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Introduction

Management Accounting
Provide information
o Financial
o Non financial
Tailored to specific needs of each decision maker
Classes of organization decision making
Planning forward looking and predictive
o Product planning
Revenues
Costs
o Production planning
Resource availability
o Strategy development
External environment
Requirements of target customers
Organizing
o Developing organization systems and the required
infrastructure required to support primary production
systems
Controlling
o Measuring and evaluationg the performance of existing
organization systems
Financial VS Managerial Accounting
Audience
Purpose

Timeliness
Restrictions
Type of Info
Nature of Info

Scope

Financial
External
Past performance
Provide contracting basis
for owners and lenders
Delayed
Historical
Regulated
Financial
Objective
Auditable
Reliable
Consistent
Precise
Highly aggregate
Entire organization

Managerial
Internal
Inform internal
decisions
Feedback and
control on operating
performance
Current
Future oriented
No regulations
Financial
Operational
Physical
Subjective
Judgemental
Valid
Relevant
Accurate
Disaggregate
Local decisions and
actions

Financial information summarizes the financial effect


ofunderlying activities but to explain financial results, managers
must dig deeper and inevitable focus on the
nonfinacial/operating data that explain the performance of the
activities that are driving the financial results
Value proposition
What the organization tries to deliver to customer
Price
o Relative price given product features and competitors
Quality
o Degree of conformance between what the customer is
promised and what the customer receives

Functionality and features


o Performance of the product
Service
o All other lements of the product relevant to the customer
Role of effective management accounting system is to
caputre, track, and report these value proposition measures,
which are the leading indicatiors of financial performance.
To deliver the value propositions, organizations use
processes that they design and manage
Cost information
Identify opportunities for process improvement
Provides information for planning
Service
Organizations,
Government
and
Not-for-Profit
Organizations
Used management accounting less than manufacturing
organizations
o Benign, noncompetitive markets
Evaluate how well and how efficently these organizations
used their funds to provede services to their customers
Behavioral Implications
Alter behavior when they know they are being studied and
their performance being measured
Focus on the variables and behavior being measured and pay
less attention to those not being measured
Resistance to change
Ethics and Management Accounting
Moral system or set of values that individuals use to regulate
their behavior
Ethical lapses can have profound implications for
organizations and their employees
Laws of society
o Define certain decisions as illegal
Societal standards
o Rule out certain types of decisions as unacceptable
although not illegal
Corporate vales
o Boundary systems
Prescriptive
Define behavior that is unacceptable and has direct
consequences
o Belief systems
Descriptive
Idenitify broad goals for organization behavior
Professional codes of conduct
o Protect clients rights to privacy
o Accountants will prepare reports that reflect their
informed and unbiased beliefs
Personal system of values
o Family
o Culture
o Religion
Corporate governance
Concerned with how to promote the achievement of the
organizations stated objectives

Senior management should provide systems of internal


controls

Cost Management Concepts and Cost Behavior


Cost
Monetary value of goods and services expended to obtain
current or future benefits
Different costs for different purposes
o The way that a cost will be used defines the way it should
be computed
External users: historical costs
Asset is sold or used: expense
Exchange of asset or liability for an asset: expenditure
Product Costs
Manufacturing costs
o Direct materials
Cost of purchased raw materials
o Durect labor
Wages of people who work directly on making the
product
o Manufacturing overhead
Costs of assets that an organization uses to convert
purchased raw materials into finished goods
Financial
o Only manufacturing costs
Conservatism
Report assets whoce ability to produce future
benefits can be estimated in a systematic way
o Total inventory cost
Evaluate how well management has used the resources
Managerial
o Manufacturing costs + other product-related costs
To estimate total costs of developing, introducing,
making and supporting a product
To evaluate product profitability
o Cost of individual unit of inventory
To make informed decisions
Cost object
Something for which management accountant computes a
cost
Flexible resources
Costs are proportional to the amount of the resource used
Variable costs
Direct costs
o Cost of a resource or activity that is acquired for or used
by a single cost object
o Costs that can be associated unequivocally and
specifically with a single cost object
Capacity related resources
Acquired and paid for in advance of when work is done
Fixed costs
Indirect costs
o Cost of a resource that is used by more than one cost
object

Vary with the amount of capacity acquired


Assuming that all costs are variable will underestimate cost
because it does not account for the costs of idle capacity
Assuming all costs are fixed will overestimate cost because it
will not reflect that the organization will need to pay only for
the flexible resources that it uses
Cost classification can vary if the cost object changes
CVP
Cost volume profit analysis
Assumption
o Costs are either variable or fixed
o Units made = units sold
o Revenue per unit does not change as volume changes
For multiproduct, use weighted values

Pr ofit Re venue Costs


Costs VariableCo sts FixedCosts
Re venue UnitsSold * Re venuePerUnit
VariableCo sts UnitsSold * VariableCo stPerUnit C
Contributi onM arg in Re venue VariableCo st
ContributionM arg in
Contributi onM arg inRatio
Re venue
VP Chart
Provides graphic picture of organizations profit behavior as
sales level vary
Incorporating fixed costs
FixedCosts

