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Cost Accounting:
Information for Decision Makers
Chapter 1
McGraw-Hill/Irwin
Copyright ©2008 The McGraw-Hill Companies, Inc. All rights reserved.
Learning Objectives:
1. Describe the way managers use accounting information to
create value in organizations.
2. Distinguish between the uses and users of cost accounting and
financial accounting information.
3. Explain how cost accounting information is used for decisionmaking and performance evaluation in organization.
4. Identify current trends in cost accounting.
5. Understand the ethical issues faced by accountants and
ways to deal with ethical problems that you face in your
career.
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♦ Cost accounting helps manages achieve the maximum
value for their organizations by providing information for
decision making and by measuring the effects of decisions
on the value creation of the organizations.
Value Chain
LO1
Describe the way managers use accounting
information to create value in organizations.
♦ The Value Chain describes a set of activities that
transforms raw material and resources into the final
goods and services which will be purchased by
customers.
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Analyzing Value Added Activities
Evaluate each Activity
Does it add value?
• Value Added – the
customer perceives
value has been added.
• Non Value Added – the
customer does not
perceive any added
value.
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Customer
Service
Value Chain
Distribution
Marketing
Production
Purchasing
Design
Research &
Development
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Value Chain
Activity
Value
Added
R&D:
Creating a new product

Design:
Developing and
engineering new products

Purchasing: Acquisition of goods and
services for production

Production: Producing the product

Marketing:

Informing customers
about the product
Distribution: Delivering the product to
customers

Service:

Supporting customers
using the product
Non Value
Added
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Accounting Systems
LO2
Distinguish between the uses and users of cost
accounting and financial accounting information.
Accounting systems are designed to provide
information to decision-makers.
Financial Accounting System
Cost Accounting System
Provides information to
external decision-makers
Provides information to
Internal decision-makers
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Accounting System, continued…
 Financial accounting reports financial position and income
according to GAAP (Generally Accepted Accounting
Principles).
(GAAP is a set of rules, standards, and conventions that
guide the preparation of financial accounting statements
for shareholders.)
 Data should be comparable across firms.
 Cost accounting measures, records and reports
information about costs.
 Data should be relevant for decisions in a particular firm.
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Customers of Cost Accounting
Customers of cost accounting are the managers
• At production level to control and improve
operations
• At middle management identify problems by
highlighting the aspect of operations is different
from expectations
• At the executive level to assess company’s
overall performance
Cost information is used to make decisions on
activities that add value to the organization
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-Supply chain is the set of firms and individuals that sell
goods and services to the firm.
-Distribution chain is the set of firms and individuals that
buy and distribute goods and services from the firm.
-These suppliers and customers are on the firm’s boundaries.
-The supply chain and distribution chain are the parts of the
value chain outside the firm.
-Value chain creates value for which the customer is willing
to pay.
-Firms must decide where in the value chain a value-added
component is performed most cost effectively.
-Cost information adds value to the organization if it
improves managers’ decisions.
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Framework for assessing accounting
systems
• 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
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Managerial Decisions
LO3
Explain how cost accounting information is used for
decision making and performance evaluation in
organization.
Calculate the financial consequences of
alternatives by estimating how costs
(revenue or assets) among the alternatives
will differ
KEY QUESTION:
What adds value to the firm?
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Carmen’s Cookies
Should Carmen expand operations?
 Are the benefits greater than the
costs?
 What are the differential revenues?
 What are the differential costs?
 What are the cost drivers?
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Cost Benefit Analysis
Consider both costs & benefits of a proposal.
Are costs greater than the benefits?
Benefits > Costs? Expand!
Benefits < Costs? Don’t Expand!
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Cost Drivers
What drives cost?
Factors that cause or ‘drive’ cost.
These are estimates and require assumptions.
What are Carmen’s cost drivers?
Number of stores.
Number of cookies.
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Carmen’s Cost Drivers
Cost
Rent
Insurance
Labor
Ingredients
Driver
# of stores
# of cookies
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Differential Costs
Costs that change in response to a
particular course of action.
Differential costs change (differ) between actions.
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Differential Revenues
Revenues that change in response to a particular course
of action.
Differential revenues change (differ) between actions.
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Differential Costs, Revenues, and Profits
Carmen’s Cookies
Projected Income Statement for One Week
Sales Revenue
(1)
(2)
(3)
Status Quo
Original Shop
Sales Only
Alternative
Wholesale & Retail
Distribution
Difference
$ 6,300
$ 8,505a
$ 2,205
1,800
2,700b
900
1,000
1,500b
500
400
600b
200
Rent
1,250
1,250
-0-
Other
1,000
1,200c
200
Total Costs
$ 5,450
$ 7,250
$ 1,800
Operating Profit
$
$ 1,255
$
Costs
Food
Labor
Utilities
850
405
(a) 35 percent
higher than
status quo
(b) 50 percent
higher than
status quo.
(c) 20 percent
higher than
status quo.
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Budget
CARMEN’S COOKIES
Budgeted Costs
For the Month Ending April 30
Number of Cookies
Materials
32,000
Labor:
Flour
$2,200
Eggs
4,700
Other
1,500
Chocolate
1,900
Total Labor
4,500
Nuts
1,900
Utilities
1,800
Other
2,200
Rent
5,000
Total Materials
$12,900
Manager
Total Cookie Costs
$3,000
$24,200
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Actual to Budget Comparisons
CARMEN’S Cookies
Actual vs Budgeted Costs
For the Month Ending April 30
Actual
Number of Cookies Sold
Budget
Difference
(Variance)
32,000
32,000
-0-
Flour
$2,100
$2,200
$(100)
Eggs
5,200
4,700
500
Chocolate
2,000
1,900
100
Nuts
2,000
1,900
100
Other
2,200
2,200
-0-
$13,500
$12,900
$ 600
Costs:
Food
Total Food
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Actual to Budget, Continued. . .
Actual
Budget
Difference
(Variance)
Labor
Manager
$3,000
$3,000
$ -0-
1,500
1,500
-0-
$ 4,500
$ 4,500
$ -0-
Utilities
1,800
1,800
-0-
Rent
5,000
5,000
-0-
$24,800
$24,200
$600
Other
Total Labor
Total Cookie Costs
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Trends in Cost Accounting
LO4
1.
2.
3.
4.
5.
6.
7.
8.
8.
9.
Identify current trends in cost accounting.
ABC – Activity Based Costing (Design)
Performance Measurement (Purchasing)
Benchmarking (Purchasing)
JIT - Just In Time Inventory (Production)
Lean Accounting (Production)
CRM - Customer Relationship Management (Marketing)
Outsourcing (Distribution)
TQM - Total Quality Management (Customer service)
COQ – Cost of Quality (Customer service)
ERP - Enterprise Resource Planning.
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ABC: Activity Based Costing
ABC assigns costs of activities needed to make
a product, then sums the cost of those
activities to compute the total cost of the
product.
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Performance Measurement
Performance Measurement
indicates how well a process is
working.
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Benchmarking
 Benchmarking methods
measure products, services,
and activities against the best
performance.
 Benchmarking is an ongoing
process resulting in continuous
improvement.
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JIT: Just In Time Inventory
JIT is an inventory system
designed to lower the cost of
maintaining excess inventory.
• Units are produced or purchased ‘just
in time’ for use, keeping inventories
at a minimum.
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CRM
