The accounting information system can be divided into two main subsystems: (1) the financial accounting information system and (2) the cost management information system. The arbitrary assignment of indirect costs to cost objects reduces the overall accuracy of the cost assignments.
Different Costs for Different Purposes
For example, Fleming Co., an Oklahoma City food distributor, notes that separating the cost of products from the cost of serving the retail customer is an important part of the flexible marketing plan.5 Individual product costs can refer to a tangible or intangible product . Figure 2-6 provides three examples of product cost definitions and some of the objectives they meet.
Product Costs and External Financial Reporting
Using more product costing methods than necessary can be confusing and undermine the credibility of the cost management information system.6. Pricing decisions, product mix decisions and strategic profitability analyzes require all traceable costs in the value chain to be allocated to the product.
Direct Materials
Direct Labor
Overhead
Nonproduction Costs
Couple this with the cost of the free samples and the wages of the thousands of Chinese who distribute them, and we see that the cost of marketing in China is a significant part of P&G's budget.8 For service organizations, the relative importance of selling and administrative costs depends on the nature of the service being performed. Examples of marketing expenses include the following: sales staff salaries and commissions, advertising, warehousing, shipping, and customer service. All costs associated with the general management of an organization that cannot reasonably be attributed to either marketing or production are administrative costs.
General administration has the responsibility to ensure that the various activities of the organization are properly integrated in order to achieve the overall mission of the firm. The president of the firm, for example, is concerned about the efficiency of marketing and production as they perform their respective roles. Examples of administrative costs are salaries of senior executives, legal fees, printing of the annual report and general accounting.
Prime and Conversion Costs
Doctors and dentists, for example, generally do very little marketing and thus have very low sales costs. The first two items are examples of order collection costs; the last three are order fulfillment costs. Proper integration of these two functions is critical to maximizing a company's overall profits.
External Financial Statements
Income Statement: Manufacturing Firm
To calculate cost of goods sold, it is first necessary to determine the cost of goods manufactured. We will next look at two supporting schedules for the income statement: cost of goods manufactured and cost of goods sold.
Cost of Goods Manufactured
The cost of completing a work in progress is then deducted to arrive at the cost of goods manufactured. If the cost of goods manufactured is for a single product, the average unit cost can be calculated by dividing the cost of goods by the number of units produced. In the statement of cost of manufactured goods, the cost of these partially completed units is reported as the cost of beginning work in progress and the cost of ending work in progress.
The cost of beginning work in process represents the manufacturing costs carried over from the previous period; the cost of ending work in process represents the manufacturing cost that will be carried over to the next period. If Amazon.com had offset those costs as cost of goods sold, its gross profit for the first quarter of 2000 would have fallen. Gross margin would have been 5 percent of sales, not the reported 22.3 percent. Amazon.com's 2002 annual report shows that fulfillment costs are still treated as operating expenses rather than cost of goods sold.
Cost of Goods Sold
In Exhibit 2-9, notice that the period's total manufacturing costs are added to the manufacturing costs established at beginning work in process. Work in process consists of all partially completed units found in production at a given time. Beginning work in progress consists of partially completed units available at the beginning of the period.
In both cases, additional production costs must be incurred to complete the units in progress. Information on fulfillment costs and gross profit for the years 2001 and 2002 can be found in the 2002 Annual Report of Amazon.com at http://media.corporate-ir.net/media_files/irol/97/97664/reports/2002_Annual_Report_FINAL. pdf. In 2001, implementation costs accounted for nearly 47 percent of Amazon.com's gross profit; in 2002 these costs accounted for almost 40 percent of gross profit.).
Income Statement: Service Organization
Functional-Based and Activity-Based Cost Management Systems
Functional-Based Cost Management Systems
A Brief Overview
Functional-Based Cost Accounting
Since unit-based activity drivers are usually not the only drivers that explain causal relationships, much of the product cost allocation activity must be classified as allocation (recall that allocation is cost allocation based on assumed relationships or convenience). We can therefore say that function-based cost accounting systems tend to be allocation-intensive. The product cost objective of a functionally based cost accounting system is typically met by allocating production costs to inventories and cost of goods for financial reporting purposes.
