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Chapter 1: Cost Management and Strategy
Cost Management Information
• The information developed and used to implement the organization’s strategy
• Consists of financial information about costs and revenues and nonfinancial information
about customer retention, productivity, quality, and other key success factors for the
organization
• Developed for use within the firm to facilitate management
• Main focus is usefulness and timliness
Cost Management
• The development and use of cost management information
Management Accounting
• Profession that involves partnering in management decision making, devising planning
and performance management systems, and providing expertise in financial reporting and
control to assist management in the formulation and implementation of an organization’s
strategy
Information Value Chain (in ascending order)
• Business events
• Data
• Information
• Knowledge
• Decisions
External Users
• Investors
• Government regulators
Financial Reports
• Focus is accuracy and compliance
Function of Management (4)
• Strategic management
o Development and implementation of a sustainable competitive position
• Planning and decision making
o Budgeting and profit planning, cash flow management, and other decisions related
to operations
• Management and operational control
o Management
System used by upper-level managers to evaluate the performance of other
managers
o Operational
Monitoring of short term operating performance
Takes place when mid-level managers monitor the activities of operating
level managers and employees
• Preparation of financial statements
o Requires management to comply with the financial reporting requirements of
regulatory agencies
Wholesalers
• Merchandisers that sell to other merchandisers
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Retailers
• Merchandisers selling directly to consumers
Public Goods
• Services provided by organizations (government and NFP)
Changes in the Business Environment (6)
• Increased global competition
• Lean manufacturing
• Advances in information technology, the internet, and enterprise resource management
• Greater focus on the customer
o Quality
o Service
o Timeliness of delivery
o Ability to respond to specific features
• New forms of management organization
• Changes in the social, political, and cultural environment of business
Current Global Economic Challenges (3)
• High public debt
• High unemployment rates
• Slow economic growth
Speed to Market
• Ability to deliver the product or service faster than the competition
Stages of the Development of Cost Management Systems (4)
• Created by Robert Kaplan
• Cost management systems are basic transaction reporting systems
• Cost management systems focus on external financial reporting
o Objective is reliable financial reports
o Usefulness of cost management is limited
• Cost management systems track key operating data and develop more accurate and
relevant cost information for decision making
o Cost management information is developed
• Strategically relevant cost management information is an integral part of the system
Critical Success Factors (CSFs)
• Measures of those aspects of the firm’s performance that are essential to its competitive
advantage and therefore to its success
• Financial performance
o Measures of profitability and market value, among others, as indicators of how
well the firm satisfies its owners and shareholders
• Customer satisfaction
o Measures of quality, service, and low cost, among others, as indicators of how
well the firm satisfies its customers
• Internal processes
o Measures of the efficiency and effectiveness with which the firm produces the
product or service
• Learning and growth
o Measures of the firm’s ability to develop and utilize human resources to meet its
strategic goals now and into the future
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Balanced Scorecard
• An accounting report that includes the firm’s critical success factors
Strategy Map
• A graphical representation of the organization’s value proposition
• Used to depict the series of causes and effects embodied in the various perspectives of an
organization’s balanced scorecard
Value Chain
• An analytic tool firms use to identify the specific steps required to provide a product or
service to the customer
Activity Analysis
• The development of a detailed description of the specific activities performed in the
firm’s operations
Activity Based Costing (ABC)
• A costing approach that assigns resource costs to cost objects based on activities
performed for the cost objects
Activity Based Management (ABM)
• Uses activity analysis and activity-based costing to help managers identify the value of
activities and to make strategic performance management decisions—adding and deleting
products, adjusting process capacities, adjusting prices, removing costs and complexities,
and more
Business Intelligence
• Also called business analytics or predictive analytics
• An approach to strategy implementation in which the management accountant uses data
to understand and analyze business performance
Target Costing
• The desired cost for a product as determined on the basis of a given competitive price, so
the product will earn a desired profit
Life Cycle Costing
• A method used to identify and monitor the costs of a product throughout its life cycle
Benchmarking
• A process by which a firm identifies its critical success factors, studies the best practices
of other firms (or other business units within a firm) for achieving these critical success
factors, and then implements improvements in the firm’s processes to match or beat the
performance of those competitors
Business Process Improvement (BPI)
• A management method by which managers and workers commit to a program of
continuous improvement in quality and other critical success factors
Total Quality Management (TQM)
• The unyielding and continuous effort by everyone in the organization to understand,
meet, and exceed customer expectations
Lean Accounting
• The accounting technique that uses value streams to measure the financial benefits of a
firm’s progress in implementing lean manufacturing
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Theory of Constraints (TOC)
• An analysis of operations that improves profitability and cycle time by identifying the
bottleneck in the operation and determining the most profitable product mix given the
bottleneck
Sustainability
• The balancing of the company’s short- and long-term goals in all three dimensions of
performance—social, environmental, and financial
Enterprise Risk Management
• A framework and process that firms use to manage the risks that could negatively or
positively affect the company’s competitiveness and success
• Risk (4)
o Hazards such as fire or flood
o Financial risks due to foreign currency fluctuations, commodity price fluctuations,
and changes in interest rates
o Operating risk related to customers, products, or employees
o Strategic risk related to top management decisions about the firm’s strategy and
implementation thereof
Strategy
• A plan for using resources to achieve sustainable goals within a competitive environment
Consequences of Lack of Strategic Information (6)
• Decision making based on intuition instead of accurate and timely information
• Lack of clarity about direction and goals
• Lack of a clear and favorable perception of the firm by customers and suppliers
• Incorrect investment decisions
o Choosing products, markets, or manufacturing processes inconsistent with
strategic goals
• Inability to effectively benchmark competitors, resulting in lack of knowledge about
more effective competitive strategies
• Failure to identify most profitable products, customers, and markets
Cost Leadership
• A competitive strategy in which a firm outperforms competitors in producing products or
services at the lowest cost
Differentiation Strategy
• A competitive strategy in which a firm succeeds by developing and maintaining a unique
value for the product (or service) as perceived by consumers
• Also called product leadership
o Refers to the innovation and features in the product
