Manacc-Cost MGT & Activity Based Costing

2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton 4 - 1
2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 4 - 1

Cost Management System
A cost management system (CMS) is
a collection of tools and techniques
that identifies how managements
decisions affect costs.
Learning
Objective 1

Cost Management System
The primary purposes of a cost
management system are to provide...
cost information for strategic
management decisions,
cost information for
operational control, and
measure of inventory value and cost
of goods sold for financial reporting.

Cost Accounting Systems
Cost accounting is that part of the cost
management system that measures
costs for the purposes of management
decision making and financial reporting.

Cost Accounting System
Cost
accumulation:
Collecting costs by some
natural classification
such as materials or labor
Cost
assignment:
Tracing costs to one or
more cost objectives
Learning
Objective 2

Cost
accumulation
Cost assignment
to cost objects
Cabinets
Desks
Tables
Material costs
(metals)
Finishing Department
Activity Activity
Activity Activity
Cabinets
Desks
Tables
Machining Department
Activity Activity
Activity Activity
1. Departments
2. Activities
3. Products

Cost
A cost is a sacrifice or giving up of
resources for a particular purpose.
Costs are frequently measured by
the monetary units that must be
paid for goods and services.

Cost Object
A cost object (objective) is anything for which
A separate measurement of costs is desired.
Customers
Departments
Processing orders
Product
Service

Direct, Indirect, and Unallocated Costs
Direct costs can be identified specifically and exclusively
with a given cost objective in an economically feasible way.
Learning
Objective 3
Indirect costs cannot be identified specifically and exclusively
With a given cost objective in an economically feasible way.
Unallocated costs are recorded but
not assigned to any cost object.

Cost Allocation
Cost allocation is used to assign indirect costs to cost objects, in proportion
to the cost objects use of a particular cost-allocation base.
A cost-allocation base is some measure of input or output that
determines the amount of cost to be allocated to a particular cost object.
An ideal cost-allocation base would measure how much
of the particular cost is caused by the cost objective.
Note the similarity of this definition to that of a cost driveran output
measure that causes costs. Therefore, most allocation bases are cost drivers.
Learning
Objective 4

Cost Allocation
Cost allocations support a companys CMSthe system
providing cost measurements for strategic decision making,
operational control, and external reporting.
Four purposes of cost allocation:
Predict the economic effects of strategic and operational control decisions.
Provide desired motivation and to give feedback for performance evaluation.
Compute income and asset valuations for financial reporting.
Justify costs or obtain reimbursement.

Cost Pool
A cost pool is a group of individual costs that a company
allocates to cost objects using a single cost-allocation base.
1. Accumulate indirect costs for a period of time.
2. Select an allocation base for each cost pool, preferably a cost driver,
that is, a measure that causes the costs in the cost pool.
3. Measure the units of the cost-allocation base used for each cost
object and compute the total units used for all cost objects.
4. Determine the percentage of total cost-allocation base units
used for each cost object.
5. Multiply the percentage by the total costs in the cost pool to
determine the cost allocated to each cost object.

Cost Allocation
Direct costs are physically traced to a cost object.
Indirect costs are allocated using a cost-allocation base.

Direct, Indirect, and Unallocated Costs
Li Companys Statement of Operating Income
Statement of Operating Income

Direct Material Costs
Direct materials include the acquisition costs
of all materials that a company identifies
as a part of the manufactured goods.
These costs are identified in
an economically feasible way.
Learning
Objective 5

Direct Labor Costs
Direct Labor costs include the
wages of all labor that can be
traced specifically and exclusively
to the manufactured goods in an
economically feasible way.

Indirect Production Costs (Manufacturing Overhead)
Manufacturing overhead includes all costs
associated with the production process
that the company cannot be traced to
the manufactured goods in an
economically feasible way.

Product Costs
Product costs are costs identified with goods
produced or purchased for resale.
These costs first become part of the inventory
on hand, sometimes called inventoriable costs.
Inventoriable costs become expenses in the form of
cost of goods sold only when the inventory is sold.