# ofUnits
o Increase computed cost of a product as demand goes
down
FixedCosts

Pr acticalLevelOfCapacity
o Charge out capacity to products based on the amount of
capacity that each product uses
o Underassigns costs since few organizations operate at
capacity
Opportunity Cost
Implicit cost
Sacrifice one makes when using a resource
Zero if there is excess capacity of that resource
Opportunity cost = contribution per unit of resource
An allocation that is volume based has the potential to distort
costs particularly when the direct costs are a tiny fraction of the
fixed costs
Types of production activities
Unit related
o Volume or level are proportional to the number of units
produced or to other measures
Batch related
o Triggered by the number of batches produced
Product sustaining
o Support the production and sale of individual products

o Provide the infrastructure that enables the production,


distribution and sale of the product but are not involved
directly in the production
o Quantity of resources used is independent of the
production and sales volumes and the quantity of
production batches and customer orders
Customer sustaining
o Enable the company to sell to an individual customer but
are independent of the volume and mix of the products
sold and delivered
o Quantity of resources used is independent of the
production and sales volumes and the quantity of
production batches and customer orders
Channel-sustaining
o Required to maintain and sustain product distribution
channels
Business sustaining
o Rquired for the basic functioning of the business
o Independent of the size of the organization or the volume
and mix of products and customers
Other support activities
o Vary in proportion to the size or complexity of the
organization
o Allocated to cost objects in a way that reflects their cause

Abandonment costs
Costs incurred when it stops using a resource or stops
making a product
Nonmanufacturing costs
Research and development
Marketing
Selling
Logistical activities
Customer accounting
To determine the profitability of dealing with different
customers
Traditional Cost Management Systems
Job order costing system
Estimates the cost of manufacturing products for many
different jobs required for specific customer orders
Applicable in organizations that treat each individual job as
a single unit of output
Costs are accumulated and unit costs calculated for each job
Tracks
o Raw materials inventory
o Work-in-process inventory
Costs of the resources for each job not yet completed
o Finished goods inventory
Process costing systems
Applicable when all units produced during a specified
timeframe are treated as one type of output
Assign unit cost
Costs are accumulated by specific department
department production reports are the key documents that
keep track of costs

Products differ in their materials content and hours of labor and


machine time
Products differ in demand they place on support activity
resources
Job costs sheet
For estimating job costs
Markup rate
Depends on
o
o
o
o
o
o

amount of support costs excluded from the cost


driver rate
target rate of return
competitive intensity
past bidding strategies adopted by key
competitors
demand conditions
overall product-market strategies

all costs associated with a cost driver are accumulated separately


Cost pool
subset of total support costs that can be associated with a
distinct cost driver
Cost driver rate

normalCostOfSupportActivity
practicalCapacityOfCostDrive
Remains stable over time and does not fluctuate as activity
levels change in the short run
If based on planned or actual short-term usage, results in
higher rates in periods of lower demand
activityCostDriverRate

Normal cost of support activity


Cost of the resources committed to the particular activity
Excludes fluctuations in costs caused by short-term
adjustments
Caused by the level of capacity of each activity that is made
available rather than by the level of actual usage of the
committed resources
Practical capacity
Long-term average usable capacity made available by the
amount of resources committed to a support activity
Excludes short-term variations in demand as reflected in
overtime or idle time
Estimated as a percentage of theoretical capacity
Combined conversion cost driver is used more in service
organizations
Separating labor from support costs is common in
manufacturing and trading establishments
Use different cost pools if the cost or productivity of resources
is different and if the pattern of demand varies across resources
Record actual costs to determine unexpected variations
Multistage process costing systems
Determine costs for each stage of the process and then
assign their costs to individual products

allows mesurement of the costs of converting the raw


materials during a time period to be made separately for
each process stage
common in process-oriented industries

Reflects cost of unused capacity


Unused capacity should not be treated as general cost; it should
be assigned

Conversion costs
directLabo r sup port Re sources

How committed costs become variable costs


Demands for capacity resources change
o Changes in quantity of activities performed
o Changes in the efficiency of performing activities
Not necessary anymore to maintain separate cost records for
individual jobs
Managers make decisions to change the supply of committed
resources to mee the new level of demand for the activities
performed by these resources
totalEstimatedConversionCost

conversionCostDriverRate

Total # of Pr ocessHours
Activity volumes > capacity of resources = bottleneck

equivalentUnits numberOfPartiallyCompletedUnits %Completion


Indirect costs increase because they increase supply of resources
to relieve the bottleneck
equivalentUnitsOf Pr oduction UnitsTrans ferredOut

Demands for indirect and support resources can decline through


equivalentUnit sin EndingWork In Pr ocessInventory
ABM or competitive or economy-wide forces

After unused capacity has been created, committed costs will


Activity-Based Cost Systems
vary downward if managers actively reduce the supply of
unused resources
Exclusive use of unit-level drivers to allocate overhead costs
leads to product cost distortion
Time-driven activity-based costing
Traditional cost systems systematically and grossly
To estimate
underestimate te cost of resources required for specialty, lowo Unit cost of supplying capacity for each department or
volume products and overestimate the resources cost of
process
producing high-volume standard products
Cost of resources that supply capacity
Practical capacity of the resources supplied
Activity-Based Cost Systems
o
Consumption capacity by each transaction or product
Use activities for accumulating costs
Estimate of the time used on a resource when an
Ask what activities are being performed by a departments
activity is performed
resources
Advantage
Assigns the resource expenses to activities on the basis of
o Data are easier to obtain and far easier to validate
how much of the resources each activity uses
o Ease of updating
Activities should describe what resources were doing
Triggered by events that require the estimates in the
Assumption is that all resources are working at full capacity
model to be modified
Concerns
o
Easily
update cost driver rates
o Time consuming and costly (interviews and surveys)

