Traditional

Cost Management
Models
 Cost Management Model
Introduction
Cost management systems have a wide variety
of uses
– The next two chapters will focus on their role in
measuring the costs of products, services, and
customers
Two cost management systems have been used
traditionally to cost products and services
– Job order costing
– Process costing
Many companies continue to use these two
systems
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Since the mid-1980s companies have been
adopting activity-based costing (ABC) for product
and customer costing
These three systems are often portrayed as
distinct; however, all cost systems work in
essentially the same way:
– Expense categories are developed and then expenses
are mapped to service departments, production
centers, or activities
– Expenses are then attached to cost objects
The way these links are made and the activities
defined is what differentiates these systems

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Definition
Cost Management is the process whereby
companies use cost accounting to report
or control the various costs of doing
business.

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Job Order v. Process Costing Systems
A job order costing system estimates the costs
of manufacturing products for different jobs
required for specific customer orders
– Applicable in organizations that treat each individual
job as a single unit of output
A process costing system is applicable when all
units produced during a specified time frame are
treated as one unit of output
– Every unit made during the time period is essentially
identical

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 Need for Job Order Costing
Products may differ
– Materials content
– Hours of labor required
– Machine time required
– Demand placed on support activity resources (i.e.,
manufacturing overhead)
– Special customer needs that require customized
production
With such variety, managers need to understand
the costs of individual products so that they can
assess product and customer profitability
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 The Cost Flow Model
The cost flow model essentially uses an
inventory concept to track costs
– Raw materials inventory
– Work-in-process (WIP) inventory
Raw materials are transformed by labor and
support resources
Costs of the resources for each job not yet
completed
– Finished goods inventory
When the goods are sold, they are accounted for
in the expense category Cost of Goods Sold

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 Job Costs And Markup
Most firms mark up the job costs by adding an
additional amount, or margin, to make a profit on
the job
The total job costs plus the margin equals the
bid price
The markup rate depends on a variety of factors:
– The amount of support costs excluded from the cost
driver rate
– The target rate of return desired by the corporation
– Competitive intensity
– Past bidding strategies adopted by key competitors
– Demand conditions
– Overall product-market strategies

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 Number of Cost Pools
The number of cost pools can vary
– Some German firms use over 1,000
The general principle is to use separate cost
pools if the cost or productivity of resources is
different and if the pattern of demand varies
across resources
The increase in measurement costs required by
a more detailed cost system must be traded off
against the benefit of increased accuracy in
estimating product costs
– If cost and productivity differences between resources
are small, having more cost pools will make little
difference in the accuracy of product cost estimates
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Comparison With Job Order Costing
Both systems have the same objective:
– Assign material, labor, and manufacturing
support activity costs to product
Process costing systems differ in that they:
– Do not maintain separate cost records for
individual jobs
– Measure costs only for process stages
– Determine cost variances only at the level of
the process stages instead of at the level of
individual jobs
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 Job Order and Multistage
Process Costing (1 of 3)
In job order costing production is carried
out in different jobs
In multistage process costing, production
is carried out continuously, semi-
continuously, or in large batches

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In job order costing, production
requirements are different for each
individual job
In multistage process costing, production
requirements are homogeneous across
products or jobs

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 Two-Stage Cost Allocation (1 of 2)
Conventional product costing systems assign
indirect costs to jobs or products in two stages
1. In the first stage:
– System identifies indirect costs with various
production and service departments
– Service department costs are then allocated to
production departments
2. The system assigns the accumulated indirect
costs for the production departments to
individual jobs or products based on
predetermined departmental cost driver rates

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 Allocating Service Department
Costs To Production Departments
There are three ways that companies allocate
service department costs to production
departments:
– Direct allocation
– Sequential allocation
– Reciprocal allocation
The last two are used when service departments
consume services provided by other departments
(Examples based on PATIENTAID information in text)

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Thank you

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