Cost accounting

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ACCT 315– COST ACCOUNTING

MODULE 1 – COST MANAGEMENT AND COST ACCOUNTING

(CHAPTER 1 & 2)

DR WAN AZMIMI WAN MOHAMED

YANBU UNIVERSITY COLLEGE

Management Science Department

Dr Wan Azmimi Wan Mohamed

LEARNING OBJECTIVES

Distinguish between financial accounting from management accounting

Explain how management accounting affects strategic decisions

Describe the set of business functions in the value chain and identify new dimensions of performance that customers are expecting of companies

Explain the 5 steps decision making process and its roles in management accounting

Describe three guidelines management accountants follow in supporting managers

Discuss how management accounting fits into an organization structure

LEARNING OBJECTIVES

Discuss what professional ethics mean to management accountants

Define and illustrate a cost object

Distinguish between variable costs and fixed costs, direct costs and indirect costs, inventoriable costs and period costs

Explain why product costs are computed in different ways for different purposes

Describe a framework for cost accounting and cost management

Accounting Discipline Overview

Managerial Accounting—measures, analyzes, and reports financial and nonfinancial information to help managers make decisions to fulfill organizational goals. Managerial accounting need not be GAAP compliant.

Financial Accounting—focus on reporting to external users including investors, creditors, and governmental agencies. Financial statements must be based on GAAP.

Dr Wan Azmimi Wan Mohamed

Major Differences Between Financial and Managerial Accounting

	Managerial Accounting	Financial Accounting
Purpose	Decision making	Communicate financial position to outsiders
Primary Users	Internal managers	External users
Focus/Emphasis	Future-oriented	Past-oriented
Rules	Do not have to follow GAAP; cost vs. benefit	GAAP compliant; CPA audited
Time Span	Ultra current to very long time horizons	Historical monthly, quarterly reports
Behavioral Issues	Designed to influence employee behavior	Indirect effects on employee behavior

Dr Wan Azmimi Wan Mohamed

Strategy and Management Accounting

Strategy—specifies how an organization matches its own capabilities with the opportunities in the marketplace to accomplish its objectives

Strategic cost management—focuses specifically on the cost dimension within a firm’s overall strategy

Dr Wan Azmimi Wan Mohamed

Strategy and Management Accounting

Management accounting helps answer important questions such as:

Who are our most important customers, and how do we deliver value to them?

What substitute products exist in the marketplace, and how do they differ from our own?

What is our critical capability?

Will we have enough cash to support our strategy or will we need to seek additional sources?

Strategies and capabilities must be effectively executed to be useful

Dr Wan Azmimi Wan Mohamed

Management Accounting and Value

Creating value is an important part of planning and implementing strategy.

Value is the usefulness a customer gains from a company’s product or service.

Question? How company go about creating this value

Dr Wan Azmimi Wan Mohamed

Management Accounting and Value

Value chain is the sequence of business functions in which customer usefulness is added to products or services.

The Value chain consists of:

Research & development – Generating and experimenting with ideas related to new products, services, or processes

Design of products and process – Detailed planning, engineering, and testing of product and processes

Production- Procuring, transporting and storing (also called inbound logistics), coordinating and assembling (also called operations)resources to produce a product or deliver a service.

Dr Wan Azmimi Wan Mohamed

Management Accounting and Value

Marketing (including sales) – Promoting and selling products or services to customers or prospective customers.

Distribution – Processing orders and shipping products or services to customers(outbound logistics)

Customer service – Providing after sales service to customers

The Value Chain Illustrated

Dr Wan Azmimi Wan Mohamed

Key Success Factors

The dimensions of performance that customers expect, and that are key to the success of a company include:

Cost and efficiency – Reducing costs (Target Cost) and Eliminate activities which is not beneficial

Quality – Customers expects high level of quality. Total Quality Management(TQM) aims to improve operations throughout the value chain and deliver products/services that exceed customers satisfactions. Products are designed for zero defects and waste & minimal inventories

Time – New product development time and Customer response time

Innovation – Constant flow of innovative products or services

Dr Wan Azmimi Wan Mohamed

Planning and Control Systems

Planning selects goals, predicts results, decides how to attain goals, and communicates this to the organization.

Budget—the most important planning tool

Control takes actions that implement the planning decision, decides how to evaluate performance, and provides feedback to the organization.

Dr Wan Azmimi Wan Mohamed

A Five-Step Decision Making Process in Planning and Control

Identify the problem and uncertainties.

Obtain information.

Make predictions about the future.

Make decisions by choosing between alternatives.

Implement the decision, evaluate performance, and learn.

Dr Wan Azmimi Wan Mohamed

Management Accounting Guidelines

Cost–benefit approach is commonly used: benefits generally must exceed costs as a basic decision rule.

