Ebook Cost Acc Chap 1 2

Fart 1 >- Costs: Concepts and Objectives
2-16
When the performance of a manager is evaluated, an important step involves classify

ing costs that are controllable by that manager. Costs that are uncontrollable by the man
ager generally are irrelevant to evaluations of the manager'sperformance, and the manager
should not be held responsible for them:These aspects of responsibility accounting are dis
Chapter 2 > Cost Conceptsand the Cost Accounting InformationSystem
2-17
Balanced Scorecard for Rappahannock Company

Strategic Initiative: improve staff's training and incentives, as a way to improve speed and qual
ity of responses to callers, enabling acquisition and retention of more customers.
cussed in Chapter 17.
Summary
Last
Current
Current
Long
Period
Period
Period
Term
Actual
Actual
Tarqet
Goal
8.5%
8.9%
10%
13.1%
13.4%
15%
Financial Perspective:
The concepts of cost object and cost traceability are fundamental to the study of cost
accounting. The different degrees of traceability and the wide variety of important cost
objects create a large number of categories into which costs are classified.
The chart of accounts is the skeleton of the cost accounting information system. The
system's output includes much of the information managers use in planning and control.
Outside the basic accounting system, but still important in managing, are the nonfinancial
performance measures now receiving increased attention.
Appendix: The Balanced Scorecard3
Sales growth, annual % rate.

Return on equity, annual %..
12.5%
30%
Customer Perspective:
Number of caller & customer complaints...
143
62
Market share in targeted market segment.

% of callers "very satisfied" in surveys
3.1%
3.5%
4%
6%
11%
27%
30%
60%
% of calls connected within 10 seconds
24%
38%
50%
100%
% of calls disconnected/hanged up/lost

% of calls resolved without calling back
26%
22%
20%
5%
33%
42%
60%
100%
Internal Business Process Perspective:
Learning & Growth Perspective:
The Balanced Scorecard is a tool for implementing an organization's strategy. It is used to
Staff turnover, annual %
64%
39%
35%
25%
communicate strategic plans throughout the organization, focus attention on critical ele
ments of strategy, and monitor progress toward strategic objectives identified for each
% of staff "very satisfied" in surveys

% of staff earning incentives > 10% of base pay...
11%
0%
37%
16%
40%
20%
100%
stage of strategy's execution.
At the simplest level, a balanced scorecard can be described as a set of important,

interconnected performance measures. It includes targets for all its performance measures,
and periodic scorecard reports compare actual results with the targets. A balanced scorecard's performance measures are grouped into different categories or perspectives. A typ
ical scorecard has four perspectives: growth and learning, internal business process,
customer, and financial.
Figure 2-2 illustrates a balanced scorecard for Rappahannock Worldwide Company

(RWC). a providerof telephone call-answeringservices for the computer software industry.
Its customers are small software-development companies that hire RWC to respond to tele
phonecalls from software users.Mostcallersask howto troubleshoot. replace, or return the

software, and the RWC staff is trained to answer these questions. All other calls are for
warded to the technical supportdepartments of the software-development companies.
RWC's owners and managers are dissatisfied with past performance and believe
improvements in managing the staff are the best remedy. At the beginning of the most
recent period, RWC began a two-partstrategic initiative: first,to implement better training
of the staffso that the responses to callerswillbe fasterand moreeffective, enabling RWC
to gain and retain more customers; second, to reward the staff in a way that motivates bet
ter performance and encourages the best of the staff to remain with RWC.
3Much ot the material in this Appendix is based on the following sources, all written by Robert S. Kaplan and
David P. Norton: "Strategy Maps." Strategic Finance, March 2004, pp. 27-35; "Why Does Business Need a
Balanced Scorecard?"Journal of Cost Management, May/June1997, pp. 5-10; and The Balanced Scorecard
Measures That Drive Performance," HarvardBusiness Review, January-February 1992. pp. 71-79. For a more
complete treatment of this subject,see Strategy Maps: Converting Intangible Assets into Tangible Outcomes,
Harvard Business School Press, Boston, Massachusetts, 2004.
40%
FIGURE 2-2 Example of a Balanced Scorecard
RWC hired new trainers; revised most of its procedures and written materials used in
training; and created a staff incentive system that enables each staff member to earn a
bonus of as much as 50% of base pay, depending on the consistency of favorable feedback
received from trainers, staff supervisors, callers, and client companies.
The Scorecard Perspectives

A balanced scorecard's growth and learning perspective may include measures of employ
ees' skills and education, measures of employees' job satisfaction, measures of the ade
quacy of information systems, and measures of the extent to which employees' rewards arc
aligned with the organization's objectives. What these measures have in common is that
they attempt to reflect the status of one or more kinds of intangible resources: human cap
ital, information, and the alignment of incentives.
There are three measures in the growth and learning perspective of RWC's scorecard
in Figure 2-2. The first measure is a report on staff retention, the first and second measures
reflect employees' job satisfaction, and the third measure reveals an aspect of the align
ment of incentives..7
A balanced scorecard's internal business process perspective reports on the organiza
tion's most important workwork in which the organization must excel in order to be suc
cessful. Depending on the nature and scope of the organization's economic activities, this
perspective may include measures of the quality, speed, and cost at which the organization
produces goods and services; measures of the responsiveness, quality, and cost of services
2-14
Joint costs occur svhen the production of one product makes it inevitable that one or
service departments.
consist of itsown direct and indirect departmental cost and theapportioned charges from
service department costs have been allocated, each producing department's overhead will
When the amounts expended to improve product quality, customer service, and employee
involvement are reported, strategic goals and objectives arethecost objects.)
Service department costs also constitute indirect costs for other departments. When all
depreciation arc examples ofindirect departmental costs. In this cost classification system,
the department is the cost object. (Similarly, when costs ofamultidivisional conglomerate
company arc allocated among its various divisions, the division serves as the cost object.
incurrence, it is referred to as an indirect departmental cost; building rent and building
visor is an example. If a cost is shared by several departments that benefit from its
inates, it%referred toasadirect departmental cost; the salary ofthe departmental super
to departments ofany organization. Ifacost istraceable to the department in which itorig
The terms direct and indirect canalso be used inconnection with charging overhead costs
directly to a unit ofoutput. In contrast, factory overhead is indirect with regard to specific
units or lots ofoutput. In such a classification system, specific output is the cost object.
In connection with materials and labor, the term direct refers to coststhat are traced
a large law firm, for example, there may be departments for tax. real estate, and probatework; these are the producing departments -thedepartments that come into direct contact
with the client. The library ofthe law firm would beanexample of a service department.
a service business, however, there are producing departments and service departments. In
processing, and food services. Do not confuse service businesses with the concept ofserv
ice departments. Service businesses do not produce atangible good as their output. Within
costs are part offactory overhead and are a cost of the product. Service departments that
are common to many organizations include maintenance, payroll, cost accounting, data
departments. Although a service department does not directly engage in production, its
some instances, these services benefit otherservice departments as well as the producing
In a service department, service is rendered for the benefit of other departments. In
expenditure is intended to benefit future periods and is reported as an asset. A revenue
expenditure benefits the current period and is reported as an expense. Assets ultimately
of product costs by dividing the department intotwoor more costcenters.
sion. These decision-making concepts are discussed in Chapter21.
these are called unavoidable costs. The avoidable costs, in contrast, are relevant to the deci
irrelevant to a decision is referred to as a sunk cost. In a decision to discontinue a product

or division, some of the product's or division's costs may be unaffected by the decision;
be called an out-of-pocket cost associated with that alternative. An amount of revenue or

other benefit that will be missed or lost if a particular alternative is followed is called an
opportunity cost,of that alternative. A cost that has already been incurred and is, therefore,
relevant items; more importantly, an irrelevant factor may be misinterpreted as relevant.

Differential cost is one name for a cost that is relevant to a choiceamong alternatives.
Differential cost is sometimes called marginal cost or incremental cost-; If a differential
cost will be incurred only if one particular alternative is followed, then that cost can also
choice. Consideration of irrelevant items is a waste of time and can divert attention from
When a choice must be made among possible actions or alternatives, it is important to

identify the costs (and the revenues, cost reductions, and savings) that are relevant to the
Costs in Relation to a Decision, Action, or Evaluation
technically they arc assets because they will be used for many years.
Forexample, trash barrels purchased for $10eachmaybe recorded as expenses, although
requires are also factors that influence the distinction between these two classifications.
costs with revenues in measuring periodic income. However, a precise distinction between
the two classifications is not always feasible. In many cases, the initial classification
depends on management's attitude toward such expenditures and on the nature of the com
pany's operations. The amount of the expenditure and the number of detailed records it
Distinguishing between capital and revenue expenditures is essential for matching
flow into the expense stream as they are consumed or lose usefulness.
Costs can be classified as capita! expenditures or as revenue expenditures. A capital
Costs in Relation to an Accounting Period
explained in Chapter 8.
more other products are also produced. The meat-packing, oil andgas, and liquor indus
tries are good examples of production that involves joint costs. In such industries, joint
costscan be allocated tojoint products only by arbitrary calculations. Dataresulting from
joint cost allocation must therefore be very carefully treated in some decisions, as
Producing and Service Departments. The departments ofa factory generally fall into
two categories: producing departments and service departments. In a producing depart
ment, manual and machine operations such as forming and assembling are performed
directly on the product or its parts. If two or more different types of machines perform
operations on a product within the same department, itis possible to increase the accuracy
paring actual costs with the budget.
basis for classifying and accumulating costs and assigning responsibility for cost control. As
aproduct passes through adepartment orcost center, itischarged with directly traceable costs
(typically direct materials and direct labor) and a share ofindirect costs (factory overhead).
To achieve the greatest degree ofcontrol, department managers should participate in
the development ofbudgets for their respective departments orcost centers. Such budgets
should clearly identify those costs about which the manager can make decisions and for
which the manager accepts responsibility. At the end ofa reporting period, the efficiency
of a department and the manager's success in controlling costs can bemeasured by com
service to several segments of the entire firm, however, it can be considered a common cost
shared by those segments.
tions.Commoncosts are particularly prevalent in organizations with manydepartments or

segments. The degree of segmentation increases the tendency for more costs to be com
mon. For example, the salary of the marketing vice-president is usually not a common cost
shared with the human resources department. If the marketing department provides its
factory into departments, processes, work cells, cost centers, or cost pools also serves as the
A business can be divided into segments having any ofa variety of names. Thedivision ofa
2-15
Common Costs and Joint Costs. Common costs and joint costs are types of indirect
costs. Common costs arecosts of facilities or services employed by twoor more opera
Chapter 2 >- Cost Concepts ami HieCostAccounliiiK InformationSystem
Costs in Relation to Manufacturing Departments or Other Segments
Part 1 >- Costs: Concepts and Objectives
Chapter 2 >- Cost Conceptsand the Cost Accounting InformationSystem
2-12
2-13
range. Control responsibility for fixed costs usually rests with middle or executive man
agement rather than operating supervisors. The following factory overhead costs usually
For any careful analysis of what causes costs or how to manage costs better, disaggre
gation of overhead into different categories is an important but often difficult step. For
are classified as fixed costs.
example, without careful disaggregation, the difference in the cost ofrunning alarge num
ber ofsmall batches ofmany different products, rather than a few large batches ofa few
products, is not discernible. Amanufacturer may be so inefficient in managing some part of
O
O
may not be reported to any responsible manager. Instead, the mismanaged cost may be just
overhead costs that a competitive disadvantage can result, but the mismanaged cost item
one ofmany components ofa large and growing total ofoverhead costs, representing some
ofthe indirect labor, some ofthe indirect materials, some energy costs, etc. In the future.
computer-integrated manufacturing (CIM), employing database management technology

on acompany-wide scale, may remedy this shortcoming oftoday's information systems.
Commercial Expenses. Commercial expenses fall into two broad classifications: mar
keting expenses and administrative expenses (also called general and administrative
expenses). Marketing expenses begin at the point at which the factory costs end. That is.
when manufacturing has been completed and the product is in salable condition. They
Salaries of production executives

