Ch1 Lecture Notes

7/30/2019 Ch1 Lecture Notes

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Lecture Notes-Key Concepts in Ch.1

Managers use accounting information to create value in organizations.

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 is 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.

Example 1: The value chain for gasoline industry may include the following.

Oil search and drilling

Oil refining

Gasoline distribution

Retail outlets

End users

Emission treatment

The entire value chain consists of vendors and suppliers in the upstream and distributors

and customers in the downstream of an organization whose efficient coordinationdepends on the information provided by the cost accounting system.

Value-added activities are those that customers perceive as adding utility to the goods or

services they purchase, including (see Exhibit 1.1)

Research and development (R&D): The creation and development of ideas related to

new products, services, or processes.


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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.

Production: The collection and assembly of resources to produce a product or deliver a

service.

Marketing and Sales: The process of informing potential customers about the attributes

of products or services and leads to their sale.

Distribution: The process for delivering products or services to customers.

Customer service: The support activities provided to customers concerning a product orservice.

Value is created when an idea is established and continues to increase along the way. Each of

the value chain components adds value to the product or service.

Administrative functions, such as human resource management and accounting, areincluded in every business function of the value chain.

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 firms 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.

Customers are concerned with the total cost of producing a product or service but notwith which firm in the supply chain incurred the cost.

Firms must decide where in the value chain a value-added component is performed

most cost effectively.

Cost accounting focuses on how the individual stages contribute to the value and how to work

with other managers to improve performance.

[Assigned Exercises 1-15, 1-16]


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Uses and users of cost accounting and financial accounting information.

Accounting systems provide information for decision makers. Depending on the perspectivesof the primary user of the information (outside versus inside the organization), the accounting

systems can be classified into financial and cost (or managerial) systems.

Investors, creditors, government agencies, tax authorities, etc. are outside the

organization. Managers are inside the organization.

Financial accounting is the field of accounting that reports financial position and

income according to accounting rules, which make financial accounting data comparable

across firms.

Managers are interested in financial accounting information as well. But such

information is not sufficient for making operational decisions.

Cost accounting is the field of accounting that measures, records, and reportsinformation about costs.

Cost accounting information must be relevant for the particular decisions to be made by

managers in a particular business environment. This perspective shapes how a cost

accounting system is designed to provide good information and to add value to theorganization.

Managers add value to the organization by the decisions they make, while accountants

add value by providing good information to managers making the decision.

The major differences between financial and cost accounting are summarized in Exhibit1.2.

External parties such as investors and creditors evaluate company and management

performance by using financial accounting information as governed by generally accepted

accounting principles (GAAP) and international financial reporting standards (IFRS).

GAAP and IFRS represent the rules, standards, and conventions that guide thepreparation of financial accounting statements for firms registered in the U.S. and in

many other countries, respectively.

Financial accounting information thus prepared is consistent and comparable acrossdifferent companies, but may not be appropriate for managerial decision making.

Cost data for managerial use within the organization are not constrained by GAAP orIFRS. Instead, decision relevancy, which affects the future, determines the type of cost

information suitable for the problems at hand.


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Cost accounting information is in demand throughout the organization. Users of such

information must be identified and provided with best possible information for

managerial purposes.

At the production level, cost accounting information is used to control and improve

operations with high frequency.

At the middle management level, deviations from the expectations (budgets) necessitate

investigation and corrective actions.

At the executive level, cost accounting information is integrated into financial

information to assess the companys overall success strategically and is provided on a

monthly, quarterly, or annual basis.

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.

Different uses of accounting information require different types of accounting

information.

How cost accounting information is used for decision making and

performance evaluation in organizations.

The goals of an organization are achieved through the decisions made by managers.

Recurring themes:

(1) The mangers job is to make decisions that determine the performance of the organization.

(2) Accounting system is a primary source of information for managers to make decisions.

(3) Accounting systems also provide information to the owners of the organization, who are not

managers, to evaluate the performance of the organization and the managers.

Nonvalue-added activities are activities that do not add value to the goods or services from the

customers perspective.

Activities cause costs. These nonvalue-added activities should be identified and eliminated; therefore the costs

associated with them can also be eliminated. Cost reduction can be translated into lower price

and/or better service to customers.

A well-designed accounting system can also identify nonvalue-added activities that cross

boundaries in the value chain.

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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Companies use the value chain and other information about the costs of activities to identify strategic

advantages in the market place.