• Also called customer focused and customer solution strategy
o Indicates that the organization succeeds on some dimension of customer service
• Weakness
o Tendency to undermine its strength by attempting to lower costs or by ignoring
the necessity of having a continual and aggressive marketing plan to reinforce the
differentiation
Commodity
• Product or service that is difficult to differentiate and becomes a natural for cost
leadership competition
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Steps of Strategic Decision Making (5)
• Determine the strategic issues surrounding the problem
• Identify the alternative action
• Obtain information and conduct analyses of the alternatives
• Based on strategy and analysis, choose and implement the desired alternative
• Provide an ongoing evaluation of the effectiveness of implementation described in the
previous step
Types of Organizations (2)
• Sets guidelines and regulations regarding management accounting practices
• Promotes the professionalism and competence of management accountants
Professional Certification Programs
• Provides a distinct measure of experience, training, and performance capability for the
management accountant
Certifications for Management Accountants (2)
• Certified management accountant (CMA)
• Certified public accountant (CPA)
Professional Ethics
• Commitment of the management accountant to provide a useful service for management
IMA Statement of Ethical Professional Practice
• Minimum standards of behavior that are intended to guide the management accountant
and to inspire a very high level of professionalism
• Standards (4)
o Competence
o Confidentiality
o Integrity
o Creditability
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Chapter 2: Implementing Strategy – The Value Chain, Balanced Scorecard, and the Strategy
Map
Tools in Strategy Implementation (4)
• SWOT analysis
• Focus on execution
• Value chain analysis
• Balanced scorecard and strategy map
SWOT Analysis
• A systematic procedure for identifying a firm’s critical success factors: its internal
strengths and weaknesses and its external opportunities and threats
Core Competencies
• Skills or competencies that the firm employs especially well
Strengths and Weaknesses (Internal)
• Product lines
• Management
• Research and development
• Operations
• Marketing
• Strategy
Opportunities and Threats (External)
• Barriers to entry
• Intensity of rivalry among competitors
• Pressure from substitute products
• Bargaining power of customers
• Bargaining power of suppliers
Value Propositions
• Critical success factors represents the critical process in the firm that delivers value to the
customer
Critical Success Factors (CSFs)
• Financial
o Profitability
o Liquidity
o Sales
o Market value
• Customer
o Customer satisfaction
o Dealer and distributor
o Marketing and selling
o Timeliness of delivery
o Quality
• Internal business processes
o Quality
o Productivity
o Flexibility
o Equipment readiness
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o Safety
• Learning and growth
o Product innovation
o Timeliness of new product
o Skill development
o Employee morale
o Competence
• Other
o Governmental and community relations
Effective Execution
• Requires a concise statement of strategy that is clearly communicated within the
organization
• Aligning strategy with action
Value Chain Analysis
• A strategic analysis tool used to identify where value to customers can be increased or
costs reduced, and to better understand the firm’s linkages with suppliers, customers, and
other firms in the industry
• Steps (2)
o Identify the value chain activities
o Develop a competitive advantage (cost leadership or differentiation)
Identify a competitive advantage
Identify opportunities for added value
Identify opportunities for reduced cost
Value Chain
• Term is used because each activity is intended to add value to the product or service for
the customer
• Phases (3)
o Upstream
Also called supply chain management
Includes product development and the firm’s linkages with suppliers
o Operations
Manufacturing operations, or for a retailer or service firm, the operations
involved in providing the product or service
o Downstream
Also called customer relationship management
Linkages with customers, including delivery, service, and other related
activites
• Steps (8)
o Design
o Raw materials acquisition
o Materials assembled into components
o Intermediate assembly
o Computer manufacturing
o Wholesaling, warehousing, and distribution
o Retail sales
o Customer service
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Value Activities
• Firms in an industry perform activities to design, manufacture, and provide customer
service
Steps of Strategic Decision Making (5)
• Determine the strategic issues surrounding the problem
• Identify the alternative actions
• Obtain information and conduct analyses of the alternatives
• Based on strategy and analysis, choose and implement the desired alternative
• Provide an ongoing evaluation of the effectiveness of implementation described in the
previous step
Balanced Scorecard
• Perspectives (4)
o Financial
o Customer
o Internal process
o Learning and growth
Reasons to Embrace a Sustainability Strategy
• Improved brand reputation
• Increased competitive advantage
• Access to new markets increased margins or market share
• Reduced costs due to energy efficiency
Environmental Performance Indicators (EPIs)
• Operational
• Management
• Environmental condition
Social Performance Indicators (SPIs)
• Working conditions that measure worker safety and opportunity
• Community involvement indicators that measure the firm’s outreach to the local and
broader community
• Philanthropy indicators that measure the direct contribution by the firm and its employees
to charitable organizations
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Chapter 3: Basic Cost Management Concepts
Cost
• Incurred when a resource is used for some purpose
• Types (3)
o Direct materials
o Direct labor
o Factory overhead
Cost Pools
• The meaningful groups into which costs are collected
• Categories (3)
o Type
o Source
o Responsibility
Cost Driver
• A factor that causes or relates to a change in the cost of an activity
• Roles (2)
o Enabling the assignment of costs to cost objects
o Explaining cost behavior, how total costs change as the cost driver changes
• Activity based
o Identified by using activity analysis
• Volume based
o Cost driver is the amount produced or quantity of service provided
o Said to satisfy the law of diminishing marginal productivity
Cost Object
• Any product, service, customer, activity, or organizational unit to which costs are
accumulated for some management purpose
Value Streams
• A group of related products; useful for preparing profitability reports as part of lean
accounting; all the activities required to create customer value for a family of products or
services
Cost Assignment
• The process of assigning costs to cost pools or from cost pools to cost objects
Direct Cost
• A cost conveniently and economically traced directly to a cost pool or a cost object
Indirect Cost
• A cost that is not conveniently or economically traceable to a specific cost pool or cost
object
Cost Allocation
• The process of assigning indirect costs to cost pools and cost objects
• Form of cost assignment in which direct tracing is not economically feasible, so cost
drivers are used instead
Allocation Bases
• The cost drivers used to allocate costs
Direct Materials Cost
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• The cost of the materials in the product and a reasonable allowance for scrap and
defective units
• Less purchase discounts but including freight and related charges
Indirect Materials Cost
• The cost of materials used in manufacturing that are not part of the product or are not
easily or economically traceable to the finished product; a component of total
manufacturing overhead
Direct Labor Cost
• The labor used to manufacture the product or to provide the service
Indirect Labor Cost
• Supervision, quality control, inspection, purchasing and receiving, and other labor-related
manufacturing support costs; a component of total manufacturing overhead
Overhead
