Chapter 1
Cost Accounting: Information for Decision Making
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 decision making and performance
evaluation in organizations.
4. Identify current trends in cost accounting.
5. Understand ethical issues faced by accountants and ways to deal with ethical problems that
you face in your career.
Chapter Overview
I. VALUE CREATION IN ORGANIZATIONS
• Why Start with Value Creation?
• Value Chain
II. ACCOUNTING SYSTEMS
• Financial Accounting
• Cost Accounting
• Cost Accounting, GAAP, and IFRS
• Customers of Cost Accounting
III. OUR FRAMEWORK FOR ASSESSING COST ACCOUNTING SYSTEMS
• The Manager’s Job Is to Make Decisions
IV. COST DATA FOR MANAGERIAL DECISIONS
• Costs for Decision Making
• Costs for Control and Evaluation
o Budgeting
• Different Data for Different Decisions
V. TRENDS IN COST ACCOUNTING THROUGHOUT THE VALUE CHAIN
• Cost Accounting in Research and Development (R&D)
• Cost Accounting in Design
• Cost Accounting in Purchasing
• Cost Accounting in Production
VI. KEY FINANCIAL PLAYERS IN THE ORGANIZATION
Chapter Overview, continued
VII. CHOICES: ETHICAL ISSUES FOR ACCOUNTANTS
• What Makes Ethics So Important?
• Ethics
• The Sarbanes-Oxley Act of 2002 and Ethics
VIII. COST ACCOUNTING AND OTHER BUSINESS DISCIPLINES
IX. APPENDIX: INSTITUTE OF MANAGEMENT ACCOUNTANTS CODE OF ETHICS
• Statements of Ethical Professional Practice
• Principles
• Standards
o Resolving Ethical Issues
Chapter Outline
LO 1-1 Describe the way managers use accounting information to create
value in organizations.
VALUE CREATION IN ORGANIZATIONS
• Why Start with Value Creation?
o Goal of cost accounting is to assist manages in achieving the maximum value for their
organizations.
• Value Chain
o Exhibit 1.1 identifies the individual components of the value chain and provides
examples of the activities in each component, along with some of the costs associated
with these activities. Although the list of value chain components suggests a sequential
process, many of the components overlap.
▪ Research and development (R&D): The creation and development of ideas related to
new products, services, or processes.
▪ Design: The detailed development and engineering of products, services, or processes.
▪ Purchasing: The acquisition of goods and services needed to produce a good or
service.
o Before product ideas are formulated, no value exists. Once an idea is established,
however, value is created.
o Administrative functions, such as human resource management and accounting, are not
included as part of the value chain; they are included instead in every business function
of the value chain.
• Supply Chain and Distribution Chain
o The supply chain includes the set of firms and individuals that sells goods and services
to the firm. (See Business Application box “Choosing Where to Produce in the Supply
Chain.”)
• Using Cost Information to Increase Value
o The measurement and reporting of costs is a valuable activity.
o Cost information that is received too late to help managers make decisions would not add
value.
• Accounting and the Value Chain
LO 1-2 Distinguish between the uses and users of cost accounting and
financial accounting information.
ACCOUNTING SYSTEMS
• Financial Accounting
o Financial accounting is the field of accounting that reports financial position and income
according to accounting rules.
▪ The managers in the company are keenly interested in the information contained in
the financial accounting reports generated; however, the information is not sufficient
for making operational decisions.
• Cost Accounting
o Cost accounting is the field of accounting that measures, records, and reports
information about costs.
• Cost Accounting, GAAP, and IFRS
o The primary purpose of financial accounting is to provide investors (for example,
shareholders) or creditors (for example, banks) information regarding company and
management performance.
o The financial data prepared for this purpose are governed by generally accepted
accounting principles (GAAP) in the United States and international financial reporting
standards (IFRS) in many other countries.
▪ Generally accepted accounting principles (GAAP) are the rules, standards, and
conventions that guide the preparation of financial accounting statements for firms
registered in the U.S.
▪ International financial reporting standards (IFRS) are the rules, standards, and
conventions that guide the preparation of the financial accounting statements in many
other countries.
o Although GAAP and IFRS are converging, differences remain.
o In contrast to cost data for financial reporting to shareholders, cost data for managerial
use (that is, within the organization) need not comply with GAAP or IFRS.