A company can proactively identify activities that customers value while providing such

activities at lower cost.

When owners of a business are not also managers, both parties interests may not be properly aligned.Accounting information system provides information to the owners about the performance of the

organization and the managers.

Cost data can be used for decision making, for control and evaluation, and for preparing budgets,

among others.

To evaluate the financial consequences of alternatives, estimates have to be made for future costs,

revenues, and/or assets based on past information.

Identification of propercost driver factor that causes, or drives, costs also helps predict future

results.

Differential costs and revenues are costs and revenues that change in response to a particular course ofaction. Items that do not change will not affect outcome, and are therefore irrelevant to the decision.

Businesses tend to group specific functions among employees into organizational units such as

departments, divisions, segments, or subsidiaries.

Responsibility center is a specific unit of an organization assigned to a manager who is held

accountable for its operations and resources.

Example: The following organization chart shows how a home builder organizes its

business units. The sales manager and the construction manager of Fox Run Estate are

responsible for revenues and costs, respectively, and report to the project manager, whois responsible for the financial success of the Fox Run Estate project and in turn reports

to a regional manager in charge of the Mid-Atlantic region. All regional managers report

to the general manager.

General Manager

Regional Manager(Mid-Atlantic Region)

Other Regional Managers

Project Manager(Fox Run Estate)

Other Project Managers

Sales Manager(Fox Run Estate)

Construction Manager(Fox Run Estate)


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As seen in Exhibit 1.4, the managers of the retail and the wholesale operations are

responsible for their own Center Margin, the difference between revenues and costs

attributable to a center. The general and administrative costs of running the company as awhole are the responsibility of the general manager and are not assigned to the

department managers.

A budget shows a financial plan of the revenues and resources needed to carry out the

responsibility centers tasks and meet financial goals.

Managers are committed to the targets set in the budget. A comparison of actual resultswith the budget at the end of each period determines whether managers fulfill their

responsibilities and whether changes can be made to improve future operations.

Exhibit 1.5 demonstrates budget versus actual results for a responsibility center.

Cost accounting requires different accounting data for different decision purposes.

[Assigned Exercise 1-17]

Current Trends in cost accounting.

Cost accounting undergoes dynamic changes over time to accommodate shifting managerial

emphases and decision contexts in all stages of the value chain, from research and development(R&D), design, purchasing, production, marketing, distribution, all the way to customer service.

In the development stage, companies partner with suppliers to ensure cost-efficient

designs and materials for products.

Design for manufacturing (DFM) is the concept that manufacturing cost and complexityneed to be considered in the design of the product.

The tradeoff between complex design for a more desirable product and difficult and

expensive manufacturing process can be manifested through cost accounting methodssuch as activity-based costing (ABC) a costing method that first assigns costs to

activities and then assigns them to products based on the products consumption of

activities.

Activity-based costing provides more detailed and accurate cost information than

traditional costing methods and enables managers to make more informed decisions,

leading to activity-based management that identifies and eliminates nonvalue-addedactivities.

In purchasing, performance measures (metrics that indicates how well an individual,business unit, product, or firm is working) are used to evaluate performance of key

suppliers and business partners.


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Benchmarking is the continuous process of measuring a companys own products,

services, and activities against best practices either inside or outside the organization.

Continuous improvement sets the performance standard ever higher to achieve betterresults throughout the supply chain.

Just-in-time (JIT) method may be used in production or purchasing where each unit ispurchased or produced just in time for its use. Cost accountants develop unique treatment

for the just-in-time environment while deemphasizing the need for inventory valuation.

Lean accounting is a cost accounting system that provides measures at the work cell or

process level and minimizes wasteful or unnecessary transaction processes. Lean

accounting provides support for lean manufacturing techniques.

Customer relationship management (CRM) is a system that allows firms to target

customers by assessing customer revenues and costs. Marketing managers use cost

accounting data to better manage different customer groups based on their profitability.

In the distribution stage, managers frequently consider activities foroutsourcing, with

which one or more of the firms activities will be performed by another firm or individualin the supply or distribution chain for improved efficiency and cost savings.

Total quality management(TQM) is a management method by which theorganization seeks to excel on all dimensions, with the customer ultimately defining

quality.

Cost of quality (COQ) is a system that identifies the costs associated with producinglow quality items, including rework, returns, and lost sales.