• All the indirect costs commonly combined into a single cost pool; called factory overhead
in a manufacturing firm
Factory Overhead
• All the indirect manufacturing costs commonly combined into a single cost pool in a
manufacturing firm
Prime Costs
• The sum of direct materials and direct labor
Conversion Cost
• Direct labor and factory overhead combined into a single amount
Relevant Range
• The range of the cost driver in which the actual value of the cost driver is expected to fall,
and for which the relationship between the cost and the cost driver is assumed to be
approximately linear
Variable Cost
• A cost that changes in total in response to changes in one or more cost drivers
• Used in connection with volume based cost drivers
• Total costs change with changes in the volume of output
Fixed Cost
• The portion of the total cost that does not change with a change in the quantity of a
designated cost driver within the relevant range
Mixed Cost
• A cost that includes both variable and fixed cost components
Step Cost
• A cost that varies with the cost driver, but in discrete steps
Unit Cost
• The total manufacturing cost (materials, labor, and overhead) divided by the number of
units of output
Structural Cost Drivers
• Strategic plans and decisions that have a long-term effect with regard to issues such as
scale, experience, technology, and complexity
Executional Cost Drivers
• Factors that the firm can manage in the short term to reduce costs such as workforce
involvement, design of the production process, and supplier relationships
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• Factors (3)
o Workforce empowerment
o Design of the production process
o Supplier relationships
Direct Tracing
• Used for assigning direct costs, and allocation is used for indirect costs
Activity Analysis
• Detailed description of the specific activities performed in the firm’s operations
• Includes each step in manufacturing the product or in providing the service
• Duties (2)
o Identifying which activities are contributing value to the customer and which are
not
o Focusing attention on those activities that are most costly or that differ from
expectations
Increasing Marginal Productivity
• Pattern of increasing costs at a decreasing rate
• Inputs are used more productively or more efficiently as manufacturing output increase
Cost of Goods Sold
• The cost of the product transferred to the income statement when inventory is sold
Product Costs
• Only the costs necessary to complete the product (direct materials, direct labor, and
factory overhead)
• Costs (3)
o Direct materials
o Direct labor
o Factory overhead
Period Costs
• All nonproduct expenditures for managing the firm and selling the product
• Also called
o Operating expenses
o Selling, general, and administrative expenses
Inventory Accounts (3)
• Materials
o Cost of the supply of materials used in the manufacturing process or to provide
the service
• Work in process
o An inventory account that contains all costs put into the manufacture of products
that are started but not complete at the financial statement date
• Finished goods
o The cost of goods that are ready for sale
Inventory Formula
• Beginning inventory + cost added = cost transferred out + ending inventory
Total Manufacturing Cost
• The sum of materials used, labor, and overhead for the period
Cost of Goods Manufactured
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• The cost of goods that were finished and transferred out of the Work-in-Process
Inventory account during a given period
Internal Accounting Controls
• A set of policies and procedures that restrict and guide activities in the processing of
financial data with the objective of preventing or detecting errors and fraudulent acts
Perpetual Inventory System
• A method that updates the finished goods inventory account for each purchase or sales
transaction
Periodic Inventory System
• A method that involves a count of inventory at the end of each accounting period to
determine the ending balance in inventory
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Chapter 4: Job Costing
Costing
• The process of accumulating, classifying, and assigning direct materials, direct labor, and
factory overhead costs to products, services, or projects
Characteristics of Costing Method (3)
• Cost accumulation method
• Cost measurement method
• Overhead application method
Actual Costing Method
• Actual costs incurred
Normal Costing System
• Uses actual costs for direct materials
Standard Costing System
• Uses standard costs and quantities for all three types of manufacturing costs
Job Costing
• A product costing system that accumulates and assigns costs to specific jobs, customers,
projects, or contracts
Job Cost Sheet
• A cost sheet that records and summarizes the costs of direct materials, direct labor, and
factory overhead for a particular job
Materials Requisition
• An online data entry or a source document used to request the release of materials into
the production process
Time Ticket
• A sheet showing the time an employee worked on each job, the pay rate, and the total
cost chargeable to each job
Overhead Application
• A process of allocating overhead costs to cost objects
Actual Costing System
• A costing process that uses actual costs incurred for direct materials, direct labor, and
factory overhead
Actual Factory Overhead
• Costs incurred in an accounting period for indirect materials, indirect labor, and other
indirect production costs, including factory rent, insurance, property tax, depreciation,
repairs and maintenance, power, light, heat, and employer payroll taxes for factory
personnel
Normal Costing System
• A costing process that uses actual costs for direct materials and direct labor and applies
factory overhead to various jobs using a predetermined application rate
Predetermined Factory Overhead Rate
• An estimated rate used to apply factory overhead cost to a cost object
• Steps (4)
o Estimate the total factory overhead costs for the upcoming operating period,
usually a year
o Select the most appropriate cost driver for applying the factory overhead costs
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o Estimate the total amount of the chosen cost driver for the upcoming operating
period
o Divide the estimated factory overhead costs by the estimated amount of the
chosen cost driver to obtain the predetermined overhead rate
• Estimated total factory overhead amount for the year / estimated total amount of cost
driver for the year
Plantwide Method of Normal Costing
• Budgeted factory overhead / budgeted number of labor hours
Factory Overhead Applied
• The amount of overhead assigned to a cost object using a predetermined factory overhead
rate
Overapplied Overhead
• The excess of applied overhead over actual factory overhead cost for a period
Underapplied Overhead
• The amount that actual factory overhead exceeds the factory overhead applied for a given
accounting period
Ways to Dispose of Underapplied and Overapplied Overhead
• Adjust the COGS account
• Adjust the production costs of the period
Potential Errors in Overhead Application (3)
• Aggregation error
• Specification error
• Measurement error
Overhead Rate
• Estimated total overhead / estimated total hours
Operation Costing
• A hybrid costing system that uses job costing to assign direct materials costs to jobs and
process costing to assign conversion costs to products or services
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Chapter 5: Activity Based Costing and Customer Profitability Analysis
Activity Based Costing
• Method for improving the accuracy of cost determination
• A costing approach that assigns resource costs to cost objects based on activities
performed for the cost objects
• Steps (3)
o Identifying resource costs and activities
o Assigning resource costs to activities
o Assigning activity costs to cost objects
• Benefits (5)
o Better profitability measures
o Better decision making
o Process improvement
o Improved planning
o Cost of unused capacity
Activity
• A specific task, action, or unit of work done
• Often listed in an activity dictionary
Resource
• An economic element applied or used to perform activities
Cost Driver
