COST ACCOUNTING

Unit 1

Cost Accounting and Information for Decision Makers

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 organization.

4. Identify current trends in cost accounting.

The Consept of Value Chain• We start our discussion with the concepts of value creation

and the value chain because in cost accounting our goal is to assist managers in achieving the maximum value for their organizations.

• Measuring the effects of decisions on the value of the organization is one of the fundamental services of cost accounting. As providers of information (accountants) or as the users of information (managers), we have to understand how the information can and will be used to increase value. We can then come back to questions about how to design accounting systems that accomplish this goal.

McGraw-Hill/Irwin Copyright ©2008 The McGraw-Hill Companies, Inc. All rights reserved.

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.

Value Chain

• In much of our discussion about cost accounting, we will be concerned with the part of the value chain that comprises the activities of a single organization (a firm, for example).

• However, an important objective of modern cost accounting is to ensure that the entire value chain is as efficient as possible. It is necessary for the firm to coordinate with vendors and suppliers and with

distributors and customers to achieve this objective.

McGraw-Hill/Irwin Copyright ©2008 The McGraw-Hill Companies, Inc. All rights reserved.

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.

Value Chain

ActivityValue Added

Non 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

Accounting SystemsLO2 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

Provides information to external decision-makers

Cost Accounting System

Provides information toInternal decision-makers

Accounting System, continued… Financial accounting reports financial position and

income according to GAAP (Generally Accepted Accounting Principles).

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.

Customers of Cost Accounting

Customers who purchase or use the commodity or service.

Managers making decisions within the firm.

Owners of the firm evaluating managers.

Managerial DecisionsLO3 Explain how cost accounting information is used for decision making and

performance evaluation in organization.

KEY QUESTION: What adds value to the firm?

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?

Cost Benefit Analysis

Consider both costs & benefits of a proposal.

Are costs greater than the benefits?

Benefits > Costs? Expand!Benefits < Costs? Don’t Expand!

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.

Carmen’s Cost Drivers

Cost DriverRent # of storesInsurance

Labor # of cookies Ingredients

Differential Costs

Costs that change in response to a particular course of action.

Differential costs change (differ) between actions.

Differential Revenues

Revenues that change in response to a particular course of action.

Differential revenues change (differ) between actions.

Differential Costs, Revenues, and ProfitsCarmen’s Cookies

Projected Income Statement for One Week

(1) (2) (3)

Status QuoOriginal Shop

Sales Only

AlternativeWholesale &

RetailDistribution

Difference

Sales Revenue $ 6,300 $ 8,505a $ 2,205

Costs

Food 1,800 2,700b 900

Labor 1,000 1,500b 500

Utilities 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

$ 850 $ 1,255 $ 405

(a) 35 percent higher than status quo

(b) 50 percent higher than status quo.

(c) 20 percent higher than status quo.

Budget

CARMEN’S COOKIESBudgeted Costs

For the Month Ending April 30

Materials

Flour $2,200

Eggs 4,700

Chocolate 1,900

Nuts 1,900

Other 2,200

Total Materials

$12,900

Labor:

Manager $3,000

Other 1,500

Total Labor 4,500

Utilities 1,800

Rent 5,000

Total Cookie Costs $24,200

Number of Cookies

32,000

Actual to Budget Comparisons

CARMEN’S CookiesActual vs Budgeted Costs

For the Month Ending April 30

Actual BudgetDifference(Variance)

Number of Cookies Sold

32,000 32,000 -0-

Costs:

Food

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-

Total Food $13,500 $12,900 $ 600

Actual to Budget, Continued. . .

Actual BudgetDifference(Variance)

Labor

Manager $3,000 $3,000 $ -0-

Other 1,500 1,500 -0-

Total Labor $ 4,500 $ 4,500 $ -0-

Utilities 1,800 1,800 -0-

Rent 5,000 5,000 -0-

Total Cookie Costs

$24,800 $24,200 $600

Trends in Cost Accounting

1. ABC – Activity Based Costing2. Performance Measurement3. Benchmarking4. JIT - Just In Time Inventory 5. CRM - Customer Relationship Management 6. Outsourcing 7. TQM - Total Quality Management8. COQ – Cost of Quality9. ERP - Enterprise Resource Planning.

LO4 Identify current trends in cost accounting.

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.

Performance Measurement

Performance Measurement indicates how well a process is

working.

Benchmarking Benchmarking methods

measure products, services, and activities against the best performance.

Benchmarking is an ongoing process resulting in continuous improvement.

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.

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.

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.

TQMTotal Quality ManagementTQM is a management method which focuses on excelling in all dimensions.• The emphasis is placed on quality.

• Quality is defined by the customer.

COQ – Cost of QualityCost 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

ERPEnterprise Resource ManagementInformation technology linking various systems of the enterprise into a single comprehensive information system.

Purchasing

Human Resources

Technology

Production

Finance

Marketing

Key Financial Managers in an Organization

Chief Financial Officer (CFO)

Treasurer

ControllerController

Internal Auditor

Cost Accountant

Manages the entire accounting and finance functions

Manages liquid assets

Plans and designs Plans and designs information and incentive information and incentive systemssystems

Ensures compliance with laws, regulations, and company policies and procedures

Records, measures, estimates, and analyzes costs

Unit 1