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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.
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Chapter Outline
I. VALUE CREATION IN ORGANIZATIONS
• Why Start With Value Creation?
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
• Decision Making Requires Information
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
• Cost Accounting in Marketing
• Cost Accounting in Distribution
• Cost Accounting in Customer Service
• Enterprise Resource Planning
• Creating Value in the Organization
VI. KEY FINANCIAL PLAYERS IN THE ORGANIZATION
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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 Resolution of Ethical Conflict
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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 The value chain is the set of activities that transforms raw resources into the goods and
services end users purchase and consume.
o It includes the treatment or disposal of any waste generated by the end users.
o Value-added activities are those that customers perceive as adding utility to the goods or
services they purchase.
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.
▪ When research and development of the product begins, value increases.
▪ As the product reaches the design phase, value continues to increase.
• 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 “Focus on 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 a decision would not
add value.
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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.
• 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.
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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.
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.
▪ Management is free to set its own definitions for cost information.
• 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.
▪ At the middle management level, cost information is used to identify problems by
highlighting when some aspect of operations is different from expectations.
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LO 1-3 Explain how cost accounting information is used for decision making
and performance evaluation in organizations.
OUR FRAMEWORK FOR ASSESSING COST ACCOUNTING SYSTEMS
• 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
o Accounting systems are important because they are a primary source of information for
managers.
• 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.
▪ Activities cause costs.
▪ In general, if activities that do not add value to the company can be eliminated, then
costs associated with them will also be eliminated.
▪ A well-designed cost accounting system can also identify nonvalue-added activities
that cross boundaries in the value chain.
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.
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• Identifying Strategic Opportunities Using Cost Analysis
company can provide at lower cost.
• Owners Use Cost Information to Evaluate Managers
o When owners of a business are not also its managers, both parties’ interests may not be
properly aligned.
o The second role of the accounting system in addition to aiding managerial decision
making is to provide information to the owners of the organization about the performance
of the organization and the manager.
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.
• 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.
• 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, they compare actual results with the budget, which
allows them to see whether changes can be made to improve future operations.
• Different Data for Different Decisions
o Different decisions often require different cost data.
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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.
• Cost Accounting in Purchasing
o Performance measures are metrics that indicates how well an individual, business unit,
product, or 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
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▪ 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.
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
o Customer relationship management (CRM) is a system that allows firms to target
customers by assessing customer revenues and costs.
• 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.
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• Cost Accounting in Customer Service
o Total quality management (TQM) is a management method by which the organization
seeks to excel on all dimensions, with the customer ultimately defining quality.
• Enterprise Resource Planning
o Enterprise resource planning (ERP) systems are integrated information systems that link
various activities in an organization.
• Creating Value in the Organization
o All these tools are meant to add value to the organization.
KEY FINANCIAL PLAYERS IN THE ORGANIZATION
o Exhibit 1.6 identifies the key financial managers in an organization, lists their major
responsibilities and primary duties, and provides example activities for each.
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LO 1-5 Understand ethical issues faced by accountants and ways to deal with
ethical problems that you face in your career.
CHOICES: ETHICAL ISSUES FOR ACCOUNTANTS
• What Makes Ethics So Important?
o Accounting information is used to evaluate the performance of managers.
▪ Managers are generally held accountable for achieving financial performance targets;
failure to achieve them can have serious negative consequences for the managers,
including losing their jobs.
▪ Both users and preparers of cost need to be aware of the implications of the way in
which information is used and when the system has the potential for abuse.
• Ethics
o The IMA code of ethics discusses the steps cost accountants should take when faced with
an ethical conflict.
▪ Discuss the conflict with your immediate superior, or, if the conflict involves your
superior, the next level in authority
▪ Clarify the relevant issues and concepts by discussions with a disinterested party or
by contacting an appropriate and confidential ethics “hotline.”
▪ Consult an attorney about your rights and obligations.
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• The Sarbanes-Oxley Act of 2002 And Ethics
o Congress passed the Sarbanes-Oxley Act of 2002 to address some of the more serious
problems of corporate governance.
▪ Provisions in Title III and IV of the Act deal with corporate responsibility and
enhanced financial disclosure, respectively.
▪ Section 404 of Title IV requires managers to attest to the adequacy of their internal
controls.
o The Sarbanes-Oxley Act of 2002 has important implications for managers who design
cost information systems.
▪ The managers must be aware of the potential for the resulting information to be
misleading or to further fraudulent activity.
▪ Compliance with Sarbanes-Oxley does not mean that the manager has met all of his
or her ethical responsibilities. (See Business Application Box “Options Backdating at
Apple.”)
COST ACCOUNTING AND OTHER BUSINESS DISCIPLINES
o The boundary between what is cost accounting and what belongs in another discipline is
often blurred.
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APPENDIX: INSTITUTE OF MANAGEMENT ACCOUNTANTS CODE OF ETHICS
• Statements of Ethical Professional Practice
• Principles
• Standards
o Resolution of Ethical Conflict
Matching
A.
