Chapter 2: Basic Cost Management Concepts

Expenses

Costs used up in the production of revenues, making them "expire"

Service Organizations

Organizations that produce intangible products

Manufacturing Organizations

Organizations that produce tangible products

Cost

The cash or cash equivalent sacrificed for goods and services that are expected to bring a current or future benefit to the organization

Error Costs

The costs associated with making poor decisions based on bad information

Measurement Costs

The costs associated with the measurements required by the cost management system

The main difference being classified as an expense or an asset is...

Timing

Conversion Cost

1) 1 of 2 types of production costs 2) The sum of direct labor cost and overhead cost 3) Can be interpreted as the cost of converting raw materials into a final product

Prime Cost

1) 1 of 2 types of production costs 2) The sum of direct materials cost and direct labor cost

Activity-based Cost (ABC) System

1) A cost accounting system that uses both unit and non-unit based activity drivers to assign activity costs to cost objects 2) Offer significant benefits such as greater product costing accuracy, improved decision making, enhanced strategic planning, and an increased ability to manage activities; however, these benefits are expensive

Loss

1) A cost that expires without producing any revenue benefit 2) Ex. Uninsured inventory destroyed by a flood

Administrative Costs

1) All costs that cannot be reasonably assigned to either marketing or production 2) Ex. Top-executive salaries, legal fees, general accounting, printing and distributing the annual report, and research and development

Absorption-costing Income

1) Also known as full-costing income 2) Income statement is referred to as this because all manufacturing costs (direct materials, direct labor, and overhead) are fully assigned to the product 3) Expenses are separated according to function and then deducted from revenues to arrive at operating income 4) 2 Major categories of expenses are: costs of goods sold and operating expenses 5) Cost of goods sold is the cost of direct materials, direct labor, and overhead attached to the units sold

Cost Objects

1) Anything for which costs are measured and assigned 2) May include products, customers, departments, projects, activities, etc. 3) Ex. If we want to determine what it costs to produce a bicycle, the cost object is the bicycle

Accuracy of Cost Assignments

1) Assigning costs accurately to cost objects is crucial 2) Accuracy is not evaluated based on some "true cost" 3) Rather, accuracy is a relative concept and has to do with the reasonableness and logic of cost assignment methods 4) The objective is to measure and assign as accurately as possible the cost of the resources used by the cost object 5) Distorted cost assignments can produce poor decisions

Traditional Operation Control System

1) Assigns costs to organizational units and then holds the organizational unit manager responsible for controlling the assigned costs 2) Performance is measured by comparing actual outcomes with standard or budgeted outcomes

Activity-based Management (ABM)

1) At the heart of a contemporary operational control system 2) Focuses on the management of activities with the objective of improving the value received by the customer and the profit received by the company in providing the value 3) More complex and requires more measurement activity than an ABC

Work in Process

1) Consists of all partially completed units found in production at a given point in time 2) Beginning WIP consists of the partially completed units on hand at the beginning of the period 3) Ending WIP consists of the incomplete units on hand at the period's end

Assets

1) Costs that do not expire in a given period and appear on the balance sheet 2) Ex. Computers and factory buildings

3 Types of Production Costs

1) Direct Materials: Those materials traceable to the goods or services being produced 2) Direct Labor: Labor that is traceable to the goods or services being produced 3) Overhead: All production costs other than direct materials and direct labor; also called "factory burden" or "manufacturing overhead" 4) Direct materials that form an insignificant part of the final product are usually lumped into an overhead category called indirect materials

Assigning Indirect Costs

1) Indirect costs cannot be traced to cost objects 2) Either there is no causal relationship between the cost and the cost object, or tracing is not economically feasible 3) Allocation is the assignment of indirect costs to cost objects 3) Allocating indirect costs is based on convenience or some assumed linkage

