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 coordination depends 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.

 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 or service. 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, are included 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 not with 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]

Uses and users of cost accounting and financial accounting information.

Accounting systems provide information for decision makers. Depending on the perspectives of 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 reports information 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 the organization. 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 Exhibit 1.2. 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 the preparation 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 across different companies, but may not be appropriate for managerial decision making. Cost data for managerial use within the organization are not constrained by GAAP or IFRS. Instead, decision relevancy, which affects the future, determines the type of cost information suitable for the problems at hand.

 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.

 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 proper cost 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 of action. 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, who is 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)

 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 a whole 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 results with 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 complexity need 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 methods such 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-added activities. 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.

 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 better results throughout the supply chain. Just-in-time (JIT) method may be used in production or purchasing where each unit is purchased 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 for outsourcing, with which one or more of the firms activities will be performed by another firm or individual in the supply or distribution chain for improved efficiency and cost savings. Total quality management (TQM) is a management method by which the organization 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 producing low quality items, including rework, returns, and lost sales. Enterprise resource planning (ERP) systems represent the information technology that 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 the current 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 shortterm investments); conducting business with banks and other financial institutions; overseeing public issues of stock and debt.

 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 auditing services 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 of the design of cost systems, affects price, reimbursement, and pay, among others. It has the potential to be misused to defraud customers, employees, or shareholders. Accounting information is used to evaluate the performance of managers. Accountants who prepare 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 the highest 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.

 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 maintain integrity 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 enhanced financial disclosure, respectively. The CEO and CFO are responsible for signing financial statements and stipulating that the 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 audit committee of the board of any fraud that involves management. Section 404 of Title IV requires managers to attest to the adequacy of their internal controls. 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. 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 will help enrich the study of cost accounting. [Assigned Exercise 1-21]