Depreciation
Property lax
Patent amortization
O
O
O
Supervisory salaries
Insuranceproperty and liability
Wages of security guards and janitors
Maintenance and repairs of buildings and grounds
Rent
Fixed costs may be thought of as the costs of being in business, while variable costs
are the costs of doing business. In some cases, management actions may determine
whether a cost is classified as fixed or variable. For example, if a truck is rented at a rate
per mile, the cost is variable. If the truck is purchased and subsequently depreciated by the
include the expenses of promotion, selling, and delivery. Administrative expenses
include expenses incurred in directing and controlling the organization. Not all such
expenses are allocated as administrative expenses. The salary of avice-president in charge
straight-line method, the cost is fixed. The same is true regardless of whether the tnick is
used in production, marketing, or administration. Marketing and administration provide
in charge of marketing canbetreated asa marketing expense.
variable and fixed factory overhead examples listed.Forexample,factory suppliesare part

of variable factory overhead, while office supplies used in sales offices are part of variable
of manufacturing can be treated as amanufacturing cost, and the salary ofavice-president
many examples of variable and fixed expenses, including close counterparts to many of the
marketing expenses.
Costs in Relation to the Volume of Production

:;
i
ii
ii
Some costs vary in proportion to changes in the volume ofproduction or output, while oth
Semivariable Costs. Some costs contain both fixed and variable elements; these are
ers remain relatively constant in amount. The tendency ofcosts to vary with output must
be considered by management ifitdesires to plan and control costs successfully.
called semivariable costs; For example, the cost of electricity is usually semivariable.
Electricity used for lighting tends to be a fixed cost because lights are needed regardless
of the level of activity, while electricity used as power to operate equipment will vary
depending on the usage of the equipment. The following are other examples of semivari
Variable Costs. The total amounts of variable costs change in proportion to changes in
activity within arelevant range. Stated differently, variable costs show arelatively constant
amount per unit as activity changes within arelevant range. They usually are assignable to
operating departments with reasonable ease and accuracy and are controllable by the super
visor of aspecific operating level. Variable costs generally include direct materials and direct
labor. The following list identifies overhead costs usually classified as variable costs.
Supplies
Fuel
Small tools
O Spoilage, salvage, and reclamation expenses

O
o
Receiving costs
Royalties
Communication costs
O
O
Overtime premium
Materials handling
Fixed Costs. Fixed costs are. constant in total amount within a relevant range ofactivity.
Stated differently, fixed costs per unit decrease as activity increases within a relevant
able overhead costs:
4--
O
O
O
O
O
O
o
O
Inspection
Cost-department services
Payroll-department services
Personnel-department services
Factory office services
Materials and inventory services
Water and sewage
Maintenance and repairs of plant machinery
Health and accident insurance
o
O
Payroll taxes
Heat, light, and power
Because each manufacturing and nonmanufacturing cost usually is classified as

either fixed or variable for analytical purposes, a semivariable cost must be divided into
its fixed and variablecomponents. Methodsof accomplishingthis division arc discussed

in Chapter 3.
Part I >- Costs: Concepts and Objectives
2-10
Chapter 2 >- CostConcepts nnd the CostAccounting Information System
2-11
cost consists of two elements: manufacturing cost and commercial expenses. Figure 2-1
illustrates this division oftotal operating cost and identifies some ofthe elements included
Direct Materials
Direct Labor
Prime Cost
Factory
in each division.
Manufacturing Costs. Manufacturing costalso called production cost or factory

costis usually defined as the sum of three cost elements-direct materials,, direct labor,
and factory overhead. Direct materials and direct labor together are called prime cost.
Direct labor andfactory overhead together are called conversion cost.
Direct materials are all materials thatforman integral part of the finished productand
+
Indirect
Indirect Labor
Materials
Includes:
Other Indirect
Costs
Factory supplies
Lubricants
that arc included explicitly incalculating the cost ofthe product. Examples ofdirect mate
Supervision
Superintendence
Inspection
Rent
Insurancefire
Salaries ol
Property tax
Depreciation
and liability
factory clerks
Defective work
rials are the lumber to make furniture and the crude oil to make gasoline. The ease with
which the materials items can be traced to the final product is a major consideration in
Maintenance
Experimental
and repairs
work
Power
Light
classifying items as direct materials. For example, the tacks in furniture form part ofthe
finished product, but because the cost ofthe tacks required for each piece offurniture is
Heat
Employer payroll
taxes
trivial, they areclassified as indirect materials.

Direct labor is labor that converts direct materials into the finished product and can
be assigned feasibly to a specific product. In highly automated factories, two problems

often arise when an attempt is made to identify direct labor as a separate cost element.
First, the same workers perform many kinds oftasks. They may shift between direct labor
tasks and indirect labor tasks so quickly and so frequently that direct and indirect labor
costs are difficult orimpossible to separate. Second, direct labor may bea trivial fraction
oftotal production costs, making itdifficult tojustify identifying direct labor asa separate
cost element. In settings in which one or both of these circumstances exist, a single con
version cost classification is appropriate, leaving direct material as the only cost element
Overhead
Includes:
Small tools
Miscellaneous
factory
overhead
Manufacturing
Cost
Marketing Expenses
Administrative Expenses =
Commercial
Exponsos
traced directly to the product.
Factory overheadalso called manufacturing overhead, production overhead, indi

rect production costs, manufacturing expenses, orfactory burdenconsists ofall manu
facturing costs not traced directly to specific output. Factory overhead generally includes
all manufacturing costs except direct materials and direct labor.
Indirect materials are those materials needed for the completion of a product but not
classified as direct materials because they do not become part of the product. Examples
include sandpaper, paper patterns, and flux. Indirect materials also include materials that
could, theoretically, be viewed asdirect material but are not worth the effort ofbeing treated
as direct costs for accounting purposes. When the consumption ofsuch materials isminimal,
orthe tracing istoo complex, treating them as direct materials becomes futile oruneconom
ical. Examples include nails, screws, washers, glue, and staples. Factory supplies, aform of
indirect materials, consist ofsuch items aslubricating oils, grease, cleaning rags, and brushes
needed tomaintain the working area and machinery in a usable and safe condition.
Indirect labor is labor not directly traced to the construction or composition of the
finished product. Indirect labor includes the wages of supervisors, shop clerks, general
helpers, maintenance workers, and, usually, material handlers. In aservice business, indi
Includes:
Sales salaries
Commissions to sales staff
Includes:
Administrative and oflico

salaries
Employer payroll taxes

Advertising
Samples
Employer payroll taxes
Entertainment
Travel expenses
Property tax
Auditing expenses
Rent
Legal expenses
Depreciation
Property tax
Telephone and telegraph

Stationery and printing
Postage
Freight and cartage out
Rent
Depreciation
zz
Uncollectible accounts
Telephone and telegraph

Stationery and printing
Postage
Miscellaneous
administrative expenses
Miscellaneous marketing
expenses
Total
Operating Cost
FIGURE 2-1 Classifications of Costs in Relation to the Product
rect labor cost can include the wages of receptionists, switchboard operators, file clerks,
butare indirect to a single unitor batch; andso on.Thissuggests oneof the fundamental
and supply clerks.
tenets ofcost accounting: different costs are meaningful and useful for different purposes.
were illustrated earlier in the discussion of the cost conceptand cost objects: setup costs
Most cost accounting systems include in factory overhead all coststhat are not trace
able to a specific unit or lot of output. In such systems, the manufacturing costs directly
traceable toa batch, a customer order, anentire production facility, a new product or prod
While only direct materials and direct labor are traced toasingle unit ofproduct, other
levels oftraceability arc also useful in understanding the nature ofproduction costs. These
are directly traceable to a batch, but are indirect to asingle unit in the batch; product design
costs are directly traceable to the sum ofall units ofthat particular product ever produced.
uct variation, or a strategicgoal are combined in a singleoverhead classification, because

none of these costsis viewed as being directly traceable to the product.
Chapter 2 >- Cost Conceptsami the Cost Accounting InformationSystem
2-8
2-9
A very different use of these and other nonfinancial performance measures is in mon
itoring the firm's progress toward attaining strategic objectives or critical success factors.
For example, nonfinancial performance measures that would be useful in pursuing an
objective of providing excellent customer service and satisfaction include the percentage
of on-time deliveries and the number of units or orders returned by customers.
Nonfinancial performance measures that would be useful in pursuing the objective of
world-class employee involvement and motivation include the average number of written
suggestions made by each employee per year (typically between one and six, but as high
as 100 in some firms). One example of this approach, called the Balanced Scorecard, is
presented in the Appendix to this chapter.
The increased interest in nonfinancial performance measures originated outside the
operations of cost accounting systems. In part, this increased interest is a response to per
ceived problems with traditional accounting measures. It would be counter-productive,
though, to view this development as a threat to the management accountant's role. Rather,
the essential skills of the management accountant can be applied to the identification,
measurement, verification, reporting, and interpretation of any performance measure,
4. Dissatisfaction with financial measures of plant utilization. These measures easily
are misinterpreted asencouraging overuse ofavailable capacity merely toimprove
the reported utilization measure. Examples of these utilization measures are fixed
overhead volume and idle capacity variances, which are examined inChapters 18
and 19.
5. Dissatisfaction with financial measures of processing efficiency. In practice, some
cost systems fail to take advantage ofthe flexibility and power ofcontrol meas
ures, producing reports that are criticized as being too late, too aggregated, too dif
ficult to interpret, or simply misleading.
Nonfinancial performance measures respond to these problems by using simple phys

