Cost Accounting: Information for Decision Making Chapter 1 Cost Accounting: Information for Decision Making We start the study of the Fundamentals of Cost Accounting with a review and overview of information necessary for decision making. McGraw-Hill/Irwin Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved. 1 - 1

Value Chain L.O. 1 Describe the way managers use accounting information to create value in organizations. The Value Chain describes a set of activities that transforms raw materials and resources into the goods and services end users purchase and consume. – Value added activities – Non value added activities The value chain describes the set of activities that increase the value of an organization’s products or services. Value-added activities are activities that customers perceive as valuable because the activity adds utility to the goods or services they purchase. In other words, customers define value. 1 - 2

The Value Chain Components LO1 The Value Chain Components Research & Development Design Purchasing Production All products start with research and development. Is research and development (creating and developing ideas related to a new product) value-added or nonvalue-added? Once we have the idea for a new product, the product must be developed and engineered. Does this add value? The purchasing department is responsible for acquiring all of the necessary components and supplies in order to produce the product. Does this add value? We must produce the product or deliver the service in order for the product or service to have value to a customer. We need to inform potential customers about the attributes of our product or service. Delivering the product or service to the customer adds value. If the customer does not have the product or service, it has no value. Finally, chances are you have experienced the value of customer service. Have you ever called the technical support line for a software application you installed on your computer? If so, I hope the support added value to your product. Marketing Distribution Customer Service 1 - 3

Accounting Systems L.O. 2 Distinguish between the uses and users of cost accounting and financial accounting information. Financial accounting position and income Reports Financial accounting information is designed for decision makers who are not directly involved in the daily management of the firm. Cost accounting information is designed for managers. Cost accounting Information about costs Reports 1 - 4

Managerial Decisions L.O. 3 Explain how cost accounting information is used for decision making and performance evaluation in organizations. Individuals make decisions. Decisions determine the performance of the organization. Managers use information from the accounting system to make decisions. The key question is: What adds value to the firm? Let’s look at how cost information adds value to the organization. Cost information adds value to the organization if that information improves managers’ decisions. Owners evaluate organizational and managerial performance with accounting information. 1 - 5

Costs for Decision Making LO3 Costs for Decision Making Carmen’s Cookies has been making and selling cookies through a small store downtown. One of her customers suggests that she expand operations and sell to wholesalers and retailers. Should Carmen expand operations? Now we are going to look at an example involving decision making. Carmen’s Cookies. 1 - 6

Carmen’s Cost Drivers Cost Rent Insurance Labor Ingredients Driver LO3 Carmen’s Cost Drivers Cost Rent Insurance Labor Ingredients Driver Number of stores What drives the cost of rent and the cost of insurance? The number of storefronts Carmen has drives rent and insurance. If Carmen opens a new storefront, her rent and insurance costs will increase. On the other hand, what drives the cost of labor or the cost of the ingredients for the cookies? How many cookies Carmen makes will determine how many employees she needs and how much flour and sugar are required. Number of cookies 1 - 7

Differential Costs, Revenues, and Profits LO3 Differential Costs, Revenues, and Profits Sales revenue Costs: Food Labor Utilities Rent Other Total costs Operating profits $6,300 1,800 1,000 400 1,250 $5,450 $ 850 $8,505a 2,700b 1,500b 600b 1,200c $7,250 $1,255 $2,205 900 500 200 -0- $1,800 $ 405 (1) Status Quo Original Shop Sales Only (2) Alternative Wholesale & Retail Distribution (3) Difference Carmen’s Cookies Projected Income Statement for One Week Look at Carmen’s projected income statement. If Carmen maintains the status quo and does not expand, revenue will be $6,300. However, she expects revenues to increase 35% if she expands. Differential revenue is $2,205. If food, labor and utilities costs all increase 50%, Carmen has differential costs of $900, $500, and $200 for those costs. Carmen determines she currently has room for increased cookie production so she will not be required to rent additional space. Therefore rent is not a differential cost. However, her other costs also increase 20% for differential costs of $200. Using this cost information to analyze revenues and costs, Carmen determines that she has differential profits of $405 if she expands rather than maintaining the status quo. (a) 35 percent higher than status quo (b) 50 percent higher than status quo (c) 20 percent higher than status quo 1 - 8

Responsibility Centers, Revenues, and Costs LO3 Responsibility Centers, Revenues, and Costs Carmen Diaz President Ray Adams Vice-President Retail Operations Cathy Peterson Wholesale Operations This is an example of an organization’s chart. Please notice that Ray Adams is in charge of retail operations and Cathy Peterson is in charge of wholesale operations. Are these responsibility centers? 1 - 9