Behavioral and technical considerations—people are involved in decisions, not just dollars and cents.

Managers use alternative ways to compute costs in different decision-making situations.

Dr Wan Azmimi Wan Mohamed

A Typical Organizational Structure and the Management Accountant

Dr Wan Azmimi Wan Mohamed

Ethical Standards for Management Accountant

Management Accountant must maintain high standards of ethical behavior because they can control the information used for important strategic management decisions.

The IMA (Institute of Management Accountants) Statement of Ethical Professional Practice, published for its management accountant membership, offers guidance for ethical behavior applicable to cost-management analysts.

Dr Wan Azmimi Wan Mohamed

Professional Ethics

The four standards of ethical conduct for management accountants as advanced by the Institute of Management Accountants:

Competence

Confidentiality

Integrity

Objectivity

Dr Wan Azmimi Wan Mohamed

Competence

Follow applicable laws, regulations and standards.

Maintain professional expertise, and communicate any limitations or constraints.

Provide decision support information and recommendations that are accurate and timely.

IMA Standards for Ethical Behavior

Dr Wan Azmimi Wan Mohamed

Confidentiality

Do not disclose confidential information unless legally obligated to do so.

Inform relevant parties about the proper use of confidential information.

Do not use confidential information for personal advantage.

IMA Standards for Ethical Behavior

Dr Wan Azmimi Wan Mohamed

Avoid conflicts of interest and advise others of potential conflicts.

Abstain from activities that might discredit the profession.

Refrain from conduct that could compromise ethical performance.

Integrity

IMA Standards for Ethical Behavior

Dr Wan Azmimi Wan Mohamed

Communicate information fairly and objectively.

Disclose all information that should influence an intended user’s understanding of reports and analyses.

Credibility

IMA Standards for Ethical Behavior

Disclose delays or

deficiencies in

information and

its processing.

Dr Wan Azmimi Wan Mohamed

Basic Cost Terminology

Cost—sacrificed resource to achieve a specific objective

Actual cost—a cost that has occurred

Budgeted cost—a predicted cost

Cost object—anything of interest for which a cost is desired (A cost of a particular thing)

Dr Wan Azmimi Wan Mohamed

Cost Object Examples at BMW

Cost Object	Illustration
Product	BMW X 5 sports activity vehicle
Service	Dealer-support telephone hotline
Project	R&D project on DVD system enhancement
Customer	Herb Chambers Motors, a dealer that purchases a broad range of BMW vehicles
Activity	Setting up production machines
Department	Environmental, Health and Safety

Dr Wan Azmimi Wan Mohamed

Basic Cost Terminology

Cost accumulation—a collection of cost data in an organized manner

Cost assignment—a general term that includes gathering accumulated costs to a cost object. This includes:

Tracing accumulated costs with a direct relationship to the cost object and

Allocating accumulated costs with an indirect relationship to a cost object

Dr Wan Azmimi Wan Mohamed

Direct and Indirect Costs

Direct costs can be conveniently and economically traced (tracked) to a cost object.

Indirect costs cannot be conveniently or economically traced (tracked) to a cost object. Instead of being traced, these costs are allocated to a cost object in a rational and systematic manner.

Dr Wan Azmimi Wan Mohamed

BMW: Assigning Costs to a Cost Object

Dr Wan Azmimi Wan Mohamed

Cost Examples

Direct Costs

Parts

Assembly line wages

Indirect Costs

Electricity

Rent

Property taxes

Dr Wan Azmimi Wan Mohamed

Factors Affecting Direct/Indirect Cost Classification

Cost materiality – smaller the amount, less likely to be traced. Economically not feasible to trace

Availability of information-gathering technology make it possible to consider costs as direct costs

Operational design – A company’s facility focusing on a specific product.

Dr Wan Azmimi Wan Mohamed

Cost Behavior

Variable costs—changes in total in proportion to changes in the related level of activity or volume.

Fixed costs—remain unchanged in total regardless of changes in the related level of activity or volume.

Costs are fixed or variable only with respect to a specific activity or a given time period.

Dr Wan Azmimi Wan Mohamed

Cost Behavior

Variable costs are constant on a per-unit basis. If a product takes 5 pounds of materials each, it stays the same per unit regardless if one, ten, or a thousand units are produced.

Fixed costs change inversely with the level of production. As more units are produced, the same fixed cost is spread over more and more units, reducing the cost per unit.