ical data rather than allocated accounting data, by being unconnected tothe general finan
cial accounting system, by being selected to measure only one specific aspect ot
performance rather than to be "all things for all purposes," or by acombination of these
factors. Some nonfinancial performance measures are simple counts or percentages of
desirable or undesirable events and are intended to measure the efficiency oreffectiveness
ofa production process. Examples ofthis kind ofnonfinancial performance measures are
the number ofdefective units produced, number of good units produced, good units as a
whether it is stated in dollars or not.
For example, if a firm's production engineers or salespeople begin ignoring financial

measures because they are viewed as being too late, too aggregated, or too unresponsive
to changing needs, then they may develop their own measures of each department's per
formance. If engineers and salespeople regard the new measures as more timely or more
relevant, then managers are likely to request the same information once they learn it is
available. The management accountant may then be required, after the fact, to verify the
information and estimate or explain its financial impact. It is more efficient for the man
percentage of total units, hours ofmachine downtime, unscheduled downtime as apercent

age of total downtime, number of days operating on schedule, days operating on schedule
as a percentage oftotal days operating, weight ofscrap material produced, and scrap
weight as a percentage of shipped weight.
Other nonfinancial performance measures turn up in JIT environments. These provide
signals of overall processing efficiency by measuring the extent to which the factory has
achieved the JITideal of minimum inventories or itscorollary, maximum material veloc
agement accountant to be involved early in the process and establish efficient and verifi
able data-gathering and reporting systems.
Rather than being a threat to management accountants' position as the firm's internal
information consultants, nonfinancial performance measures can be a signal that manage
ment accounting is more important than ever. The essential challenge to management
accountants and to accounting systems is clear and simple: their roles must be defined
broadly enough to involve many kinds of measurement, regardless of whether the meas
ures are tied to the financial accounting system.
ity. Examples of such measures are the average number of units in process, the maximum
number ofunits in process during a period, and total lead time between receipt of acus
tomer order and shipment. One popular measure ofthis type is manufacturing cycle effi
ciency, which measures processing time as a fraction of the total time a unit is in the
factory. It is calculated as:
Processing Time/[Processing Time +Waiting Time +Moving Time +Inspection Time]

.
Only processing time adds any value to the product, so it is desirable for processing time
to be as large afraction oftotal time as possible. Unfortunately, cycle efficiencies are often
Classifications of Costs
less than0.1. and levels as low as 0.01 are not unheardof.
Cost classifications are essential for meaningful summarization of cost data. The most
commonly used classifications are based on the relationship of costs to the following:
Athird type ofnonfinancial performance measure indicates success in simplifying a
process. Simplification is an important step in improving the management of costs and is

aprecondition for successful automation ofaprocess. Examples of nonfinancial measures
that are relevant to planning and controlling asimplification effort are the number oftimes
a unit ishandled in the factory, the number oftimes a unit isretrieved from and returned
to storage, the number oftimes aunit is moved between any two locations, and the total
distance a unit is moved within the factory before shipment.
The three types of measures presented thus far are not mutually exclusive. For exam
ple, gradual implementation ofJIT is a popular way ofachieving simplification, so many
ofthe JIT-related measures can also bemeasures ofsimplification, and vice versa. All three
types ofnonfinancial measures can serve as tools for planning and controlling production
processes and for evaluating the performance of adepartment, ateam of workers and man
agers, a product, or a plant.
1.
2.
3.
4.
The
The
The
The
product (a single lot. batch, or unit of a good or service)

volume of production
manufacturing departments, processes, cost centers, or other subdivisions
accounting period.
5.
A decision, action, or evaluation
Costs in Relation to the Product
The process of classifying costs and expenses can begin by relating costs to the differ
ent phases in the operation of a business. In a manufacturing concern, total operating
2-6
^^^^^^^
of huge corporations.
The use ofEDP systems enables controllers and their staffs to become the nerve centers
One advantage of the analysis required in programming an EDP system is that vague
accounting procedures may become more concise and better understood in the process.
Programming includes analyzing each task, preparing flowcharts that reduce the task to
a logical design, and writing the detailed code ofinstructions for the system to follow.
of the variables, managers reduce the uncertainty in making decisions.

When EDP is used, accounting tasks must becarefully programmed for thesystem.
agement to use mathematical models orsimulations to plan operations. For example, man
agers can use acomputer to simulate acomplete operating budget and manipulate product
mix. price, cost factors, and the marketing program. By studying alternative combinations
report any circumstances that deviate from prescribed boundaries, so that the concept of
management by exception is applied. The system also greatly expands the ability ofman
An electronic data processing (EDP) system can be programmed to recognize and
maintain general and subsidiary records.
The speed and flexibility ofcomputers have led businesses to convert data processing
to electronic systems, replacing paper documents and ledgers with magnetic recording
media. These systems can handle large amounts of routine data easily, verify their accu
racy, provide summaries; automatically write checks, reports, and other documents; and
management
called data processing, and the procedures, forms, and equipment used in the process are
called the dataprocessing system. Any accounting system, even acash register inasuper
market, is a data processing system designed to provide pertinent, timely information to
sion making by collecting, classifying, analyzing, and reporting data. These activities are
ers; and when policies and objectives must becommunicated from executive management
toseveral levels ofmiddle and operating management. The information system aids deci
reports are required by taxing authorities, regulatory agencies, employees, and stockhold
more complex when a company has more than one plant, located throughout one ormore
countries; when product lines contain a wide array of product variations; when many
Successful management is a process ofcontinual decision making. The decision making is
Electronic Data Processing
Income Taxes (890-899)
Other Income (800-849)
AdministrativeExpenses (600-699)
Other Expenses (700-749)
Marketing Expenses (500-599)
Factory Overhead (400-499)
Cost of Goods Sold (350-399)
Sales (300-349)
INCOME STATEMENT ACCOUNTS (300-899)
Capital (250-299)
Long-Term Liabilities (220-229)
Current Liabilities (200-219)
Intangible Assets (170-179)
Property, Plant, and Equipment (130-159)
BALANCE SHEET ACCOUNTS (100-299)

Current Assets (100-129)
2-7
3.
2.
fications of performance measures.
Often theresult is a considerable delay in responding to users' requests for modi
rules; and its vulnerability to misstatement, unauthorized access, and misuse.
examined for its auditability; its compliance with law, regulation, and reporting
cessing departments can add, delete, or modify traditional financial measures

when theneed arises. Financial data typically are processed by large, highly sys
tematized data processing systems. In such systems, any proposal for change is
Dissatisfaction with the slow pace atwhich acompany's accounting and data pro
ing-balance depreciation.
Growing recognition that traditional financial measures are affected by phenom

enathat arenot necessarily relevant tothepurpose athand. Examples ofthese phe
nomena are the essentially arbitrary choices of accounting methods, such as
first-in, first-out versus weighted-average costing, andstraight-line versus declin
agers, departments, products, and product lines.
always regarded as serving any particular decision-making purpose. This limited

usefulness isa result of these financial measures being produced byanaccounting
system that serves many purposes simultaneously, including external reporting,
routine planning and control of operations, planning and control of unusual or
nonrecurring events anddecisions, strategic planning, and the evaluation of man
measures, such as total cost or income for a product line or a division, are not
1. Dissatisfaction with financial measures. Comprehensive financial performance
to nonfinancial measures include:
not limited toperformance evaluation. The reasons for the increased attention being given
Many managers have found that the usefulness of nonfinancial performance measures is
Nonfinancial Performance Measures
in many organizations.
performance evaluation and decision making. Now automation, JIT. intensified competi
tion, and other changes inthe business environment have created a need to modify and fur
ther broaden the range of information with which management accountants deal,
regardless of whether such information is integrated into the accounting journals and
ledgers. This has prompted anincrease in attention to nonfinancial performance measures
is defective, neither of which necessarily requires measurement in dollars to be useful in
late, report, and interpret a wide range of useful information. The cost accounting infor
mation system has never been restricted to information that is exclusively financial
(exclusively measured in dollars). For example, cost accounting reports routinely include
physical measures of output produced each period and the percentage of total output that
losophy seeks to reduce dramatically the investment in inventories, which alters account
ing's traditional focus on tracking large stocks of work in process.
Management accountants have always beencalled on to identify, measure, accumu
Highly automated, robotics-oriented manufacturing may employ little ifany labor directly
traceable to each unit of output; this minimizes planning and controlling direct labor and
calls for methods ofcost allocation that are not based on labor. The just-in-time (JIT) phi
Sensitivity to Changing Methods
Chapter 2 > Cast Concepts and the Cost Accounting Information System
Chapter 2 >* Cost Conceptsand the CostAccounting InformationSystem
2-4
2-5
identify and select strategies, and decide on adjustments and improvements in the organi
zation. An integrated and coordinated information system provides the information needed
by managers and communicates it promptly in a form understandable to the user.
Opportunities can be missed because of poor communication.
Accounting data are accumulated in many forms, methods, and systems due to the
Following the pattern of the continuum, the next costs are those traceable to the
process used in making the product, then the costs traceable tothe department in which the
process iscarried out. then the costs traceable tothe building orplant location in which the
department islocated, and soon. Ineach ofthese steps, asufficiently broad redefinition of
the cost object causes some coststo be reclassified as directly traceable costs.
varying types and sizes of businesses. A successful information system shouldbe tailored
At the far extreme of the continuum are those costs that can be identified with a unit
of product only by the most arbitrary and indefensible allocations. An example is the allo
to give the most efficient blend of sophistication and simplicity. Designing a cost account
cation of a small fraction of general corporate-level costs, suchas income taxes and bond
interest, to each unit of product produced byeach department, of each plant, ofeach divi
sion of thecorporation. The number ofarithmetic steps involved insuch anallocation, and
thevery arbitrary choices of methods used and quantities estimated at each step, make the
the type of information required. The system may enhance or thwart the achievement of
desired results, depending on the extent to which sound behavioral judgment is applied in
developing, administering, and improving the system and in educating employees to ful
results questionable for practically any purpose related to prediction ordecision making.
Among those manufacturers who have come to view cost accounting information asa
competitive weapon, and who have begun thoroughly toexamine and restructure their cost
fill the system's requirements.

