Cost management accounting and control 5th ed

Examples of the topics covered in this sectioninclude activity-based customer and supplier costing, strategic cost management, activity-based budgeting, activity-based management, proces

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Over the past twenty years, changes in the business environment have profoundly

af-fected cost accounting and cost management A few examples of these changes are an

increased emphasis on providing value to customers, total quality management, time as

a competitive element, advances in information and manufacturing technology,

global-ization of markets, service industry growth, deregulation, and heightened awareness of

ethical and environmental business practices These changes are driven by the need to

create and sustain a competitive advantage For many firms, the information required to

realize a competitive advantage can no longer be derived from a traditional cost

manage-ment information system The traditional system relies on functional-based costing and

control In a functional-based system, costing and control are centered on organizational

functions Unfortunately, this functional-based approach often fails to provide information

that is detailed, accurate, and timely enough to support the requirements of this new

envi-ronment This has resulted in the emergence of an activity-based cost management system

Typically, an activity-based cost management system is more detailed and more accurate than

a functional-based cost management system and, thus, more costly to operate Furthermore,the need to add a formal guidance mechanism to the new activity-based system has created

a demand for strategic-based cost management Thus, the new cost management system might

be more accurately referred to as an activity- and strategic-based cost management system Theemergence and acceptance of activity- and strategic-based cost management therefore suggeststhat in many cases the benefits of this more sophisticated system outweigh its costs On theother hand, the continued existence and reliance on functional-based systems suggests the op-posite for other firms

The coexistence of functional-based systems with activity- and strategic-based cost agement systems necessitates the study of both systems, thus providing flexibility and depth

man-of understanding In creating a text on cost management, we had to decide how to designits structure We believe that a systems approach provides a convenient and logical frame-work Using a systems framework allows us to easily integrate the functional- and activity-based approaches in a way that students can easily grasp Integration is achieved bydeveloping a common terminology—a terminology that allows us to define each system

and discuss how they differ Then the functional and activity-based approaches can be

com-pared and contrasted as they are applied to costing, control, and decision making We

be-lieve this integration will allow students to appreciate the differences that exist between

functional and activity-based approaches This integration is especially useful in the

decision-making chapters, as it allows students to see how decisions change as the

infor-mation sets change For example, how does a make-or-buy decision change as we move

from a functional-based, traditional cost management system to the richer, activity-based

cost management system?

This text has been streamlined by combining and eliminating some material The

number of chapters totals 21, as opposed to 24 Notably, international cost

manage-ment has been eliminated as a separate chapter Instead, important material has been

reorganized into decision-making chapters More specific international cost topics are

left for international finance classes Activity-based budgeting is now located in the

budgeting chapter, where it can be compared and contrasted with traditional

bud-geting topics Activity-based costing is now located early in the text, in Chapter 4,

where it can include traditional plantwide overhead rates and applications

Audience

This text is written primarily for students at the undergraduate level The text

pre-sents a thorough treatment of traditional and contemporary approaches to cost

management, accounting, and control and can be used for a one- or two-semester

course In our opinion, the text also has sufficient depth for graduate-level courses

In fact, we have successfully used the text at the graduate level

Key Features

We feel that the text offers a number of distinctive and appealing features—features thatshould make it much easier to teach students about the emerging themes in today’s busi-ness world One of our objectives was to reduce the time and resources expended by in-structors so that students can be more readily exposed to today’s topics and practices Tohelp you understand the text’s innovative approach, we have provided a detailed descrip-tion of its key features

Structure

The text’s organization follows a systems framework and is divided into four parts:

1 Part 1: Foundation Concepts Chapters 1 through 4 introduce the basic concepts and

tools associated with cost management information systems

2 Part 2: Fundamental Costing and Control Chapters 5 through 10 provide thorough

coverage of product costing, planning, and control in both functional-based and based costing systems

activity-3 Part 3: Advanced Costing and Control Chapters 11 through 16 present the key elements

of the new cost management approaches Examples of the topics covered in this sectioninclude activity-based customer and supplier costing, strategic cost management, activity-based budgeting, activity-based management, process value analysis, target costing, kaizencosting, quality costing, productivity, environmental cost management, and the BalancedScorecard

4 Part 4: Decision Making Chapters 17 through 21 bring the costing and control tools

to-gether in the discussion of decision making

This edition’s structure permits integrated coverage of both the traditional and activity-basedcosting systems In this way, students can see how each system can be used for costing, con-trol, and decision making and can evaluate the advantages and disadvantages of each system.This approach helps students to see how cost management is applied to problems in today’sworld and to understand the richness of the approaches to business problems

activity-Historical Perspective

Chapter 1 provides a brief history of cost accounting The historical perspective allowsstudents to see why functional-based cost management systems work well in some set-tings but no longer work for other settings The forces that are changing cost man-agement practices are described The changing role of the management accountant

is also covered with particular emphasis on why the development of a cross-functionalexpertise is so critical in today’s environment

