Chapter 3: Basic Cost Management Concepts

Summary

There are several important concepts for the management accountant, which Chapter 3 presents in four groups: (1) cost objects, cost drivers, and cost pools, (2) product and service costing for the preparation of financial statements, (3) planning and decision making, and (4) operational and management control. Group 1 includes concepts that are important in all management functions, while groups 2, 3, and 4 are three of the four management functions. Concepts for the fourth management function, strategic management, are covered in Chapters 1 and 2.

The first group of concepts includes the four types of cost drivers: activity based, volume based, structural, and executional. Activity-based cost drivers are at the detail level of operations: equipment setup, materials handling, and clerical or other tasks. In contrast, volume-based cost drivers are at the aggregate level: usually the number of units produced. Structural cost drivers involve plans and decisions having long-term effects; executional cost drivers have short-term decision frames. The most important volume-based concepts are variable costs, which change according to a change in the level of output, and fixed costs, which do not. Direct costs are defined as costs that can be traced directly to a cost object in contrast to indirect costs, which cannot.

The important concepts in product costing are product costs, which are the costs of direct materials, direct labor, and indirect manufacturing (called overhead) required for the product and production process. Nonproduct costs (also called period costs) are the selling, administrative, and other costs not involved in manufacturing. The inventory formula is used to determine the cost of materials used in production, the cost of goods manufactured, and the cost of goods sold for a given period.

The most important concept in planning and decision making is relevant cost-a cost that differs for each option and will occur in the future. When considering options, the management accountant considers relevant costs. All past costs (also called sunk costs) are irrelevant because they will not change regardless of the option chosen.

The two key concepts in management and operational control are controllability and risk preferences. Distinguishing controllable costs from other costs is important be-cause evaluation, even in part, on the basis of costs a manager cannot control can be negatively motivating. It is also important for the management accountant to recognize in the development of cost management systems that managers tend to be relatively risk averse, which can cause them to make decisions that are not consistent with top management's objectives.