Changes
in the prices of resources supplied
o Updated infrequently so cost driver rates are out-of-date

Shift
in
the
efficiency of the activity
o Cost assignments are based on individuals subjective
o
Relax
the
assumption
that all orders of a particular type
estimates
are
the
same,
requiring
the same amount of time to
o Difficult to add new activities or add more detail to an
process
existing activity
o As the activity dictionary expands, the demands on the
Time equations
computer model used to store and process the data
Enables the model to reflect how particular order and
escalate dramatically
activity characteristics cause processing times to vary
o Few individuals report that a significant percentage of
thier time is idle or unused
Customers differ in their use of marketing, selling, distribution
and administrative resources
Activity cost drivers
Represent the quantity of activities used to produce
How to turn unprofitable customers to profitable customers
individual products
Process improvements

Activity-based pricing
activityExpense
activityCostDriverRate
o Establishes a base price for producing and delivering a
totalQuantitOfEachActivityCostDriver
standard quantity for each standard product
Activity-based management
Managing customer relationships
Actions managers take, on the basis of an ABC study, to
o Persuading customers to use a greater scope of the
improve the efficiency of activities and the profitability of
companys products and services
products

unitCost

cos tOfCapacitySupplied
practicalCapacityOf Re sourceSupp lied

Why service companies are ideal for ABC


All costs appear to be fixed
Variable cost is close to zero

Do not have direct, traceable costs to serve as convenient


allocation bases
No material costs
Manufacturing costs are customer independent
Measuring revenues and costs at customer level provides far
more relevant information
Implementation issues
Lack of clear business purpose
Lack of senior management commitment
Delegating the project to consultatnts
o Do not have the needed familiarity with the companys
operations and business problems
Poor ABC model design
o Gets lost in the details
o Too complicated to build and maintain
Individual and organizational resistance to change
People feel threatened
o Unprofitable products
o Unprofitable customers
o Inefficent activities and processes
o Substantial unused capacity
Management Accounting Information for Activity and Process
Decisions
Relevant costs
costs and revenues that differ across the decision alternatives
Sunk costs
costs of resources that already have been committed and
cannot be influenced by any current action of decision
Concentrate only on the relevant costs
Sunk costs are not relevant
Not all fixed costs are sunk costs and not all sunk costs are fixed
costs
Assuming responsibility for decisions
Managers are concerned about their reputations within their
own organizations
Behavior may be viewed as suboptimial
Might garner more respect from colleagues for accepting
responsibility
Difficult time distinguishing sunk cost business decisions
from sunk cost personal decisions
Critical: identifying what is relevant and disentangling
personal responses
Make or buy decisions
Avoidable costs
o Eliminated when a part, product, product line, or busines
segment is discontinued
Qualitative factors
o Reputation of the selected outside supplier
o Reliability of the supplier in meeting the required quality
standards and in making deliveries on time
o Technological innovations is an important determination
of competitive advantage
Theory of Constraints

TOC
Operating income can be increased by carefully managing
bottlenecks in a process
Three measures
o Throughput contribution
Revenue direct materials (for the quantity of product
sold)
o Investments
Material costs of raw materials + Material costs of
work-in-process + Material costs of finished goods
o Operating costs
All other costs except direct material costs
Emphasizes short-run optimization of througput contribution
Bottleneck
Any condition that impedes or constrains the efficient flow
of a process
Identified by determining points at which excessive amounts
of work-in-process inventories are accumulating
Facility Layout Systems
Process layouts
o All similar equipment or functions are grouped together
o Where production is done in small batches of unique
products
o Long production paths
o High inventory levels
Store work in process in each area while it awaits the
next operation
Use of batches reduce setting up, moving and handling
costs
Rate at which each processing area handles work is
unbalanced
Supervisors evaluate many processing area managers
on their ability to meet production quotas
Product layouts
o Equipment is organized to accomodate the production of a
specific product
o High volume production
o Placement of equipment or processing units is made to
reduce the distance that products must travel
Cellular manufacturing
o Organization of a plant into a number of cells so that
within each cell all machines required to manufacture a
group of similar products are arranged in close proximity
o Machines are flexible and can be adjusted easily
o U shapre provides better visual control of the work flow
Batch production creates inventory costs and delays associated
with storing and moving inventory which increase cycle times,
thereby reducing service to customers
Inventory related costs
Moving, handling and storing work-in-process costs
Costs due to obsolescence or damage
Costs of rework
Financing
PCE
Processing cycle efficiency

o Clerical process of management accounting is simplified


by JIT manufacturing because there are fewer inventories
Pr oces sin gTime
PCE
to monitor and report
Pr oces sin gTime MovingTime StorageTim e InspectionTime

Streamlining manufacturing processes reduces the demand


placed on many support-activity resources

Cost Information for Pricing and Product Planning

CONC
Cost of nonconformance to quality standards

Incremental cost per unit


Amount by which the total costs of production and sales
increase when one additional unit of that product is produced
and sold