Value Chain Analysis

The provision of value to customers is illustrated by the internal value chain, which

is first introduced in Chapter 1 and defined and illustrated more completely inChapter 2 Chapter 11 provides a detailed discussion of value chain analysis and

introduces the industrial value chain Value chain analysis means that managers must

understand and exploit internal and external linkages so that a sustainable competitive

advantage can be achieved Exploitation of these linkages requires a detailed

under-standing of the costs associated with both internal and external factors This edition

ex-pands the treatment of value chain analysis by introducing, defining, and illustrating

activity-based supplier costing and activity-based customer costing The costing examples

developed show how the value chain concepts can be operationalized—a characteristic

not clearly described by other treatments Thus, we believe that the operational examples

are a significant feature of the text

Accounting and Cost Management Systems

In Chapter 2, the accounting information system and its different subsystems are defined

Distinctions are made between the financial accounting and the cost management

informa-tion systems and the differing purposes they serve The cost management informainforma-tion

sys-tem is broken down into the cost accounting information syssys-tem and the operational control

system The differences between functional-based and activity-based cost management systemsare defined and illustrated The criteria for choosing an activity-based system over a functional-based system are also discussed

In Chapter 2, three methods of cost assignment are delineated: direct tracing, driver ing, and allocation Activity drivers are also defined Once the general cost assignment model

trac-is establtrac-ished, the model trac-is used to help students understand the differences between based and activity-based cost management systems A clear understanding of how the two sys-tems differ is fundamental to the organizational structure that the text follows

functional-Activity Costs Change as functional-Activity Usage Changes

Chapter 3 is a comprehensive treatment of cost behavior First, we define variable, fixed, and

mixed activity cost behavior Then, we discuss the activity resource usage model and detail

the impact of flexible and committed resources on cost Finally, we describe the methods of

breaking out fixed and variable activity costs This text goes beyond the typical text in

ex-plaining to students how to use the computer spreadsheet programs to perform regression

analysis The chapter on cost behavior analysis is more general than usual chapters that treat

the subject Traditional treatment usually focuses on cost as a function of production

vol-ume We break away from this pattern and focus on cost as a function of changes in

ac-tivity usage with changes in production acac-tivity as a special case The acac-tivity resource

usage model is used to define activity cost behavior (in terms of when resources are

ac-quired) and is defined and discussed in Chapter 3 This resource usage model plays an

important role in numerous contemporary applications It is used in value chain

analy-sis (Chapter 11), activity-based management (Chapter 12), and tactical decision and

rel-evant costing analysis (Chapter 18) The extensive applications of the activity resource

usage model represent a unique feature of the text

Activity-Based Costing

Much has been written on the uses and applications of ABC This text presents a

comprehensive approach to based costing and management The

activity-based product costing model is introduced in Chapter 2 and described in detail in

Chapter 4 In this chapter, the advantages of ABC over functional-based costing are

related A completed discussion of how to design an ABC system is given This

in-cludes identifying activities, creating an activity dictionary, assigning costs to

activ-ities, classifying activities as primary and secondary, and assigning costs to products

We have added new material that explores methods on simplifying a complex ABC

system The objectives of these methods are to reduce the number of drivers and

activities used without significant reductions in product-costing accuracy To fully

understand how an ABC system works, students must understand the data needed

to support the system Thus, we show how the general ledger system must be bundled to provide activity information We also define and illustrate an ABC relationaldatabase This unique feature of the text helps the student understand the very practi-cal requirements of an ABC system

un-Activity-Based Budgeting

Activity-based budgeting is now combined with traditional budgeting concepts in ter 8 This integrated treatment helps students to see how budgets can be extended withthe power of activity-based cost concepts This chapter introduces the basics of activity-based budgeting and gives an expanded example in a service setting Flexible budgetingand the behavioral impact of budgets are also included in this chapter

Chap-Just-in-Time Effects

JIT manufacturing and purchasing are defined and their own cost management practices cussed in Chapters 11 and 21 JIT is compared and contrasted with traditional manufactur-ing practices The effects on areas such as cost traceability, inventory management, productcosting, and responsibility accounting are carefully delineated

dis-Life Cycle Cost Management

In Chapter 11, we define and contrast three different life cycle viewpoints: production life cle, marketing life cycle, and consumable life cycle We then show how these concepts can beused for strategic planning and analysis In later chapters, we show how life cycle concepts areuseful for pricing and profitability analysis (Chapter 19) The use of life cycle costing for en-vironmental cost management is also discussed (Chapter 16) The breadth, depth, and nu-merous examples illustrating life cycle cost applications allow the student to see the powerand scope of this methodology

