Management Accounting Department of Accounting Chapter 3 Cost Management Concepts and Cost Behavior.

Management AccountingManagement Accounting

Department of Accounting

Chapter 3

Cost Management Concepts and Cost Behavior



Chapter 3 objectives:

1. To be able to explain why the appropriate derivation of a cost depends on how the cost will be used.

2. 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.

3. To be able to state the difference between flexible costs and capacity-related costs and why the difference is important.4. 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.5. To be able to explain the notion of life-cycle cost and how that idea is used in

new product and product purchasing decisions.



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.



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 thework 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.



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 Share of the product cost assigned to the products actually sold sold during a specific period.



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.All costs incurred transforming raw materials into

finished product.

Period (nonmanufacturing) costs.All an organizations other costs.

1. Direct manufacturing costs.Costs directly traceable to a specific product initiating the cost.

1. distribution costs.Costs involved in delivering finished products to customers..

2. Indirect manufacturing costs.Costs more based on a cause-and-effect with capacity. Rater than with individualunits of productions.

3. selling costs.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 theabove categories.



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.



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.




Summary of Direct,Indirect, Flexible,and Capacity-Related Costs

Flexible Capacity Related

Direct Cost The cost of a resource whoseconsumption and cost variesin proportion to product.

The cost of special-purposecapacity (person orequipment) that was acquiredfor, and used by, only onecost object.

Indirect Cost The cost of a resource that isconsumed in proportion toproduction but which isprohibitively expensive toaccount for a direct cost.

The cost of general-purposecapacity (person orequipment) that is used by anumber of cost objects.




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. Long-run costs are the sum of flexible and capacity-related costs associated with a cost object.



How Organizations Create Costs

Starting up

Early growth

Reaching existing capacity

Expanding capacity

Redefining the business

Continued growth



Cost Structures Today- History

History timeline 1900 2000------------------------------------------------------------------------------------------------------------->

Primary focus on Higher focusmeasuring and on measuringcontrolling direct and controllinglabor and materials capacity related

costs



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 manufac-tured.

• Product sustaining Those activities that support the production and sales of activities individual products but are independent of actual

prodution volumes and batches.

• Customer sustaining Those activities that enable the company to sell to an activities individual customer but are independent of the volume

and mix of the products sold and delivered to the customer.

• Business sustaining Those activities required for the basic functioning of the activities business, independent of production or sales volumes

and mix.• Other Support activities



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

activites

unit level costs batch level costs product level costs support level costs customer costs

Cost object



Cost Structures Today- Understanding the underlying behavior of costs

Exhibits 3-1, 3-13

Exhibits 3-8, 3-9, 3-10, 3-11



Cost Structures Today- Life-cycle costs

• The product development and planning phase• Introduction phase• Growth phase• Product maturity phase• Product decline and abandonment phase

Management Accounting Department of Accounting Chapter 3 Cost Management Concepts and Cost Behavior.

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