• A factor that causes or relates to a change in the cost of an activity
• Types (2)
o Resource consumption
A measure of the amount of resources consumed by an activity
o Activity consumption
A measure of the demand placed on the resources by products, services, or
customers
Two Stage Cost Assignment
• A procedure that assigns a firm’s resource costs to cost pools and then to cost objects
Levels of Activities
• According to resource consumption
• Levels (4)
o Unit level
An activity performed for each unit of the cost object
o Batch level
An activity performed for each batch of products or services
o Product level
An activity performed to support the production of a specific type of
product or service
o Facility level
An activity performed to support operations in general (that is, an activity
not related to volume of output, number of batches produced, or the
support of individual products)
Cross Subsidization
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• Overcosting and undercosting
• Often in the direction of undercosting the low volume products and overcosting the high
volume products using the volumes based approach
Strategic Decision Making Steps (5)
• Determine the strategic issues surrounding the problem
• Identify the alternative actions
• Obtain information and conduct analyses of the alternatives
• Based on strategy and analysis, choose and implement the desired alternative
• Provide an ongoing evaluation of the effectiveness of implementation chosen in the
previous step
Activity Based Management (ABM)
• Manages resources and activities to improve the value of products or services to
customers and increase the firm’s competitiveness and profitability
• Draws on activity based costing as its major source of information and focuses on the
efficiency and effectiveness of key business processes and activities
• Categories (2)
o Operational
Enhances operational efficiency and asset utilization and lower costs
Focus is on doing things right and more efficiently
Management techniques used (4)
Activity analysis
Business process improvement
Total quality management
Performance measurement
o Strategic
Focuses on choosing appropriate activities for the operation, eliminating
nonessential activities, and selecting the most profitable customers
Management techniques used (3)
Process design
Customer profitability analysis
Value chain analysis
Process Map
• A diagram that identifies each step in making a product or providing a service
High Value Added Activity
• Something that, in the eyes of the consumer, adds value to a product or service
Low Value Added Activity
• Consumes time, resources, or space, but adds little in regard to satisfying customer needs
Customer Profitability Analysis
• Identifies customer service activities, cost drivers, and the profitability of each individual
customer or customer group
Customer Cost Analysis
• Identifies cost activities and cost drivers related to servicing customers
Customer Lifetime Value
• The net present value of estimated future profits from a given customer; in practice, a
firm is likely to estimate this value over the next three to five years
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Customer Costs (5)
• Customer unit level
o Resources consumed for each unit sold to a customer
• Customer batch level
o Resources consumed for each sales action
• Customer sustaining
o Resources consumed to service a customer regardless of the number of units or
batches sold
• Distribution channel
o Resources consumed in each distribution channel the firm uses to service
customers
• Sales sustaining
o Resources consumed to sustain sales and service activities that cannot be traced to
an individual unit, batch, customer, or distribution channel
Multistage Activity Based Costing
• The assignment of resource costs to certain activities which in turn are assigned to other
activities before being assigned to the final cost objects
Resource Consumption Accounting (RCA)
• A comprehensive and fully integrated management accounting approach that provides
management with decision support information based on an operational view of the
organization
• Foundational concepts (3)
o View of resources
Resources are the suppliers of capacity
o Quantity based model
Operational view of the organization based on the concept that there is a
casual relationship that can be expressed in terms of input and output units
o Cost behavior
Characteristics of the cost are inherent to the underlying resource and
consumption of those resources by value creating operations
Time Drive Activity Based Costing (TDABC)
• The assignment of resource costs directly to cost objects using the cost per time unit of
supplying the resource, rather than first assigning costs to activities and then from
activities to cost objects
• Disadvantages (2)
o Reliance on the accuracy of the time estimates
o Effort to determine time estimates could be very time consuming and costly
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Chapter 7: Cost Allocation – Departments, Joint Products, and By Products
Service Department
• A unit of the organization that performs one or more support tasks for production
departments
Joint Cost Types
• The costs of production departments and service departments shared by two or more
different products
• The joint manufacturing costs for products that are not separately identifiable until some
later point in the manufacturing process
Strategic Role of Cost Allocation Objectives (4)
• Determine accurate departmental and product costs as a basis for the evaluation of the
cost efficiency of departments and the profitability of different products, financial
reporting and tax compliance
o Must comply with the financial accounting standards board (FASB)
• Motivate managers to exert a high level of effort to achieve the goals of top management
• Provide the right incentive for managers to make decisions that are consistent with the
goals of top management
• Fairly determine the rewards earned by the managers for their effort and skill and for the
effectiveness of their decision making
o Cause and effect relationship
o Ability to bear
Ethical Issues (3)
• When costs are allocated to products or services that are produced for both a competitive
market and a public agency or government department
• Governmental unit reimburses the costs of a private institution or when it provides a
service for a fee to the public
• Effect of the chosen allocation method on the costs of products sold to or from foreign
subsidiaries
Volume Based Approach
• Overhead costs could be allocated to products in a single step, using a single overhead
rate
Departmental Approach
• Takes into account differences in costs incurred in the different departments and
differences in consumption of the department’s resources by the products, thus leading to
more accurate product costs
Activity Based Approach
• Assigns costs at a much more detailed level, that of the operating activity rather than the
department
Departmental Cost Allocation Phases (3)
• Trace all direct manufacturing costs and allocate manufacturing overhead costs to both
the service departments and the production departments
• Allocate the service department costs to the production departments
o Methods (2)
Direct method
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Service department cost allocation accomplished by using the
service flows only to production departments and determining each
production department’s share of that service
Step method
A cost allocation method that uses a sequence of steps in allocating
service department costs to production departments
Reciprocal method
A cost allocation method that considers all reciprocal flows
between service departments through simultaneous equations
• Allocate the production department costs to the product
• Issues to consider (3)
o Disincentive effects when the allocation base is unrelated to usage
o Disincentive effects when the allocation base is actual usage
o Disincentive effects when allocated costs exceed external purchase cost
Reciprocal Flows
• The flow of services back and forth between service departments
Dual Allocation
• A cost allocation method that separates fixed and variable costs and traces variable