cy-Activity-Based Management and the Balanced Scorecard

There are three types of responsibility accounting systems: functional-based, activity-based,and strategic-based These three systems are compared and contrasted, and the activity-and strategic-based responsibility accounting systems are discussed in detail Activity-basedresponsibility accounting focuses on controlling and managing processes The mechanismfor doing this process value analysis is defined and thoroughly discussed in Chapter 12.Numerous examples are given to facilitate understanding Value-added and non-value-added cost reports are described Activity-based responsibility accounting also covers ac-tivity measures of performance, which are thoroughly covered in Chapter 13 TheBalanced Scorecard is equivalent to what we are calling strategic-based responsibility ac-counting The basic concepts and methods of the Balanced Scorecard are presented inChapter 13

Costs of Quality: Measurement and Control

Often, textual treatments simply define quality costs and present cost of quality ports We go beyond this simple presentation (in Chapter 14) and discuss cost ofquality performance reporting We also describe quality activities in terms of theirvalue-added content Finally, we introduce and describe ISO 9000, an importantquality assurance and reporting system that many firms must now follow

re-Productivity: Measurement and Control

The new manufacturing environment demands innovative approaches to mance measurement Productivity is one of these approaches; yet it is either onlysuperficially discussed in most cost and management accounting texts or not

treated at all In Chapter 15, we offer a thorough treatment of the topic, including

some new material on how to measure activity and process productivity

Strategic Cost Management

A detailed introduction to strategic cost management is provided in Chapter 11

Un-derstanding strategic cost analysis is a vital part of the new manufacturing environment

Strategic cost management is defined and illustrated Strategic positioning is discussed

Structural and executional cost drivers are introduced Value chain analysis is described

with the focus on activity-based supplier and customer costing The role of target costing

in strategic cost management is also emphasized

Environmental Costs: Measurement and Control

Chapter 16 reflects the growing strategic importance of environmental cost management

This chapter introduces and discusses the concept of ecoefficiency It also defines, classifies,and illustrates the reporting of environmental costs and how to assign those costs to prod-ucts and processes The role of life-cycle costing in environmental cost management is de-tailed Finally, we describe ways the Balanced Scorecard can be extended to include anenvironmental perspective

Theory of Constraints

We introduce the theory of constraints (TOC) in Chapter 21 A linear programming work is used to facilitate the description of TOC and provide a setting where students can seethe value of linear programming In fact, our treatment of linear programming is motivated

frame-by the need to develop the underlying concepts so that TOC can be presented and discussed.This edition expands the coverage of TOC by adding a discussion of constraint accounting

Service Sector Focus

The significance of the service sector is recognized in this text through the extensive

appli-cation of cost management principles to services The text explains that services are not

sim-ply less complicated manufacturing settings but instead have their own characteristics These

characteristics require modification of cost management accounting principles Sections

ad-dressing services appear in a number of chapters, including product costing, pricing, and

quality and productivity measurement

Professional Ethics

Strong professional ethics need to be part of every accountant’s personal foundation We

are convinced that students are interested in ethical dimensions of business and can be

taught areas in which ethical conflicts occur Chapter 1 introduces the role of ethics and

reprints the ethical standards developed by the Institute of Management Accountants

To reinforce coverage of ethics, every chapter includes an ethics case for discussion In

addition, many chapters include sections on ethics For example, Chapter 19, on

pric-ing and revenue analysis, includes material on the ethical dimensions of pricpric-ing

Behavioral Issues

Ethical behavior is just one aspect of human behavior that is affected by cost

man-agement systems The systems used for planning, control, and decision making can

affect the way in which people act Insights from behavioral decision theory are

pre-sented in appropriate sections of the text For example, a discussion of the ways

profit measurement can affect people’s behavior is included in Chapter 19

Chap-ter 8, on activity-based budgeting, includes a section on the behavioral impact of

budgets We believe that an integration of behavioral issues with accounting

is-sues leads to a more complete understanding of the role of the accountant today

Real World Examples

Our years of experience in teaching cost and management accounting have convinced

us that students like and understand real world applications of accounting concepts.These real world examples make the abstract accounting ideas concrete and providemeaning and color Besides, they’re interesting and fun Therefore, real world examplesare integrated throughout every chapter Use of color for company names that appear

in the chapters and the company index at the end of the text will help you locate theseexamples

Outstanding Pedagogy

We think of this text as a tool that can help students learn cost accounting and cost agement concepts Of paramount importance is text readability We have tried to write a veryreadable text and to provide numerous examples, real world applications, and illustrations ofimportant cost accounting and cost management concepts Specific “student-friendly” features

man-of the pedagogy include the following:

• Whenever possible, graphical exhibits are provided to illustrate concepts In our experience,some students need to “see” the concept; thus, we have attempted to portray key concepts

to enhance understanding Of course, many numerical examples are also provided

• All chapters (except Chapter 1) include at least one review problem and solution Theseproblems demonstrate the computational aspects of chapter materials and reinforce the stu-dents’ understanding of chapter concepts before they undertake end-of-chapter materials

• A glossary of key terms is included at the end of the text Key terms lists at the end of eachchapter identify text pages for fuller explanation

• All chapters include comprehensive end-of-chapter materials These are divided into tions for Writing and Discussion,” “Exercises,” and “Problems.” The Questions for Writ-ing and Discussion emphasize communication skill development Exercises and Problems

“Ques-to support every learning objective are included, and the relevant “Ques-topics and learning jectives are noted in the text margins The exercises and problems are graduated in diffi-culty from easy to challenging CMA exam problems are included to enable the student

ob-to practice relevant problem material Each chapter includes at least one ethics case Allchapters also include a cyber research case to give students practice in doing research onthe Internet

• This edition continues to offer cooperative learning exercises in the end-of-chapter terials in each chapter These exercises encourage students to work in groups to solvecost management problems

ma-• Spreadsheet template problems are identified in the end-of-chapter materials with anappropriate icon These problems are designed to help students use spreadsheet ap-plications to solve cost accounting problems

Comprehensive Supplements Package

Check Figures.Key figures for solutions to selected problems and cases are vided in the solutions manual as an aid to students as they prepare their answers.Instructors may copy and distribute these as they see fit

pro-Study Guide, 0-324-23311-6 (Prepared by Al Chen, North olina State University) The study guide provides a detailed review of eachchapter and allows students to check their understanding of the material through

review questions and exercises Specifically, students are provided with learning

objec-tives, a chapter summary, a chapter review correlated to the learning objecobjec-tives,

self-test questions and exercises, and a “Can You?” Checklist that helps self-test their knowledge

of key concepts in the chapter Answers are provided for all assignment material

Instructor’s Manual, 0-324-23321-3 (Prepared by Kim Foreman,

James Madison University) The instructor’s manual contains a complete set of

lecture notes for each chapter, a listing of all exercises and problems with estimated

dif-ficulty and time required for solution, and a set of transparency masters

Solutions Manual, 0-324-23313-2 (Prepared by Don Hansen and

Maryanne Mowen) The solutions manual contains the solutions for all

end-of-chapter questions, exercises, and problems Solutions have been error-checked to ensure

their accuracy and reliability

Solutions Transparencies, 0-324-23314-0.Acetate transparencies for selected lutions are available to adopters of the fifth edition

so-Test Bank, 0-324-23315-9 (Prepared by Jane Stoneback, Central necticut State University) Extensively revised for the fifth edition, the test bank offersmultiple-choice problems, short problems, and essay problems Designed to make exam prepa-ration as convenient as possible for the instructor, each test bank chapter contains enough ques-tions and problems to permit the preparation of several exams without repetition of material

Con-ExamView Testing Software. This supplement contains all of the questions in theprinted test bank This program is an easy-to-use test creation software compatible with Mi-crosoft Windows Instructors can add or edit questions, instructions, and answers, and selectquestions (randomly or numerically) by previewing them on the screen Instructors can alsocreate and administer quizzes online, whether over the Internet, a local area network (LAN),

or a wide area network (WAN)

Spreadsheet Templates (Prepared by Michael Blue, Bloomsburg

Uni-versity).Spreadsheet templates using Microsoft Excel®provide outlined formats of

solu-tions for selected end-of-chapter exercises and problems These exercises and problems are

identified with a margin symbol The templates allow students to develop spreadsheet and

“what-if ” analysis skills

PowerPoint Slides (Prepared by Peggy Hussey).Selected transparencies of

key concepts and exhibits from the text are available in PowerPoint presentation

soft-ware These slides provide a comprehensive outline of each chapter

Instructor’s Resource CD-ROM, 0-324-23317-5.Key instructor

ancillar-ies (solutions manual, instructor’s manual, test bank, and PowerPoint slides) are

pro-vided on CD-ROM, giving instructors the ultimate tool for customizing lectures

and presentations

Web Site (http://hansen.swlearning.com). A Web site designed

specifi-cally for Cost Management, fifth edition, provides online and downloadable resources

for both instructors and students The Web site features an interactive study center

organized by chapter, with learning objectives, Web links, glossaries, and online

quizzes with automatic feedback

Personal Trainer® 3.0, 0-324-31164-8. Instructors consistently cite

reading the text and completing graded homework assignments as a key to student

success in managerial accounting; however, finding time to grade homework is

dif-ficult Personal Trainer solves this problem by allowing professors to assign

text-book exercises and problems Personal Trainer will grade the homework and then

post the grade into a full-blown gradebook, all in real time! Personal Trainer is

an Internet-based homework tutor where students can complete the textbook work assignments, receive hints, submit their answers and then receive immediate feed-back on their answers

home-WebTutor™ Advantage with Personal Trainer®.WebTutor Advantage

com-plements Cost Management, fifth edition, by providing interactive reinforcement

