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Quarles, ACC 564, CMS1
Cost Measurement Systems
Traditional and Contemporary Approaches
Sam Houston State University
ACC 564
R. Quarles
Quarles, ACC 564, CMS2
Cost Measurement Systems
• Should not be confused with accounting
• Do not address external reporting issues
• Are based on the idea of being approximately correct rather than precisely wrong
• Do not provide the answer
• Are not dictated by a board of wise persons in Connecticut or by a bunch of clowns in Washington
Quarles, ACC 564, CMS3
Cost Measurement Systems
• Cost measurement systems provide more questions and sometimes answers to questions related to strategic objectives of – Quality– Cost – Time
Quarles, ACC 564, CMS4
Strategic Objectives
• Quality– Features– Reliability
• Costs involved– How much do features/reliability cost?– Can customers afford the level of quality provided?– How much does it cost to add new features or
increase reliability?– How do we determine the cost of each feature or
reliability element?
Quarles, ACC 564, CMS5
Strategic Objectives
• Cost– Must be measured in order to be managed– Related directly/indirectly to a product/service
• Final reckoning - all costs incurred to provide product/services
– What causes costs?– Poor cost measurement may result in
incorrectly leaving or remaining in a market– Cost system must identify, track, report costs of
providing services or creating/delivering/supporting a product
Quarles, ACC 564, CMS6
Strategic Objectives
• Time– Meeting delivery deadlines– Bringing product/service to market rapidly and
proper point in time– Late delivery within the firm can delay other
steps and increase costs– Altering process time schedules affects costs– Cost system must identify/measure time factors
and costs of delays/alterations
Quarles, ACC 564, CMS7
Attributes of a Good Cost System
• Technical Attributes– Decision Relevance
• Cost data related to strategic objectives– Cost of features/reliability– Identification of causes of cost for management attention
• Provide data for decision regarding– What customers/markets to target– Product prices/profitability plans– What products to promote– Levels of quality/service to provide– How manage costs/allocate resources
Quarles, ACC 564, CMS8
Attributes of a Good Cost System
• Technical Attributes– Process Understanding
• Help management understand work processes• Help management understand economic impact of
activities that reduce/increase– Quality/Costs/Time
• Identifies costs across all steps in process - where are delays/cost multipliers
• Identifies relationship between work done and cost incurred - ripple effect of activities in one area
• Helps understand why work occurs and what drives costs
Quarles, ACC 564, CMS9
Attributes of a Good Cost System
• Behavioral Attributes– Cost data
• Increases visibility of activities• Focuses attention• Communicates managerial intent
– Cost structure visibility - highlights cost drivers• Decisions on products and processes affect costs• Cost data affects decision behaviors
– Communications with operations personnel• Non-accountants tolerate but do not understand • Bookkeeping versus working
Quarles, ACC 564, CMS10
Attributes of a Good Cost System
• Behavioral Attributes– Employee Motivation
• Cost data traditionally used to FIX BLAME– Leads to short-run decision emphasis– Cost data can be used to focus on how to work better, not
who to blame
Quarles, ACC 564, CMS11
Attributes of a Good Cost System
• Cultural Attributes– Culture can emphasize blame or process
improvement• Who spent the money versus is what is being done• Cross functional participation
– Focus on cost objects reduces emphasis on departments– Activities necessary to produce cost cross departmental
boundaries– Employees in different departments must work together to
carry on activities
• Cost system should encourage process improvement and cross functional participation rather than fixing blame
Quarles, ACC 564, CMS12
Attributes of a Good Cost System
• Improves strategic decisions by providing data on quality, cost, and time performance
• Facilitates process management by providing data on the cost of the processes (activities and operations) used, and the underlying causal relationships (drivers) that cause costs to change.
• Encourages behaviors consistent with strategic objectives
• Creates mindsets and values that promote a healthy and positive organizational culture.
