Cost Management Systems and ActivityBased Costing

1
Introduction to Management Accounting
2
Introduction to Management Accounting
Chapter 4
Cost Management Systems and Activity-Based
Costing
3
Cost Management System
Learning Objective 1
A cost management system (CMS) is a collection of
tools and techniques that identifies how
managements decisions affect costs.
4
Cost Management System
The primary purposes of a cost management system
are to provide...
5
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.
6
Cost Accounting System
Learning Objective 2
Cost accumulation
Collecting costs by some natural
classification such as materials or labor
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Cost Accounting System
Cost accumulation
Cost assignment to cost objects
Finishing Department Activity Activity Activity Ac
tivity
Machining Department Activity Activity Activity Ac
tivity
1. Departments
2. Activities
3. Products
8
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.
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Cost Object
A cost object (objective) is anything for which
A separate measurement of costs is desired.
Customers
Departments
Service
Product
Processing orders
10
Direct, Indirect, and Unallocated Costs
Learning Objective 3
Direct costs can be identified specifically and
exclusively with a given cost objective in an
economically feasible way.
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.
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Cost Allocation
Learning Objective 4
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.
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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.

13
Cost Pool
A cost pool is a group of individual costs that a
company allocates to cost objects using a single
cost-allocation base.

• Accumulate indirect costs for a period of time.
• Select an allocation base for each cost pool,
  preferably a cost driver,
• that is, a measure that causes the costs
  in the cost pool.
• Measure the units of the cost-allocation base
  used for each cost
• object and compute the total units used
  for all cost objects.
• Determine the percentage of total cost-allocation
  base units
• used for each cost object.
• Multiply the percentage by the total costs in the
  cost pool to
• determine the cost allocated to each cost
  object.

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Cost Allocation
Direct costs are physically traced to a cost
object. Indirect costs are allocated using a
cost-allocation base.
15
Statement of Operating Income
Direct, Indirect, and Unallocated Costs
Li Companys Statement of Operating Income
16
Direct Material Costs
Learning Objective 5
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.
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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.
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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.
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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.
20
Period Costs
Period costs are deducted as expenses during the
current period without going through an inventory
stage.
21
Financial Statement Presentation Merchandising
Companies
Learning Objective 6
Merchandising Company (Retailer or Wholesaler)
Sales
Minus
Product (Inventoriable)
Costs
Cost of Goods Sold (Expenses)
Merchandise Purchases
Merchandise Inventory
Expiration
Equals Gross Margin Minus
Selling Expenses and Administrative Expenses
Period Costs
Equals Operating Income
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Financial Statement Presentation Manufacturing
Companies
Manufacturing Company
Direct Material Inventory
Direct Material Purchases
Product (Inventoriable)
Costs
Finished Goods Inventory
Sales
Direct Labor
Minus
Indirect Manufacturing
Cost of Goods Sold (Expenses)
Expiration
Work-in-Process Inventory
Equals Gross Margin Minus
Selling Expenses and Administrative Expenses
Period Costs
Equals Operating Income
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Current Asset Sectionsof Balance Sheets
24
Income Statement Presentationof Costs for a
Manufacturer
The manufacturers cost of goods produced and
then sold is usually composed of the three major
categories of cost
Direct materials
Direct labor
Indirect manufacturing
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Income Statement Presentationof 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.
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Traditional Costing System
Learning Objective 7
All Indirect Resources 220,000
All Unallocated Value Chain Costs 100,000
Cost Driver Direct Labor Hours
Direct Materials For Cell Phone Casings 12,000

Direct Labor For Cell Phone Casings 15,000
Direct Materials For Pen Casings 22,500
Direct Labor For Pen Casings 135,000
Sales 80,000
Sales 360,000
Unallocated 00,000
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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
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ABC System
Plant and Machinery 180,000
Engineers and CAD Equipment 40,000
All Unallocated Value Chain Costs 100,000
20
80
75
25
Processing Activity 135,000 8,000 143,000
Production Support Activity 45,000 32,000
77,000
Cost Driver Direct Labor Hours
Cost Driver Distinct Parts
Direct Materials For Cell Phone Casings
12,000
Direct Labor For Pen Casings 135,000
Direct Labor For Cell Phone Casings 15,000
Direct Materials For Pen Casings 22,500
Sales 80,000
Sales 360,000
Unallocated 00,000
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Activity-Based Cost Allocation System
Internal Purposes
External Reporting
Cell Phone Casings
Pen Casings
30
Activity-Based Management
Learning Objective 8
ABM is using the output of an activity-based
cost accounting system to aid strategic
decision making and to improve operational
control.
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.
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Activity-Based Management
Benchmarking
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.
32
Benefits of Activity-Based Costing and Management
Systems
Companies adopt ABC systems to

• 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

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Design of a Traditional Costing System
34
Design of an Activity-Based Cost Accounting
System
Learning Objective 9
Step 1
Determine the key components of the cost
accounting system.

• Cost objectives
• Key activities
• Resources
• Related cost drivers

35
Design of an Activity-Based Cost Accounting
System
Key Activity
Cost Driver
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
36
Design of an Activity-Based Cost Accounting
System
Determine the relationships
among cost
objectives,activities, and resources.
Step 2
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
37
Design of an Activity-Based Cost Accounting
System
Collect relevant data
concerning costs and the physical
flow of the cost-driver units among
resources and activities.
Step 3
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
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Design of an Activity-Based Cost Accounting
System
Step 4
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
39
Design of an Activity-Based Cost Accounting
System
Total traceable costs for the 5 activity cost
pools.
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
40
Design of an Activity-Based Cost Accounting
System
Activity-based cost per account for each customer
class
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 Ac
count 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
41
Strategic Decisions, Operational Cost Control,
and ABM
Outsourcing
Reducing operating costs
Identifying nonvalue-added activities
Improving both strategic and operational decisions
42
The End
End of Chapter 4