Customer Relationship Management
CRM is a system that allows firms to target profitable
customers by assessing customer revenues and
costs. Some examples are:
• In Las Vegas, Harrah’s Entertainment provides
“complimentary” services to some customers.
• In the airline industry, frequent flyers
accumulate ‘points’ that can be redeemed for
services.
• Many credit cards issue ‘points’ which can be
traded for products or services.
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Outsourcing
Outsourcing occurs when a firm’s activities
are performed by another organization or
individual in the supply or distribution
chain. Some examples are:
• Nikon relies on UPS for distribution.
• Several computer manufacturers use
Intel chips in their final products.
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TQM
Total Quality Management
TQM is a management method which
focuses on excelling in all dimensions.
• The emphasis is placed on quality.
• Quality is defined by the customer.
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COQ – Cost of Quality
Cost of Quality is a system that identifies the
cost of producing low quality items.
Examples are:
 Identifying the costs associated with producing
defective units
 Quantifying the cost of lost sales due to producing
sub-standard products
 Tracking the cost of returns due to a lack of quality
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ERP
Enterprise Resource Management
Information technology linking various systems of the
enterprise into a single comprehensive information
system.
Purchasing
Production
Technology
Human
Resources
Finance
Marketing
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Key Financial Managers in an Organization
Chief Financial Officer (CFO)
Treasurer
Manages the entire accounting
and finance functions
Manages liquid assets
Controller Plans and designs
information and incentive
systems
Internal Auditor
Cost
Accountant
Ensures compliance with laws, regulations,
and company policies and procedures
Records, measures,
estimates, and analyzes
costs
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Ethical Issues For Accountants
LO5
Understand ethical issues faced by accountants and
ways to deal with ethical problems that you face in
your career.
Many accountants or business people have
done small things, none of which appeared
seriously wrong, but these small things added
up to big trouble.
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Discover Unethical Conduct?
Now what??
Follow the Institute of Management
Accountants (IMA) guidelines:
Discuss problems with the immediate
superior, unless the superior
is involved.
Clarify the relevant issues and
concepts by discussion with a
disinterested party or contact
the appropriate confidential
ethics “hotline.”
Consult an attorney about your
rights and obligations.
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SOX
Sarbanes-Oxley Act of 2002
What’s the
intent?
Address problem
of corporate
governance
Who’s
impacted?
Accounting firms
&
corporations
How are
Corporations
Impacted?
Corporate
responsibility
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Corporate Responsibility
Who is impacted?
• CEO–Chief Executive Officer – Manages entire corporation
• CFO-Chief Financial Officer – Manages accounting and finance
What is the impact?
• The officers of the corporation must sign the financial
reports stipulating that the financial statements do not
omit material information
• The company must disclose the evaluation of their internal
controls
• The company must disclose notification of any fraud
involving management to Auditors, the Audit Committee,
and the Board of Directors
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Appendix 1A
Institute of Management
Accountants’ Code of Ethics
IMA Code of Ethics - Elements
1. Competence
2. Confidentiality
3. Integrity
4. Credibility
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Competence
Members have a responsibility to:
1. Maintain an appropriate level of
professional competency by ongoing
development of their knowledge and skills.
2. Perform professional duties in accordance
with relevant laws, regulations, and
technical standards.
3. Provide decision support information and
recommendations that are accurate, clear,
concise, and timely.
4. Recognize and communicate professional
limitations or other constraints that would
preclude responsible judgment or
successful performance of activity.
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Confidentiality
Members have a responsibility to:
1. Keep information confidential except
when disclosure is authorized or
legally required.
2. Inform all relevant parties regarding
appropriate use of confidential
information.
3. Refrain from using confidential
information for unethical or illegal
advantage.
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Integrity
Members have a responsibility to:
1. Mitigate actual conflicts of interest,
regularly communicate with business
associates to avoid apparent conflicts
of interest. Advise all parties of any
potential conflicts.
2. Refrain from engaging in any conduct
that would prejudice carrying out
duties ethically.
3. Abstain from engaging in or supporting
any activity that might discredit the
profession.
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Credibility
Members have a responsibility to:
1. Communicate information fairly and
objectively.
2. Disclose all relevant information that
could reasonably be expected to
influence an intended user’s
understanding of the reports, analyses,
or recommendations.
3. Disclose delays or deficiencies in
information, timeliness, processing, or
internal controls in conformance with
organization policy and/or applicable
law.
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Jim is a florist who runs Bountiful Flower Shop as a sole owner. His
average monthly operating results include the following: Sales revenue
$4,000, Flower costs $ 800, Supplies $300, Labor costs $600, Utilities $250,
Rent $720, and Other costs $350. He recently attended a trade show and was
attracted by a national chain that offered him referral service, baskets, and
new flower arrangements in exchange for a monthly licensing fee of $1,000.
He figures that the additional business from referrals will increase his
revenues by 40 percent, flower materials, supplies, and labor costs by 45
percent, utilities by 10 percent, and other costs by 20 percent. Rent will not
change as he still uses the same facility.
Required:
Should Jim expand his business to be associated with the national
chain? Please explain.
If Jim can negotiate a different term with the national chain, what
licensing fee makes him indifferent between the two choices (i.e., the
status quo of going solo vs. the alternative of being associated with
the national chain)?
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