Dr Wan Azmimi Wan Mohamed

Cost Behavior Summarized

	Total Dollars	Cost per Unit
Variable Costs	Change in proportion with output More output = More cost
Fixed Costs	Unchanged in relation to output	Change inversely with output More output = lower cost per unit

Total Dollars

Cost Per Unit

Variable Costs

Change in proportion with output

More output = More cost

Unchanged in relation to output

Fixed Costs

Unchanged in relation to output

Change inversely with output

More output = lower cost

per unit

Dr Wan Azmimi Wan Mohamed

Cost Behavior Visualized

Dr Wan Azmimi Wan Mohamed

Other Cost Concepts

Cost driver—a variable that causally affects costs over a given time span

Relevant range—the band of normal activity level (or volume) in which there is a specific relationship between the level of activity (or volume) and a given cost

For example, fixed costs are considered fixed only within the relevant range.

Dr Wan Azmimi Wan Mohamed

Relevant Range Visualized

Dr Wan Azmimi Wan Mohamed

A Cost Caveat

Unit costs should be used cautiously. Because unit costs change with a different level of output or volume, it may be more prudent to base decisions on a total dollar basis.

Unit costs that include fixed costs should always reference a given level of output or activity.

Unit costs are also called average costs.

Managers should think in terms of total costs rather than unit costs.

Dr Wan Azmimi Wan Mohamed

Multiple Classification of Costs

Costs may be classified as:

Direct/Indirect, and

Variable/Fixed

These multiple classifications give rise to important cost combinations:

Direct and variable

Direct and fixed

Indirect and variable

Indirect and fixed

Dr Wan Azmimi Wan Mohamed

Multiple Classification of Costs, Visualized

Dr Wan Azmimi Wan Mohamed

Different Types of Firms

Manufacturing-sector companies purchase materials and components and convert them into finished products.

Merchandising-sector companies purchase and then sell tangible products without changing their basic form.

Service-sector companies provide services (intangible products).

Dr Wan Azmimi Wan Mohamed

Types of Manufacturing Inventories

Direct materials—resources in-stock and available for use

Work-in-process (or progress)—products started but not yet completed, often abbreviated as WIP

Finished goods—products completed and ready for sale

Dr Wan Azmimi Wan Mohamed

Types of Product Costs

Also known as inventoriable costs

Direct materials—acquisition costs of all materials that will become part of the cost object.

Direct labor—compensation of all manufacturing labor that can be traced to the cost object.

Indirect manufacturing—factory costs that are not traceable to the product in an economically feasible way. Examples include lubricants, indirect manufacturing labor, utilities, and supplies.

Dr Wan Azmimi Wan Mohamed

Accounting Distinction Between Costs

Inventoriable costs—product manufacturing costs. These costs are capitalized as assets (inventory) until they are sold and transferred to Cost of Goods Sold.

Period costs—have no future value and are expensed in the period incurred.

Dr Wan Azmimi Wan Mohamed

Cost Flows

The Cost of Goods Manufactured and the Cost of Goods Sold section of the Income Statement are accounting representations of the actual flow of costs through a production system.

Note the importance of inventory accounts in the following accounting reports, and in the cost flow chart.

Dr Wan Azmimi Wan Mohamed

Cost Flows Visualized

Dr Wan Azmimi Wan Mohamed

Multiple-Step Income Statement

STEP 4

Dr Wan Azmimi Wan Mohamed

Cost of Goods Manufactured

STEP 1

STEP 3

STEP 2

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Other Cost Considerations

Prime cost is a term referring to all direct manufacturing costs (materials and labor).

Conversion cost is a term referring to direct labor and indirect manufacturing costs.

Overtime labor costs are considered part of indirect overhead costs.

Dr Wan Azmimi Wan Mohamed

Different Definitions of Costs for Different Applications

Pricing and product-mix decisions—decisions about pricing and maximizing profits

Contracting with government agencies—very specific definitions of allowable costs for “cost plus profit” contracts

Preparing external-use financial statements—GAAP-driven product costs only

Dr Wan Azmimi Wan Mohamed

Different Definitions of Costs for Different Applications

Dr Wan Azmimi Wan Mohamed

Three Common Features of Cost Accounting and Cost Management

Calculating the cost of products, services, and other cost objects

Obtaining information for planning and control, and performance evaluation

Analyzing the relevant information for making decisions

Dr Wan Azmimi Wan Mohamed

END OF MODULE

PANEL A: INCOME STATEMENT

Revenues$210,000

Costs of goods sold:

Beginning finished goods inventory, January 1, 2011$22,000

Costs of goods available for sale$104,000

Costs of goods manufactured (see Panel B)$126,000

Ending finished goods inventory, December 31, 2011$18,000

Cost of goods sold$108,000

Gross margin (or gross profit)$102,000

Operating costs

R&D, design, mktg., dist., & cust.-service cost$70,000

Total operating costs$70,000

Operating income$32,000

Cellular Products

Income Statement

For the Year Ended December 31, 2011 (in thousands)