Period Costs
Period costs are deducted as expenses
during the current period without
going through an inventory stage.
1 2 3
4 5 6 7 8 9 10
11 12 13 14 15 16 17
18 19 20 21 22 23 24
25 26 28 29 30 31 27

Merchandising Company
(Retailer or Wholesaler)

Merchandise
Purchases
Merchandise
Inventory
Sales
Minus
Cost of
Goods Sold
(Expenses)
Selling Expenses and
Administrative
Expenses
Period
Costs
Equals Gross Margin
Minus
Equals Operating
Income
Product
(Inventoriable)
Costs
Expiration
Financial Statement Presentation
Merchandising Companies
Learning
Objective 6

Manufacturing Company
Direct
Material
Purchases
Finished
Goods
Inventory
Sales
Minus
Cost of
Goods Sold
(Expenses)
Selling Expenses and
Administrative
Expenses
Period
Costs
Equals Gross Margin
Minus
Equals Operating
Income
Product
(Inventoriable)
Costs
Expiration
Financial Statement Presentation
Manufacturing Companies
Work-in-
Process
Inventory
Direct
Material
Inventory
Direct Labor
Indirect
Manufacturing

Current Asset Sections
of Balance Sheets
Cash $ 4,000
Receivables 25,000
Subtotal $29,000
Finished goods 32,000
Work in process 22,000
Direct material 23,000
Total inventories $77,000
Other current assets 1,000
Total current assets $107,000
Manufacturer
Cash $ 4,000
Receivables 25,000

Merchandise inventories 77,000
Other current assets 1,000
Total current assets $107,000
Retailer or Wholesaler

Income Statement Presentation
of Costs for a Manufacturer
Direct labor
Indirect manufacturing
The manufacturers cost of goods produced
and then sold is usually composed of
the three major categories of cost:
Direct materials

Income Statement Presentation
of Costs for a Retailer
The merchandisers cost of goods sold
is usually composed of the purchase
cost of items, including freight-in,
that are acquired and then resold.

Traditional Costing System
Learning
Objective 7

Direct
Materials
For Pen
Casings
$22,500

Direct
Labor
For Pen
Casings
$135,000
Direct
Materials For
Cell
Phone
Casings
$12,000
Direct
Labor For
Cell Phone
Casings
$15,000
Sales $360,000 Sales $80,000 Unallocated $00,000
All
Indirect
Resources
$220,000
All Unallocated
Value Chain
Costs
$100,000
Cost Driver
[Direct Labor
Hours]

Traditional Costing System
Statement of Operating Income
Traditional Cost Allocation System
Pen
Casings
Cell Phone
Casings
Sales $440,000 $360,000 $80,000
Direct materials 34,500 22,500 12,000
Direct labor 150,000 135,000 15,000
Indirect manufacturing 220,000 198,000 22,000
Gross profit $ 35,500 $ 4,500 $31,000
Corporate expenses 100,000
Operating loss ($ 64,500)
Gross profit margin 8.07% 1.25% 38.75%

ABC System

Direct
Materials
For Pen
Casings
$22,500

Direct
Labor
For Pen
Casings
$135,000
Direct
Materials For
Cell
Phone
Casings
$12,000
Direct
Labor For
Cell Phone
Casings
$15,000
Sales $360,000 Sales $80,000 Unallocated $00,000
Plant and
Machinery
$180,000
All Unallocated
Value Chain Costs
$100,000
Cost Driver
[Direct Labor Hours]
Cost Driver
[Distinct Parts]
Engineers and
CAD Equipment
$40,000
Processing
Activity
$135,000
+ 8,000
$143,000
Production Support
Activity
$45,000
+32,000
$77,000
75% 25%
20% 80%

Activity-Based Cost Allocation System
Sales $440,000 $360,000 $80,000
Direct materials 34,500 22,500 12,000
Direct labor 150,000 135,000 15,000
Processing activity 143,000 128,700 14,300
Production support activity 77,000 15,400 61,600
Gross profit $ 35,500 $ 58,400 ($22,900)
Corporate expenses 100,000
Operating loss ($ 64,500)
Gross profit margin 8.07% 16.22% (28.63%)
External
Reporting
Internal Purposes
Pen
Casings
Cell
Phone
Casings

ABM is using the output of an activity-based
cost accounting system to aid strategic decision
making and to improve operational control.
Activity-Based Management
A value-added cost is the cost of an activity
that cannot be eliminated without affecting
a products value to the customer.
In contrast, nonvalue-added costs are costs
that can be eliminated without affecting
a products value to the customer.
Learning
Objective 8

Activity-Based Management
Benchmarking is the continuous process of
comparing products, services, and activities
to the best industry standards.
Benchmarking is a tool to help an organization measure
its competitive posture. Benchmarks can come from
within the organization, from competing organizations,
or from other organizations having similar processes.