Web-Tutor’s online teaching and learning environment brings together content management,assessment, communication, and collaboration capabilities for enhancing in-class instruc-tion or for delivering distance learning For more information, including a demo, visit http://webtutor.swlearning.com/

The Business & Company Resource Center.An easy way to give students cess to a dynamic database of business information and resources is offered by way of theBusiness & Company Resource Center (BCRC) The BCRC provides online access to a widevariety of global business information including current articles and business journals, de-tailed company and industry information, investment reports, stock quotes, and much more.The BCRC saves valuable time and provides students a safe resource in which to hone theirresearch skills and develop their analytical abilities Other benefits of the BCRC include:

ac-• Convenient access from anywhere with an Internet connection, allowing students to accessinformation at school, at home, or on the go

• A powerful and time-saving research tool for students—whether they are completing a caseanalysis, preparing for a presentation, creating a business plan, or writing a reaction paper

• Serving as an online coursepack, allowing instructors to assign readings and research-basedassignments or projects without the inconvenience of library reserves, permissions, and printedmaterials

• Acts as a filter, eliminating the “junk” information often found when searching the net, providing only high-quality, safe, and reliable news and information sources

Inter-• Infomarks that make it easy to assign homework, share articles, create journal lists, andsave searches Instructors can combine the BCRC with their favorite Harvard BusinessSchool Publishing cases to provide students a case analysis research tool at no additionalcost Contact your local Thomson South-Western representative to learn how to includeBusiness & Company Resource Center with your text

Harvard Business Case Studies The leader in business education publishing ners with the leader in business cases to offer Harvard Business Case Studies As part ofThomson South-Western’s commitment to giving customers the greatest choice of teach-ing and learning solutions possible, we are proud to be an official distributor of HarvardBusiness School Publishing case collections and article reprints The combination of pre-eminent cases and articles from Harvard Business School Publishing with the unparal-leled scope and depth of customizable content from Thomson Business & ProfessionalPublishing provides instructors and students with a wide array of learning materials Youcan draw from multiple resources and disciplines to match the unique needs of yourcourse This bundling offers the following conveniences:

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Many people have helped us to write this text We appreciate the comments of

re-viewers and others who have helped make this a more readable text

Jack Bailes, Oregon State University

Frank Collins, Schreiner College

Michael Cornick, University of North Carolina— Charlotte

Alan B Czyzewski, Indiana State University

John B Duncan, University of Louisiana at Monroe

Fara Elikai, University of North Carolina at Wilmington

Alan H Friedberg, Florida Atlantic University

Donald W Gribben, Southern Illinois University

Jeri W Griego, Laramie County Community College

Jan Richard Heier, Auburn University at Montgomery

Eleanor G Henry, State University of New York at Oswego

James Holmes, University of Kentucky

David R Honodel, University of Denver

Dick Houser, Northern Arizona University

K E Hughes II, Louisiana State University

Bill Joyce, Eastern Illinois University

Leslie Kren, University of Wisconsin—Milwaukee

Ron Kucic, University of Denver

Amy Hing-Ling Lau, The Hong Kong Polytechnic University

Otto Martinson, Old Dominion University

William Ortega, Western Washington University

Joseph Weintrop, Baruch College

Special thanks are due to our verifiers, Judy Beebe of Western Oregon University, James Emig

of Villanova University, and Kim Richardson of James Madison University They error-checked

the study guide, solutions manual, and test bank Their efforts helped us to produce a

higher-quality text and supplement package

To the many students at Oklahoma State University who have reacted to the material

in Cost Management: Accounting and Control, we owe special thanks Students represent

our true constituency The common sense and good humor of our student reviewers have

resulted in a clearer, more readable text

We also want to express our gratitude to the Institute of Management Accountants

for its permission to use adapted problems from past CMA examinations and to reprint

the ethical standards of conduct for management accountants We are also grateful to the

American Institute of Certified Public Accountants for allowing us to adapt selected

ques-tions from past CPA examinaques-tions

Finally, we wish to acknowledge the exceptional efforts of our project team at

South-Western Publishing and Litten Editing and Production (LEAP) Allison Rolfes,

devel-opmental editor extraordinaire, consistently provided outstanding support Her

orga-nizational and creative skills, not to mention flexibility and unflagging good humor,

made this book a reality Kara ZumBahlen, production editor, with Malvine Litten

and Denise Morton of LEAP, took manuscript and transformed it into a text suited

for the 21st century Bethany Casey, designer, and Deanna Ettinger, photo manager,

helped us transform abstract accounting concepts into state-of-the-art graphics and

photos The support and creative efforts of Keith Chasse, acquisitions editor, and