Quality factors
Satisfying customer expectations regarding attributes and
performance
Ensuring that the technical aspects of the product conform to
the manufactureres standard
Costs of quality control
Prevention costs
o To ensure that companies produce products according to
quality standards
Appraisal costs
o Relate to inspecting products to make sure they meet both
internal and extenral customers requirements
Internal failure costs
o Results when the manufacturing process detects a
defective component or product before it is shipped to an
external customer
External failure costs
o When customer discover defects
It is much less expensive to prevent defects than to detect and
repair them
COQ
Cost of quality report
Illustrates the financial mangnitude of quality factors
Helps managers set priorities for the quality issues and
problems they should address
Allows managers to see the big picture of quality issues and
allows them to try to find the root causes
JIT
Just-in-time manufacturing
Requires making a product or service only when the
customer, internal or external, requires it
No work-in-process inventory
o A problem anywhere in the system can stop all production
Needs a highly-trained workforce whose task is to carry out
activities using the highest standards of quality
Measures
o Defect rates
o Cycle times
o Percent of time that deliveries are on time
o Order accuracy
o Actual production as a percent of planned production
o Actual machine time available compared with planned
machine time available
Implications for management accounting
o Management accounting must support the move to JIT
manufacturing by monitoring, identifying, and
communicating the sources of delay, error and waste in
the system

Why study product cost and pricing


When to offer discounts
Decide the best mix of products to manufacture and sell
How best to deploy marketing and promotion resources and
how much commission to provide
Short-term and long-term pricing considerations
Whether surplus capacity is available for additional
production
Whether shortages of available capacity limit additional
production alternatives
How long a firm must commit its production capacity
o Opportunity costs
o Additional expensive new capacity to handle future sales
increase
Use of subcontractors
Introduce new products or eliminate existing products
Price taker
Chooses its product mix given the prices set in the
marketplace for its products
Price setters
Relatively little competition that enjoy large marketshare
and exercise leadership
Short-term product mix decision: price takers
The contribution margin per unit of the constrained resource
is the criterion used to decide which products are most
profitable to produce and sell at the prevailing price
Managers must decide which costs are relevant to the shortterm product mix decision
Managers have little flexibility to alter the capacities of
some resources
Relevant costs
o opportunity costs
o short-run variable costs
Short-term pricing decisions: price setters
available surplus capacity
o minimum available acceptable price must at least cover
the incremental costs that the company will incur to
produce and deliver the order
no available surplus capacity
o minimum acceptable price must cover all incremental
costs but when the firm must acquire additional capacity
to satisfy the order, more incremental costs are involved
Long-term pricing decisions: price setters
use full costs when
o contracts for customized products

o regulated industries
o long-term contractual relationships
most activities will depend on the production decisions
because it has great flexibility in adjusting the level of
commitment
o serves as a benchmark or target price from which the firm
can adjust prices up or down depending on demand
conditions
long-term average tends to equal the price based on the
full costs that will be recovered in a long-term contract
markups
o increase with the strength of demand
o depend on elasticity of demand
elastic
customers are very sensitive to the price
markups are smaller
quantities sold will decrease sharply when prices
increase
inelastic
profits increase when prices increase
o fluctuate with the intensity of competition
o lower for strategic reasons
penetration pricing
new product to penetrate the market
skimming pricing
higher price is charged to customers who are willing
to pay more for the privelege of possessing the latest
technological innovations
Long-term product mix decisions: price takers
relevant
o product sustaining costs
o batch related costs
Managers cannot easily change the amount of commited cost
in the short run
Managers can adjust the supply of most resources for long
run
Comparing product costs with market prices reveals which
products are not profitable in the long term
o Full product line for customers to enjoy one-stop
shopping
o Reengineer/redesign unprofitable products to eliminate or
reduce costly activities
o Phase out a product to help improve profitabitlity
if managers eleminate the activity resources no longer
required to support the discontinued product
if managers redeploy the resources from the eliminated
products
capacity constraints are likely to be less of a concern
comparison of the price of a product with its acitvity-based
costs provides a valuable evaluation of the long-run
profitability
Management Accounting and Control Systems: Assessing
Performance over the Value Chain
Management accounting and control systems
MACS
One of the central performance measurement systems at the
core
Technical characteristics
o Scope of the system

Measure and assess only actual production process


Pre and postproduction costs are ignored
Disadvantage when trying to understand the total
life cycle costs
Must be comprehensive and include all activities across
the entire value chain
o Relevance of the information generated
Accurate
Most accurate information possible subject to costbenefit trade-off
Timely
Results of performance musst be fed back to the
appropriate units in the most expedient way possible
Consistent
Language used and technical methods do not
conflict within various parts of an organization
Flexible
Customize application for local decisions
If not possible, an employees motivation to make
the best decision may be lessened
Control
Set of procedures, tools, performance measures and systems
that organizations use to guide and motivate employees
Stages
o Planning
Developing an organizations objectives
choosing activities to accomplish the objectives
selecting measures
o Execution
Implementing the plan
o Monitoring
Meausring the systems current level of performance
o Evaluation
Feedback about the systems current level of
performance is compared to the planned level
o Correcting
Taking the appropriate actions to return the system to
an in-control state
Management must have the ability to correct situations
One key difference in the control process lies in determining the
most appropriate types of performance measures
Behavioral considerations
Embedding the organizations ethical code of conduct
Using a mix of short- and long-term qualitative and
quantitative performance measures
Empowering employees to be involved in decision making
and MACS design
Developing an appropriate incentive system to reward
performance
Value chain
Sequence of activities that should contribute more to the
ultimate value of the product than to its cost
Total-Life-Cycle Costing
Process of managing all costs along the value chain
Provides information for managers to understand and
manage costs through a products