Benefits of Activity-Based Costing and
Management Systems
set an optimal product mix
to estimate profit margins of new products
determine consumption of companys shared resources
keep pace with new product techniques
and technological changes
decrease the costs associated with bad decisions
take advantage of reduced cost of ABC
systems due to computer technology
Companies adopt ABC systems to:

Design of a Traditional Costing System

Design of an Activity-Based
Determine the key
components of the
cost accounting
system.
Cost objectives
Key activities
Resources
Related cost drivers
Learning
Objective 9

Account billing
Bill verification
Account inquiry
Correspondence
Other activities
Number or printed pages
Number of accounts verified
Number of inquiries
Number of letters
Number of printed pages
Key
Activity
Cost
Driver

Activity Performed
Resource Account
Used to Inquiry Correspondence Billing Verification All Other
Perform Activity Activity Activity Activity Activity Activities Total

Supervisor 40% 10% 30% 20% 100%
Account inquiry labor 90 10 100%
Billing labor 30 70 100%
Verification labor 100 100%
Paper 100 100%
Computer 45 5 35 10 5 100%
Telecommunications 90 10 100%
Occupancy 65 15 20 100%
Printing machines 5 90 5 100%
All other department resources 100 100%
Determine the relationships among
cost objectives,activities, and resources.

Collect relevant data concerning costs and the physical
flow of the cost-driver units among resources and activities.
Number of Cost Driver Units
Activity Cost Driver Units Residential Commercial Total
Account inquiry Inquiries 20,000 5,000 25,000
Correspondence Letters 1,800 1,000 2,800
Bill printing Printed pages 120,000 40,000 160,000
Verification Accounts verified 20,000 20,000
Other activities Printed pages 120,000 40,000 160,000

Calculate and interpret the new
activity-based information.
Determine the traceable costs for
each of the activity cost pools.
Determine the activity-based cost per
account for each customer class

Activity Cost Pool
Cost (from Account
Resource slide 4-33) Inquiry Correspondence Billing Verification Other
Supervisors $ 33,600 $ 13,440* $ 3,360** $ 10,080*** $ 6,720****
Account inquiry
labor 173,460 156,114 17,346
Billing labor 56,250 16,875 $39,375
Verification labor 11,250 11,250
Paper 7,320 7,320
Computer 178,000 80,100 8,900 62,300 17,800 8,900
Telecommunication 58,520 52,668 5,852
Occupancy 47,000 30,550 7,050 9,400
Printers 55,000 2,750 49,500 2,750
Other resources 67,100 67,100
Total traceable
cost $687,500 $332,872 $32,356 $153,125 $68,425 $100,722
*From slides 33 and 36, account inquiry activity uses 40% of the supervisor resource. So the allocation is 40% $33,600 = $13,440.
**10% $33,600
***30% $33,600
****20% $33,600
Total traceable costs for the 5 activity cost pools.

Driver Costs
Total Number of
Traceable Costs Driver Units Cost per
(from Exhibit 4-12) (From Exhibit 4-11) Driver Unit
Activity (Driver Units) (1) (2) (1) (2)
Account inquiry (inquiries) $332,872 25,000 Inquiries $13,314880
Correspondence (letters) 32,356 2,800 Letters $11.555714
Account billing (printed pages) 153,125 160,000 Printed pages $ 0.957031
Bill verification (accounts verified) 68,425 20,000 Accounts verified $ 3.421250
Other activities (printed pages) 100,722 160,000 Printed pages $ 0.629513

Cost per Customer Class
Residential Commercial
Cost per Number of Number of
Driver Unit Driver Units Cost Driver Units Cost
Account inquiry $13.314880 20,000 Inquiries $266,298 5,000 Inquiries $ 66,574
Correspondence $11.555714 1,800 Letters 20,800 1,000 Letters 11,556
Account billing $ 0.957031 120,000 Pages 114,844 40,000 Pages 38,281
Bill verification $ 3.421250 20,000 Accts. 68,425
Other activities $ 0.629513 120,000 Pages 75,541 40,000 pages 25,181
Total cost $477,483 $210,017
Number of accounts 120,000 20,000
Cost per account $ 3.98 $ 10.50
Cost per account, traditional
system from slide 33 $ 4.58 $ 6.88
Activity-based cost per account for each customer class

Strategic Decisions, Operational Cost
Control, and ABM
Outsourcing
Reducing operating costs
Identifying nonvalue-added activities
Improving both strategic
and operational decisions

End of Chapter 4
The End

Manacc-Cost MGT & Activity Based Costing

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2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton 4 - 1

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