Quarles, ACC 564, CMS13
Nature of Cost Measurement Systems
• Cost Measurement– Must exist separately from bookkeeping system
• Emphasis on accountability for expenditures• Tracking of cost of resources PURCHASED as
opposed to those USED
– Reorganizes data on resources acquired to provide strategic cost data
• Not to be confused with accounting
14Quarles, ACC 564, CMS
• Transformation engine that converts raw data on resources purchased into cost information about resources used
TYPICAL COST MEASUREMENT SYSTEM
Basic Cost Elements
•Materials purchased
•Wages and salaries
•Utilities paid
•Equipment purchases
•Lease payments
•Other expenditures
The Building Blocks•Cost Objects
•Cost flows/tracking procedures
•Allocation rules
Output
Strategic Cost Information
•What products are most profitable?
•What does each process step add to costs?
•Which customers are profitable?
•What are the key cost drivers?
Quarles, ACC 564, CMS15
Nature of Cost Measurement Systems
• Building blocks of Cost Measurement– Cost Objects
• Any item for which a measure of cost is desired– Products, customers, lines of business, markets, etc.
• Corresponds to strategic decision needs
– Tracking Procedures• Traditional Systems
– Resources to Departments to Cost Objects
• Contemporary Systems– Resources to Activities to Cost Objects
Quarles, ACC 564, CMS16
Nature of Cost Measurement Systems
• Building blocks of Cost Measurement– Allocation Rules
• Direct Costs– Cost of consumption of resources directly traceable to or
assignable to a particular cost object» Direct labor Direct material
• Indirect Costs– Cannot be directly traced or directly attributable to a
particular cost object– Must be allocated to cost objects in some consistent,
logical, and informative manner
Quarles, ACC 564, CMS17
Design of Cost Measurement Systems
• Affects on Cost Systems– Mass Production
• Substantial inventories leads to emphasis on inventory measurement and manufacturing product cost
• Unskilled labor with authority vested in functional departmental manager - responsibility accounting
– Responsibility center cost tracking
• Little product variety allows use of single allocation base for all indirect costs
Quarles, ACC 564, CMS18
Traditional Cost Measurement
• Two Approaches– Job Order and Process Costing
• Job order appropriate where specific, unique jobs or batches can be identified
– One of a kind or custom manufacturing
• Process costing appropriate for high volume of identical products using a continuous process
– Oil refining, brewing, bread, cement, chemical manufacturing, etc.
– Resources• Period expenses: not associated with creating
inventory• Product cost: creation of inventory
Quarles, ACC 564, CMS19
Job Order Costing
• Resource cost traced to functional areas– Resources consumed by manufacturing area
will be product costs– Cost centers– Costs within cost centers
• Direct materials, direct labor, common costs
– Costs within the cost center traced to specific jobs or batches
• Materials by requisition sheets• Direct labor by time cards• Others allocated based on some allocation basis
20Quarles, ACC 564, CMS
•Materials
•Wages and salaries
•Utility costs
•Sales commissions
•Equipment purchase
•Advertising
•Supplies
Functional Costs
•Engineering
•Purchasing
•Manufacturing
•Customer Support
•Sales/marketing
•General business support
Manufacturing Departments
•Stamping
•Assembly
•Testing
Product Inventory
Cost
Cost per Heat
Exchanger
Building Blocks
Customer Jobs
•Sweden
•Zimbabwe
•Others
Cost Elements
Period Expenses
TRADITIONAL JOB COST SYSTEMS
Quarles, ACC 564, CMS21
Job Order Costing• Costs traced to specific jobs or batches
Exhibit 4: Analysis of Manufacturing Costs by Jobs
Sweden Zimbabwe Other TotalsDirect Materials
