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- 1. Cost Accounting: Information for Decision Making Chapter 1 Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin
- 2. LEARNING OBJECTIVES • After reading this chapter, you should be able to: • L.O.1 Describe the way managers use accounting information to create value in organizations. • L.O.2 Distinguish between the uses and users of cost accounting and Financial accounting information. • L.O.3 Explain how cost accounting information is used for decision making and performance evaluation in organizations. • L.O.4 Identify current trends in cost accounting. • L.O.5 Understand ethical issues faced by accountants and ways to deal with ethical problems that you face in your career.
- 3. Definition of Cost Accounting • Cost Accounting is the field of accounting that measures ,record and reports information about costs • Key Financial Players in the organization Partial Organization chart • Board of Director • Chief Executive Officer • Chief Operation Officer • 1.Industrial Department 2. Staff and Administration Department • Financial vice present • 1.Tresesurer 2. Controller 3. Internal Auditor • Cost Accounting
- 4. Self Study Questions 1. Who are the key Financial players in the organizations? 2 Name the important things that each type of key financial players does?
- 5. Value Chain – Value added activities – Non value added activities • The Value Chain describes a set of activities that transforms raw materials and resources into the goods and services end users purchase and consume. L.O. 1 Describe the way managers use accounting information to create value in organizations. 1 - 5
- 6. Value Added Activity Value Added Activity Those activities that customers perceive as adding utility to the goods or services they purchase. Non value-added activities Activities that do not add value to the good or service from the customer’s perspective. (for example, wages for employees and costs of equipment to move the goods)
- 7. The Value Chain Components Research & Development Design Purchasing Marketing Distribution Customer Service Production LO1 1 - 7
- 8. The Value Chain Components, Example Activities, and Example Costs
- 9. Supply Chain and Distribution Chain Supply chain Set of firms and individuals that sells goods and services to the firm. Distribution chain Set of firms and individuals that buys and distributes goods and services from the Firm
- 10. Self Study Questions 1. Explain the differences between financial accounting and cost accounting. Why are these differences important? 2. Distinguish between the value chain and the supply chain.?
- 11. Accounting Systems Financial accounting Financial position and income Reports Cost accounting Information about costs Reports L.O. 2 Distinguish between the uses and users of cost accounting and financial accounting information. 1 - 11
- 12. Accounting Systems Financial accounting Financial accounting information is designed for decision makers who are not directly involved in the daily management of the firm. Cost accounting Cost accounting information is designed for managers.
- 13. Comparison of Financial and Cost Accounting
- 14. Cost Accounting, GAAP, and IFRS Generally Accepted Accounting Principles (GAAP) Rules, standards, and conventions that guide the preparation of financial accounting statements for firms registered in the U.S. International Financial Reporting Standards (IFRS) Rules, standards, and conventions that guide the preparation of the financial accounting statements in many other countries.
- 16. Managerial Decisions • Individuals make decisions. • Decisions determine the performance of the organization. • Managers use information from the accounting system to make decisions. • Owners evaluate organizational and managerial performance with accounting information. L.O. 3 Explain how cost accounting information is used for decision making and performance evaluation in organizations. 1 - 16
- 17. Term Related Cost Data for Managerial Decisions Cost Driver Factor that causes, or "drives,” costs. Differential Costs Costs that change in response to a particular course of action. Differential Revenues Revenues that change in response to a particular course of action
- 18. Costs for Decision Making • Carmen’s Cookies has been making and selling cookies through a small store downtown. • One of her customers suggests that she expand operations and sell to wholesalers and retailers. • Should Carmen expand operations? LO3 1 - 18
- 19. Carmen’s Cost Drivers Driver Cost Rent Insurance Labor Ingredients Number of stores Number of cookies LO3 1 - 19
- 20. Differential Costs, Revenues, and Profits Sales revenue Costs: Food Labor Utilities Rent Other Total costs Operating profits $6,300 1,800 1,000 400 1,250 1,000 $5,450 $ 850 $8,505a 2,700b 1,500b 600b 1,250 1,200c $7,250 $1,255 $2,205 900 500 200 -0- 200 $1,800 $ 405 (1) Status Quo Original Shop Sales Only (2) Alternative Wholesale & Retail Distribution (3) Difference Carmen’s Cookies Projected Income Statement for One Week (a) 35 percent higher than status quo (b) 50 percent higher than status quo (c) 20 percent higher than status quo LO3 1 - 20
- 21. Costs for Control and Evaluation Responsibility center Specific unit of an organization assigned to a manager who is held accountable for its operations and resources.
