1. Chapter 15 Financial Management Cost Accounting Traditions and Innovations Barfield, Raiborn, Kinney

2. Learning Objectives (1 of 2) Explain why cost consciousness is important to all members of the organization Define committed costs and discretionary costs Describe how the benefits of discretionary cost expenditures are measured Identify when standards are applicable to discretionary costs Explain how a budget helps control discretionary costs

3. Learning Objectives (2 of 2) Describe how an activity-based budget differs from traditional budgets List the objectives of cash management (Appendix) Explain how program budgeting is used in not-for-profit entities (Appendix) Describe how zero-base budgeting is useful in cost control

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

5. Planning and Control Model PLAN EXECUTE EVALUATE RESPOND PLANNING CONTROL

6. Budgeting, Standard setting Monitoring, Correcting Providing feedback Cost understanding Cost containment, Cost avoidance Cost reduction Before During After ACTIVITY COST CONSCIOUSNESS ATTITUDE

7. Why Costs Change Cost Behavior –Reaction of variable and mixed costs to changes in activity level Inflation/Deflation Supply/Supplier Cost Adjustments –Supply/demand adjustments Taxes Regulatory Requirements Quantity Purchased

8. Cost Containment Cannot contain inflation tax regulatory changes supply and demand adjustments Use cost containment for reduced competition seasonality quantities purchased Interorganizational arrangements Long-term or single-source contracts

9. Cost Avoidance and Reduction Avoidance - finding acceptable alternatives Reduction - lowering current costs –Benchmarks –Outsourcing –Consultants –Redesign operations

10. Implement Cost Control System Investigate/understand types of costs Communicate need for cost containment Motivate employees (education/incentives) Review results and consider improvements View as long-run process

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

12. Controlling Committed Costs Compare expected benefits to expected costs Analyze operating leverage Perform postinvestment audit; compare actual to expected results

13. Discretionary Costs Vary in type and magnitude Vary in quality of performance Not easy to measure benefits in terms of money

14. Budgeting Discretionary Costs Perceived significance to the achievement of objectives and goals Expected level of operations Managerial negotiations Spend all of the appropriation, or Spend less than the appropriation

15. Measuring Benefits from Discretionary Costs Use surrogate measures –Reduction in unplanned downtime –Number of coupons clipped from ads –Reduction in number of customer complaints Compare discretionary costs to benefits to measure efficiency and effectiveness

16. Actual Result Compared to Desired Result Efficiency = Actual Output Actual Input Planned Output Planned Input Efficiency = Actual Input Actual Output Planned Input Planned Output Effectiveness = Actual Output Planned Output Preestablished Standard Discretionary Cost Measures OR

17. Controlling Discretionary Costs To determine variances, compare actual to standards or budgeted amounts Use engineered costs –Costs that bear observable and known relationship to a quantifiable activity base –Compute fixed or variable variances

18. Activity-Based Budgeting Apply activity drivers to estimate the levels and costs of activities necessary to provide the budgeted quantity and quality of production

19. Activity-Based Budgeting Steps Select Function Identify Activities Identify Activity Drivers Estimate Driver Volume Identify Resources Estimate Costs

20. Cash Management Issues Cash level –sufficient to cover all needs –low enough to allow for alternative uses of cash What variables influence the optimal level of cash? What are the sources of cash? What variables influence the cost of carrying cash?

21. Cash Management Issues What variables influence the optimal level of cash? Uncertainty of timing of cash inflows and outflows Variability in cash requirements throughout the year Ability to arrange short-term financing Bond and loan covenants

22. Cash Management Issues What are the sources of cash? Sale of equity or debt instruments Sale of unneeded or unproductive assets Normal operations –Reduce inventory –Increase A/R turnover –Decelerate payments

23. Cash Collection Cycle Cash Materials Inventory Work in Process Inventory Finished Goods Inventory Accounts Receivable Balance Sheet Current Assets Outflow Inflow

24. Cash Management Issues What variables influence the cost of carrying cash? Cost of borrowing and cost of issuing equity capital Opportunity costs of holding cash

25. Program Budgeting Use in government, not-for-profits, and service activities in for-profits Relates resource inputs to service outputs Define objectives in terms of output results, not quantity of input activities Analyze alternative activities that may achieve the objectives Use surrogate measures of output

26. ? When should results be measured? What results should be used as output measures? –Are all results equally important? What program actually caused the result? Did the program actually affect the target population? Program Budgeting Questions

27. Zero-Base Budgeting Considers the priorities and alternatives for current and proposed activities in relation to organizational objectives Reevaluates activities –continue –eliminate –adjust funding

28. Questions What are committed costs and discretionary costs? How does a budget help to control discretionary costs? How does an activity-based budget differ from traditional budgets?