o Design
o Development
o Manufacturing
o Marketing
o Distribution
o Maintenance
o Service
o Disposal
Opportunity costs play a heightened role
Research Development and Engineering Cycle
Market research
o Emerging customer needs are assesed
o Ideas are generated
Product design
o Develop the technical aspects of products
Product development
o Creates features critical to consumer satisfaction and
design prototypes, production processes and any special
tooling
80% to 85% are comitted to decisions made in the RD&E
cycle
Decisions made here are critical because an additional dollar
spent on activities that occur during this cycle can save at
least $8 to $10 on manufacturing and postmanufacturing
activities
Manufacturing Cycle
Costs are incurred in the production of the proudct
Not as much room for engineering flexibility
Much higher cost than RD&E
Postsale Service and Disposal Cycle
Costs here are committed in the RD&E stage
Overlaps with the manufacturing cycle
Stages
o Rapid growth from the first time the product is shipped
through the growth stage of its sales
o Transition from the peak of sales to the peak of service
cycle
o Maturity from the peak in the service cycle to the time of
the last shipment made, disposal occurs at the end of a
products life and lasts until the customer retires the final
unit of the product
Disposal costs include elimination of any harmful effects of
the product
Breakdown of costs for each functional life cycles will differ
depending on the industry and specific product produced
Understanding of total-life-cycle costs can lead to cost-effective
product designs that are easier to service and easier and less
costly to dispose
Target Costing
Cost reduction focus on design stage but also considers all
aspects of the value chain and explicitly recognizes totallife-cycle costs
Market research
o Customer driven
Customer input obtained continually throughout the
process
Concurrent design and engineering

Uses total-life-cycle concepts


o Key goal is to minimize cost of ownership of a product
Price-led costing
o Target selling price and target product volume are
chosen on the baisis of the companys perceived value
of the product
o Target profit margin results from long-run profit
analysis
o Determine target cost
C tc S tc Ptc
o Determine target costs for each component through value
engineering
Examination of each component of a product to
determine whether it is possible to reduce costs while
maintaining functionality, reliability, mantainability,
quality, safety, recyclability, usability and performance
Analyzes both product and manufacturing process
design
Subactivities
Identifying components for cost reduction
Compute value index
Ratio of the value to the customer and the
percentage of total cost devoted to each
component
If < 1 candidates for value engineering
If high value candidates for enhancements
Optimal value zone
Based on experience and opinions
Wider at the bottom of the value index chart
low cost and low importance
Narrower at the top features are important
and cost variations are larger
Above the zone candidates for cost
reduction
Below the zone candidates for
enhancements
Generating cost reduction ideas
Reduced
Eliminated
Combined
Substituted
Rearranged
Enhanced
Use cross-functional product teams throughout the entire
process to guide the process
Suppliers play a critical role
o Companies may offer incentive plans to suppliers who
come up with the largest cost reduction ideas
o Some use supply chain management
Develops cooperative, mutually beneficial, long-term
relationships
Concerns
o Lack of understanding of the target costing concept
o Poor implementation of the teamwork concept
o Employee burnout
o Overly-long development time
Cost Analysis
Developing a list of product components and functions
Doing a functional cost breakdown

Determining relative ranking of customer requirements


Relating features to functions
o Quality function deployment matrix
Systematically arraying information about
Features
Functions
Competitive evaluation
Highlights relationships among competitive offerings,
customer requirements and design parameters
Developing relative functional rankings
o Through QFD
Convert feature rankigs into functional or component
rankings
Need information about percentage contribution of
each component to a customer features
Kaizen Costing
Reducing costs during the manufacturing stage
Making improvements to a process in small, incremental
amounts
Tied into the profit-planning system
Target reduction rate
o Ratio of the target reduction amount to the cost base
o Applied over time to all variable costs
Variance analysis
o Comparisons between actual reduction amounts to the
preestablished targeted reduction amounts
o Goal: actual production costs < cost base
Workers are assumed to have superior knowledge about how
to improve processes
Gives workers the responsibility and control to improve
processes and reduce costs
Concerns
o Enormous pressure on employees to reduce every
conceivable cost
Use a cost-sustained period to address this problem
Provides opportunity to learn any new procedures
before the company imposes Kaizen and target costs
on them
o Leads to incremental rather than radical process
improvements
Can cause myopia as management tends to focus on
details
Environmental Costing
Involves selecting suppliers whose philosophy and practice
in dealing with the environment match those of buyers
Use activity-based costing method to control and reduce
environmental costs
o Identify activities that cause environmental costs
o Costs of these activities must be determined
o Costs must be assigned to the most appropriate products,
distribution channels and customers
Explicit costs
o Direct costs of modifying technology and processes
o Cost of cleanup and disposal
o Costs of permits to operate a facility
o Fines levied by government agencies
o Litigation fees
Implicit costs

o Costs tied to infrastructure required


environmental issues
o Administration and legal counsel costs
o Employee education and awareness
o Loss of goodwill