• Customers of Cost Accounting
o Cost information itself is a product with its own customers; the customers are managers.
▪ At the production level, where products are assembled or services are performed,
information is needed to control and improve operations.
o Cost accountants must work with the users (or customers) of cost accounting information
to provide the best possible information for managerial purposes.
o The most serious problems with accounting systems appear to occur when managers
attempt to use accounting information that was developed for external reporting for
decision making.
OUR FRAMEWORK FOR ASSESSING COST ACCOUNTING SYSTEMS
LO 1-3 Explain how cost accounting information is used for decision making
and performance evaluation in organizations.
• The Manager’s Job Is to Make Decisions
o The common theme among all managerial jobs, however, is decision making.
o Managers are paid to make decisions.
• Decision Making Requires Information
• Finding and Eliminating Activities that Don’t Add Value
o Nonvalue-added activities are activities that do not add value to the goods or services
from the customer’s perspective.
o Cost-benefit analysis is the process of comparing benefits (often measured in savings or
increased profits) with costs associated with a proposed change within an organization.
▪ Managers should perform cost-benefit analyses to assess whether proposed changes
in an organization are worthwhile.
• Identifying Strategic Opportunities Using Cost Analysis
o Companies use the value chain and other information about the costs of activities to
identify strategic advantages in the marketplace.
o Alternatively, a company can identify activities that customers value and which the
company can provide at lower cost.
• Owners Use Cost Information to Evaluate Managers
COST DATA FOR MANAGERIAL DECISIONS
• Costs for Decision Making
o To evaluate the financial consequences of alternatives, estimates have to be made for
future costs, revenues, and/or assets based on past information.
▪ Experience and knowledge of the company’s costs can be used to estimate cost
changes.
▪ A cost driver is a factor that causes, or “drives,” costs.
o When there are two or more alternatives to be considered:
See Demonstration Problem
• Costs for Control and Evaluation
o Organizations divide responsibility for specific functions among employees.
o A responsibility center is a specific unit of an organization assigned to a manager who is
held accountable for its operations and resources.
o Exhibit 1.4 illustrates an organization chart along with the statements for two centers.
o Budgeting
▪ Each responsibility center has a budget, which is a financial plan of the revenues and
resources needed to carry out activities and meet financial goals.
▪ Budgeting helps managers decide whether their goals can be achieved and, if not,
what modifications are necessary.
▪ Managers are responsible for achieving the targets set in the budget.
• Different Data for Different Decisions
o Different decisions often require different cost data.
o “One size fits all” does not apply to cost accounting.
LO 1-4 Identify current trends in cost accounting.
TRENDS IN COST ACCOUNTING THROUGHOUT THE VALUE CHAIN
• Cost Accounting in Research and Development (R&D)
o Lean manufacturing techniques are not simply about production.
• Cost Accounting in Design
o Design for manufacturing (DFM) is the concept that manufacturing cost and complexity
need to be considered in the design of the product.
o Cost accountants held designers understand the tradeoff between complex design for a
more desirable product and difficult and expensive manufacturing.
• Cost Accounting in Purchasing
o Performance measures are metrics that indicate how well an individual, business unit,
product, firm, and so on, is working.
o Benchmarking is the continuous process of measuring a company’s own products,
services, and activities against competitors’ performance.
• Cost Accounting in Production
▪ When the just-in-time (JIT) method is used in production or purchasing, each unit is
purchased or produced just in time for its use.
• Using just-in-time methods, companies produce or purchase units just in time for
use, keeping inventories at a minimum.
o Lean accounting systems provide measures for lean manufacturing techniques.
▪ Lean accounting is a cost accounting system that provides measures at the work cell
or process level and minimizes wasteful or unnecessary transaction processes.
▪ In addition, these systems are designed to avoid unnecessary transactions, in effect
eliminating “waste” from the accounting processes.
o Service firms produce or provide services demanded by customers. Efficient use of
capacity (employees) in providing services is critical in increasing value.
• Cost Accounting in Marketing
• Cost Accounting in Distribution
o Cost accountants work with managers to estimate whether it is more efficient (less costly)
to perform an activity in the firm or to have another firm produce the product or perform
the service.