Stamping 384,000 192,000 2,624,000 3,200,000Assembly 108,000 72,000 1,020,000 1,200,000
Testing 54,000 18,000 228,000 300,000Direct Labor 0
Stamping 5,000 3,000 242,000 250,000Assembly 5,000 26,250 718,750 750,000
Testing 24,000 16,500 109,500 150,000Overhead 0
Stamping 48,750 32,500 1,543,750 1,625,000Assembly 292,500 146,250 4,436,250 4,875,000
Testing 97,500 29,250 848,250 975,000Total Job Cost 1,018,750$ 535,750$ 11,770,500$ 13,325,000$ Number of Units 8 6 86Current Status in process completeCost per Unit 127,344$ 89,292$
Quarles, ACC 564, CMS22
Process Costing
• Products are not unique within a production run– Identical and therefore consume equal amounts
of resources– Simple procedure is to determine costs of
production runs and divide by number of units produced to determine cost per unit
Quarles, ACC 564, CMS23
Process Costing
• Complicating factor– Work in process
• Beginning and ending WIP in various stages of completion
• Completion as to % of cost incurrence• WIP at end of period is come % complete as to the
total cost that will be incurred in its completion• Equivalent Units of Production
Quarles, ACC 564, CMS24
Process Costing
Calculation of EUP (weighted average)
Units completed and transferred 1,000,000
Ending WIP
40,000 units 60% complete 24,000
__________
Equivalent Units Produced 1,024,000
Cost incurred / EUP = Cost per unit
Quarles, ACC 564, CMS25
TRADITIONAL COST SYSTEMS• Reflect a management philosophy of:
– Responsibility by departments or cost centers
– Financial rather than operational control– After-the-fact cost control rather than
cost planning• Primary focus
– Manufacturing costs (same as product cost)
– Inventory and labor reporting• Cost flows from department to products
Quarles, ACC 564, CMS26
Traditional Systems
• Weaknesses– Product cost is not the total cost of the
product• Manufacturing cost only• Ignores design,creation, installation,service, etc.
– Indirect cost (overhead) significant element of total cost but no data provided of what causes these costs in relation to particular products or volumes or processes
Quarles, ACC 564, CMS27
Cost Measurement Systems
• New concepts affecting systems– TQM
• Cross functional management of processes reduce emphasis on responsibility accounting
– Lean Manufacturing or TQM• Reduces/eliminates inventory issues
– World Class Competition• Identify and manage costs, not purchases
– Total Product Cost• Manufacturing cost plus all costs of getting
product/service to customer
Quarles, ACC 564, CMS28
Activity Based Costing
– Emphasis on activities and their relationships to resources and cost objects
• Steps in ABC
• Step 1: identify activities and objects used by jobs/processes
• Process map• Activities are related tasks that are accomplished
in order to do what the work
Quarles, ACC 564, CMS29
Activity Based Costing• Step 2: compute the cost of activitiesExhibit 12: Activity Cost for Heat Exchangers
Activity or Operation CostVisit prospective customers 83,600$ Develop product specifications 608,000Draft contract 270,000Purchase materials 288,000Set up stamping machines 1,176,000Stamp steel plates 3,952,000Build frame 756,000Insert plates into frames 5,040,000Attach cover 126,000Move unit to paint shop 9,000Paint 480,000Test 770,000Transport to customer site 910,000Final assembly 702,000Final inspection 504,000Bill customer 8,400Other activities 87,000
Total Activity Cost 15,770,000$
Quarles, ACC 564, CMS30
Activity Based Costing
• Step 3: determine cost drivers for each activity– Cost drivers
• (activity usage drivers) must be identified• what causes the activities to cost what they do
31Quarles, ACC 564, CMS
Activity Based Costing• Cost drivers for each activityExhibit 13: Activity Cost for Heat Exchangers
A B A / BDriver Cost per
