Chapter 2 Cost Accounting

Chapter 2: Basic Cost Management Concepts’;/;’l

Systems Framework

• Definition of a System:

  • A set of interrelated parts that performs one or more processes to achieve specific objectives.

  • Functions by transforming inputs into outputs.

• Accounting Information System:

  • Provides information to individuals in a company.

  • Collects, classifies, summarizes, analyzes, and manages data.

  • Inputs: Usually economic events.

  • Operational Model: Critical for users of information.

  • Major Subsystems:

    • Financial Accounting Information System:

    • Outputs for external users; inputs governed by regulatory bodies such as SEC, FASB, IASB.

    • Cost Management Information System:

    • Outputs for internal users, not bound by external criteria.

Operational Model of Accounting Information System

• Inputs:

  • Economic Events.

• Processes:

  • Collection of data.

  • Classification: Organizing data by categories.

  • Summarization: Bringing data to a usable format.

  • Analysis: Interpreting data for insights.

  • Management: Overall handling and administration of data.

• Outputs:

  • Special reports, financial statements, budgets, performance reports, personal communication.

Financial Accounting Information System

• Focus: Produces outputs primarily for external users.

• Inputs: Well-specified economic events documenting transactions.

• Processes: Governed by established accounting rules.

• Outputs: Financial statements geared towards external parties.

Cost Management Information System

• Focus: Outputs primarily for internal users.

• Inputs/Processes: Set by management; flexible compared to external regulations.

• Outputs Characteristics:

  • Information for costing services/products.

  • Useful for planning, controlling, and decision-making.

Value Chain

• Definition:

  • A sequence of activities required to design, develop, produce, market, deliver, and provide post-sales service for products and services.

• Stages of the Value Chain:

  • Design, Develop, Produce, Market, Deliver, Post-Sale Service.

Relationship to Operational Systems and Functions

• Cost Management System:

  • Integrates with all operational systems, receiving and providing information.

• Enterprise Resource Planning (ERP) Systems:

  • Cross-functional systems that coordinate information for timely decision-making.

Different Systems for Different Purposes

• Cost Accounting Information System:

  • Assigns costs to products and services.

• Operational Control Information System:

  • Provides performance feedback to help managers improve.

Subsystems of the Accounting Information System

• Accounting Information System Overview:

  • Financial Accounting Information System

  • Cost Management Information System

• Cost Accounting Information System

• Operational Control Information System

Cost Assignment: Concepts and Methods

• Cost: Cash value sacrificed for goods/services.

• Expenses: Expired costs deducted from revenues.

• Loss: Cost without revenue benefit.

• Assets: Costs not yet expired, shown on balance sheet.

• Cost Objects: Things for which costs are measured (products, customers, departments, etc.).

• Activity: A basic unit of work significant for cost assignment.

• Traceability: Ability to directly assign cost to a cost object.

  • Direct Costs: Can be easily traced.

  • Indirect Costs: Not easily traceable.

• Tracing Methods:

  • Direct Tracing: Identifying and assigning costs specifically tied to the cost object.

  • Driver Tracing: Assigning costs based on factors (drivers) that influence resource usage.

• Allocation: Assignment of indirect costs can decrease accuracy if not done properly.

Product and Service Costs

• Tangible Products: Goods produced from raw materials.

• Services: Tasks or activities performed for or by customers.

  • Differences between Tangible Products and Services:

    • Intangibility: Services cannot be experienced before purchase.

    • Perishability: Services cannot be stored.

    • Inseparability: Direct contact between producer and consumer often necessary.

Product Costs and External Financial Reporting

• Production Costs: Costs tied to manufacturing goods or providing services, referred to as manufacturing costs.

• Nonproduction Costs: Costs linked to selling and administration, referred to as nonmanufacturing costs.

• Types of Costs:

  • Direct Materials: Materials traceable to the final product.

  • Direct Labor: Labor directly tied to production.

  • Overhead: All other production costs (includes supplies, indirect materials).

• Prime Cost: The sum of direct materials and direct labor costs.

• Conversion Cost: Energy and labor needed to convert raw materials into work.

• Nonproduction Costs Categories:

  • Marketing Costs: Costs related to selling (advertising, shipping).

  • Administrative Costs: Costs not assigned to production or marketing (executive salaries, legal fees).

• Period Costs: Costs that do not get inventoried, expensed when incurred.

External Financial Statements

• Income Statement for Manufacturing Firms:

  • Follows a standard format categorized by functional expenses to derive operating income.

• Cost of Goods Manufactured: Total costs of completed goods during a period, include direct materials, labor, and overhead only.

• Supporting Schedule: Details the cost assignment in the cost of goods manufactured.

Traditional and Activity-Based Cost Management Systems

• Traditional Cost Accounting: Classifies all costs as fixed or variable based on production volume, relying on unit-based drivers for cost assignment.

  • Focused on managing costs within organizational units and performance accountability.

• Activity-Based Cost Management Systems (ABC):

  • Tracing costs more accurately through both unit- and non-unit-based drivers.

  • Activity-based management (ABM) focuses on managing activities to improve customer value and profit.

Trade-Offs in Cost Management Systems

• Activity-based Cost Management Advantages:

  • Greater accuracy in product costing.

  • Enhanced decision-making and strategic planning capabilities.

  • Improved ability to manage activities effectively.

• Measurement Costs: Expenses incurred for measurement requirements of the system.

• Error Costs: Costs incurred due to bad decisions from inaccurate cost information.

Exhibits

• Exhibit 2.7: Activity-Based Management Model.

• Exhibit 2.8: Comparison of Traditional and Activity-Based Cost Management Systems in terms of drivers, costing flexibility, performance focus, and performance measures.

• Exhibit 2.9: Trade-Off Between Measurement and Error Costs.

• Exhibit 2.10: Shifting Measurement and Error Costs Analysis.