Chapter 16 Managing Costs and Uncertainty Cost Accounting Foundations and Evolutions Kinney and Raiborn Seventh Edition COPYRIGHT © 2009 South-Western, a part of Cengage Learning. South-Western is a trademark used herein under license.

Learning Objectives (1 of 3) Explain the functions of an effective cost control system Describe the generic approaches to cost control List factors that cause costs to change from period to period or to deviate from expectations

Learning Objectives (2 of 3) List the two primary types of fixed costs and describe the characteristics of each type Describe typical approaches to controlling discretionary fixed costs List the objectives of cash management

Learning Objectives (3 of 3) Explain how technology is reducing the costs of supply chain transactions Contrast the uncertainty of dealing with future events and past events List the four generic approaches to managing uncertainty

Cost Control Systems Provide information for planning and for determining the efficiency of activities while they are being planned and after they are performed

Planning and Control Model Plan –Where do we want to go? –How do we compare to peers? –What is the impact of these decisions?

Planning and Control Model Execute –What do we have to do? –Can we achieve the targets? –How do we allocate resources?

Planning and Control Model Evaluate –Where are we? –How are we doing compared to plan? –What actually happened?

Planning and Control Model Respond –What decisions do we make? –What are the alternatives? –Why did it happen?

Cost Consciousness A companywide employee attitude toward the topics of –understanding cost changes –cost containment –cost avoidance –cost reduction

Why Costs Change Cost behavior Inflation/deflation Supply/supplier cost adjustments Quantity purchased Higher taxes Additional regulations

Cost Containment Cannot contain inflation tax regulatory changes supply and demand adjustments Use cost containment for reduced supplier competition seasonality quantities purchased Develop interorganizational arrangements Arrange long-term or single-source contracts An approach to minimize cost increases

Cost Avoidance and Reduction Avoidance - finding acceptable alternatives; substituting lower cost inputs Reduction - lowering current costs –Benchmarks –Outsourcing –Consultants –Operation redesign

Fixed Costs Discretionary Costs important but optional activities –employee travel –repairs and maintenance –advertising –research and development –employee training and development Committed Costs plant assets and personnel structure –depreciation –lease rentals –property taxes –Staff salaries Cannot be easily reduced Can be reduced

Cash Management Issues Cash level –sufficient to cover all needs –low enough to allow for alternative uses of cash

Banking Relationships Accurate, conservative accounting and cash flow information affects –Loan eligibility –Loan limits –Credit terms

Banking Relationships Banks assess –Credit history –Ability to generate cash flow –Quality of collateral –Character of senior officers –Operational plans and strategies

Supply Chain Management A set of processes that convert inputs into products and services for the firm’s customers

Uncertainty Uncertainty - doubt or lack of precision in specifying future outcomes Causes of cost management uncertainty –Lack of identification or understanding of cost drivers Random – some portion of the cost is not predictable based on the cost driver –Unforeseen events

Dealing with Uncertainty Explicitly factor uncertainty into estimates of future costs Structure costs to automatically adjust to uncertain outcomes Use options and forward contracts to mitigate uncertainty Purchase insurance to cover unexpected occurrences

Questions What are committed costs and discretionary costs? What are three approaches to cost control? How can a firm reduce uncertainties associated with business activities?

Potential Ethical Issues Refusing to grant sales price decreases when costs decline Artificially contracting with suppliers to force price increases to customers Acquiring excessive quantities of inputs to generate favorable price variances Acquiring counterfeit goods to obtain lower prices

Potential Ethical Issues Outsourcing production or procurement to companies with unacceptable labor or environmental practices Slowing payments to creditors to generate more investment returns Manipulating or falsifying financial statements to obtain credit or lower interest rates on borrowed funds