Measurement Cost

Error Cost

Low Accuracy

Optimal Level

High Accuracy

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Functional-Based and Activity-Based Cost Management Systems

Shifting Costs
Cost Old Measurement Cost New Measurement Cost New Error Cost

Old Error Cost

Old Optimum Accuracy New Optimum High
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Low

End of Chapter 2

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