More comprehensive product cost definitions, such as the value chain and operating cost definitions illustrated in Exhibit 2-6, are not available for management use. However, functionally based cost accounting systems often produce useful variants of traditional product cost definitions. Variable manufacturing costs include direct materials, direct labor, and variable overhead, with variable overhead being based on the number of units produced.
Functional-Based Cost Control
So we can say that an activity-based costing system tends to be tracking intensive. The activity-based cost management system is capable of producing cost information for a variety of management objectives, including the financial reporting objective. The activity-based operational control subsystem also differs significantly from that of a functional-based system.
Activity-based management (ABM) focuses on managing activities with the objective of improving the value received by the customer and the profit received by the company in providing this value. This definition of activity-based management and the illustrative model in Figure 2-11 are based on the following source: Norm Raffish and Peter B. Other terms throughout the text related to activity-based management are also drawn from this source.
Choice of a Cost Management System
Depending on the trade-offs, the optimal cost management system may well be a simpler, functionally based system. As the cost of measurement decreases and the cost of errors increases, the existing cost management system is no longer optimal. As the exhibit illustrates, a more accurate cost management system is required due to changes in errors and measurement costs.
The cost management system is a subsystem of the accounting information system and must be designed to meet the objectives of cost accounting, controlling and decision-making. The main feature of the operational model of the cost accounting system is the cost allocation process. The main goal of the cost accounting system is the allocation of costs to cost objects.
The objectives of costing and control serve to define two major subsystems: the cost accounting system and the operational control system. Allocation is the least accurate and least desirable approach, and in general a cost accounting system should be designed to minimize allocations. Given the increasing scope of the service sector, you should pay particular attention to what services are and how they differ from tangible products.
Cost management for service organizations will receive more emphasis in this text than is traditionally available. Exhibits 2-12 show some of the major differences between the two systems and should be studied carefully. A deep, detailed understanding of the differences will come only after studying the chapters that focus on the different types of systems.
R e quir e d
L UTIO N
Her mother, who has copies of the deposit slips for Kate's account, sends a check (from her own account) with a deposit slip to Kate's account. The goals of Kate's financial system are to keep Kate financially solvent and to provide a clear and accurate picture of her current account balance and accounts accrued at any time. Identify the three cost elements that determine the cost of making a product (for external reporting).
Students first throw any waste paper (e.g. napkins) into the trash can, then put it next to the opening in the dishwashing area and put away the trays. When the racks come out of the other end of the dishwasher, they contain clean, germ-free items. Discuss how a cost management information system is similar to and different from a dishwashing system.
Based on your operating model, determine which definition of product costs applies: value chain, operational, or functional manufacturing.
P RODUCT C OST D EFI N ITIO N S
C OST D EFI N ITIO N S
Because glaxan is the first drug in its "family of drugs" to be produced commercially, there is no experience with possible side effects. Extensive testing didn't expose any real problems (besides occasional heartburn and insomnia), but the company couldn't be sure that such side effects didn't exist.
F U N CTIO N AL -B ASED S YSTE M S
Material handling: The extra batches caused by the smallpox increased the demand for material handling. We only inspect one sample taken from each batch, but please understand that the number of batches has increased with this new product line.
Required
S YSTEMS C ONCEPTS , F UNCTIONAL -B ASED VERSUS
A CTIVITY -B ASED C OST A CCOUNTING S YSTEMS
Draw an operational model illustrating each cost accounting system - with the items belonging to the system used as examples for each component of the model. Based on the operating models, comment on the relative costs and benefits of the two systems.
A CTIVITY -B ASED VERSUS F UNCTIONAL -B ASED O PERATIONAL C ONTROL S YSTEMS
I NCOME S TATEMENT , C OST OF G OODS M ANUFACTURED
C OST OF G OODS M ANUFACTURED , C OST
I DENTIFICATION , S OLVING FOR U NKNOWNS
I NCOME S TATEMENT , C OST OF S ERVICES P ROVIDED , S ERVICE A TTRIBUTES
C OST OF G OODS M ANUFACTURED , I NCOME S TATEMENT
C OLLABORATIVE L EARNING E XERCISE
C YBER R ESEARCH C ASE