Chris McNamee, marketing manager, are much appreciated

Don R Hansen and Maryanne M Mowen

About the Authors

Don R Hansen

Dr Don R Hansen is Head of the School of Accounting at Oklahoma State

Univer-sity He received his Ph.D from the University of Arizona in 1977 He has an

under-graduate degree in mathematics from Brigham Young University His research interests

include activity-based costing and mathematical modeling He has published articles in

both accounting and engineering journals including The Accounting Review, The

Jour-nal of Management Accounting Research, Accounting Horizons, and IIE Transactions He

has served on the editorial board of The Accounting Review His outside interests include

family, church activities, reading, movies, watching sports, and studying Spanish

Maryanne M Mowen

Dr Maryanne M Mowen is Associate Professor of Accounting at Oklahoma State

Univer-sity She received her Ph.D from Arizona State University in 1979 Dr Mowen brings an

interdisciplinary perspective to teaching and writing in cost and management accounting,

with degrees in history and economics In addition, she does research in areas of behavioral

decision making, activity-based costing, and the impact of the Sarbanes-Oxley Act She has

published articles in journals such as Decision Science, The Journal of Economics and

Psychol-ogy, and The Journal of Management Accounting Research Dr Mowen’s interests outside the

classroom include reading mysteries, traveling, and working crossword puzzles

Brief Contents

Part 1: Foundation Concepts 1

CHAPTER 1 Introduction to Cost Management 3

CHAPTER 2 Basic Cost Management Concepts 28

CHAPTER 3 Cost Behavior 67

CHAPTER 4 Activity-Based Costing 121

Part 2: Fundamental Costing and Control 178

CHAPTER 5 Product and Service Costing: Job-Order System 180

CHAPTER 6 Product and Service Costing: A Process Systems

Approach 226

CHAPTER 7 Allocating Costs of Support Departments and Joint

Products 276

CHAPTER 8 Budgeting for Planning and Control 325

CHAPTER 9 Standard Costing: A Functional-Based Control

Approach 382

CHAPTER 10 Decentralization: Responsibility Accounting,

Performance Evaluation, and Transfer Pricing 430

Part 3: Advanced Costing and Control 484

CHAPTER 11 Strategic Cost Management 486

CHAPTER 12 Activity-Based Management 548

CHAPTER 13 The Balanced Scorecard: Strategic-Based Control 590

CHAPTER 14 Quality Cost Management 621

CHAPTER 15 Productivity Measurement and Control 664

CHAPTER 16 Environmental Costs: Measurement and Control 695

Part 4: Decision Making 734

CHAPTER 17 Cost-Volume-Profit Analysis 736

CHAPTER 18 Activity Resource Usage Model and Tactical Decision

Making 781

CHAPTER 19 Pricing and Profitability Analysis 823

CHAPTER 20 Capital Investment 878

CHAPTER 21 Inventory Management: Economic Order Quantity,

JIT, and the Theory of Constraints 929

Glossary 967Subject Index 979Company Index 1003

Part 1: Foundation Concepts 1

CHAPTER 1 Introduction to Cost Management 3

Financial Accounting versus Cost Management 3Factors Affecting Cost Management 4

Global Competition 5 Growth of the Service Industry 5 Advances

in Information Technology 5 Advances in the Manufacturing Environment 6 Customer Orientation 8 New Product Development 8 Total Quality Management 8 Time as a Competitive Element 9 Efficiency 9

A Systems Approach 10Cost Management: A Cross-Functional Perspective 11

The Need for Flexibility 11 Behavioral Impact of Cost Information 12

The Role of Today’s Cost and Management Accountant 12

Line and Staff Positions 12 Information for Planning, Controlling, Continuous Improvement, and Decision Making 14

Accounting and Ethical Conduct 15

Benefits of Ethical Behavior 15 Standards of Ethical Conduct for Management Accountants 16

Cost Assignment: Direct Tracing, Driver Tracing, andAllocation 34

Cost Objects 35 Accuracy of Assignments 35

Product and Service Costs 37

Different Costs for Different Purposes 38 Product Costs and External Financial Reporting 39

External Financial Statements 41

Income Statement: Manufacturing Firm 42 Income Statement:

Basics of Cost Behavior 68

Measures of Activity Output 68 Fixed Costs 68 Variable Costs 70 Linearity Assumption 71 Mixed Costs 72 Time Horizon 73

Resources, Activities, and Cost Behavior 74

Flexible Resources 75 Committed Resources 75 Implications for Control and Decision Making 76 Step-Cost Behavior 77 Activities and Mixed Cost Behavior 79

Methods for Separating Mixed Costs into Fixed andVariable Components 80

The High-Low Method 81 Scatterplot Method 82 The Method of Least Squares 85 Using Regression Programs 87