- 22. Responsibility Centers, Revenues, and Costs Carmen Diaz President Ray Adams Vice-President Retail Operations Cathy Peterson Vice-President Wholesale Operations LO3 1 - 22
- 23. Responsibility Centers, Revenues, and Costs Carmen’s Cookies Income Statement For the Month Ending April 30 Sales revenue Department costs: Food Labora Utilities Rent Total department costs Center marginb General and admin. costs: General manager’s salaryc Other (administrative) Total general and admin. costs Operating profit $28,400 13,500 4,500 1,800 5,000 $24,800 $ 3,600 $23,600 9,800 3,200 2,100 2,500 $17,600 $ 6,000 $52,000 23,300 7,700 3,900 7,500 $42,400 $ 9,600 5,000 3,200 $ 8,200 $ 1,400 Retail Operations Wholesale Operations Total (a) Includes department managers’ salaries but excludes Carmen’s salary (b) The difference between revenues and costs attributable to a responsibility center (c) Carmen’s salary LO3 1 - 23
- 24. budget Financial plan of the revenues and resources needed to carry out activities and meet financial goals.
- 25. Responsibility Centers, Revenues, and Costs Carmen’s Cookies Retail Responsibility Center Budgeted versus Actual Costs For the Month Ending April 30 Food: Flour Eggs Chocolate Nuts Other Total food Labor: Manager Other Total labor Utilities Rent Total cookie costs Number of cookies sold $ 2,100 5,200 2,000 2,000 2,200 $13,500 3,000 1,500 $ 4,500 1,800 5,000 $24,800 32,000 $ 2,200 4,700 1,900 1,900 2,200 $12,900 3,000 1,500 $ 4,500 1,800 5,000 $24,200 32,000 $ (100) 500 100 100 -0- $ 600 -0- -0- $ -0- -0- -0- $ 600 -0- Actual Budget Difference LO3 1 - 25
- 26. Cont… Another important use of cost accounting information is the evaluation of the performance of an organization. Comparing the actual results to the budgeted results allows managers to evaluate the performance of the organization and owners to evaluate the performance of individual managers. For example, look at Carmen’s actual activity and costs compared to her budgeted activity and costs. If Carmen budgeted selling 32,000 cookies and actually sold 32,000 cookies in the month of April, why were her food costs $600 higher than she anticipated? In evaluating activities for April, Carmen is also interested in seeing that actual labor costs equaled the amount budgeted. As part of the planning and control process, managers prepare budgets containing expectations about revenues and costs for the coming period. At the end of the period, managers compare actual results with the budget. This allows them to see whether changes can be made to improve future operations.
- 27. Trends in Cost Accounting 1. Research and development 2. Design 3. Purchasing 4. Production 5. Marketing 6. Distribution 7. Customer service 8. ERP – Enterprise resource planning 9. Creating value in the organization L.O. 4 Identify current trends in cost accounting. 1 - 27
- 28. Trends in Cost Accounting Cost Design , Activity Base Costing (ABC) Costing method that first assigns costs to activities and then assigns them to products based on the products’ consumption of activities In Purchasing , performance measure Metric that indicates how well an individual, business unit, product, or firm is working. Benchmarking Continual process of measuring a company’s own products, services, and activities against competitors’ performance.