The cost accounting information system must reflect the division of authority so that
individual managers can be held accountable. The system should be designed to promote
ing information systemrequires an understanding of both the organizational structureand
accounting systems, there is a trend toward relying on traceability as the most important
the concept of management by exception. That is, it should provide management with
basis for classifying and understanding costs.
information that facilitates prompt identification of activities that require attention.

Although the accounting records will not provide all the necessary information for effec
tive management, the accountant who designs the system must know how employees are
paid, how inventories arc controlled, how equipment is costed, machine capacities, and
other operating information.
The information system should focus management's attention. Some significant
aspects of performance may be difficult to measure, while some easily measured but less
significant factors may cause the firm to pursue or overemphasize the wrong activities.
Managers should be informed of appropriate, intended uses and limitations of information.
Some requirements for record keeping and reporting are imposed on an organization
by external forces. These legal, regulatory, and contractual requirements must be met by a
cost-effective system. Any sophistication in a system beyond these requirements is justi
fied solely by its value to management.
Cost Traceability in Service Industries

The traceability of costs is as important for decision making in service businesses as in
manufacturing. Forroutine pricing decisions, bidding on jobs, and dropping or adding a
service, knowing thecostsof different services is of paramount importance inanycompet
itive environment, and the traceability of costsis as fundamental incalculating the costof
a service as it is in calculating the cost of a manufactured good.
Asimple andcommon example is found in thehotel business. Room service menus com
monly include a statement such as"AS2delivery charge will beadded toeach order." Why
not adjust the listed prices ofall items onthemenu byjustenough to recover delivery cosLs.
rather than apply a separate delivery charge? Thereason is that anarbitrary allocation would
berequired tocalculate theamount ofdelivery costthat should beadded toeachitem. Should
it be the same for a $1 item as for a S30 item? Should it be largeenough to justify delivering
Chart of Accounts
a single-item order? The answer isthat theprice necessary tojustify thecosts ofdelivering an
order should beapplied toeach order, rather than applying some fraction of ittoeach item.
Notice theexplicit useof multiple costobjects in theroom-service example. The room
service menu listseach item with a separate price.In determining that price, management
treats an individual unit of each item as the cost object. In determining the delivery charge
to be added to each order, the order is treated as the cost object. This is a reasonable pat
tern of pricing because the cost of a delivery is not traceable to an item, but to the deliv
eryofanorder. Donot beconfused bythetrivial casein which anorder consists ofa single
item. Thedelivery cost of a single-item order is traceable to the item only because theitem
and the order arc identical in that instance. In general, it is the order, of any size, that
causes the delivery cost to be incurred.
The Cost Accounting Information System

Systematic, comparative cost information and analytical cost and profit data are needed so
that managers can set profit goals, establish departmental targets for middle and operating
management, evaluate the effectiveness of plans, pinpoint specific successes or failures.
Every profit and nonprofit organization, regardless of its size and complexity, must main
tain some type of general ledger accounting system. For such a system to function, data
are collected, identified, and coded for recording in journals and posting to ledger
accounts. The prerequisite for efficiently accomplishing these tasks is a well-designed
chart of accounts for classifying costs and expenses.1!:
In a chart of accounts, the accounts should be arranged and designated to give maxi*
mum information with a minimum of supplementary analysis;.They should provide detail
sufficient for costs to be identified with the responsible manager and, ideally, with the
activity causing the costs.
A typical chart of accounts is divided into two parts: balance sheet accounts for assets,
liabilities, and capital; and income statement accounts for sales, cost of goods sold, factory
overhead, marketing expenses, administrative expenses, and other expenses and income.
Account numbers are commonly used to avoid the confusion created by different
spellings and abbreviations of the same account title. The use of numbers to represent
accounts is the simplest form of symbolizing and is essential when electronic data process
ing equipment is used. A condensed chart of accounts is illustrated as follows, using threedigit account numbers:
2-2
to the production and delivery ofgoods and the rendering ofservices . . . expense in
its broadest sense includes all expired costs which are deductible from revenues. 2
To contrast cost and expense, consider a purchase of raw materials for cash. Because
net assets arc unaffected, there is no expense. The firm's resources aresimply converted
from cash to materials. The materials are acquired at some cost, but they are not yet an
expense: When the firm later sells the output into which the raw materials have been incor
porated, the cost ofthe materials iswritten off among expenses on the income statement.
Every expense is a.cost, but no'tevery cost is an expense;assets are costs, Tor example, but
they are not (yet) expenses.
The term cost is made specific when it is modified by such descriptions as direct,
prinje, conversion, indirect, fixed', variable, controllable, product, period', joint, estimated,
standard, sunk'pr out ofpocket. Each modification implies acertain attribute that is impor
tant inmeasuring cost. Each ofthese costs isrecorded and accumulated when management
assigns costs to inventories, prepares financial statements, plans and controls costs, makes
strategic plans and decisions, chooses among alternatives, motivates personnel, and evalu
ates performance. The accountant involved in planning and decision making must also
work with future, replacement, differential, and opportunity costs, none of which is
recorded and reported in external financial statements.
Cost Objects
Acost object, or cost objective, is defined as any item or activity for which costs are accu
mulated and measured. The following items andactivities can be costobjects:
Chapter 2 >- Cost Concepts and the Cost Accounting Information System
2-3
The traceability of costs to a cost object varies by degree. A common way of charac
terizing costs is to label them as either direct or indirect costs of a particular cost object,
as if there were only two degrees of traceability. In fact, degrees of traceability exist along
a continuum.
To illustrate the different degrees of traceability on the continuum, the cost object is
defined here as a product unit. This is the most commonly used definition; for example,
when the terms direct cost and indirectcost are used without a specified cost object, it is
customary to assume that a single unit of product is the cost object.
At the extreme of directly traceable costs are those items that can be physically or con
tractually identified as components of the finished unit of:product; For example, the unit
can be examined, weighed, and measured to find the type and quantity of each raw mate
rial and component part incorporated in it, and royalty or patent license agreements can be
read to find what fee is owed to a patent holder for permission to manufacture the unit.
These are the clearest examples of direct costs.
Near that cxtreihc arc the costs that can be empirically traced to the unit's production
by observing the production process. These include: the labor expended to convert raw
materials into finished product and some material-handling labor; paper patterns and other
materials that are consumed in the production of each unit but are not physically incorpo
rated into it; and some energy costs. Of course, not all items that are physically or empir
ically traceable to a unit will be important enough to justify the effort required to trace and
record them. Whether tracing is justified depends on how precise a measure of direct costs
is needed and how difficult or costly the tracing will be. For that reason, cost accounting
systems generally treat as direct costs only some of the cost items that conceivably could
be traced directly to the product unit.
Beyond those cost items that arc physically, contractually, or empirically traceable,
some degree of arbitrariness enters any attempt to identify additional costs for a product
Product
Batch of like units
Process
Customer order
Division
Contract
Product line
Project
Strategic goal
Department
The concept ofa cost object is one of the most pervasive ideas in accounting. The
selection ofacost object provides the answer tothe most fundamental question about cost:
The cost of what?
Because ofthe multiple needs in cost finding, planning, and control, cost accounting sys
tems are multidimensional. For example, itisnecessary toassign costs to each product unit.
but also necessary to plan and control costs for which individual managers arc assigned
responsibility, on a departmental, geographical, or functional basis. The design of cost

accounting systems and their implementation must address these multiple requirements.
Traceability of Costs to Cost Objects

Once the cost object isselected, measurement ofcosts depends heavily on the traceability
ofcosts to the cost object. The traceability ofcosts determines how objective, reliable, and
meaningful the resulting cost measure will be, and therefore how confident a decision
maker can be in understanding and relying on the cost measure as a basis for prediction
and decision making.
7Ibid., p. 49.
unit. For example, the traceable material and labor costs of a small number of defective
units that may be produced along with the good units could be included logically as part
of the cost of the good units. Butexactly how much should be included is subject to debate.
Is it the average actual amount of the cost of defective units? Is it the actual amount that
occurs on the next production run? Or is it the amount that would occur under ideal con
ditions (which may be zero)? Even when the purpose of the ultimate cost measure is
known in advance, the answer to this question is not always clear.
Moving from this extreme toward the middle of the continuum, we find costs traceable
to a batch or lot of like units of the product, such as setup cost (the cost of adjusting
machinery before the batch can be produced). Setup cost can be identified with a single
product unit in the batch only by means of an allocation: the setup costs can be divided by
the actual number of units produced in a batch, or by the normal number, or by the ideal
number. Again, an essentially arbitrary choice is required if these costs are to be allocated
to each unit of product. Notice that if the batch is defined as the cost object, setup costs
can be classified as directly traceable.
Further along on the continuum are costs traceable to all the units of a particular
product ever produced. These include the costs of initial product design, development,
testing, process engineering, and worker training. To identify these with a single prod
uct unit requires allocation over the total number of units of the product to be produced
in the entire product life cycle. That number of units is generally difficult to predict, and
even the most experienced manager in the industry would estimate it with considerable
forecasting error.
1-20
Chapter 2
assured by our salespeople that ifa 14% increase is what the company needs, then they can
give me 14%, so that's what were going to do. They're team players, Joseph, and I know
you'll be a team.player, too."
Required:
(1) Which of the 15 responsibilities in the Standards of Ethical Conduct apply to
Cost Concepts and the Cost Accounting

Information System
Rodriquez's situation?
(2) What might Rodriquez have done differently to avoid ormitigate this problem?
(3) In addition to his ethical responsibilities to CD, what other ethical responsibilities does
Learning Objectives
Rodriquez need to consider?

After studying this chapter, you will be able to:
Cl-5 Ethics. Mary Jones is controller of the Non-Ferrous Metals Division of Southeast
Manufacturing Incorporated (SMI) inTuscaloosa, Alabama. Last year, she served as her
division's representative on an SMI corporate-level task force charged with developing
specific objectives and performance specifications for anew computer system that is to be
purchased this year. Due to her pivotal role on that task force, she has just been named to
a new SMI corporate-level committee charged with reviewing, evaluating, and ranking the
10 to 20 proposals that SMI expects to receive from computer vendors now that SMI has
put the proposed system out for bids.
Asingle parent, Jones expects to incur over S400,000 in medical expenses resulting
from treatments for her youngest child, who has contracted a potentially fatal disease.
Approximately SI50.000 ofthat amount will not be covered by insurance. Due to this per
sonal financial situation, Jones has investigated some career opportunities that would
involve higher salary and more generous insurance benefits, but no position has been
offered to her. Her most recent interview was for the controller position at Crimson
Systems, a supplier oflarge-scale computer hardware and custom-designed software.