service department costs to the user departments; fixed costs are allocated based on either
equal shares among departments or a predetermined budgeted proportion
Joint Production Process
• A process that yields multiple outputs from a common resource input
Joint Products
• Products from the same production process that have relatively substantial sales values
By Products
• Products in a joint production process whose total sales values are minor in comparison
with the total sales value of all the joint products
Split Off Point
• The point in a joint production process where products with individual identities emerge
Separable Processing Costs
• In a joint production process, costs incurred after the split-off point, traceable to
individual products
Methods for Allocating Joint Costs to Joint Products (3)
• Physical measure
o A method that uses a physical measure such as pounds, gallons, yards, or units of
volume produced at the split-off point to allocate the joint costs to joint products
o Advantages (2)
Easy to use
Criterion for the allocation of the joint costs is objective
o Disadvantages
Ignores the revenue producing capability of individual products that can
vary widely among the joint products and have no relationship at all to any
physical measure
• Sales value at split off
o A method that allocates joint costs to joint products on the basis of their relative
sales values at the split-off point
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o Advantages
Easy to calculate
Allocated according to the individual product’s revenues
o Disadvantage
Market prices for some industries change constantly
• Net realizable value (NRV)
o The estimated sales value of the product at the split-off point; determined by
subtracting the separable processing and selling costs beyond the split-off point
from the ultimate sales value of the product
o Estimated ultimate sales value – separable processing and selling cost
Average Cost Method
• A method that uses units of output to allocate costs to products
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Chapter 8: Cost Estimation
Cost Estimation
• The development of a well-defined relationship between a cost object and its cost drivers
for the purpose of predicting the cost
• Steps (6)
o Define the cost object for which the related costs are to be estimated
o Determine the cost drivers
o Collect consistent and accurate data on the cost object and the cost drivers
Consistent
Each period of data is calculated using the same accounting basis
o Graph the data
o Select and employ an appropriate estimation method
o Evaluate the accuracy of the cost estimate
• Methods (2)
o High low method
A method using algebra to determine a unique cost estimation line
between representative high and low points in a given data set
Advantage
Requires the management accountant to prepare and study a graph
of the data
o Regression analysis
A statistical method for obtaining the unique cost-estimating equation that
best fits a set of data points
Minimizes the sum of the squares of the estimation errors
Also called least squares regression
A cost-estimation method in which the variable and fixed cost
coefficients are found by minimizing the sum of the squares of the
estimation errors
Variables (2)
Dependent
o In cost estimation, the cost to be estimated
Independent
o A cost driver used to estimate the value of the dependent
variable
Mean Absolute Percentage Error (MAPE)
• A measure of cost-estimation accuracy, calculated as the mean (average) absolute
percentage prediction error
Simple Regression
• Used to describe regression applications having a single independent variable
• Used when one independent variable is used
Multiple Regression
• Used to describe regression applications having two or more independent variables
Outliers
• Unusual data points that strongly influence a regression analysis
Goals When Choosing a Variable (2)
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• Change when the dependent variable changes, there is a predictive relationship
(correlation) between the dependent and independent variables
• Do not duplicate other independent variable
Dummy Variable
• Used in a regression model to represent the presence or absence of a condition
Precision
• Refers to the accuracy of the estimates from the regression
Reliability
• Indicates whether the regression reflects actual relationships among the variables
• Is the regression likely to continue to predict accurately
• Degree to which an independent variable has a valid, stable, long term relationship with
the dependent variable
Statistical Measures (4)
• R-squared
o Also called coefficient of determination
o Measure the reliability of the regression
o A number between zero and one. Often it is described as a measure of the
explanatory power of the regression; that is, the degree to which changes in the
dependent variable can be explained by changes in the independent variable
• T-value
o Measure the reliability of the regression
o A measure of the reliability of each of the independent variables
o Generally should be more than 2
• Standard error of the estimate (SE)
o A measure of the dispersion of the actual observations around the regression line;
as such it provides a measure of the accuracy of the regression’s estimates
• P-value
o Measure the reliability of the regression
o Measures the risk that a particular independent variable has only a chance
relationship to the dependent variable
Multicollinearity
• The condition when two or more independent variables are highly correlated with each
other
Correlation
• Present when a given variable tends to change predictably in the same or opposite
direction for a given change in the other, correlated variable
Confidence Interval (CI)
• In regression analysis, the CI refers to a range around the regression line within which the
management accountant can be confident the actual value of the predicted cost will likely
fall
Time Series Regression
• The application of regression analysis to predict future amounts, using prior periods’ data
Cross Sectional Regression
• A method of cost estimation for a particular cost object based on information on other
cost objects and variables, where the information for all variables is taken from the same
period of time
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Chapter 9: Short Term Profit Planning – Cost Volume Profit (CVP) Analysis
Cost Volume Profit (CVP) Analysis
• A short-term profit-planning model; that is, a method for analyzing how various
operating decisions and marketing decisions will affect short-term profit
• Applications
o Setting prices for products and services
o Deciding whether to introduce a new product or service
o Determining the desirability of replacing a piece of equipment
o Determining the break even point
o Deciding whether to make or buy a given product or service
o Determining the best product mix
o Performing strategic “what if” analysis
Operating Profit
• Sales – total costs
• Sales – variable costs – fixed costs
• (units sold x selling price per unit) – (units sold x variable cost per unit) – fixed costs
Contribution Margin Per Unit
• The difference between the selling price per unit and the variable cost per unit; it is a
measure of the change in operating profit for each unit change in sales
Total Contribution Margin
• The contribution margin per unit − multiplied by the number of units sold
Contribution Margin Ratio
• The ratio of the contribution margin per unit to the selling price per unit
Contribution Income Statement
• In a contribution income statement variable costs are subtracted from sales to get total
contribution margin, from which fixed costs are subtracted, to yield the amount of
operating profit for the period
Breakeven Point
• The point at which total revenues equal total costs, so that operating profit is zero
CVP Graph
• A diagrammatic representation (expressed in units) of how revenues and total costs
change over different levels of sales volume
Profit Volume Graph
• Illustrates how the level of operating profit changes over different levels of sales volume
Sensitivity Analysis