Benchmarking
G.
Enterprise resource planning
B.
Cost accounting
H.
Just-in-time method
C.
Cost-benefit analysis
I.
Outsourcing
D.
Cost driver
J.
Responsibility center
E.
Differential revenues
K.
Supply chain
F.
Distribution chain
L.
Value chain
_____ 1. The set of activities that transforms raw resources into the goods and services end
users purchase and consume, and includes the treatment or disposal of any waste
generated by the end users.
_____ 2. The field of accounting that measures, records, and reports information about costs.
_____ 3. Factor that causes, or “drives,” costs.
_____ 4. The set of firms and individuals that buy and distribute goods and services from the
firm.
_____ 5. A specific unit of an organization assigned to a manager who is held accountable for
its operations and resources.
_____ 6. The continuous process of measuring a company’s own products, services, and
activities against best practices either inside or outside the organization.
_____ 7. May be used in production or purchasing where each unit is purchased or produced
just in time for its use.
_____ 8. Represents the information technology that links the various systems of the enterprise
into a single comprehensive information system.
_____ 9. One or more of the firm’s activities will be performed by another firm or individual in
the supply or distribution chain for improved efficiency and cost savings.
_____ 10. Revenues that change in response to a particular course of action.
_____ 11. The process of comparing benefits (often measured in savings or increased profits)
with costs associated with a proposed change within an organization.
_____ 12. The set of firms and individuals that sell goods and services to the firm.
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Matching Answers
1. L
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Multiple Choice Questions
1. Cost accounting:
a. Provides information to managers for decision making.
b. Information is not comparable across organizations.
c. Is not based on GAAP.
d. All of the above.
2. A cost accounting system:
a. Adds value to the organization.
b. Is part of Enterprise Resource Planning (ERP) systems.
c. Is beyond any ethical issues.
d. Both a and b.
3. Which of the following positions/functions is not under the supervision of the Chief
Financial Officer (CFO)?
a. Treasurer
b. Controller
c. Human resources
d. Cost accountants
4. Which of the following statements is correct?
a. All activities add value to the organization.
b. All value chain functions are within the organization.
c. Supply chain and value chain do not overlap.
d. Cost information reduces value.
5. In cost-benefit analysis:
a. Benefits are often measured in savings or increased profits.
b. Proposed changes within the organizational structure are evaluated.
c. Benefits should outweigh costs to be acceptable.
d. All of the above.
6. Cost drivers are:
a. Factors that drive costs.
b. Activities that consume resources in Activity-Based Costing (ABC).
c. Few in traditional costing systems.
d. All of the above.
Use the following information to answer questions 7and 8:
Company A’s quarterly sales revenue and operating costs are $12,000 and $9,500, respectively.
Operating costs include $1,500 of leasing charge for computers. A new product line will increase
sales revenue by 30 percent and costs (other than the leasing charge which remains unchanged)
by 35 percent.
7. If Company A includes the new product line:
a. Sales revenue will increase by $3,200.
b. Operating costs will increase to $12,300.
c. Operating profits will increase by $1,100.
d. Operating costs are not relevant.
8. The leasing charge:
a. Is differential.
b. Is relevant to the decision.
c. Plays no role in the decision.
d. Will not change in the future.
9. New trends in cost accounting include:
a. Just-in-time method.
b. Total quality management.
c. Benchmarking and continuous improvement.
d. All of the above.
10. Ethical conflicts in cost accounting:
a. Are governed by the code of ethics of the professional organizations.
b. Will not have implications for cost accountants’ decisions.
c. Should be resolved to meet the demands of managers.
d. Will never lead to resignation of cost accountants.
11. Financial statements for external users are characterized as:
a. User-specific.
b. Managerial reports.
c. General-purpose.
d. Not consistent with GAAP.
12. Which of the following statements is correct?
a. Design for manufacturability is not compatible with activity-based costing.
b. Performance of key suppliers and business partners must be constantly evaluated.
c. Cost of quality is a system that identifies the costs of producing high quality items.
d. Enterprise resource planning system duplicates the effort and costs of stand-alone
systems.
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Multiple Choice Answers
1. d (LO1)
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Demonstration Problem
Jim is a florist who runs Bountiful Flower Shop as a sole owner. His typical 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 would still use the same facility.
Required:
1. Should Jim expand his business to be associated with the national chain? Support your
answer.
2. 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)?
Demonstration Problem – Solution
Part 1
Jim should not expand his business because the projected results show that he will be worse off
by $260 per month. Rent remains the same under either option and is irrelevant to the decision.
Bountiful Flower Shop
Projected Income Statement
For One Month
Alternative:
Associate with
National Chain
Difference
Sales revenue
$5,600
a
$1,600
Costs:
Flower
1,160
b
360
Supplies
b
135
Labor
b
270
Utilities
c
Rent
Licensing fee
Other costs
d
70
Total costs
$1,860
Operating profits