to

monitor

Three ways to learn about and adopt a method


Bring in outside consultants to implement a particular
method
o Effective but costly
Develop their own systems internally
o Satisfying, highly costly and time consuming
Benchmarking
o Understand their current operation and approaches
o Then look to the best practices of other organizations for
guidance on improving
o Highly cost effective
o Selecting appropriate benchmarking partners is critical
o Process
Internal study and preliminary competitive analyses
Decide which key areas to be benchmark for study
Determine how it currently performs on these
dimensions
Preliminary internal competitive analyses
Preliminary external competitive analyses
These will determine the scope and significance
of the study
Developing
long-term
commitment
to
the
benchmarking
project
and
coalescing
the
benchmarking team
Obtaining the support of senior management to give
the benchmarking team the authority to spearhead
changes
Developing a clear set of objectives for guidance
Empowering employees to make change
Team should include individuals from all functional
organizations
Lack of training of benchmarking methods will lead
to failure of implementation
Identifying benchmarking partners
Critical factors
Size of the partners
Depend on specific activity/method
Number of partners
As the number of partners increases, so do the
issues of coordination, timeliness and concern
over proprietary information disclosure
Relative position of the partners within and across
industries
Newcomers or declining performance seek a
wide variety of benchmarking partners
Industry leaders benchmark because of
commitment to continuous improvement
Degree of trust among partners
Obtaining truthful and timely information
Information gathering and sharing methods
Type of information
Product benchmarking
Examining other organizations products
Functional benchmarking

Other organizations practices and costs with


respect to functions or processes
Strategic benchmarking
Other organizations strategies and strategic
decisions
Methods of information collection
Unilateral benchmarking
Independently gather information about one or
several other companies that excel in the area
of interest
Relies on data that can be obtained from
industry trade associations or clearinghouses of
information
Cooperative benchmarking
Voluntary sharing of information
Database
Large amount of information in one place
Insights what the data mean and how to use
it are not available
Indirect/third party
Outside consultant to act as a liason among
firms engagned in benchmarking
Members remain anonymous
Group
Meet openly
Abide by a code of conduct
Opportunity for better understanding of the
other parties involved
Most effective method and most costly
Determine benchmarking gap
Taking action to meet or exceed the benchmark
Simply judging the effects of a benchmarking effort in the short
term on the basis of financial indicators may lead to premature
abandonment of what has been learned during the benchmarking
project
Motivating Behavior in Management Accounting and Control
Systems
Major role for control systems is to motivate behavior congruent
with the desires of the organization
Scientific management school
Most people found work objectionable
Individuals cared little for making decisions or exercising
creativity on the job
Money was the driving foce behind performance
Management believes that employees should follow highlydetailed, prescribed procedures
Behavior should be monitored and controlled
Human relations movement
People had needs that went beyond performing simple
repetitive task at work
Financial compensation was only one aspect of what
workers desired
Employees wanted respect, discretion over their jobs and a
feeling that they contributed something valuable
Improve morale and job satisfaction and the overall quality
of working life

Human resources model of motivation


High level of employee responsibility for and participation
in decisions in the work environment
Assumption
o Organization operate under a system of beliefs about the
values, purpose and direction of their organization
o People find work enjoyable
o People desire to participate in developing objectives,
making decisions and attaining goals
o Employees have a great deal of knowledge and
information about their jobs
o Individuals are highly creative, ethical and responsible
o Individuals desire opportunities to effect change
Individuals are motivated by both financial and nonfinancial
means of compensation
A well-designed MACS should incorporate the principles of the
organizations code of ethical conduct
Ethical framework embedded in the system design will
influence the behavior of all users
Pressures from job circumstances
Requests to tailor information to favor particular individuals
or groups
Pleas to falsify reports or test results
Solicitations for confidential information
Pressures to ignore a questionable or unethical practice
System designers might ensure the following to incorporate ethical
principles
That the organization has formulated, implemented and
communicated to all employees a comprehensive code of
ehtics
That all employees understand the organizations code of
ethics and the boundary systems
That a system in which employees have confidence exists to
detect and report violations
Five categories that capture the broad array of ethical
considerations
Legal rules
Societal norms
Professional memberships
Organizational or group norms
Personal norms
Ethical hierarchy provides a set of constraints on a decision
Ethical conflicts occur when one systems of values diverges
from a more fundamental system
Dealing with ethical conflicts
Maintain a hierarchical ordering of authority
o Avoiding ambiguity or misunderstanding
Way that the chief executive and other senior managers
behave and conduct business
If the organizations code of ethics is more stringent than an
individualss code, conflicts may arise
Employees faced with ethical conflicts must make sure to
document the events and discussions and list the parties
involved so that a case can be made

Conflicts between the organizations stated and practiced values


Individual should ensure that the facts are correct and that a
conflict does exist
Individual should determine whether this conflict is
institutional or whether it reflects the decisions and actions
of only a small minority of employees
Choices
o Point out the discrepancy to a superior and refuse to act
unethically
o Point out the discrepancy to a superior and act unethically
o Take the discrepancy to a mediator
o Work with respected leaders to change the discrepancy
o Go outside to publicly resolve the issue
o Go outside anonymously to publicly resolve the issue
o Resign and go public
o Resign and remain silent
o Do nothing
If the organization is serious about its stated code of ethics, it
should have an effective ethics control system to ensure and
provide evidence that the organizations stated and practiced
ethics are the same
Elements of an effective ethical control system
Statement of the organizations values and code of ethics
written in practical terms
Clear statement of the employees ethical responsibilities for
every job description and a specific review of the
employees ethical performance
Adequate training
Evidence that senior management expects members to
adhere to its code of ethics
o Provide a statement of the consequences of violating the
code of ethics
o Establish a means of dealing with violations
o Provide visible support of ethical decision making
o Provide a private line of communication
Evidence that employees can make ethical decisions or
report violations
An ongoing internal audit
Three dimensions of motivation
Direction
Intensity
Persistence
Careful attention to motivation is a key step for the organization
and its employees to align their respective goals
Employee self control
Employees monitor and regulate their own behavior and
perform to their highest levels
Diagnostic control systems
Feedback systems that monitor organizational outcomes and
correct any deviations from predetermined performance
standards
Interactive control systems
Force a dialogue among all organizational participants about
the data coming out of the system and what action to take