• The name for a variety of methods that examine how an amount changes if factors
involved in predicting that amount change
What If Analysis
• The calculation of an amount given different levels of a factor that influences that amount
Monte Carlo Simulation
• Method of resampling values of factors in a model
Margin of Safety (MOS)
• The amount of planned (or actual) sales above the breakeven point
• Planned (or actual) sales – breakeven sales
Margin of Safety (MOS)Ratio
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• MOS / planned sales
Operating Leverage
• The extent of fixed costs in an organization’s cost structure
Degree of Operating Leverage (DOL)
• A measure, at any level of sales volume, of the sensitivity of operating profit to changes
in volume; defined as the ratio of contribution margin to operating profit at any output
level
• Contribution margin / operating profit
Sales Mix
• The relative proportion in which a company’s products (or services) are sold
Weighted Average Contribution Margin Per Unit
• An average per-unit contribution margin based on an assumed sales mix determined on
the basis of physical units (not sales dollars)
Weighted Average Contribution Margin Ratio
• An average contribution margin ratio for a given sales mix based on sales dollars (not
units)
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Chapter 10: Strategy and the Master Budget
Budget
• A detailed plan for the acquisition and use of financial and other resources over a
specified period of time—for example, a year, a month, or a quarter
Budgeting
• The process of preparing one or more budgets
Long Range Plan
• A plan that identifies actions required during the 5- to 10-year period covered by the plan
to attain the organization’s strategic goals
Capital Budgeting
• A process of identifying, evaluating, selecting, and controlling an organization’s capital
investments (i.e., its long-term projects and programs)
Strategic Budget Expenditures
• Planned spending on projects and initiatives that lead to long-term value and competitive
advantage
Master Budget
• An aggregation of all subunit budgets into an integrated plan of action for the budget
period
• Comprehensive budget for a specific period
Operating Budgets
• An aggregation of all subunit budgets into an integrated plan of action for the budget
period
Financial Budgets
• Budgets that identify and relate to sources and uses of funds for planned operations and
capital expenditures
• Includes the cash budget, budgeted statement of cash flows, budgeting balance sheet, and
the capital expenditures (including strategic expenditures) budget
Controls
• Set of procedures used to monitor the progress of the organization in terms of
accomplishing its stated goals and objectives and implementing corrective actions if
needed
Budgeting Process
• Budgeting committee
o Oversees all budget matters and often is the highest authority in an organization
for all matters related to the budget
• Budget period
o Prepared for a set time, most commonly for the fiscal year with subperiod budgets
for each of the constituent quarters or months
• Budget guidelines
• Negotiation, review, and approval
• Revision
Sales Budget
• A schedule showing forecasted sales, in units and dollars, for an upcoming period
Sales Forecasting Factors
• Current sales levels and sales trends for the past few years
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• General economic and industry conditions
• Competitors’ actions and operating plans
• Pricing policies
• Credit policies
• Advertising and promotional activities
• Level of unfilled back orders
Production Budget
• Budget showing planned output (production) for an upcoming period
Budgeting production = budgeted sales + desired ending inventory – beginning inventory
Direct Materials Usage Budget
• A plan that shows the amount and budgeted cost of direct materials required for planned
production
Direct Materials Purchases Budget
• A budget that shows the physical amount and cost of planned purchases of direct
materials
Total amount of direct materials needed in production during the month
+ Required direct materials inventory at the end of the month
= Total direct materials needed for the month
-
Direct materials on hand at the beginning of the month
= Direct materials to be purchased during the month
Manufacturing Cells
• A set of machines, typically laid out in the form of a semicircle, needed to produce a
particular product or part
Merchandise Purchases Budget
• A budget that shows the amount (and cost) of merchandise a firm plans to purchase
during the budget period
Sources of Cash Receipts
• Cash sales
• Bank credit card sales
• Collection of credit sales
Discounts for early payment of credit sales are recorded on the income statement as deductions
from gross sales to arrive at net sales
Bad debts expense is included on the income statement as a noncash component of variable
selling expenses
Cash Budget
• A schedule depicting the effects on cash of all budgeted activities
• Sections (3)
o Net cash flows from operating activities
Reflect cash flows from the company’s transactions and events related to
its main operating activity
o Net cash flows from investing activities
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Provide information regarding the net cash effect of acquisitions and
divestitures of investments and long term assets
o Net cash flows from financing activities
Provide information regarding the net effect of issuance of, payments
toward, and retirements of borrowings (debt) and equity
What If Analysis
• Examine how a change in one or more budgetary items affects another variable or budget
of interest
Sensitivity Analysis
• Tool or method that budget planners use to determine the extent to which a change in the
forecasted value of one or more budgetary inputs affects individual budgets and the set of
pro forma financial statements produced as part of the master budgeting process
Scenario Analysis Concluding Points (3)
• Possible to enhance the analysis by assigning subjective probabilities to each of the
various scenarios
• Process of identifying realistic scenario is complicated in practice and therefore suggests
the need for a cross functional team
• Most sophisticated way to handle uncertainty in the budgeting process is through the use
of Monte Carlo simulation
Zero Base Budgeting (ZBB)
• A budgeting process that requires managers to prepare budgets each period from a base
of zero
• Assumes that most if not all current activities and functions will continue into the budget
period
• Allows no activities or functions to be included in the budget unless managers can justify
their needs
Activity Based Budgeting (ABB)
• A budgeting process that is based on activities and associated activity costs to support
production and sales; an extension of the traditional form of activity-based costing (ABC)
Time Driven Activity Based Budgeting (TDABB)
• A method of budget preparation used in conjunction with a time-driven activity-based
cost (TDABC) system
Practical Capacity
• Theoretical capacity reduced by normal output losses due to personal time, normal
maintenance, and so on; the measure of capacity used to estimate cost-driver rates under
ABC and TDABC systems
Kaizen Budgeting
• A budgeting approach that incorporates continuous improvement expectations in the
budget
• Adjusts required resource demands based on targeted efficiency and productivity gains
• Can be used as a complement to both traditional and activity based budgeting systems
• Not limited to internal improvements
Budgetary Slack
• The difference between budgeted performance and expected performance; a “cushion”
managers intentionally build into budgets to help ensure success in meeting the budget
Goal Congruence
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• The consistency between the goals of the firm, its subunits, and its employees. It is
achieved when the manager acts independently in such a way as to simultaneously
achieve personal objectives and those of top management
• Factors influenced by (3)
o Extent to which employees participate in the budgeting process
o Level of difficulty embedded in the budget
o Whether and how compensation is linked to budgeted performance