Sheet1

PANEL A: INCOME STATEMENT
Cellular Products
Income Statement
For the Year Ended December 31, 2011 (in thousands)
Revenues		$210,000
Costs of goods sold:
Beginning finished goods inventory, January 1, 2011	$22,000
Costs of goods available for sale	$104,000
Costs of goods manufactured (see Panel B)	$126,000
Ending finished goods inventory, December 31, 2011	$18,000
Cost of goods sold		$108,000
Gross margin (or gross profit)		$102,000
Operating costs
R&D, design, mktg., dist., & cust.-service cost	$70,000
Total operating costs		$70,000
Operating income		$32,000
PANEL B: COST OF GOODS MANUFACTURED
Cellular Products
Schedule of Cost of Goods Manufactured*
For the Year Ended December 31, 2011 (in Thousands)
Direct materials:
Beginning inventory, January 1, 2011	$11,000
Purchases of direct materials	$73,000
Cost of direct materials available for use	$84,000
Ending inventory, December 31, 2011	$8,000
Direct materials used		$76,000
Direct manufacturing labor		$9,000
Manufacturing overhead costs:
Indirect manufacturing labor	$7,000
Supplies	$2,000
Heat, light, and power	$5,000
Depreciation-plant building	$2,000
Depreciation-plant equipment	$3,000
Miscellaneous	$1,000
Total manufacturing overhead costs		$20,000
Manufacturing cost incurr3ed during 2011		$105,000
Beginning work-in-progress inventory, January 1, 2011		$6,000
Total manufacturing costs to account for		$111,000
Ending work-in-progress inventory, December 31, 2011		$7,000
Cost of goods manufactured (to income Statement)		$104,000
* Note that this schedule can become a Schedule of Cost of Goods Manufactured and Sold simply by including the beginning and ending finished goods inventory figures in the supporting schedule rather than in the body of the income statement.

Sheet2

Sheet3

PANEL B: COST OF GOODS MANUFACTURED

Direct materials:

Beginning inventory, January 1, 2011$11,000

Purchases of direct materials$73,000

Cost of direct materials available for use$84,000

Ending inventory, December 31, 2011$8,000

Direct materials used$76,000

Direct manufacturing labor$9,000

Manufacturing overhead costs:

Indirect manufacturing labor$7,000

Supplies$2,000

Heat, light, and power$5,000

Depreciation-plant building$2,000

Depreciation-plant equipment$3,000

Miscellaneous$1,000

Total manufacturing overhead costs$20,000

Manufacturing cost incurr3ed during 2011$105,000

Beginning work-in-progress inventory, January 1, 2011$6,000

Total manufacturing costs to account for$111,000

Ending work-in-progress inventory, December 31, 2011$7,000

Cost of goods manufactured (to income Statement)$104,000

Schedule of Cost of Goods Manufactured*

For the Year Ended December 31, 2011 (in Thousands)

* Note that this schedule can become a Schedule of Cost of Goods Manufactured and Sold simply by including the beginning and

ending finished goods inventory figures in the supporting schedule rather than in the body of the income statement.

Cellular Products

Sheet1

PANEL A: INCOME STATEMENT
Cellular Products
Income Statement
For the Year Ended December 31, 2011 (in Thousands)
Revenues		$210,000
Costs of goods sold:
Beginning finished goods inventory, January 1, 2011	$22,000
Costs of goods available for sale	$104,000
Costs of goods manufactured (see Panel B)	$126,000
Ending finished goods inventory, December 31, 2011	$18,000
Cost of goods sold		$108,000
Gross margin (or gross profit)		$102,000
Operating costs
R&D, design, mktg., dist., & cust.-service cost	$70,000
Total operating costs		$70,000
Operating income		$32,000
PANEL B: COST OF GOODS MANUFACTURED
Cellular Products
Schedule of Cost of Goods Manufactured*
For the Year Ended December 31, 2011 (in Thousands)
Direct materials:
Beginning inventory, January 1, 2011	$11,000
Purchases of direct materials	$73,000
Cost of direct materials available for use	$84,000
Ending inventory, December 31, 2011	$8,000
Direct materials used		$76,000
Direct manufacturing labor		$9,000
Manufacturing overhead costs:
Indirect manufacturing labor	$7,000
Supplies	$2,000
Heat, light, and power	$5,000
Depreciation-plant building	$2,000
Depreciation-plant equipment	$3,000
Miscellaneous	$1,000
Total manufacturing overhead costs		$20,000
Manufacturing cost incurr3ed during 2011		$105,000
Beginning work-in-progress inventory, January 1, 2011		$6,000
Total manufacturing costs to account for		$111,000
Ending work-in-progress inventory, December 31, 2011		$7,000
Cost of goods manufactured (to income Statement)		$104,000
* Note that this schedule can become a Schedule of Cost of Goods Manufactured and Sold simply by including the beginning and ending finished goods inventory figures in the supporting schedule rather than in the body of the income statement.