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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. 1-2 ♦ 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. 1-3 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. 1-4 Customer Service Value Chain Distribution Marketing Production Purchasing Design Research & Development 1-5 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 1-6 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 1-7 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. 1-8 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 1-9 -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. 1-10 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 1-11 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? 1-12 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? 1-13 Cost Benefit Analysis Consider both costs & benefits of a proposal. Are costs greater than the benefits? Benefits > Costs? Expand! Benefits < Costs? Don’t Expand! 1-14 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. 1-15 Carmen’s Cost Drivers Cost Rent Insurance Labor Ingredients Driver # of stores # of cookies 1-16 Differential Costs Costs that change in response to a particular course of action. Differential costs change (differ) between actions. 1-17 Differential Revenues Revenues that change in response to a particular course of action. Differential revenues change (differ) between actions. 1-18 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. 1-19 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 1-20 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 1-21 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 1-22 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. 1-23 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. 1-24 Performance Measurement Performance Measurement indicates how well a process is working. 1-25 Benchmarking Benchmarking methods measure products, services, and activities against the best performance. Benchmarking is an ongoing process resulting in continuous improvement. 1-26 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. 1-27 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. 1-28 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. 1-29 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. 1-30 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 1-31 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 1-32 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 1-33 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. 1-34 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. 1-35 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 1-36 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 1-37 Appendix 1A Institute of Management Accountants’ Code of Ethics IMA Code of Ethics - Elements 1. Competence 2. Confidentiality 3. Integrity 4. Credibility 1-38 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. 1-39 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. 1-40 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. 1-41 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. 1-42 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)? 1-43 1-44