Crimson Systems' vice-president for finance declined to offer Jones the controller
position, but instead said, "We're offering you a temporary consulting engagementSunday afternoons for the next four monthshelping us write our proposal for the SMI
1. Define the term cost object arid give examples of cost objects relevant to different types
of decisions.
2. Describe several degrees of cost traceability'implicd by the terms direct mv/'and indirect..
cost.
3. State the considerations involved in creating a cost accounting information system.

4. Explain why increased attention is being given to nonfinancial performance measures.
5. Name and describe the ways costs are classified.
Cost accounting was once considered to apply only to manufacturing. Today, however,
every type and size of organization benefits from the use of cost accounting. For example,
cost accounting is used by financial institutions, transportation companies, professional
service firms, hospitals, churches, schools, colleges, universities, and governmental units,
as well as the marketing and administrative activities of manufacturing firms.
Chapter 1 introduced cost accounting as part of the management function and
described influences on cost accounting from internal and external environments. This
chapter presents the fundamental concepts of cost accounting and introduces cost account
ing as an information system.
job: your fee will be $500 per hour."

Required:
(1) Which ofthe 15 responsibilities in the Standards ofEthical Conduct apply toJones'
situation?
(2) What might Jones have done in her interview with Crimson Systems to precipitate this
problem?
(3) What might Jones have done differently toavoid or mitigate this problem?
(4) In addition to her ethical responsibilities to SMI, what other ethical responsibilities
does Jones have to consider?
The Cost Concept

Cost concepts have developed according to the needs of accountants, economists, and
engineers. Accountants have defined cost as "an exchange pricey a forgoing, a sacrifice
made to secure benefit. In financial accounting, the forgoing or sacrifice at date of acqui
sition is represented by a current or future diminution in cash or other assets."1

Frequently the term cost is used synonymously with expense? However, an expense
may be defined as a measured outflow of goods or services,(which is matched with rev
enue to determine income, or as:
... the decrease in net assets as a result of the use of economic services in the cre
ation of revenues or of the imposition of taxes by governmental units. Expense is

measured by the amount of the decrease in assets or the increase in liabilities related
' Robert T. Sprouse and Maurice Moonitz, Accounting Research Study No. 3, "A Tentative Set of Broad
Accounting Principles for Business Enterprises," (New York: American Instituto of Certified Public Accountants.
1962), p. 25.
2-1
1-14
Cost Accounting Standards Board
Chapter 1 >- Management, the Controller, and Cost Accounting
Summary
The Cost AccountingStandards Board, established by Congress in 1970,sets cost account
Management can be viewed as encompassing the processes of planning, organizing, and

control. The management team includes the controller, who coordinates planning and con
trol for the firm. The cost department coordinates with other departments and plays a cen
tral role in budgeting, cost control, pricing, reporting, and choosing among alternatives.
Both professional certification and a code of ethics now exist for management account
ants. These and other external constraints exert significant influence on cost accounting.
ing standards fordomestic companies that arc awarded large federal contracts or subcon
tracts, whether civilian or defense related. In 1980 the CASB was dissolved because
Congress believed the board'spurpose hadbeen accomplished; however, the board'sstan

dards became part of all major federal procurement regulations and remained in effect.
Congress reestablished the board in 1988.
The CASB issues Cost Accounting Standards (CASs) that address all aspects of cost
allocation affecting the costof federal contracts, including methods of allocation, defini
tion and measurement of costs which may be allocated, and determination of the account
ingperiod to which costs arcassignable. Full allocation of allcosts of a period, including
administrative expenses andall otherindirect costs, is thebasis fordetermining thecostof
1-15
Key Terms
planning (1-2)
strategic plans (1-2)
short-range plans (1-2)
long-range plans (1-2)
organizing (1-3)
control (1-3)
authority (1-4)
responsibility (1-4)
accountability (1-4)
organization chart (1-4)
responsibility accounting (1-4)
a contract.
Although specific CASs are discussed where appropriate in subsequent chapters, it

should benoted here that four ofthe standardsnumbers 409, 414, 416, and 417hive a
potential impact far beyond thegovernment contracting area. CAS 409 requires contrac
tors to depreciate their assets for contract-costing purposes over lives that are based on
documented historical usefulness, irrespective of the lives used for financial and tax report
ing. CASs 414and 417 recognize as a contract cost the imputed cost of capital committed
to facilities, thereby overturning the government's long-standing practice of disallowing
interestand other financing costs. CAS 416, in contrastto financial reporting and income
tax rules, recognizes a costforself-insurance; under thisstandard, a long-term average loss
is assigned to each period regardless of the timing of actual losses.
As a condition of contracting, contractors can be required to disclose their cost
accounting practices. Disclosures include the major elements of directcosts, methods used
to charge materials costs(fifo, lifo, standard cost,etc.),methods of charging direct labor
(actual rates, average rates, standard rates, etc.),andthe allocation bases used forcharging
controller (1-5)
management by exception (1-5)

budget (1-9)
responsibility accounting systems (1-10)

standard costs (1-10)
non-value-added activities (1-10)
indirect costs to contracts.
direct costing or variable costing (1-11)

absorption costing (1-11)
Certified Management Accountant (CMA) (1-12)
Certified Financial Manager (CFM) (1-12)
Discussion Questions
Ql-l
Define the concepts of planning and control and discuss how they relate to each other and
contribute to progress toward achieving objectives.
Ql-2
Distinguish between short-range and long-range plans.
Ql-3
Distinguish between long-range plans and strategic plans.
Ql-4
Is responsibility accounting identical with the concept of accountability? Explain.
Ql-5
In what manner does the controller exercise control over the activities of other members
of management?
Resolution of Ethical Conflict
mendations presented.
understanding of the reports, comments, and recom
Disclose fully all relevant information that could rea

sonably be expected to influence an intended user's
Confidentiality
maintenance of that confidentiality.
their work and monitor their activities to assure the
and decision making mustconsider tax consequences at all these levels.
acting under authority granted by Congress, issues regulations (Title 26 of the Code of
Federal Regulations) which interpret the tax statutes enacted by Cohgress. The Internal
Revenue Service, a branch of theTreasury Department, collectstaxesand issues rulings and
procedures as guidance to taxpayers. Revenue Rulings and Revenue Procedures are pub
lished weekly inthe Internal Revenue Bulletin and semiannually in the Cumulative Bulletin.
The influence of these statutes, regulations, rulings, and procedures cannot be ignored.
Similar considerations apply for state and local income taxation. Management's planning
of the United StatesCode) as enacted and amended by Congress.The Treasury Department,
Federal income tax liability isdetermined according to theInternal Revenue Code (Title 26
Taxation
all appropriate parties of any potential conflict.
of possible courses of action.
flict, it may also be appropriate to notify other parties.
resignation, depending on the nature of the ethical con
appropriate representative of the organization. After
tion and to submit an informative memorandum to an
If the ethical conflictstill exists after exhausting all lev

els of internal roview. there may be no other recourse
on significant matters than to resign from the organiza
rights concerning the ethical conflict.
Consult your own attorney as to legal obligations and
York: Institute of Management Accountants. 1997). All rights reserved. Reprinted with permission.
3"Standards of EthicalConduct for Practitionersof Management Accounting and FinancialManagement"(New
Financial Management-1
EXHIBIT 1-1 Standards of Ethical Conduct for Practitioners of Management Accounting and
*- Refrain from engaging in any activity that would preju

dice their ability to carry out their duties ethically.
Refuse any gift, favor, or hospitality that would influ
ence or would appear to influence their actions.
->- Refrain from either actively or passively subverting the
attainment of the organization's legitimate and ethical
objectives.
-- Recognize and communicate professional limitations or
other constraints that would preclude responsible judg
ment or successful performance of an activity.
Counseling Service) to obtain a better understanding
sidered appropriate.
Clarify relevant ethical issues by confidential discus
sion with an objective advisor (e.g., IMA Ethics
+
Practitioners of management accounting and financial

management have a responsibility to:
*- Avoid actual or apparent conflicts of interest and advise
Except where legally prescribed, communication of

such problems to authorities or individuals not
employed or engaged by the organization is not con
superior should be initiated only with the superior's

knowledge, assuming the superior is not involved.
or owners. Contact with levels above the immediate
tive committee, board of directors, board of trustees,
gerial level.
If the immediate superior is the chief executive offi
cer, or equivalent, the acceptable reviewing authority
may be a group such as the audit committee, execu
presented, submit the issues to the next higher mana
lution cannot be achieved when the problem is initially
the next higher managerial level. If a satisfactory reso
Discuss such problems with the immediate superior

except when it appears that the superior is involved, in
which case the problem should be presented initially to
Integrity
through third parties.
Refrain from using or appearing to use confidential

information acquired in the course of their work for
unethical or illegal advantage either personally or
courses of action:
In the public sector, there arc federal, state, andlocal government regulations embodied
in manyaccounting systems. At the national level, the Internal Revenue Service (IRS) andthe
CostAccounting Standards Board (CASB) have a significant influence oncostaccounting.
--
fidentiality of information acquired in the course of