- 29. Cont… In Production just-in-time (JIT) method In production or purchasing, each unit is produced or purchased just in time for its use. lean accounting A cost accounting system that provides measures at the work cell or process level and minimizes wasteful or unnecessary transaction processes. In Marketing customer relationship management (CRM) System that allows firms to target profit table customers by assessing customer revenues and costs.
- 30. Cont… In Customer Services total quality management (TQM) Management method by which the organization seeks to excel on all dimensions, with the customer ultimately defining quality. cost of quality (COQ) System that identifies the costs of producing low-quality items, including rework, returns, and lost sales.
- 31. Self Study Questions What are the major causes of changes in cost accounting systems in recent years?
- 32. Enterprise Resource Planning • Information technology linking various processes of the enterprise into a single comprehensive information system Technology Purchasing Human Resources Marketing Production Finance LO4 1 - 32
- 33. Ethical Issues for Accountants • The design of the cost accounting system has the potential to be misused to defraud customers, employees, or shareholders. L.O. 5 Understand ethical issues faced by accountants and ways to deal with ethical problems that you face in your career. 1 - 33
- 34. Cont… Accountants report information that can have a substantial impact on the careers of managers who are generally held accountable for achieving financial performance targets. Failure to achieve a target can have serious negative consequences for a manager. Therefore, accountants may find themselves under pressure by management to make accounting choices that improve performance reports rather than accurately reflect performance. As a professional accountant, manager, or business owner, you will face ethical situations on an everyday basis.
- 35. Ethics The IMA Code of Ethics discusses the steps cost accountants should take when faced with an ethical conflict. Essentially, these steps are: • DISCUSS the conflict with your immediate superior or, if the conflict involves your superior, the next level in authority. This might require contacting the board of directors or an appropriate committee of the board, such as the audit committee or the executive committee; • CLARIFY the relevant issues and concepts by discussions with a disinterested party or by contacting an appropriate and confidential ethics “hotline”; • CONSULT your attorney about your rights and obligations.
- 36. Sarbanes-Oxley Act of 2002 What is the intent? Who is impacted? How are corporations impacted? Address problem of corporate governance Accounting firms and corporations Corporate responsibility LO5 1 - 36
- 37. Appendix 1 Institute of Management Accountants’ (IMA) Code of Ethics: Standards 1. Competence 2. Confidentiality 3. Integrity 4. Credibility 1 - 37
- 38. Self Study Questions What are the three essential steps a cost accountant should take when faced with an ethical conflict?
- 39. End of Chapter 1 Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin
Editor's Notes
- We start the study of the Fundamentals of Cost Accounting with a review and overview of information necessary for decision making.
- The value chain describes the set of activities that increase the value of an organization’s products or services. Value-added activities are activities that customers perceive as valuable because the activity adds utility to the goods or services they purchase. In other words, customers define value.
- All products start with research and development. Is research and development (creating and developing ideas related to a new product) value-added or nonvalue-added? Once we have the idea for a new product, the product must be developed and engineered. Does this add value? The purchasing department is responsible for acquiring all of the necessary components and supplies in order to produce the product. Does this add value? We must produce the product or deliver the service in order for the product or service to have value to a customer. We need to inform potential customers about the attributes of our product or service. Delivering the product or service to the customer adds value. If the customer does not have the product or service, it has no value. Finally, chances are you have experienced the value of customer service. Have you ever called the technical support line for a software application you installed on your computer? If so, I hope the support added value to your product.
- Distinguish between the value chain and the supply chain.
- Financial accounting information is designed for decision makers who are not directly involved in the daily management of the firm. Cost accounting information is designed for managers.
- 1.1
- The key question is: What adds value to the firm? Let’s look at how cost information adds value to the organization. Cost information adds value to the organization if that information improves managers’ decisions.
- Now we are going to look at an example involving decision making. Carmen’s Cookies.
- What drives the cost of rent and the cost of insurance? The number of storefronts Carmen has drives rent and insurance. If Carmen opens a new storefront, her rent and insurance costs will increase. On the other hand, what drives the cost of labor or the cost of the ingredients for the cookies? How many cookies Carmen makes will determine how many employees she needs and how much flour and sugar are required.