Task control
Process of finding ways to control human behavior so that a
job is completed in a prespecified manner
Preventive control
o Much of the discretion is taken out of performing a task
because of the precision required or the nature of the
materials involved
o As the accomplishment of a task requires increasingly
greater judgement, the building of preventive control
systems becomes more difficult
Monitoring
o Inspecting the work or behavior of employees while they
are performing a task
o Negative consequence
Unnecessary stress
Undermines the level of trust
Most appropriate
o When there are legal requirements to follow specific rules
or procedures to protect public safety
o When employees handle liquid assets to reduce
opportunity for temptation and fraud
o When the organization can control its environment and
eliminate uncertainty and the need for judgement
Results control
Focus on measuring employee performance against stated
objectives
To be effective
o must have clearly defined objectives
o communicated the objectives to appropriate organization
members
o designed performance measures consistent with the
objectives
most effective
o when organization members understand the organizations
objectives and their contribution to those objectives
o when organization members have the knowledge and skill
to respond to changing situations
o when the performance measurement system is designed to
assess individual contributions
central to the design is the development of a performance
measurement system that fully reflects the multiple
objectives and goals of an organization
Non-Goal Congruent
Employees are so motivated to achieve a single goal that
they engage in non-goal congruent or dysfunctional behavior
Gaming the performance indicator
o Employee might alter his or her actions specifically in an
attempt to manipulate a performance indicator through
job-related acts
Data falsification
Smoothing
o Form of earnings management that occurs when
individuals accelerate or delay the preplanned flow of
data without altering the organizations activities
o Same bottom-line financial outcomes
o But organization does not have a clear picture of
performance for a defined time period
Multiple performance measures

Cause employees to recognize the various dimensions of


their work and to be less intent on trying to maximize the
performance on a single target
Tall organizations
Traditional hiearchical organizations
Flat organizations
Fewer layers
Business process reengineering
Designers begin with a vision of what organizational
participants would like their process or product to look like
or how they would like it to function and then radically
redesign it
Led to the need for new information requirements and
measures
New measures must take into account group-level
performance measures and cross-functional business process
measures
Essential elements in empowering employees in MACS design
Allowing employees to participate in decision making
o Employees who participate in decision making evince
greater feelings of morale and job satisfaction
Translate to increase productivity
o People still perform the major portion of work and have
superior information and understanding in regard to how
work is best accomplished and how to improve products
and processes
Ensuring that employees understand the information they are
using and generating
o To be able to take actions that lead to superior
performance
o Employees have to be constantly reeducated as the system
and its performance measures change
Intrinsic rewards
Those that come from within an individual and reflect
satisfaction from doing the job and from the opportunities
for growth that the job provides
Reflect the nature of the organization and type of work one
is performing
Extrinsic rewards
Any rewards that one person provides to another to
recognize a job well done
Reinforce the notion that employees have distinguished
themselves
Reinforce the common perception that the wage
compensates the employee for a minimally acceptable effort
and organization must use additional rewards to motivate the
employee to provide additional effort
Incentive compensation
o Pay-for-performance systems
o Provide monetary rewards based on measure results
o Base rewards on achieving or exceeding some measured
performance
o Work best in organizations in which employees have the
skill and authority to react to conditions and make
decisions
o Must focus primarily on outcomes that the employee
controls or influences
o Should reflect the nature of their responsibilities

o Categories
Those that rely on internal measures
Those that rely on performance of the organizations
share price in the stock market
o Types
Cash bonuses
Lump-sum reward
Pay for performance
Merit pay
Pays cash on the basis of some measured
performance
One-time award
Can be fixed and triggered when measured
performance exceeds the target
Can be proportional to the level of performance
relative to the target
Profit sharing
Calculated as a percentage of an organization units
reported profit
Group incentive compensation plan focused on
short-term performance
Based on residual income/economic value added
Procedures
Must prepare a means to calculate profits
Monitored and attested to by an external
auditor
When a deduction is to be made from the pool
that is based on the owners inverstment, the
management accounting system must provide a
measure of invested capital
If based on some level of performance,
management accounting system must provide the
underlying measures of performance and the
overall performance score
Gain sharing
System for distributing cash bonuses from a pool
when the total amount available is a function of
performance relative to some target
Group incentive
Uses a formula to specify the amount and
distribution of the rewards and a base period of
performance as the benchmark for comparing
subsequent performance
Promotes teamwork and participation in decision
making
Improshare
Improved productivity sharing

cos tPool t arg etLevelOfLaborCost actualLe


Specifies how the difference will be shared
between the shareholders and the employees and
how to calculate the amount distributed to each
employee
Scanlon plan

payrollCos ts
baseRatio
valueOfGoodsOrServices Pr oduced
If < baseRatio labor savings are added to a
bonus pool