* Refrain from disclosing confidential information
acquired in the course of their work except when
authorized, unless legally obligated to do so.
-- Inform subordinates as appropriate regarding the con
such conflict. If these policies do not resolve the ethical

conflict, such practitioner should consider the following
policies of the organization bearing on the resolution of
resolving an ethical conflict. When faced with significant

ethical issues, practitioners of management accounting
and financial management should follow the established
-- Prepare complete and clear reports and recommenda

tions after appropriate analysis of relevant and reliable
information.
encounter problems in identifying unethical behavior or in
-<- Perform their professional duties in accordance with rel

evant laws, regulations, and technical standards.
In applying the standards of ethical conduct, practitioners of

management accounting and financial management may

-- Maintain an appropriate level of professional competence
by ongoing development of their knowledge and skills.
Competence
contrary to these standards nor shall they condone the com

mission of such acts by others within their organizations.
- Communicate information fairly and objectively.
Objectivity
that would discredit the profession.
mation and professional judgments or opinions.
Refrain from engaging in or supporting any activity
highest standards of ethical conduct. In recognition of this

obligation, the Institute of Management Accountants has
promulgated the following standards of ethical conduct for
practitioners of management accounting and financial man
agement. Adherence to these standards, both domestically
and internationally, is integral to achieving the Objectives of
Management Accounting. Practitioners of management
accounting and financial management shall not commit acts
their profession, the public, and themselves to maintain the
Communicate unfavorable as well as favorable infor
1-13
Practitioners of management accounting and financial man

agement have an obligation to the organizations they serve,
*
Chapter 1 >- Management, the Controller,and Cost Accounting
Cooperation and Development (OECD).
The rapid growth of international business has led several international organizations
to becomeinvolved in accounting, including cost accounting. Theseorganizations include
the International Accounting Standards Board (IASB) and the Organization for Economic
Accountants (IMA), the American Accounting Association (AAA), and the Financial
Executives Institute (FEI). In addition, cost accounting can be influenced by universityresearch, individuals, and private companies.
American Institute of Certified Public Accountants (AICPA), the Institute of Management
Occasionally the research and pronouncements of professional organizations contribute to

thedevelopment of costaccounting. Theseorganizations include the Financial Accounting
Standards Board (FASB), the Governmental Accounting Standards Board (GASB), the
Influence of Private and Governmental Organizations
Accounting andFinancial Management, is presented in Exhibit 1-1. Among the published

codes of ethics of various professional groups, these Standards of Ethical Conduct are dis
tinct in thatdiey prescribe steps tobe followed in resolving anethical conflict.
modifiedin 1997. The result.Standards of Ethical'Conductfor Practitioners of Management
Management Accountants (IMA)issued a code of ethics. Although individuals practicing

as independent certified public accountants had long been subject to acodeofconduct, these
standards were the firstever issued for management accountants. This code of ethics was
In 1983 the National Association of Accountantslater renamed the Institute of
Certified FinancialManager (CFM), whichare formal recognition of professional compe

tenceandeducational achievement in the field. Requirements forthe CMAand CFMcertifi
cates include passing demanding examinations offered by the Institute of Certified
Management Accountants and completing two yearsof professional experience.
to by their professional certifications. Certified Management Accountant (CMA) and
Persons engaged incost accounting or otheraccounting functions within anorganization are

referred toas"management accountants" or "financial managers." They may alsobereferred
Certification and Ethics
1-12
1-10
only weak effects on managers' attitudes and performance.2 Budgeting is examined in

depth in Chapters 15, 16, and 17.
Controlling Costs
The responsibility for cost control should be assigned to specific individuals who are also
accountable for budgeting the costs under their control. Each manager's responsibilities
should be limited to the costs and revenues that arc controllable by the manager, and per
formance is generally measured by comparing actual costs and revenues with the budget.
Systems designed to achieve these goals are called responsibility accounting systems.
To aid in controlling costs, the cost accountant may use predetermined cost amounts
called standard cosf. Standard costs also can be the foundation for budgets and cost
reports. Standard costs are examined in Chapters 18 and 19.
Another important aspect of cost control is the identification of the costs of different
activities rather than the costs of different departments and products. In a complex produc
tion setting, often only a small fraction of total activity actually adds value to the final out
put. Other activities, called non-value-added activities, generally are a result of the
complexity of production settings and are not specific to the production of any particular
good or service. Examples of non-value-added activities in a factory are retrieving, han
dling, and moving materials; expediting; holding inventories; and reworking defective
units. Reporting the costs of non-value-added activities is a first step toward their reduc
tion or elimination.
Pricing
Management's pricing policy ideally should assure long-run recovery of all costs and a
profit, even under adverse conditions} Although supply and demand usually are determin
ing factors in pricing, the establishment of a profitable sales price requires consideration
of costs. Competitively bidding on a proposed job. for example, is a difficult pricing deci
sion if there is little or no past experience with the kind of good or service involved.
Determining Profits
Cost accounting is used to calculate the cost of the output sold during a period; this and
other costs are matched with revenues to calculate profits. Costs and profits may be
reported for segments of the firm or for the entire firm, depending on management's needs
and the external reporting requirements.
The matching process involves identifying short-run and long-run costs, and variable
and fixed (capacity) costs. Variable manufacturingcosts are assigned first to the units man
ufactured and then matched with revenue when those units arc sold. (Nonmanufacturing
costs, both fixed and variable, typically are matched with revenues of the period.) Fixed
manufacturingcosts are matched with revenues by one of the following alternatives:
Chapter 1 >- Management, the Controller, and Cos! Accounting
1-11
1. Matching total fixed costs of a period with revenues of that period; this alternative
is called direct costing or variable costing.'-'
2. Matching some or all of the fixed manufacturing costs with units of product; these
costs arc then expensed as part of the income statement's cost of goods sold fig
ure when the related units are sold. This alternative is called absorption costing
and is required for GAAP and income tax reporting.
These alternatives give the same reported results in the long run but yield a different
profit for individual short periods such as years. These alternatives are examined in more
detail in Chapter 20.
Choosing Among Alternatives

Cost accounting provides information concerning the different revenues and costs that
might result from alternative actions. Based on this information, management makes shortrange and long-range decisions concerning entering new markets, developing new prod
ucts, discontinuing individual products or whole product lines, buying versus making a
necessary component of a product, and buying versus leasing equipment. In the decisions
to add new products and discontinue existing products, reliable cost information is espe
cially crucial to the competitive success of the firm. Misstated costs create the possibility
that undesirable business might be initiated or continued and desirable business rejected.
In these ways, cost information plays an essential role in identifying, evaluating, and
selecting strategies for the organization.
Cost Accounting and Manufacturing Technology

Factory automation, which has spread rapidly, results in capital-intensive processes, often
with computerized systems that use robot-controlled machinery. Automation is expensive,
however, and is not a cure-all for an obsolete production process. Many problems are
rooted in systems and attitudes, and by focusing on those areas first, the firm can reap even
greater gains from automation. In automating a process, employee involvement and moti
vation are the first step, and simplification of the existing process is second. Only then
should a large investment in automation be considered. Innovative and experimental appli
cations, including changes in systems and attitudes, now permeate business from product
design to production scheduling, the manufacturing process, inventory management, qual
ity control, and strategic decision making.
Changes in manufacturing technology have spawned a long list of new terminology,
including computer-aided design (CAD), computer-aided engineering (CAE). computeraided manufacturing (CAM), just-in-time production (JIT), computer numerical control
machinery (CNC), optimized production technology (OPT), the theory of constraints
(TOC), flexible manufacturing systems (FMS), and computer-integrated manufacturing
(CIM). These innovations are discussed in appropriate places throughout this text.
Technology is changing the nature of costs, producing, for example, lower inventory
levels, less use of labor, and increasing levels of fixed costs. In this new environment, cost
accounting systems are being challenged to evolve and take on increased relevance.
Reliable cost accounting information has become a competitive weapon.
2lzzettin Kenis, "Effects of Budgetary Goal Characteristics on Managerial Attitudes and Performance," The
Accounting Review. Vol.LIV, No. 4, pp. 707-721.
Part 1 > Costs: Concepts and Objectives
I-S
l-'J
Budgeting
4. Determining company costs and profit for anannual accounting period or a shorter
period. This includes determining the cost of inventory and cost of goods sold
The budget is the quantified, written expression of management'splans.All levelsof man
agement should be involved in creating it. A workable budget promotes coordination of
personnel, clarification of policies, andcrystallization of plans. It alsocreates greater inter
nal harmony and unanimity of purpose among managers and workers.
In recent years, considerable attention hasbeengiven to thebehavioral implications of
providing managers with data required for planning and control. Budgeting plays an
important role in influencing individual and group behaviorat all stages of the manage
ment process, including (1)setting goals. (2)informing individuals about whatthey should
contribute to the accomplishment of the goals, (3) motivating desirable performance, (4)
evaluating performance, and (5) suggesting when corrective action should be taken. In
short, accountants cannot ignore the behavioral sciences (psychology, social psychology,
and sociology) becausethe decision-making function of accounting is essentially a behav
according to external reporting rules.
5. Choosing among two or more short-run or long-run alternatives that might alter
revenues or costs.
Notice thedistinction between determining thecostof a product in task 3 andthecost
ing ofinventory for external reporting intask 4 The distinction isthat the cost ofa prod
uct(task 3) can be calculated for many purposes, including predicting costs and making
decisions, while inventory costing for external reporting (task 4) deals with satisfying
external reporting rules. Invery simple production settings, the two are often the same. For
example, if all units produced in a facility are alike, any reasonable way ofdividing the
total cost equally among the units will suffice for both external reporting and for many
decision-making purposes. Although thecosts incurred in such a setting may belarge and
complex, the product line isextremely simpleall units arc identicaland sothe costing
ofeach unit ofthe product issimple, too. This isthe model of manufacturing that is often
ioral function.
Managers' attitudes toward the budget depend a great deal on relationships within the
management group. Guided by the company plan, with opportunities for increased com
pensation, greater satisfaction, and eventually promotion, middle and lower management
can achieve remarkable results. A discordant management group, unwilling to accept the
budget's underlying assumptions, may perform unacceptably.
The following elements have been suggested as means for motivating personnel to aim
forgoals set forth in a budget.1
assumed in economic theory.
Many actual manufacturing settings arc much more complicated than the economist's
model. A firm can produce a diverse product line in a single facility, where the same
resources areused very differently inproducing different products. Inaddition toa diverse
product line, some settings exhibit complex cost structures, and the combination ofthe two
makes it difficult to predict or identify the costs of producing one unit ofone product. In
these settings, thechallenge tocost accounting isto measure thecostofall the things con
sumed in making a unit orlotof a product. When precision is needed insuch a calculation
(for example, in quoting a fiercely competitive price to a customer who needs a million
1. A compensation system that builds and maintains a clearly understood relation

ship between results and rewards.
2. A system for performance appraisal that employees understand with regard to

their individual effectiveness and key results, their tasks and their responsibilities,
units or batches), then the levelof detail needed in calculatingcost goes far beyond any
thing required by external reporting rules.
their degree and span of influence in decision making, as well as the time allowed
Service businesses provide excellent examples of thedistinction between tasks 3 and
to judge their results.
4. Consider a walk-in medical clinic, auto oil-change and lubrication shop, or hairdresser,
3. A system of communication that allows employees to query their superiors with
in which alljobsare of such short duration that there are no fully or partially completed
jobs onhand at the end of a business day. In such a setting, the inventory costing role in
external reporting (task 4) simply does not exist, but product costs (task 3) still must be
known by management to permit decisions such as which services to provide and what
prices to charge.
In sum. the information needs of managers range from simple to complex, anddepend
on the nature of products and processes, the particular decision tobe made' the competi
tiveenvironment, and other factors. In contrast, the natureof inventory costingrequired in
external reporting isconstant through time unless anexternal reporting rule ischanged. In
addition, inventory costing must satisfy only thefollowing: (1) it must be based on actual
historical costs, verifiable through documented transactions: (2) it must beconsistent from
period toperiod; and (3) it must include all manufacturing costs in the cost calculated for
each unit of output.
The simplest cost accounting systems can generate product cost data that satisfy
external reporting rules (task 4). There is a dangerous tendency among some executives
to endorse only thecost accounting effort needed for external reporting, ignoring man
agers' potentially much greater needs for detailed, reliable product cost information
trust and honest communication.
4. A system of promotion that generates and sustains employee faith in its validity
and judgment.
.
5. A systemof employeesupport through coaching,counseling, and career planning.