Responsibility Centers, Revenues, and Costs LO3 Responsibility Centers, Revenues, and Costs Carmen’s Cookies Income Statement For the Month Ending April 30 Sales revenue Department costs: Food Labora Utilities Rent Total department costs Center marginb General and admin. costs: General manager’s salaryc Other (administrative) Total general and admin. costs Operating profit $28,400 13,500 4,500 1,800 5,000 $24,800 $ 3,600 $23,600 9,800 3,200 2,100 2,500 $17,600 $ 6,000 $52,000 23,300 7,700 3,900 7,500 $42,400 $ 9,600 $ 8,200 $ 1,400 Retail Operations Wholesale Total Do you think that general and administrative costs should be distributed to the two operations? (a) Includes department managers’ salaries but excludes Carmen’s salary (b) The difference between revenues and costs attributable to a responsibility center (c) Carmen’s salary 1 - 10

Responsibility Centers, Revenues, and Costs LO3 Responsibility Centers, Revenues, and Costs Carmen’s Cookies Retail Responsibility Center Budgeted versus Actual Costs For the Month Ending April 30 Food: Flour Eggs Chocolate Nuts Other Total food Labor: Manager Total labor Utilities Rent Total cookie costs Number of cookies sold $ 2,100 5,200 2,000 2,200 $13,500 3,000 1,500 $ 4,500 1,800 5,000 $24,800 32,000 $ 2,200 4,700 1,900 $12,900 $24,200 $ (100) 500 100 -0- $ 600 $ -0- $ 600 Actual Budget Difference A budget, or a financial plan for the revenues and resources needed to meet financial goals, is an important tool for the financial success of both individuals and organizations. Do you have a budget? Another important use of cost accounting information is the evaluation of the performance of an organization. Comparing the actual results to the budgeted results allows managers to evaluate the performance of the organization and owners to evaluate the performance of individual managers. For example, look at Carmen’s actual activity and costs compared to her budgeted activity and costs. If Carmen budgeted selling 32,000 cookies and actually sold 32,000 cookies in the month of April, why were her food costs $600 higher than she anticipated? In evaluating activities for April, Carmen is also interested in seeing that actual labor costs equaled the amount budgeted. As part of the planning and control process, managers prepare budgets containing expectations about revenues and costs for the coming period. At the end of the period, managers compare actual results with the budget. This allows them to see whether changes can be made to improve future operations. 1 - 11

Trends in Cost Accounting L.O. 4 Identify current trends in cost accounting. Research and development Design Purchasing Production Marketing Distribution Customer service 8. ERP – Enterprise resource planning 9. Creating value in the organization Cost accounting continues to experience dramatic changes. Developments in information technology (IT) have nearly eliminated manual bookkeeping. Emphasis on cost control is increasing in all types of organizations. 1 - 12

Enterprise Resource Planning LO4 Enterprise Resource Planning Information technology linking various processes of the enterprise into a single comprehensive information system Purchasing Production Technology Human Resources Finance Enterprise resource planning (ERP) uses information technology to link the various processes of the enterprise into a single comprehensive information system. Because all the company’s processes are integrated, ERP has significant potential for providing information on the cost of products and services. However, implementation problems are keeping many companies from realizing this potential. Marketing 1 - 13

Ethical Issues for Accountants L.O. 5 Understand ethical issues faced by accountants and ways to deal with ethical problems that you face in your career. The design of the cost accounting system has the potential to be misused to defraud customers, employees, or shareholders. Accountants report information that can have a substantial impact on the careers of managers who are generally held accountable for achieving financial performance targets. Failure to achieve a target can have serious negative consequences for a manager. Therefore, accountants may find themselves under pressure by management to make accounting choices that improve performance reports rather than accurately reflect performance. As a professional accountant, manager, or business owner, you will face ethical situations on an everyday basis. 1 - 14

Sarbanes-Oxley Act of 2002 Address problem What is the of corporate LO5 Sarbanes-Oxley Act of 2002 What is the intent? Address problem of corporate governance Who is impacted? Accounting firms and corporations When there is a public perception of widespread ethical problems, the result is often legislation making certain conduct is not only unethical, but also illegal. Congress passed the Sarbanes-Oxley Act of 2002 to address some of the more serious problems of corporate governance that surfaced in the late 1990s and early 2000s. How are corporations impacted? Corporate responsibility 1 - 15

Appendix 1 Institute of Management Accountants’ (IMA) Code of Ethics: Standards Competence Confidentiality Integrity Credibility In Appendix 1 to Chapter 1 is the Institute of Management Accountants’ Code of Ethics. The code of ethics addresses four standards; competence, confidentiality, integrity, and credibility. 1 - 16

End of Chapter 1 McGraw-Hill/Irwin Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.