Reliability of Cost Formulas 89

Hypothesis Test of Parameters 89 Goodness of Fit Measures 89 Confidence Intervals 90

Multiple Regression 93The Learning Curve and Nonlinear Cost Behavior 95

Cumulative Average-Time Learning Curve 95 Incremental Time Learning Curve 97

Unit-Managerial Judgment 98

CHAPTER 4 Activity-Based Costing 121

Unit-Level Product Costing 122

Overhead Assignment: Plantwide Rates 123 Disposition of Overhead Variances 124 Overhead Application: Departmental Rates 126

Limitations of Plantwide and Departmental Rates 127

Non-Unit-Related Overhead Costs 127 Product Diversity 128

An Example Illustrating the Failure of Unit-Based Overhead Rates 128

Activity-Based Costing System 133

Activity Identification, Definition, and Classification 134 Assigning Costs to Activities 138 Assigning Secondary Activity Costs to Primary Activities 139 Cost Objects and Bills of Activities 140 Activity Rates and Product Costing 140 Classifying Activities 142

Reducing the Size and Complexity of an ABC System 142

Approximately Relevant ABC Systems 143 Equally Accurate Reduced ABC Systems 144

ABC System Concepts 146

ABC Database 147 ABC and ERP Systems 148

Part 2: Fundamental Costing and Control 178

CHAPTER 5 Product and Service Costing:

Job-Order System 180

Characteristics of the Production Process 180

Manufacturing Firms versus Service Firms 181 Unique versus Standardized Products and Services 184

Setting Up the Cost Accounting System 185

Cost Accumulation 186 Cost Measurement 186 Cost Assignment 188 Choosing the Activity Level 190

The Job-Order Costing System: General Description 191

Overview of the Job-Order Costing System 191 Materials Requisitions 192 Job Time Tickets 193 Overhead Application 194 Unit Cost Calculation 195

Job-Order Costing: Specific Cost Flow Description 195

Accounting for Direct Materials 196 Accounting for Direct Labor Cost 196 Accounting for Overhead 198 Accounting for Finished Goods Inventory 199 Accounting for Cost of Goods Sold 201 Accounting for Nonmanufacturing Costs 203

Single versus Multiple Overhead Rates 204Appendix: Accounting for Spoilage in a Traditional Job-Order System 206

CHAPTER 6 Product and Service Costing: A Process Systems

Approach 226

Process-Costing Systems: Basic Operational and CostConcepts 226

Cost Flows 227 The Production Report 229 Unit Costs 230

Process Costing with No Work-in-Process Inventories 231

Service Organizations 231 JIT Manufacturing Firms 232 The Role of Activity-Based Costing 232

Process Costing with Ending Work-in-Process Inventories 233

Equivalent Units as Output Measures 233 Cost of Production Report Illustrated 234 Nonuniform Application of Productive Inputs 235 Beginning Work-in-Process Inventories 236

FIFO Costing Method 236

Step 1: Physical Flow Analysis 237 Step 2: Calculation of Equivalent Units 238 Step 3: Computation of Unit Cost 238 Step 4:

Valuation of Inventories 238 Step 5: Cost Reconciliation 239 Journal Entries 241

Weighted Average Costing Method 241

Step 1: Physical Flow Analysis 241 Step 2: Calculation of Equivalent Units 241 Step 3: Computation of Unit Cost 242 Step 4:

Valuation of Inventories 243 Step 5: Cost Reconciliation 243 Production Report 243 FIFO Compared with Weighted Average 243

Treatment of Transferred-In Goods 245

Step 1: Physical Flow Schedule 247 Step 2: Calculation of Equivalent Units 247 Step 3: Computation of Unit Costs 247 Step 4: Valuation of Inventories 247

Operation Costing 249

Basics of Operation Costing 249 Operation Costing Example 250

Appendix: Spoiled Units 252

CHAPTER 7 Allocating Costs of Support Departments and Joint

Products 276

An Overview of Cost Allocation 276

Types of Departments 277 Types of Allocation Bases 279 Objectives of Allocation 280

Allocating One Department’s Costs to Another Department 282

A Single Charging Rate 282 Dual Charging Rates 283 Budgeted versus Actual Usage 285 Fixed versus Variable Bases: A Note of Caution 287

of the Three Methods 294

Departmental Overhead Rates and Product Costing 295Accounting for Joint Production Processes 296

Cost Separability and the Need for Allocation 297 Distinction and Similarity between Joint Products and By-Products 298 Accounting for Joint Product Costs 299 Allocation Based on Relative Market Value 301

CHAPTER 8 Budgeting for Planning and Control 325

The Role of Budgeting in Planning and Control 326

Purposes of Budgeting 326 The Budgeting Process 327 Gathering Information for Budgeting 329