6. A system that considers not only company objectives, but also employees' skills
and capacities.
7. A system that does not settle for mediocrity, but reaches for realistic and attainable
standards, stressing improvement and providing an environment in which the con
cept of excellence can grow.
Empirical research in this field contributes to a useful understanding of the inter

relationships of budgeting and human behavior. Numerous research projects have been
undertaken and more arc needed. Illustrating the insights that such studies provide, one
research project indicated that budgetary participation and budgetgoal clarity had signifi
cant positive effectson managers'attitudes and performance, while excessively highgoals
had adverse effects. The study also found that budgetary evaluation and feedback exerted
(task 3).
'Paul E. Sussman, "MotivatingFinancial Personnel," The Journalof Accountancy,Vol.141, No. 2, p. 80.
!-(>
Chapter I >- Management Hie Controller, and Cost Accounting
department also coordinates with the manufacturing, personnel, treasury, marketing, pub
lic relations, legal, and other departments.
The manufacturing departments, under the direction of engineers and factory superin
tendents, design and control production. In research and design, cost estimates are used in
deciding whether to accept, improve, or reject a design. Likewise, scheduling, production,
and inspection are measured for efficiency in terms of quantity, quality, costs, and, to the
STOCKHOLDERS
BOARD OF DIRECTORS
DIRECTOR OF
CORPORATE PLANNING
SECRETARY AND
DIRECTOR OF
LEGAL SERVICES
extent practical, benefits.
& CONTROL
CHIEF EXECUTIVE
1-7
MANAGER OF
MANAGER
ASSISTANT
POLICY
DATA PROCESSING
DIRECTIVES
CENTER
DIRECTOR
OF PLANNING
The personnel department interviews and selects employees and maintains personnel
records, including wage rates. This information forms the basis for computing payroll
costs and for calculating the labor-related costs qf any activity, service, or good produced.
The treasury department is responsible for financial administration of a company. In
scheduling cash requirements and expectations, it relies on budgets and related reports
from the cost department.
The marketingdepartment needs a quality product at a competitive price to attract cus

tomers. Prices generally are not set merelyby adding a predeterminedpercentageto cost, but
costs cannot be ignored. Marketing managers use cost data to determine which productsare
profitableand to determine sales policies, plan promotions', and evaluate marketsegments.
The'public relations department has the function of maintaining good relations
between the company and its public, especially its customers and stockholders. Points of
friction are likelyto include prices, wages, profits, and dividends. The cost department pro
vides information for public releases concerning these areas.
The legal department uses cost information as an aid in maintaining compliance with
ASSISTANT
DIRECTOR OF
DIRECTOR OF
DIRECTOR OF
RESOURCES
PROCESS ACTIVITIES
DIRECTOR OF
HUMAN
MANAGERIAL
CONTROL
INTERRELATIONS
ASSISTANT
ASSISTANT
ASSISTANT
DIRECTOR OF:
DIRECTOR OF:
DIRECTOR OF:
HUMAN RESOURCES
PRODUCTS & SERVICES
FINANCE
MANUFACTURING
PHYSICAL ASSETS
MARKETING
INTANGIBLE ASSETS
STOCKHOLDER & FINANCIAL

COMMUNITY RELATIONS
contracts and laws, including the Equal Pay Act, union contracts, the Robinson-Patman
Act. the Employee Retirement Security Act of 1974, and the income tax, social security,
and unemployment compensation laws, all of which can affect costs.
LABOR & EMPLOYEE RELATIONS
(- CUSTOMER RELATIONS
PUBLIC & COMMUNITY RELATIONS
L- GOVERNMENT RELATIONS
The Role of Cost Accounting

FIGURE 1-3 Organization Chart Based on Functional-Teamwork Concept
Using the accounting system and other systems, the controller provides infomiation
for planning a company's future and for controlling its activities. This information goes far
beyond the basic financial statements. Investors, government agencies, and other external
partiesalsoreceive information by which management's effectiveness may bejudged.This

information is usually communicated to external users by means of quarterly and annual
reports that include financial statements but lack the depth of explanatory detail available
to internal decision makers.
The Cost Department

The .cost department, under the direction of the controller, is responsible for gathering,
compiling, and communicating information regarding a company's activities.This depart
ment analyzes costs and issues performance reports and other decision-making data to
managers for use in controlling and improving operations. Analysis of costs and prepara
tion of reports are facilitated by proper division of functions within the cost department
and by coordination with other accounting functions, such as general accounting. The cost
In the past, cost accounting was widely regarded as the calculation of the inventory cost
presented in the balance sheet and cost of goods soldjfigure in the income statement. This
view limits the broad range of information that managers need for decision making to
nothing more than the product cost data that satisfy external reporting rules. Examples of
these rules are income tax regulations, accounting rules prescribed for government con
tracts, and generally accepted accounting principles (GAAP). Such a restrictive definition
is inappropriate today and is certainly an inaccurate description of the uses of cost infor
mation. Cost accounting furnishes management with necessary tools for planningand con
trolling activities, improving quality and efficiency, and making both routine and strategic
decisions. The collection, presentation, and analysis of information regarding costs and
benefits helps management accomplish the following tasks:
1. Creating and executing plans and budgets for operating under expected competi
tive and economic conditions. An important aspect of plans is their potential for
motivating people to perform in a way consistent with company goals.
2. Establishing costing methods that permit control of activities, reductions of costs,
and improvements of quality.
3. Controlling physical quantities of inventory, and determining the cost of each

product or service produced for the purpose of pricing and for evaluating the per
formance of a product, department, or division.
1-4
1-5
The concept of control in business also differs from that used in military and police
work, in which the need for coercive force is always possible, although undesirable, in
STOCKHOLDERS
achieving control.In business, control is achieved through others' actions only with their
cooperatidh.
BOARD OF DIRECTORS
Authority, Responsibility, and Accountability

In a small firm, planning and control are performed by a single person, usually the owner
or general manager intimately familiar with the firm's products, processes, financing, and
customers. In a large company with many organizational units and a variety of products or
services, planning and control are larger tasks. Large firms assign planning and control
VICE-PRESIDENT
MARKETING
VICE-PRESIDENT
VICE-PRESIDENT
MANUFACTURING
RESEARCH AND
DEVELOPMENT
functions to many people, so that reportsand corrective actionswillnot be too far removed
TREASURER
CONTROLLER
from the activity being controlled.
Authority is the power to direct others to perform or not perform activities. Authority
is the key to the managerialjob and the basis for responsibility. It is the force that binds
the organization together. Authority originates with executive management, which dele
gates it to lower levels. Delegation is essential to organizational structure. Through dele
gation, a manager's area of influence is extended, but the manager remains responsible for
delegated functions because delegation does not remove responsibility.
Responsibility, or obligation, is closely related to authority. It originates principally in
the superior-subordinate relationship in that the superior has the authority to require specific
work from others. If subordinatesaccept the obligation to perform, they create their own
responsibility. The superior still is ultimately responsible for subordinates' performance.
One facet of responsibility is accountabilityreporting results to higher authority.
Reporting is important because it enables measurement of the extent to which objectives
are reached. Usually accountability is imposed on an individual rather than a group. This
principle of individual accountability is well established in both profit and nonprofit organ
izations. If the organizational structure permits pooling of judgment, responsibility is dif
fused and accountability nullified.
The Organization Chart

An organization chart shows an entity's principal management positions, helps to define
authority, responsibility, and accountability, and is essential in developing a cost account
ing system capable of reporting the responsibilities of individuals. Tne coordinated devel
opment of a company's organization with the cost and budgetary system leads to an
approach to accounting and reporting called responsibility accounting.
Most organization charts are based on the line-staff concept. The assumption of this
concept is that all positions or functional units can be categorized into two groups: the line,
which makes decisions, and the staff, which gives advice and performs technical functions.
A line-staff organization chart is illustrated in Figure 1-2.
Another type of organization chart is based on the functional-teamwork concept of

management, which emphasizes the most important functions of an enterprise: resources,
processes, and human interrelations. The resources function involves the acquisition, dis
posal, and prudent management of a wide variety of resourcestangible and intangible,
human and physical. The processes function deals with activities such as product design,
research and development, purchasing, manufacturing, advertising, marketing, and billing.
WORKS MANAGER
PRODUCTION
WORKS MANAGER
DIRECTOR
GENERAL
COST
PLANT ENGINEERING
INDUSTRIAL RELATIONS
ACCOUNTING"
ACCOUNTING
EMPLOYMENT
OPERATING
STANDARDS
SERVICE
DEPARTMENTS
OPERATIONAL DEPARTMENTS
INTERNAL
AUDITING
WELFARE
GENERAL
OFFICE
MANAGEMENT
TAXES
MAINTENANCE
MEDICAL
FIGURE 1-2 Organization Chart Based on Line-Staff Concept
The human interrelations function directs the company's efforts concerning the behavior
of people inside and outside the company. A functional-teamwork organization chart is
illustrated in Figure 1-3.
The Controller's Participation in Planning and Control

