2 -1

Basic
Management
Accounting
Concepts
CHAPTER
2 -2
1. Describe 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. Outline the differences between functional-
based and activity-based management
accounting systems.
Objectives
After studying this
chapter, you should
be able to:
2 -3
Exactly what is
meant by cost?
Cost is the cash or cash-equivalent value
sacrificed for goods and services that is
expected to bring a current or future
benefit to the organization.
I see Its a dollar
measure of the
resources used to
achieve a given
benefit.
2 -4
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.
2 -5
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: I f a hospital is the cost object,
the cost of heating and
cooling the hospital is
a direct cost.
2 -6
I ndirect 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.
2 -7
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 objects resource consumption.
2 -8
Cost Assignment Methods
Cost of Resources
Direct
Tracing
Driver
Tracing
Allocation
Physical
Observation
Causal
Relationship
Assumed
Relationship
Cost Objects
2 -9 I nterface of Services with
Management Accounting
1. Intangibility
2. Perishability
3. Inseparability
4. Heterogeneity

Services cannot be stored.
No patent protection.
Cannot display or
communicate services.
Price difficult to set.

Derived Properties
Services benefits expire
quickly.
Services may be repeated
often for one customer.
Customer directly
involved with
production of service.
Centralized mass
production of services
difficult.
Wide variation in service
products possible.
2 -10 I nterface of Services with
Management Accounting
No inventories.
Strong ethical code.
Price difficult to set.
Demand for more accurate
cost assignments.

Impact on Management
Accounting
No inventories.
Need for standards and
consistent high quality.
Costs often accounted
for by customer type.
Demand for measure-
ment and control of
quality to maintain
consistency.
Productivity and quality
measurement and
control must be
ongoing.
Total quality manage-
ment critical.
1. Intangibility
2. Perishability
3. Inseparability
4. Heterogeneity
2 -11
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.
2 -12
Design
Produce
Market
Distribute
Service Develop
2 -13
Product Costing Definitions
Pricing Decisions
Product-Mix Decisions
Strategic Profitability
Analysis
Strategic Design Decisions
Tactical Profitability
Analysis
External Financial
Reporting
Research and
Development
Production
Marketing
Customer
Service
Value-Chain
Product Costs
Production
Marketing
Customer
Service
Operating Product
Costs
Traditional Product
Costs
Production
2 -14
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
2 -15
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
2 -16
Overhead are all other production costs.
Depreciation on building
and equipment
Maintenance
Supplies
Supervision
Power
Property taxes
2 -17
Noninventoriable (period) costs
are expensed in the period in
which they are incurred.
Salaries and commissions of
sales personnel (marketing)
Advertising (marketing)
Legal fees (administrative)
Printing the annual report
(administrative)
2 -18
Prime Cost :
Direct Materials Costs + Direct Labor Costs

Conversion Cost:
Direct Labor Costs + Overhead Costs
2 -19
External
Financial
Statements
2 -20
Manufacturing Organization
Income Statement
For the Year Ended December 31, 2004
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


2-20
2 -21
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
Statement of Cost of Goods Manufactured
For the Year Ended December 31, 2004
2-21
continued on next slide
2 -22
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.
2 -23
Service Organization
Income Statement
For the Year Ended December 31, 2004
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
2-23
2 -24
Functional-Based
Management Model
Efficiency
Analysis
Performance
Analysis
Operational View
Resources
Functions
Products
Cost View
2 -25
Activity-Based
Management Model
Resources
Activities
Products and
Customers
Cost View
Driver
Analysis
Performance
Analysis
Process View
Why? What? How Well?
2 -26
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

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

Functional-Based Activity-Based
2 -27
The End
Chapter Two
2 -28