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

2. Learning Objective 1
Describe the purposes of
cost management systems.
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3. Cost Management System
A cost-management system (CMS) is a
collection of tools and techniques that
identifies how management’s decisions
affect costs.
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4. What is Cost Accounting?
Cost accounting is that part of the
accounting system that measures costs
for the purposes of management decision
making and financial reporting.
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5. Learning Objective 2
Explain the relationships
among cost, cost objective,
cost accumulation, and
cost allocation.
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6. Cost Accounting System
Collecting costs by some
Cost
“natural” classification
Accumulation
such as materials or labor
Cost Tracing costs to one or
Allocation more cost objectives
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7. Cost Accounting System
Cost Accumulation RAW MATERIAL
Cost Allocation COSTS (METALS
to Cost Objects:
1. Departments MACHINING FINISHING
DEPARTMENT DEPARTMENT
2. Activities ACTIVITY ACTIVITY ACTIVITY ACTIVITY
CABINETS CABINETS
DESKS DESKS
3. Products
TABLES TABLES
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8. 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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9. 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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10. Learning Objective 3
Distinguish among direct,
indirect, and unallocated costs.
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11. Direct Costs
What are direct costs?
Direct costs can be identified specifically
and exclusively with a given cost
objective in an economically
feasible way.
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12. Indirect Costs
What are indirect costs?
Indirect costs cannot be identified
specifically and exclusively with a
given cost objective in an economically
feasible way.
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13. 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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14. 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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15. Categories of
Manufacturing Costs
 All costs which are eventually allocated
to products are classified as either…
1 direct materials,
2 direct labor, or
3 indirect manufacturing.
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16. 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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17. 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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18. Indirect Manufacturing Costs...
– or factory overhead, 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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19. 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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20. Period Costs...
– are costs that are deducted as expenses
during the current period without going
through an inventory stage.
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4 5 6 7 8 9 10
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21. 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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22. Period Costs – Merchandising
and Manufacturing
 In both merchandising and manufacturing
accounting, selling and general
administrative costs are period costs.
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23. 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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24. Financial Statement Presentation
– Merchandising Companies
Balance Sheet Income Statement
Sales
–
Merchandise Expiration Cost of Goods Sold
Inventory (an expense)
Equals Gross Margin
–
Selling and
Period Administrative
Costs Expenses
Equals Operating Income
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25. Financial Statement Presentation
– Manufacturing Companies
Balance Sheet Income Statement
Sales
Direct
–
Material
Expiration Cost of Goods Sold
Inventory (an expense)
Equals Gross Margin
–
Work-in- Finished Selling and
Period
Process Goods Administrative
Costs
Inventory Inventory Expenses
Equals Operating Income
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26. 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 of goods sold
is different.
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27. 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:
1 Direct materials
2 Direct labor
3 Indirect manufacturing
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28. 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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29. 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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30. Traditional Cost System
Direct Direct All All
Material Labor Indirect Unallocated
Resource Resource Resources Value Chain
Costs
Direct Direct
Trace Trace Cost
Driver
Products Unallocated
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31. Two-Stage Activity-Based
Cost System
Direct Direct Other Indirect Indirect All
Material Labor Direct Resource Resource Unallocated
Resource Resource Resources A Z Value Chain
Costs
Direct Direct % % % %
Trace Trace Activity Activity
1 10
Cost Cost
Driver Driver
Products Unallocated
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32. 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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33. Activity-Based Costing
Example of Activities and Cost Drivers:
Activities: Cost Drivers:
Account billing No. of lines
Bill verification No. of accounts
Account iniquity No. of labor hours
Correspondence No. of letters
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34. Learning Objective 6
Identify the steps involved in the
design and implementation
of an activity-based
costing system.
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35. Designing and Implementing an
Activity-Based Costing System
Step 1 Step 2
Determine cost of Develop a process-based
activities, resources, map representing the flow
and related cost of activities, resources, and
drivers. their interrelationships.
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36. Designing and Implementing an
Activity-Based Costing System
Step 3
Collect relevant data concerning costs
and the physical flow of the cost-driver
units among resources and activities.
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37. Designing and Implementing an
Activity-Based Costing System
Step 4
Calculate and interpret the new
activity-based information.
Using an activity-based costing system to
improve the operations of an organization
is activity-based management (ABM).
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38. 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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39. Activity-Based Management
 A value-added cost is the cost of an activity
that cannot be eliminated without affecting
a product’s value to the customer.
 In contrast, non-value-added costs are costs
that can be eliminated without affecting a
product’s value to the customer.
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40. Learning Objective 7
Use activity-based cost
information to improve the
operations of an organization.
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41. 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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42. Learning Objective 8
Understand cost accounting’s
role in a company’s
improvement efforts across
the value chain.
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43. 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.
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