The controller is the executive manager responsible for the accounting function. The con
troller coordinates management's participation in planning and controlling the attainment
of objectives, in determining the effectiveness of policies, and in creating organizational

structuresand processes. The controlleralso is responsible for observing methods of plan
ning and control throughout the enterprise and for proposing improvements in them.
Effective control depends on communicating information to management. By issuing
performance reports, the controller advises other managers of activities requiringcorrec
tive action.These reports emphasize deviations from a predetermined plan, following the
principle of management by exception. The principle of management by exception is a
belief that managers should be provided with information that directs their attention to
activities that require corrective action. The concept is premised on the belief that man
agers do not have time to reviewevery action of every subordinate nor to consult with each
subordinate priorto each action. This is not to say that managers' main task is correcting
problemsor "puttingout fires," butsimply that managers neednot take actionsin the many
areas where the work is proceeding as planned.
1-2
fuses are simple examples of engineering controls. In contrast, the control process in busi
trol actions are based includes financial information, and the control activity is periodic
Three kinds of plans are identifiable inbusiness entities. Strategic p!3ns arc formu
lated at the highest levels ofmanagement, lake the broadest view ofthe company and its
environment, are the leasT quantifiable, and are formulated at irregular intervals by an
essentially unsystematic process that begins with identifying an external threat or oppor
tunity. Strategic planning decisions shape the future nature ofthe firm, its products, and its
In addition to these two kinds ofplans are the long-range plans prepared by some enti
ties. Long-range plans, orlong-range budgets, typically extend three to five years into the
future. In terms oftheir degree ofdetail and quantiliability, long-range plans arc tin inter
mediate step between short-range plans and strategic plans. For example, along-range plan
may culminate in a highly summarized set of financial statements or other quantified
objectives such as targeted financial ratios (e.g., earnings per share) as ofadate five years
quarter, or year.
Short-range plans, often called budgets, are sufficiently detailed to permit prepara
tion ofbudgeted financial statements for the entity as ofafuture date (typically the end of
the budget period). These plans are prepared through a systematized process, are highly
quantified, are expressed in financial terms, focus mainly on the organization itself by tak
ing the external environment as agiven, and usually are prepared for periods ofa month,
customers, and they have the potential to alter the external environment.
and meet social responsibilities.
trols are designed to work continuously, to use physical measures as their information
cost, and ata price that will win cooperation ofemployees, gain the goodwill ofcustomers,
or
BOARD OF DIRECTORS
x'
Leadinglo
Modifications
orTaclical
NewDocisions
~*
Reports
Issues
MANAGER
or
PRESIDENT
FIGURE 1-1 Control Diagram
>"
<
EXECUTIVECOMMITTEE
Decisions
and Making
Policy
Soiling
Objoctlvos
rather than continuous.
FINANCE
ENGINEERING
Result Data Assembled inCOST and'orBUDGET DEPARTMENTS
MARKETING MANUFACTURING
- Decisions, Plans. Instructions to
ness always mcludes a human decision milker. In addition, the information on which con
inputs, and to work largely independently of human decision makins. Thermostats and
Ihe concept of control in business differs from that used in engineering, where con
Similar relationships exist atall management levels within the organization
be taken. Figure 1-1 .Ilustrates the control process, using top management as an example.
Control is management's systematic effort to achieve objectives? Activities are continually
monitored to see that results stay within desired boundaries. Actual results of each activ
ity are compared with plans, and ifsignificant differences are noted, remedial actions may
Control
relationships among managers and between superiors and subordinates.
Management assigns work to each organizational unit created. An effective division of

work among employees is vital in attaining company objectives. Also important are the
turing firm for example, usually consists of three fundamental units: manufacturing, market
ing, and administration. Within these units, departments are formed according to the nature
location, and amount of work, the degree of specialization, and the number of employees '
sections, or branches. These units are created to permit specialization of labor. Amanufac
Organizing efforts include motivating people to work together for the good of the company
Organization usually involves the establishment of functional divisions, departments
parts into one unit. Organizing requires bringing the many functional units of an enterprise
into a coordinated structure and assigning authority and responsibility to individuals
Organizing is the establishment of the framework within which activities are to be per
formed. The terms organize and organization refer to the systematization of interdependent
Organizing
in the future. As along-range plan is revised and refined during the early portions of the
planning period, it serves as astarting point for successive sets of short-range plans.
Chapter 1>- Management, the Controller, and Cost Accounting
objective. The companies best able to maximize profits are those that produce goods or
services at an excellent level ofquality and value, in a volume, ata time and place, at a
profit is indispensable in a successful business, it is only one goal and cannot be the sole
Effective planning requires participation and coordination ofall parts of the entity.
Planning includes determining company objectives, which are measurable targets or
results. In stating the objectives ofa business, many people first think ofprofit. Although
among them into a "programmable" tak.
sions that it defies any attempt to reduce all the relevant variables and the relationships
routine planning include executive management's responses to the appearance of a new,

major competitor, a new orproposed government regulation ofthe industry, ora revolu
tionary new technology. This kind of planning involves so many unique, complex deci
of any kind; the decisions are all "programmed." At the other extreme, examples ofnon-
routine that the personnel involved are not likely to seethat their work involves decisions
tain days so that the cash balance stays within adesired range. This kind ofplanning is so
toaccomplish these objectives. Planning investigates the nature ofthe company's business,
its major policies, and the timing of major action steps. Effective planning is based on
analyses offacts and requires reflective thinking, imagination, and foresight.
An example of routine planning is the estimation ofan organization's daily cash bal
ances for the next 30days, with plans made to buy orsell short-term investments oncer
Planning, the construction of adetailed operating program, is the process ofsensing exter
nal opportunities and threats, determining desirable objectives, and employing resources
Planning
other planning- for longer and shorter cycles ofactivity, and the control ofother activities.
activity takes place simultaneously with the planning for the next cycle ofthat same activity,
reality, planning and control are simultaneous, inseparable, and interwoven processes. Time
frames such as short- and long-range periods are not clearly distinguishable. Control ofan
Chapter 1
Management, the Controller,
and Cost Accounting
Learning Objectives
After studying this chapter, you will be able to:
1. Model ilie management process as three interrelated activities;.-planning. organizing, and
,;
".:
2. Identify and distinguish |hfce kinds of plans: sjiqrt-rat1ge..'jbng-raiigc. and strategic.

m
>
3. Identify and differentiate the tasks in which management is aided by information about
costs and bpnefitSi
4. Identify which of the management accountant's ethical responsibilities apply to a partic
;.;
ular ethical issue.
5. State the role of the pronouncements of the Cost Accounting Standards Board.
This chapter describes the environment of cost accounting from internal and external per
spectives. Within the organization, cost accounting is presented as gart of the management
function, and the roles of the controller and C$st department are discussed. In the external
environment, the certification movement, ethical expectations, and other private and gov
ernmental influences on cost accounting are examined.
Management
-'
Management is composed of three groups: (I)'operating management, consisting of.'super

visors; (2) middle management, represented by department heads, division managers, and
branch managers: and (3) executive management, consisting of the- president, executive
vjcerpresidents, and executives in charge of marketing, purchasing, engineering, manufac
turing, finance, and accounting.
Management consists of many activities, including making decisions, giving orders,
establishing policies, providing work and rewards, and hiring people to carry out policies.
Management sets objectives to be achieved by integrating its knowledge and skills withthe
abilities of the employees. Planning and control may be the centerpiece of an organiza
tion's approach to management. This was true in many organizations in the past.
Alternatively, planning and controlmay be pushedinto the background and becomealmost
invisible to line workers unless a major problem or failure occurs. Even when the planning
and control functions are not in the forefront of day-to-day activities, management still
must effectively perform the basic functions of planning, organizing, and control to be suc
cessful. All three functions require participation by all management levels.
Planning and control arc divided for theoretical purposes, just as time frames arc divided
into discreteoperatingperiods. However, these divisions are artificially designed for the
convenience of analysis and do not reflect the dynamic way in which an entity evolves. In
1-1

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Fart 1 >- Costs: Concepts and Objectives

When the performance of a manager is evaluated, an important step involves classify

Chapter 2 > Cost Conceptsand the Cost Accounting InformationSystem

Balanced Scorecard for Rappahannock Company

cussed in Chapter 17.

Appendix: The Balanced Scorecard3

Sales growth, annual % rate.

Market share in targeted market segment.

% of calls connected within 10 seconds

% of calls disconnected/hanged up/lost

Internal Business Process Perspective:

Learning & Growth Perspective:

The Balanced Scorecard is a tool for implementing an organization's strategy. It is used to

Staff turnover, annual %

% of staff "very satisfied" in surveys

stage of strategy's execution.

At the simplest level, a balanced scorecard can be described as a set of important,

Figure 2-2 illustrates a balanced scorecard for Rappahannock Worldwide Company

phonecalls from software users.Mostcallersask howto troubleshoot. replace, or return the

FIGURE 2-2 Example of a Balanced Scorecard

The Scorecard Perspectives

incurrence, it is referred to as an indirect departmental cost; building rent and building

to departments ofany organization. Ifacost istraceable to the department in which itorig

In a service department, service is rendered for the benefit of other departments. In

expenditure is intended to benefit future periods and is reported as an asset. A revenue

of product costs by dividing the department intotwoor more costcenters.

sion. These decision-making concepts are discussed in Chapter21.

irrelevant to a decision is referred to as a sunk cost. In a decision to discontinue a product

be called an out-of-pocket cost associated with that alternative. An amount of revenue or

relevant items; more importantly, an irrelevant factor may be misinterpreted as relevant.

When a choice must be made among possible actions or alternatives, it is important to

Costs in Relation to a Decision, Action, or Evaluation

Forexample, trash barrels purchased for $10eachmaybe recorded as expenses, although

Distinguishing between capital and revenue expenditures is essential for matching

Costs can be classified as capita! expenditures or as revenue expenditures. A capital

Costs in Relation to an Accounting Period

paring actual costs with the budget.

tions.Commoncosts are particularly prevalent in organizations with manydepartments or

Chapter 2 >- Cost Concepts ami HieCostAccounliiiK InformationSystem

Costs in Relation to Manufacturing Departments or Other Segments

Part 1 >- Costs: Concepts and Objectives

Chapter 2 >- Cost Conceptsand the Cost Accounting InformationSystem

Part 1 >- Costs: Concepts and Objectives

are classified as fixed costs.

products, is not discernible. Amanufacturer may be so inefficient in managing some part of

computer-integrated manufacturing (CIM), employing database management technology

Salaries of production executives

Maintenance and repairs of buildings and grounds

include the expenses of promotion, selling, and delivery. Administrative expenses

in charge of marketing canbetreated asa marketing expense.

variable and fixed factory overhead examples listed.Forexample,factory suppliesare part

of manufacturing can be treated as amanufacturing cost, and the salary ofavice-president

Costs in Relation to the Volume of Production

O Spoilage, salvage, and reclamation expenses

able overhead costs:

Health and accident insurance

Because each manufacturing and nonmanufacturing cost usually is classified as

its fixed and variablecomponents. Methodsof accomplishingthis division arc discussed

Part I >- Costs: Concepts and Objectives

Chapter 2 >- CostConcepts nnd the CostAccounting Information System

Manufacturing Costs. Manufacturing costalso called production cost or factory

trivial, they areclassified as indirect materials.

be assigned feasibly to a specific product. In highly automated factories, two problems