- Look at Carmen’s projected income statement. If Carmen maintains the status quo and does not expand, revenue will be $6,300. However, she expects revenues to increase 35% if she expands. Differential revenue is $2,205. If food, labor and utilities costs all increase 50%, Carmen has differential costs of $900, $500, and $200 for those costs. Carmen determines she currently has room for increased cookie production so she will not be required to rent additional space. Therefore rent is not a differential cost. However, her other costs also increase 20% for differential costs of $200. Using this cost information to analyze revenues and costs, Carmen determines that she has differential profits of $405 if she expands rather than maintaining the status quo.
- This is an example of an organization’s chart. Please notice that Ray Adams is in charge of retail operations and Cathy Peterson is in charge of wholesale operations. Are these responsibility centers?
- Do you think that general and administrative costs should be distributed to the two operations?
- A budget, or a financial plan for the revenues and resources needed to meet financial goals, is an important tool for the financial success of both individuals and organizations. Do you have a budget? Another important use of cost accounting information is the evaluation of the performance of an organization. Comparing the actual results to the budgeted results allows managers to evaluate the performance of the organization and owners to evaluate the performance of individual managers. For example, look at Carmen’s actual activity and costs compared to her budgeted activity and costs. If Carmen budgeted selling 32,000 cookies and actually sold 32,000 cookies in the month of April, why were her food costs $600 higher than she anticipated? In evaluating activities for April, Carmen is also interested in seeing that actual labor costs equaled the amount budgeted. As part of the planning and control process, managers prepare budgets containing expectations about revenues and costs for the coming period. At the end of the period, managers compare actual results with the budget. This allows them to see whether changes can be made to improve future operations.
- Cost accounting continues to experience dramatic changes. Developments in information technology (IT) have nearly eliminated manual bookkeeping. Emphasis on cost control is increasing in all types of organizations.
- Cost Design , Activity Base Costing (ABC) Costing method that first assigns costs to activities and then assigns them to products based on the products’ consumption of activities In Purchasing , performance measure Metric that indicates how well an individual, business unit, product, or firm is working. Benchmarking Continual process of measuring a company’s own products, services, and activities against competitors’ performance. In Production just-in-time (JIT) method In production or purchasing, each unit is produced or purchased just in time for its use. lean accounting A cost accounting system that provides measures at the work cell or process level and minimizes wasteful or unnecessary transaction processes. In Marketing customer relationship management (CRM) System that allows fi rms to target profi table customers by assessing customer revenues and costs. In Distribution outsourcing Having one or more of the firm’s activities performed by another fi rm or individual in the supply or distribution chain. In Customer Services total quality management (TQM) Management method by which the organization seeks to excel on all dimensions, with the customer ultimately defining quality. cost of quality (COQ) System that identifies the costs of producing low-quality items, including rework, returns, and lost sales.
- Enterprise resource planning (ERP) uses information technology to link the various processes of the enterprise into a single comprehensive information system. Because all the company’s processes are integrated, ERP has significant potential for providing information on the cost of products and services. However, implementation problems are keeping many companies from realizing this potential.
- Accountants report information that can have a substantial impact on the careers of managers who are generally held accountable for achieving financial performance targets. Failure to achieve a target can have serious negative consequences for a manager. Therefore, accountants may find themselves under pressure by management to make accounting choices that improve performance reports rather than accurately reflect performance. As a professional accountant, manager, or business owner, you will face ethical situations on an everyday basis.
- When there is a public perception of widespread ethical problems, the result is often legislation making certain conduct is not only unethical, but also illegal. Congress passed the Sarbanes-Oxley Act of 2002 to address some of the more serious problems of corporate governance that surfaced in the late 1990s and early 2000s.
- In Appendix 1 to Chapter 1 is the Institute of Management Accountants’ Code of Ethics. The code of ethics addresses four standards; competence, confidentiality, integrity, and credibility.