Participative Budgeting Process
• Bottom up approach that involves the people affected by the budget including lower level
employees in the budget preparation process
Authoritative Budgeting
• Top down budgeting process, top management prepares budgets for the entire
organization including those for lower level operations
Fixed Performance Contract
• An incentive compensation plan whereby compensation (reward) is a function of actual
performance compared to a fixed (budgeted) target
Gaming the Performance Measure
• Non-value-adding actions taken by managers to improve indicated performance
Linear Compensation Plan Characteristics (2)
• Managerial reward is independent of budgeted targets
• Managerial reward is a linear function of actual performance: the greater the
performance, the greater the managerial reward (monetary and nonmonetary)
Relative Performance (or Relative Improvement) Contracts
• Contracts that reward managers for performance based on a comparison of actual results
with specified benchmarks, not budgeted (fixed) targets
Rolling Financial Forecasts
• A constant planning horizon with the use of regularly updated forecasts
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Chapter 11: Decision Making with a Strategic Emphasis
Relevant Costs
• A future cost that differs between and among decision alternatives; an avoidable cost
• Must be incurred in the future and will differ between and among the decision maker’s
options
Sunk Cost
• Costs that have been incurred in the past or committed for the future and are therefore
irrelevant for decision-making purposes
Opportunity Costs
• The benefit lost when choosing one option precludes receiving the benefits from an
alternative option
Groups of Cost Elements (3)
• Unit level costs
• Batch level costs
• Facilities level costs
Value Stream
• A group of related products; useful for preparing profitability reports as part of lean
accounting; all the activities required to create customer value for a family of products or
services
Bill of Materials
• Detailed list of the components of the manufactured product
Joint Production Process
• A process that yields multiple outputs from a common resource input
Split Off Point
• The point in a joint production process where products with individual identities emerge
Joint Production Costs
• Costs incurred prior to the split-off point
• Common costs
Separable (Traceable) Processing Costs
• In a joint production process, costs incurred after the split-off point, traceable to
individual products
Production Possibilities Given by the Production Constraints (2)
• One production constraint
• Two or more production constraints
Predatory Pricing
• Exists when a company has set prices below average variable cost and plans to raise
prices later to recover the losses from the lower prices
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Chapter 13: Cost Planning for the Product Life Cycle – Target Costing, Theory of Constraints,
and Strategic Pricing
Cost Life Cycle
• The sequence of activities within the firm that begins with research and development,
followed by design, manufacturing, marketing/distribution, and customer service
Sales Life Cycle
• The sequence of phases in a product’s or service’s life in the market—from the
introduction of the product or service to the market, to growth in sales, and finally
maturity, decline, and withdrawal from the market
Target Cost
• Competitive price – desired profit
• Steps (5)
o Determine the market price
o Determine the desired profit
o Calculate the target cost at market price less desired profit
o Use value engineering to identify ways to reduce product cost
o Use kaizen costing and operational control to further reduce costs
• Advantages
o Helps the firm achieve desired profitability on new or redesigned products
o Orients the organization toward the customer, as design is focused on customer
values
o Reduces costs, through more effective and efficient design
o Can decrease the total time required for product development, through improved
coordination of design, manufacturing, and marketing functions
o Can increase communication and cooperation among departments
o Can improve overall product quality, as the design is carefully developed and
manufacturing issues are considered explicitly in the design phase
Value Engineering
• Used in target costing to reduce product cost by analyzing the trade-offs between
different types of product functionality and total product cost
Functional Analysis
• A type of value engineering in which the performance and cost of each major function or
feature of the product is examined
Design Analysis
• A form of value engineering in which the design team prepares several possible designs
of the product, each having similar features with different levels of both performance and
cost
Cost Tables
• Computer-based databases that include comprehensive information about the firm’s cost
drivers
Group Technology
• A method of identifying similarities in the parts of products manufactured so the same
part can be used in two or more products, thereby reducing costs
Concurrent Engineering
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• An engineering method that integrates product design with manufacturing and marketing
throughout the product’s life cycle
• Also called simultaneous engineering
Quality Function Development (QFD)
• The integration of value engineering, marketing analysis, and target costing to assist in
determining which components of the product should be targeted for redesign
• Steps (4)
o Determine the customer’s purchasing criteria and how these criteria are ranked
o Identify the components of the product and the manufacturing cost of each
component
o Determine how each component contributes to customer satisfaction
o Determine the important index of each component
Cycle Time
• The amount of time between receipt of a customer order and shipment of the order
• Also called manufacturing lead time or throughput time
Manufacturing Cycle Efficiency (MCE)
• The ratio of processing time to total cycle time
• Processing time / total cycle time
Constraints
• Those activities that slow the product’s total cycle time
Theory of Constraints Steps (5)
• Identify the constraints
• Determine the most profitable product mix given the constraint
• Maximize the flow through the constraint
• Add capacity to the constraint
• Redesign the manufacturing process for flexibility and fast cycle time
Flow Diagram
• A flowchart of the work done that shows the sequence of processes and the amount of
time required for each
Throughput Margin
• A TOC measure of product profitability; it equals price less materials cost, including all
purchased components and materials handling costs
Takt Time
• The speed at which units must be manufactured to meet customer demand
• Available manufacturing time / customer demand
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Chapter 16: Operational Performance Measurement – Further Analysis of Productivity
Uses of Flexible Budget by Sales Variances (2)
• Analyzing differences between actual sales and the master budget sales
• Analyzing changes in sales over the prior year
Determinants of Productivity (3)
• Control of waste
• Product and manufacturing process innovation
• Fluctuations in demand due to changes in the business cycle or for other reasons
Lean Manufacturing
• Focus on waste and balanced production flows
Productivity
• Ratio of output to input
• Output / input
• Can ignore the effects of changes in demand for the product, changes in selling prices of
the goods or services, and changes in special purchasing or selling arrangements on
productivity
Operational Productivity
• The ratio of output units to the number of units of an input factor
Financial Productivity
• The ratio of output to the dollar amount of one or more input factors
Partial Productivity
• A productivity measure that focuses only on the relationship between one of the inputs
and the output attained
• Number of units manufactured / number of units or cost of a single input resource
• Examples (3)
o Direct materials productivity (output/units of materials)
