COST MANAGEMENT

Accounting & Control

Hansen▪Mowen▪Guan

Chapter 2
Basic Cost Management
Concepts
COPYRIGHT © 2009 South-Western Publishing, a division of Cengage Learning. 1
Cengage Learning and South-Western are trademarks used herein under license.
 Study Objectives
1. Explain 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. Explain the differences between traditional and
contemporary cost management systems.

2
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:
– Direct tracing: relies on physical observance of
causal relationships to assign costs to cost objects.
– Driver tracing: relies on drivers as causal factors to
assign costs to cost objects.

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Cost Assignment Methods

5
Examples of Product Cost
Definitions

6
 Product Costs
• Direct materials: those materials directly
traceable to the goods or services being produced.
– Example: The cost of wood in furniture.
• Direct labor: labor that is directly traceable to the
goods or services being produced.
– Example: Wages of assembly-line workers.
• Overhead: all other manufacturing costs.
– Example: Plant depreciation, utilities, property
taxes, indirect materials, indirect labor, etc.

7
Prime and Conversion Costs

Direct + Direct = Prime

Materials Labor Costs

Direct + Overhead = Conversion

Materials Costs Costs

8
 Nonproduction Costs
• Amount and timing of benefit cannot be
reasonably estimated
• Period costs
– Not inventoried
– Expensed as incurred
• Examples
– Research and development
– Marketing costs
– Administrative costs
9
Production and Nonproduction
Costs

10
 External Financial Statements
• Income Statement ~ Manufacturing Firm
– Functional categories of expense
• Cost of goods sold
• Operating expenses
– Supporting schedules
• Cost of goods manufactured
• Cost of goods sold
• Income Statement ~ Service Organization
– No finished goods inventory
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Income Statement: Manufacturing Firm
Manufacturing Organization
Income Statement
For the Year Ended December 31, 2009

Sales $ 2,000,000
Less: Cost of Goods Sold 1,300,000
Gross margin $ 700,000
Less operating expenses:
Research and development $ 100,000
Selling 300,000
Administrative 150,000 550,000
Operating income $ 150,000
From the Cost of
Goods Sold Schedule
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Statement of Cost of Goods
Manufactured

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Cost of Goods Sold Schedule

14
 Cost Management Systems
• Functional-Based
– Assumes a linear production cost behavior
– Assigns costs to organizational units

• Activity-Based
– Emphasizes tracing over allocation
– Identifies non-unit-based activity drivers

15
 Functional-Based
Cost Management
• Unit-based drivers
• Allocation-intensive
• Narrow and rigid product costing
• Focus on managing costs
• Sparse activity information
• Maximization of individual unit
performance
• Uses financial measures of performance
16
 Activity-Based
Cost Management
• Unit- and non-unit-based drivers
• Tracing intensive
• Broad, flexible product costing
• Focus on managing activities
• Detailed activity information
• System-wide performance maximization
• Uses both financial and nonfinancial
measures of performance
17
Trade-Off between Measurement
Costs and Error Costs

18
Shifting Costs

19
COST MANAGEMENT
Accounting & Control
Hansen▪Mowen▪Guan

End Chapter 2

COPYRIGHT © 2009 South-Western Publishing, a division of Cengage Learning. 20

Cengage Learning and South-Western are trademarks used herein under license.