Cost and management accounting systems & a bc costig

1. Cost Management Systems
and Activity-Based Costing
Khalid Aziz
ACCOUNTING OF ICMAP, CA..B,C &
D, PIPFA, BBA, MBA, M.COM, B.COM
STATISTICS OF MA-ECONOMICS
0322-3385752

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Learning Objective 1
Describe the purposes of
cost management systems.

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Cost Management System
A cost-management system(CMS) is a
collection of tools and techniques that
identifies how management’s decisions
affect costs.

4. 4
What is Cost Accounting?
Costaccountingis that part of the
accounting system that measures costs
for the purposes of management decision
making and financial reporting.

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Learning Objective 2
Explain the relationships
among cost, cost objective,
cost accumulation, and
cost allocation.

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Cost Accounting System
Cost
Accumulation
Collecting costs by some
“natural” classification
such as materials or labor
Cost
Allocation
Tracing costs to one or
more cost objectives

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Cost Accounting System
MACHINING
DEPARTMENT
ACTIVITYACTIVITY
FINISHING
DEPARTMENT
ACTIVITYACTIVITY
RAW MATERIAL
COSTS (METALS
CABINETS CABINETS
DESKS DESKS
TABLESTABLES
Cost Accumulation
Cost Allocation
to Cost Objects:
1. Departments
2. Activities
3. Products

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Cost
A cost may be defined as 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 Objective
What is a cost object or cost objective?
It is anything for which a separate measurement
of costs is desired.

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Learning Objective 3
Distinguish among direct,
indirect, and unallocated costs.

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Direct Costs
Direct costs can be identified specifically
and exclusively with a given cost
objective in an economically
feasible way.
What are direct costs?

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Indirect Costs
Indirect costs cannot be identified
specifically and exclusively with a
given cost objective in an economically
feasible way.
What are indirect costs?

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What Distinguishes
Direct and Indirect Costs?
Managers prefer to classify costs as direct
rather than indirect whenever it is
“economically feasible” or “cost effective.”
Other factors also influence whether a cost
is considered direct or indirect.
The key is the particular cost objective.

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Categories of
Manufacturing Costs
Any raw material, labor, or other input
used by any organization could,
in theory, be identified as a
direct or indirect cost
depending on the
cost objective.

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Categories of
Manufacturing Costs
All costs which are eventually allocated
to products are classified as either…
1direct materials,
2direct labor, or
3indirect manufacturing.

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Direct Material Costs...
–include the acquisition costs of all materials
that are physically identified as a part of the
manufactured goods and that may be traced
to the manufactured goods in an
economically feasible way.

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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 Manufacturing Costs...
–or factoryoverhead,include all costs
associated with the manufacturing process
that cannot be traced to the manufactured
goods in an economically feasible way.

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Product Costs...
–are costs identified with goods produced
or purchased for resale.
Product costs are initially identified as part
of the inventory on hand.
These costs, inventoriable costs, become
expenses (in the form of cost of goods sold)
only when the inventory is sold.

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Period Costs...
–are costs that 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 3127

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Period or Product Costs
In merchandising
accounting, insurance, depreciation, and
wages are period costs (expenses of the
current period).
In manufacturing accounting, many of these
items are related to production activities and
thus, as indirect manufacturing, are product
costs.

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Period Costs –Merchandising
and Manufacturing
In both merchandising andmanufacturing
accounting, selling and general
administrative costs are period costs.

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Learning Objective 4
Explain how the financial
statements of merchandisers
and manufacturers differ
because of the types of goods
they sell.

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Financial Statement Presentation
–Merchandising Companies
Merchandise
Inventory
Sales
Cost of Goods Sold
(an expense)
Selling and
Administrative
Expenses
Balance Sheet Income Statement
–
Equals Gross Margin
Equals Operating Income
–
Expiration
Period
Costs

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Financial Statement Presentation
–Manufacturing Companies
Finished
Goods
Inventory
Sales
Cost of Goods Sold
(an expense)
Selling and
Administrative
Expenses
Balance Sheet Income Statement
–
Equals Gross Margin
Equals Operating Income
–
Expiration
Period
Costs
Direct
Material
Inventory
Work-in-
Process
Inventory

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Costs and Income Statements
On income statements, the detailed
reporting of selling and administrative
expenses is typically the same for
manufacturing and merchandising
organizations, but the cost ofgoods sold
is different.

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Cost of Goods Sold
for a Manufacturer
The manufacturer’s cost of goods produced
and then sold is usually composed of the
three major categories of cost:
1Direct materials
2Direct labor
3Indirect manufacturing

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Cost of Goods Sold
for a Retailer or Wholesaler
The merchandiser’s 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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Learning Objective 5
Understand the main
differences between traditional
and activity-based costing
systems and why ABC systems
provide value to managers.

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Traditional Cost System
All
Unallocated
Value Chain
Costs
Direct
Material
Resource
Direct
Labor
Resource
All
Indirect
Resources
Products
Direct
Trace
Direct
Trace
Cost
Driver
Unallocated

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Two-Stage Activity-Based
Cost System
All
Unallocated
Value Chain
Costs
Direct
Material
Resource
Direct
Labor
Resource
Indirect
Resource
A
Products
Direct
Trace
Direct
Trace
Activity
1
Unallocated
Other
Direct
Resources
Indirect
Resource
Z
Activity
10
% %% %
Cost
Driver
Cost
Driver

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Activity-Based Costing
Understanding the relationships
among activities, resources,
costs, and cost drivers is the key
to understanding ABC and how
ABC facilitates managers’
understanding of operations.

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Example of Activities and Cost Drivers:
Activities:
Account billing
Bill verification
Account iniquity
Correspondence
Cost Drivers:
No. of lines
No. of accounts
No. of labor hours
No. of letters
Activity-Based Costing

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Learning Objective 6
Identify the steps involved in the
design and implementation
of an activity-based
costing system.

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Designing and Implementing an
Activity-Based Costing System
Determine cost of
activities, resources,
and related cost
drivers.
Develop a process-based
map representing the flow
of activities, resources, and
their interrelationships.
Step 1 Step 2

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Designing and Implementing an
Activity-Based Costing System
Collect relevant data concerning costs
and the physical flow of the cost-driver
units among resources and activities.
Step 3

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Designing and Implementing an
Activity-Based Costing System
Calculate and interpret the new
activity-based information.
Using an activity-based costing system to
improve the operations of an organization
is activity-basedmanagement(ABM).
Step 4

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Activity-Based Management
Activity-based management aims
to improve the value received by
customers and to improve profits
by identifying opportunities for
improvements in strategy and
operations.

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Activity-Based Management
A value-added costis the cost of an activity
that cannot be eliminated without affecting
a product’s value to the customer.
In contrast, non-value-added costsare costs
that can be eliminated without affecting a
product’s value to the customer.

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Learning Objective 7
Use activity-based cost
information to improve the
operations of an organization.

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Using ABC Information
Activity-based management…
provides costs of value-added and
non-value-added activities.
improves managers’ understanding of operations.

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Learning Objective 8
Understand cost accounting’s
role in a company’s
improvement efforts across
the value chain.

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Cost Accounting and
the Value Chain
A good cost accounting system is critical to
all value-chain functions from research and
development through customer service.