Enterprise resource planning (ERP) systems represent the information technologythat links the various systems of the enterprise into a single comprehensive information

system. By integrating purchasing, production, human resources, and finance, managers

hope to avoid lost orders, duplication of effort, and costly studies to determine what thecurrent state of the enterprise is.

All these tools are meant to add value to the organization. They also provide

opportunities for people interested in cost accounting to contribute to the organization.

As shown in Exhibit 1.6, key financial players in an organization and their activities include:

Chief financial officer (CFO): The top financial personnel and usually a senior vice

president; in charge of the entire accounting and finance function of a company.

Treasurer: The person responsible for managing liquid assets (such as cash and short-

term investments); conducting business with banks and other financial institutions;

overseeing public issues of stock and debt.


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Controller: The person in charge of accounting functions, including planning, decision

making, designing information systems and incentive systems, and helping managers

make operating decisions.

Internal auditors: Part of an internal audit department that ensures compliance with

laws, regulations, and company policies and procedures; provides consulting and auditingservices within the firm; also assists external auditors examining external financial

reports and reviewing companies internal control systems; often reports directly to the

audit committee of the Board of Directors as whistle blowers.

Cost accountants: A group of people who record, measure, determine, and analyze

costs; work with financial and operational managers to provide relevant information for

decisions.

People from engineering, production, marketing, finance, and accounting often work together

in cross-functional teams to solve problems.

Value is added by

(1) bringing a variety of expertise and perspectives to a problem,(2) ensuring that the product is appropriate for its customer base,

(3) giving production a chance to formulate an efficient production process,

(4) obtaining financing for the project, and(5) determining whether the project is economically feasible.

Ethical issues faced by accountants and ways to deal with ethical problems

that you face in your career.

Cost assignment to activities, products, projects, corporate units, and people, as the result ofthe design of cost systems, affects price, reimbursement, and pay, among others. It has thepotential to be misused to defraud customers, employees, or shareholders.

Accounting information is used to evaluate the performance of managers. Accountants whoprepare the numbers are under constant pressure to make accounting choices that will influence

performance reports.

Both the preparers and users of cost information need to be aware of the incentives

created by performance measurement systems and how those incentives may lead to

unethical (or even illegal) conduct.

Professional organizations such as the Institute of Management Accountants (IMA),

Institute of Internal Auditors (IIA) and the American Institute of Certified Public

Accountants (AICPA) have developed codes of ethics to help their members maintain thehighest levels of ethical conducts and resolve ethical dilemmas. Many businesses also use

these codes to train their employees and to demonstrate their commitment to certain

business practices with respect to their customers and as a guide for their employees.


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Appendix to this chapter shows IMA code of ethics in detail. Members of IMA are

expected to maintain an appropriate level of professional competence, refrain from

disclosing confidential information acquired in the course of their work, and maintainintegrity and objectivity in their work. Any resolution of ethical conflict should follow

the established policies of the organization. Suitable courses of action are also

recommended if the policies do not resolve the ethical conflict.

IMA code of ethics discusses the steps cost accountants should take when faced with an

ethical conflict, including(1) discuss the conflict with the immediate superior, or, if the conflict involves the

superior, the next level in authority,

(2) clarify the relevant issues and concepts by discussions with a disinterested party, and

(3) consult an attorney about rights and obligations.

Congress passed the Sarbanes-Oxley Act of 2002 to counter many illegal practices, including

manipulation of accounting results, designed to increase the compensation of managers at the

expense of the investing and consuming public.

Provisions in Title III and IV of the Act deal with corporate responsibility and enhancedfinancial disclosure, respectively.

The CEO and CFO are responsible for signing financial statements and stipulating thatthe financial statements do not omit material information.

The CEO and CFO must further disclose that they have evaluated the companys

internal controls and that they have notified the companys auditors and the auditcommittee of the board of any fraud that involves management.

Section 404 of Title IV requires managers to attest to the adequacy of their internalcontrols.

The Sarbanes-Oxley Act of 2002 has important implications for managers who designcost information systems. The managers must be aware of the potential for the resulting

information to be misleading or to further fraudulent activity. See In Action box for a

discussion of options backdating at Apple, Inc. and its pitfalls.

Cost accounting information interacts with other business disciplines in the organization to

solve problems. Cost accounting system permeates the organization and influences a myriad of

decisions. A good grasp of other disciplines such as organizational behavior and marketing willhelp enrich the study of cost accounting.

[Assigned Exercise 1-21]

Ch1 Lecture Notes

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