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Management Accounting
Chapter 3
Cost Management
Concepts and Cost Behavior
Department of Accounting
Management Accounting
Chapter 3 objectives:
1.
2.
3.
4.
5.
To be able to explain why the appropriate derivation of a cost depends on how
the cost will be used.
To be able to explain why management accountants have developed the notions
of long-run and short-run costs and how these different costs are used in
decision making.
To be able to state the difference between flexible costs and capacity-related
costs and why the difference is important.
To be able to show why the concept of opportunity cost is used in short-run
decision making and how opportunity cost relates to conventional accounting
costs.
To be able to explain the notion of life-cycle cost and how that idea is used in
new product and product purchasing decisions.
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Management Accounting
What Does Cost Mean When the purpose is to compute the cost of something:
In Management Accounting terms there is no single definition of cost. It is
”different cost for different purposes”
Definitions:
A cost object:
Something for which we want to compute a cost.
A direct cost:
A cost of a resource og activity that is acquired for or used by a single
cost object.
An indirect cost:
The cost of a resource that was aquired to be used by more than one
cost object.
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Management Accounting
What Does Cost Mean When organizing cost based on the way they are created
Flexible resources
Resources whose costs are proportional to the amount of
the resource used.
Flexible costs
The cost of flexible resources.
Capacity-related resources
Resources acquired and paid for in advance of when the
work is completed and whose costs depend upon the
amount required rather than the amount used.
Capacity-related costs
The costs associated with capacity-related resources.
Department of Accounting
Management Accounting
How the Use of Cost Information Defines Its
Focus and Form
- Using cost information outside the organization
GAAP = Generally Accepted Accounting Principles
Cost
GAAP defines cost as ”the monetary value of goods and services
expended to obtain current or future benefits.
Expenses
The cost of goods or services that have expired.
Product cost
Cost incurred to produce the volume and mix of products made
during the period.
Cost of goods
sold
Share of the product cost assigned to the products actually sold
during a specific period.
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Management Accounting
How the Use of Cost Information Defines Its
Focus and Form
- Using cost information outside the organization, continued …..
Summary of Cost Classifications
according to GAAP
Product (manufacturing) costs.
Period (nonmanufacturing) costs.
All costs incurred transforming raw materials into
finished product.
All an organizations other costs.
1. Direct manufacturing costs.
1. distribution costs.
Costs directly traceable to a specific product initiating the cost.
Costs involved in delivering finished products to customers..
2. Indirect manufacturing costs.
3. selling costs.
Costs more based on a cause-and-effect with capacity. Rater than with individual
units of productions.
Costs related to the activity of selling the products og services.
4. marketing costs.
Advertising and promotion expenses.
5. after-sales costs.
Advertising and promotion expenses.
6. research and development costs.
Expenditures for designing and bringing new products to market.
general and administrative costs.
Other general overhead such as executive officers salaries and any other cost not related to the
above categories.
Department of Accounting
Management Accounting
How the Use of Cost Information Defines Its
Focus and Form
- Using cost information inside the organization
Two broad categories:
•
Cost structured for planning purposes
(example: Determining the selling price of a specific product).
•
Cost structured for evaluation purposes
(example: Evaluation of profitability of a certain product).
In general:
Costs are used by decision makers to make decisions and to control the processes they
manage. Benefits from providing cost information should exceed the cost of developing
them.
Department of Accounting
Management Accounting
How the Use of Cost Information Defines Its
Focus and Form
- Using cost information inside the organization, continued …
From a Management Accounting perspective a valid statement is :
Different costs for different purposes.
Opportunity cost.
The sacrifices incurred when using resources for one purpose instead of another.
Opportunity cost perspectives are widely used in organizations as a base for decision
making.
Department of Accounting
Management Accounting
How the Use of Cost Information Defines Its
Focus and Form
- Using cost information inside the organization, continued …
Summary of Direct,
Indirect, Flexible,
and CapacityRelated Costs
Flexible
Capacity Related
Direct Cost
The cost of a resource whose
consumption and cost varies
in proportion to product.
The cost of special-purpose
capacity (person or
equipment) that was acquired
for, and used by, only one
cost object.
Indirect Cost
The cost of a resource that is
consumed in proportion to
production but which is
prohibitively expensive to
account for a direct cost.
The cost of general-purpose
capacity (person or
equipment) that is used by a
number of cost objects.
Department of Accounting
Management Accounting
How the Use of Cost Information Defines Its
Focus and Form
- Using cost information inside the organization, continued …
How perspective determines the cost definition
Short-run costs:
The short-run is defined as the period over which a decision
maker cannot adjust capacity.
The only cost that vary in the short run are those that vary in
proportion to production.
Long-run costs:
The long-run is defined as the period over which a decision
maker can influence flexible and capacity-related cost. Longrun costs are the sum of flexible and capacity-related costs
associated with a cost object.
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Management Accounting
How Organizations Create Costs
Starting up
Early growth
Reaching existing capacity
Expanding capacity
Redefining the business
Continued growth
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Management Accounting
Cost Structures Today
- History
History timeline
1900
2000
------------------------------------------------------------------------------------------------------------->
Primary focus on
measuring and
controlling direct
labor and materials
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Higher focus
on measuring
and controlling
capacity related
costs
Management Accounting
Cost Structures Today
- Types of production activities
• Unit related activities
Those activities whose volume or level is proportional to
the number of units produced or sold
• Batch related activities
Those activities triggered by the number of batches
produced rater than by the number of units manufactured.
• Product sustaining
activities
Those activities that support the production and sales of
individual products but are independent of actual
prodution volumes and batches.
• Customer sustaining
activities
Those activities that enable the company to sell to an
individual customer but are independent of the volume
and mix of the products sold and delivered to the
customer.
• Business sustaining
activities
Those activities required for the basic functioning of the
business, independent of production or sales volumes
and mix.
• Other Support activities
Department of Accounting
Management Accounting
Cost Structures Today
- Types of production activities, continued ….
activities on
individual units
activities on
batches of units
product level
activities
other support
activities
customer sustaining
unit level costs
batch level costs
product level costs
support level costs
customer costs
Cost object
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activites
Management Accounting
Cost Structures Today
- Understanding the underlying behavior of costs
Exhibits 3-1, 3-13
Exhibits 3-8, 3-9, 3-10, 3-11
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Management Accounting
Cost Structures Today
- Life-cycle costs
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•
•
•
•
The product development and planning phase
Introduction phase
Growth phase
Product maturity phase
Product decline and abandonment phase
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