Activity or Operation Cost Driver Quantity Unit of DriverVisit prospective customers 83,600$ Number of trips 22 3,800$ Develop product specifications 608,000 Engineering hours 3,800 160Draft contract 270,000 Legal staff hours 1,800 150Purchase materials 288,000 Per purchase order 2,400 120Set up stamping machines 1,176,000 Per production run 120 9,800Stamp steel plates 3,952,000 Per machine hour 520 7,600Build frame 756,000 Per component 420 1,800Insert plates into frames 5,040,000 Per plate 6,300 800Attach cover 126,000 Attachment points 2,100 60Move unit to paint shop 9,000 Per unit 120 75Paint 480,000 Surface area sq ft 32,000 15Test 770,000 Per test 275 2,800Transport to customer site 910,000 Per trip 140 6,500Final assembly 702,000 Per unit 120 5,850Final inspection 504,000 Per unit 120 4,200Bill customer 8,400 Per bill 28 300Other activities 87,000
Total Activity Cost 15,770,000$
Quarles, ACC 564, CMS32
Activity Based Costing
• Step 4: create cost pools for common drivers– Simplify calculations and emphasizes drivers
that account for significant costs
Quarles, ACC 564, CMS33
Activity Based Costing• Step 5: assign costs to jobs/processes based
on cost driversExhibit 14: Cost Assigned to Jobs
Units of Cost per Cost Units of Cost per CostActivity or Operation Driver Driver Assigned Driver Driver Assigned
Visit prospective customers 4 3,800$ 15,200$ 1 3,800$ 3,800$ Develop product specifications 1,400 160 224,000 300 160 48,000Draft contract 18 150 2,700 4 150 600Purchase materials 240 120 28,800 90 120 10,800Set up stamping machines 11 9,800 107,800 3 9,800 29,400Stamp steel plates 22 7,600 167,200 8 7,600 60,800Build frame 38 1,800 68,400 25 1,800 45,000Insert plates into frames 280 800 224,000 95 800 76,000Attach cover 122 60 7,320 90 60 5,400Move unit to paint shop 14 75 1,050 6 75 450Paint 3,800 15 57,000 825 15 12,375Test 18 2,800 50,400 6 2,800 16,800Transport to customer site 0 6,500 0 2 6,500 13,000Final assembly 0 5,850 0 6 5,850 35,100Final inspection 0 4,200 0 6 4,200 25,200Bill customer 0 300 0 1 300 300
Total Activity Cost 953,870$ 383,025$
Sweden Job Zimbabwe Job
Quarles, ACC 564, CMS34
Activity Based Costing
• Step 6: determine unit product cost(Direct Material + Activity Cost) / # of units
Exhibit 15: Comparison of Job CostSweden Zimbabwe
Total Job Cost Cost per Unit Total Job Cost Cost per Unit
Activity ViewMaterial Cost 546,000 68,250 282,000 47,000
Activities Cost 953,870 119,234 383,025 63,838Total Cost 1,499,870 187,484 665,025 110,838
Traditional ViewDirect Materials 546,000 68,250 282,000 47,000
Direct Labor 34,000 4,250 45,750 7,625Manufacturing Overhead 438,750 54,844 208,000 34,667
Total Cost 1,018,750 127,344 535,750 89,292
35Quarles, ACC 564, CMS
Basic Cost Elements Salaries & Wages Utilities Depreciation Materials & Supplies Taxes
Basic Cost Elements Salaries & Wages Utilities Depreciation Materials & Supplies Taxes
DEPARTMENTS JOBS
PRODUCTSACTIVITIES/
OPERATIONS
PRODUCTS
JOBS
TRADITIONAL V. CONTEMPORARY COST SYSTEMS
36Quarles, ACC 564, CMS
Non-traceable Activities•Management training• Others
Engineering Activities • Write specifications• Others
Business Support Activities•Investigate credit•Draft contract•Bill customer• Others
Marketing Activities•Generate customer order• Others
Customer Support Activities•Install exchangers• Others
CONTEMPORARYPRODUCT
COST
TRADITIONALPRODUCT
COST
Manufacturing Activities•Purchase materials•Receive and inspect materials•Move materials•Set up machines•Stamp steel•Move stamped steel•Assemble plates•Inspection•Rework•Others
TRADITIONAL V. CONTEMPORARY COST SYSTEMS
Quarles, ACC 564, CMS37
Assignment Notes
• Yamazoo– Conversion Cost
• The total of Direct Labor and Overhead (all manufacturing cost except Direct Materials)