3 Ways Services Differ from Tangible Products

1) Intangibility: Buyers of services cannot see, feel, hear, or taste a service before it is bought 2) Perishability: Services cannot be stored 3) Inseparability: Producers of services and buyers of services must usually be in direct contact for an exchange to take place (ex. an eye doctor's appointment requires both an optometrist and patient to present)

Enterprise Resource Planing System (ERP)

1) Integrative, cross-functional systems that coordinate information to facilitate timely and accurate reporting and decision making 2) Ideally, data must be entered only once; then it is available to people across the company for whatever purpose it may serve 3) In this way, information collected for one purpose may serve other needs as well

2 Types of Non-production Costs

1) Marketing (Selling) Costs 2) Administrative Costs 3) Both marketing and administrative costs are not inventoried, making them period costs 4) Period costs are expensed in the period in which they are incurred 5) Period costs appear on the income statement--not the balance sheet

2 Function Categories of Costs

1) Production Costs: Costs associated with manufacturing goods or providing services 2) Non-production Costs: Costs associated with the functions of selling and administration

Activities

1) Special kinds of cost objects 2) A basic unit of work performed within an organization 3) Essential elements of an activity-based accounting system 4) Ex. Setting up equipment for production, moving materials and goods, purchasing parts, billing customers, paying bills, etc.

Traceability

1) The ability to assign a cost directly to a cost object in an economically feasible way by means of a causal relationship 2) The more costs that can be traced to the object, the greater the accuracy of the cost assignments 3) Costs are directly or indirectly associated with cost objects 4) Direct costs are those costs that can be traced easily and accurately to a cost object 5) Indirect costs are those costs that cannot be traced easily and accurately to a cost object 6) Cost management systems typically deal with many cost objects; thus, a particular cost object could be classified as both a direct and indirect cost

Marketing (Selling) Costs

1) The costs needed to market and distribute a product or service 2) Often referred to as "order-getting" and "order-filling" costs 3) Ex. Salaries and commissions of salespersons, advertising, warehousing, shipping, and customer service

Direct Tracing

1) The process of identifying and assigning costs to a cost object that are specifically or physically associated with the cost object 2) Most often accomplished by physical observation (ex. the materials and labor put into a pair of blue jeans is physically observable) 3) Ideally, all costs should be charged to cost objects using direct tracing

Cost of Goods Manufactured

1) The total manufacturing cost of goods completed during the current period 2) The only costs assigned to the goods completed are the manufacturing costs are direct materials, direct labor, and overhead 3) The details of this cost assignment are given in a supporting schedule, called the statement of cost of goods manufactured

2 Classifications for Cost Management Systems

1) Traditional Cost Management System 2) Activity-based Cost Management System

Driver Tracing

1) Unfortunately, it is often impossible to physically observe the exact amount of cost objects being used by a cost object 2) The next best approach is to observe drivers: factors that cause changes in resource usage, activity usage, costs, and revenues 3) Driver tracing is the use of drivers to assign costs to cost objects 4) Less precise than direct tracing, but driver tracing can be accurate if the cause-effect relationship is sound 5) Ex. Sewing machines for blue jeans factory have an electrical cost of $0.10/hour. If there are 200,000 machine hours per year, $20,000 of electricity cost is assigned to the machines

Activity-based Cost Management Systems

1) Unit and non-unit 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

Traditional Cost Management Systems

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

Traditional Cost System

A cost accounting system that uses only unit-based activity drivers to assign costs to objects

System

A set of interrelated parts that performs one or more processes to accomplish specific objectives

Tangible Products

1) 1 of 2 types of organizational output 2) Goods produced by converting raw materials into finished products through the use of labor and capital inputs such as plant, land, and machinery 3) Ex. Televisions, hamburgers, automobiles

Services

1) 1 of 2 types of organizational output 2) Tasks or activities performed for a customer or an activity performed by a customer using an organization's products or facilities 3) Ex. Insurance coverage, dental care, car rental, video rental