o Workforce productivity (output per labor hour or output per person employed)
o Process productivity (output per machine hour or output per kilowatt hour)
• Types
o Financial
Considers the effects of both cost and quantity of an input resource on
productivity
Can be used in operations that use more than one production factor
o Operational
Measures only one input resource at a time
• Limitations (4)
o Measures only the relationship between an input resource and the output; ignores
any effect that changes in other manufacturing factors have on productivity
o Ignores any effect that changes in other production factors have on productivity
o Analysis and interpretation should include effects that changes in the firm’s
operating characteristics have on the productivity of the input resource
o An improved partial productivity does not necessarily mean that the firm or
division operates efficiently
Total Productivity
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• A productivity measure that includes all input resources in computing the ratio of the
output attained to the input resources consumed
• Unit or sales value of output / total cost of all input resources
• Financial productivity measure
• Limitation
o Measure in performance evaluations decreases the possibility of manipulating
some of the manufacturing factors to improve the productivity measure of other
manufacturing factors
• Deterioration in total productivity can result from an increase in the cost of resources or
decrease in the productivity of some of the input resources, both of which may be beyond
the control of the manager
Selling Price Variance
• Actual sales units x change in price
Sales Quantity Variance
• Focuses on deviations between the number of units sold and the number of units
budgeted to be sold and measures the effect of those deviations on operating results
• Elements (3)
o The difference between the budgeted and actual total sales quantity
o The budgeted sales mix of the product
o The budgeted contribution margin per unit of the product
• (total units of all products sold – budgeted total units of all products) x budgeted sales
mix of the product x budgeted contribution margin per unit of the product
Sales Mix
• The relative proportion in which a company’s products (or services) are sold
Sales Mix Variance
• The product of the difference between the actual and budgeted sales mix multiplied by
the actual total number of units of all products sold and by the budgeted contribution
margin per unit of the product
• (actual sales mix of the product – budgeted sales mix of the product) x total units sold x
budgeted contribution margin per unit of the product
Market Share Variance
• A comparison of the firm’s actual market share to its budgeted market share and
measurement of the effect of changes in the firm’s market share on its total contribution
margin and operating income
• (actual market share – budgeted market share) x actual market size (in units) x weighted
average budgeted contribution margin per unit
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Chapter 18: Strategic Performance Measurement – Cost Centers, Profit Centers, and the
Balanced Scorecard
Performance Measurement
• A measurement that identifies items that indicate the work performed and the results
achieved by an activity, process, or organizational unit as compared to some
preestablished criteria
Management Control
• The system used by upper-level managers to evaluate the performance of other managers
Operational Control
• The monitoring of short-term operating performance; takes place when mid-level
managers monitor the activities of operating-level managers and employees
Strategic Performance Measurement
• Responsible for implementing the organization’s strategy
Operational Performance Measurement
• Control at the operating level
Strategic Business Unit (SBU)
• A well-defined set of controllable operating activities over which an SBU manager is
responsible
Objectives of Management Control (3)
• Motivate managers
• Provide the right incentive for managers
• Determine fairly the rewards earned by managers
Employment Contract
• An agreement between the manager and top management, designed to provide incentives
for the manager to act autonomously to achieve top management’s objectives
Principal Agent Model
• A conceptual model that contains the key elements that contracts must have to achieve
the desired objectives
• Aspects of management performance (3)
o Uncertainty
o Risk aversion
o Lack of observability
Recipients of Performance Reports (4)
• Firm’s owners, directors, or shareholders
• Firm’s creditors
• Community or governmental units affected by its operations
• Firm’s employees
Formal Management Control Systems (4)
• Hiring policies
• Promotion policies
• Leadership development
• Strategic performance measurement systems
Strategic Performance Measurement
• An accounting system used by top management for the evaluation of SBU managers
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Decentralization
• Delegation of responsibility
• A decision-making approach in which top management delegates a significant amount of
decision authority and responsibility to subunit (SBU) managers
Cost Centers
• A firm’s production or support unit that is evaluated on the basis of cost
Revenue Centers
• A business unit with responsibility for sales, defined either by product line or by
geographical area, that focuses on the selling function
Profit Center
• A business unit whose manager is responsible for revenues and expenses, but not the
level of invested capital, in the unit
Investment Centers
• A business unit that includes in its financial-performance metric the level of assets
(capital) employed by the unit as well as profit generated by that unit
Strategic Issues (3)
• Cost shifting
• Excessive short term focus
• Role of budget slack
Budget Slack
• The difference between budgeted performance and expected performance
Discretionary Cost Method
• Used when costs are considered largely uncontrollable; an input-oriented approach that
applies discretion at the planning stage
Engineered Cost Method
• An output-oriented method that considers costs to be variable and therefore controllable
Outsourcing
• Firm’s decision to have a source or product currently provided by a support department
supplied by an outside firm
Dual Allocation
• A cost allocation method that separates fixed and variable costs and traces variable
service department costs to the user departments; fixed costs are allocated based on either
equal shares among departments or a predetermined budgeted proportion
Revenue Drivers
• The factors that affect sales volume, such as price changes, promotions, discounts,
customer service, changes in product features, delivery dates, and other value-added
factors
Order Getting Costs
• Expenditures to advertise and promote the product
Order Filling Costs
• Expenditures for freight, warehousing, packing and shipping, and collections
Contribution Income Statement
• In a contribution income statement variable costs are subtracted from sales to get total
contribution margin, from which fixed costs are subtracted, to yield the amount of
operating profit for the period
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Contribution by Profit Center (CPC)
• Measures profit after all traceable costs and is therefore a performance measure that is
controllable by the profit center manager
Controllable Fixed Costs
• Fixed costs that the profit center manager can influence in approximately a year or less
Noncontrollable Fixed Costs
• Costs that are not controllable within a year’s time, usually including facilities-related
costs such as depreciation, taxes, and insurance
Controllable Margin
• A margin determined by subtracting short-term controllable fixed costs from the
contribution margin
Full costing income exceeds variable costing income (by the amount of fixed cost in the
inventory change) when inventory in units increase, and variable costing income is higher than
full costing income when inventory in units decreases
Balanced Scorecard Performance Measure Perspectives (4)
• Customer satisfaction
• Financial performance
• Internal business processes
• Learning and innovation