If > baseRatio labor costs deducted from


bonus pool

o Ensures that the employee perceives the reward system as


fair and predictable
o Critical management role
amtAddedTo BonusPool (valueOf Pr oduction baseRatio) specifying and developing a clear relationship among
effort, performance, and result
actualPayrollCosts
ensuring that all employees understand this relationship
Rucker plan
designers of the performance measurement system must
payrollCos ts
make a careful choice about whether it measures employees
ruc ker S tan dard
production Value
inputs or outputs

o outputs often reflect circumstances and conditions that are


production Value netSales inventoryChange
beyond the employees control
perceived link between individuals efforts and
materialsAndSuppliesUsed
measured results is reduced
Idea is to define a baseline relationship between
elements of performance that the performance measurement
payroll costs and the value of production and then
system monitors and rewards should reflect the
to reward workers who improve efficiency
organizations critical success factors
Must reflect performance levels that are reasonable
o ensures that the performance system is relevant and
Belief that montly or weekly performance awards
motivates intended performance that matters to the
are best because they provide rapid feedback,
organizations success
additional motivation

reward
system must set clear standards for performance that
Short-cycle feedback can put strains on the
employees
accept
organizations management accounting system when
o
determines
employees beliefs about whether the
the need for recording and accruing labor costs
performance
system
is fair
increases both the cost and potential for error in the
measurement system must be calibrated so that it can
management accounting system
accurately assess performance
Culture must promote cohesive relationships within
o ensures that a clear relationship between performance and
the group and between the group and management
outcome is established
Stock options

when
it is critical that employees coordinate decision
Right to purchase a unit of the organizations stock at
making,
the reward system should reward group rather than
a specified price (option price)
individual
performance
Set the option price at 105% of the stocks market
price at the time the organization issues the stock
option
Restricted to senior executives
Argument: stock price increases often reflect
general market trends that have nothing to do
with the performance
Stock option price should be keyed to the
performance of the organizations shares
relative to the performance of the prices of
comparable prices
Valuable only if the organizations share price
increases more rapidly than the share prices of
comparable organizations
Performance shares stock
Stock appreciation rights
Participation units
Employee stock ownership plans
Measures of absolute performance
o Number of acceptable quality units produced
o Oragnizations esults
o Organizations share price performance
o Ability to exceed a performance target level
o Amount of a bonus pool
o Degree to which performance exceeds the average
performance level of a comparable group
Compensation policy can be affected by government regulations
Six attributes of a measurement system
Employees must understand their jobs and reward system
and believe that it measures what they control and contribute
to the organization

Instances when rewards are based on inputs


when it is possible to measure outcomes consistently
when outcomes are affected by factors beyond the
employees control
when outcomes are expensive to measure
input-based compensation
measures the time, knowledge and skill level that the
employee brings with the expectation that the unmeasured
outcome is correlated with these inputs
some believe it is particularly inappropriate for companies to
continue operating compensation systems in which executive
rewards bear no relation to corporate performance
the idea behind stock related incentive plans is to motivate
employees to act in the long term interests of the organization
by engaging in activities that increase the organizations market
value
Using Budget to Achieve Organizational Objectives
A long-term planning process drives the capital spending plan
Use the projected balance sheeet as an overall evaluation of the net
effect of operating and financing decisions during the budget
period
Use the income statement as an overall test of the profitability of
the planners proposed activities
Cash flow forecast help organization plan the appropriate mix of
external financing to minimize the long-run cost of capital
Capacity Levels

flexible resources that the organization can acquire in the


short term
o provides the ability to use existing capacity
capacity resources that the organization must acquire for the
intermediate term
o general purpose capacity that is transferrable among
organizations given time
capacity resources that the organization must acquire for the
long term
o impose financial risk on the organization
o chosen level of this capacity reflects the organizations
assessment of its long-term growth trend
o special purpose capacity that is customized for the
organizations use
planners classify activities by type because they plan, budget
and control short-, intermediate-, and long-term expenditures
differently
analysts evaluate short-term activities by considering
efficiency
analysts evaluate intermediate- and long-term activities by
using efficiency and effectiveness considerations
choosing the capacity plan commits the firm to its
intermediate- and long-term expenditures
choosing the production plan fixes the short-term
expenditures

What-if analysis
explore the effects of alternative marketing, production, and
selling strategies
only as good as the model used to represent what is being
evaluated
model
o must be complete
o must reflect relationships accurately
o use accurate estimates
Sensitivity analysis
proess of selectively varying a plans or a budgets key
estimates for the purpose of identifying over what range a
decision option is preferred
if small forecasting errors of an estimate used in the production
plan change the plan, model is sensitive to that estimate
if performance consequences from a bad estimate are sever,
invest time and resources to improve the accuracy of their
estimates

production Minimum(demand , production Capacity )

netCashFlow cashInflows cashOutflows

cashOutflow unitsOfFlexible Re sourcePurc hased price


Financing section of cash flow statement summarizes the effects
on cash transactions that are not a part of the normal operating
activities

endingCash netOperatingCashFlow openingCash financingCash


Sources and uses of cash
Operations
Investments or withdrawals
Long-term financing activities related to issuing or retiring
stock or debt
Short-term financing activities
o Obtain a line of credit
Allows and organization to borrow up to a specified
amount at any time
Secured
Organization has pledged an asset that the financial
institution can seize if borrower defaults
unsecured
use of budget information
identify broad resource requirements
o help develop plans to put needed resources in place
identify potential problems
o help avoid problems or to deal with them systematically
compare projected operating and financial results
o serve as a measure for comparison with operating and
financial results of competitors
o use to test the efficiency of the organizations operating
processes

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