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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
# 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
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
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
Conversion costs
directLabo r sup port Re sources
conversionCostDriverRate
Total # of Pr ocessHours
Activity volumes > capacity of resources = bottleneck
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
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
CONC
Cost of nonconformance to quality standards
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
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
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
to
monitor
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
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
payrollCos ts
baseRatio
valueOfGoodsOrServices Pr oduced
If < baseRatio labor savings are added to a
bonus pool
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
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