Preparing the Operating Budget 331

Operating Budgets for Merchandising and Service Firms 337

Preparing the Financial Budget 338

The Cash Budget 338 Budgeted Balance Sheet 342 Shortcomings

of the Traditional Master Budgeting Process 342

Flexible Budgets for Planning and Control 345

Static Budgets versus Flexible Budgets 345

Activity-Based Budgets 351The Behavioral Dimension of Budgeting 355

Characteristics of a Good Budgetary System 356

CHAPTER 9 Standard Costing: A Functional-Based Control

Approach 382

Developing Unit Input Standards 383

Establishing Standards 383 Usage of Standard Costing Systems 384

Standard Cost Sheets 385Variance Analysis and Accounting: Direct Materials andDirect Labor 387

Calculating Direct Materials Price and Usage Variances 388 Accounting for Direct Materials Price and Usage Variances 391 Calculating Direct Labor Variances 391 Accounting for the Direct Labor Rate and Efficiency Variances 393 Investigating Direct Materials and Labor Variances 393 Disposition of Direct Materials and Direct Labor Variances 395

Variance Analysis: Overhead Costs 396

Four-Variance Method: The Two Variable Overhead Variances 396 Four-Variance Analysis: The Two Fixed Overhead Variances 400 Accounting for Overhead Variances 404 Two- and Three-Variance Analyses 405

Mix and Yield Variances: Materials and Labor 407

Direct Materials Mix and Yield Variances 407 Direct Labor Mix and Yield Variances 408

CHAPTER 10 Decentralization: Responsibility Accounting,

Performance Evaluation, and Transfer Pricing 430

Responsibility Accounting 431

Types of Responsibility Centers 431 The Role of Information and Accountability 431

Decentralization 432

Reasons for Decentralization 432 The Units of Decentralization 434

Measuring the Performance of Investment Centers 435

Return on Investment 435 Residual Income 439 Economic Value Added 441 Multiple Measures of Performance 444

Measuring and Rewarding the Performance of Managers 445

Incentive Pay for Managers—Encouraging Goal Congruence 445 Managerial Rewards 445 Measuring Performance in the Multinational Firm 448

Transfer Pricing 450

The Impact of Transfer Pricing on Income 450

Setting Transfer Prices 451

Market Price 451 Negotiated Transfer Prices 452 Cost-Based Transfer Prices 457 Transfer Pricing and the Multinational Firm 459

Part 3: Advanced Costing and Control 484

CHAPTER 11 Strategic Cost Management 486

Strategic Cost Management: Basic Concepts 487

Strategic Positioning: The Key to Creating and Sustaining a Competitive Advantage 487 Value-Chain Framework, Linkages, and Activities 489 Organizational Activities and Cost Drivers 491 Operational Activities and Drivers 492

Value-Chain Analysis 493

Exploiting Internal Linkages 493 Exploiting Supplier Linkages 496 Exploiting Customer Linkages 498

Life-Cycle Cost Management 501

Product Life-Cycle Viewpoints 501 Interactive Viewpoint 503 Role

of Target Costing 507

Just-In-Time (JIT) Manufacturing and Purchasing 509

Inventory Effects 510 Plant Layout 511 Grouping of Employees 512 Employee Empowerment 513 Total Quality Control 513

JIT and Its Effect on the Cost Management System 513

Traceability of Overhead Costs 514 Product Costing 515 JIT’s Effect on Job-Order and Process-Costing Systems 516 Backflush Costing 516

CHAPTER 12 Activity-Based Management 548

The Relationship of Based Costing and Based Management 549

Activity-Process Value Analysis 550

Driver Analysis: Defining Root Causes 550 Activity Analysis: Identifying and Assessing Value Content 550 Assessing Activity Performance 553

Financial Measures of Activity Efficiency 554

Reporting Value- and Non-Value-Added Costs 554 Trend Reporting

of Non-Value-Added Costs 556 Drivers and Behavioral Effects 557 The Role of Kaizen Standards 557 Benchmarking 558 Activity Flexible Budgeting 559 Activity Capacity Management 562

Implementing Activity-Based Management 563

Discussion of the ABM Implementation Model 563 Why ABM Implementations Fail 565

Financial-Based versus Activity-Based ResponsibilityAccounting 566

Assigning Responsibility 567 Establishing Performance Measures 568 Evaluating Performance 569 Assigning Rewards 570

CHAPTER 13 The Balanced Scorecard: Strategic-Based Control 590

Activity-Based versus Strategic-Based ResponsibilityAccounting 591

Assigning Responsibility 592 Establishing Performance Measures 592 Performance Measurement and Evaluation 594 Assigning

Rewards 595

Basic Concepts of the Balanced Scorecard 595

Strategy Translation 595 The Financial Perspective, Objectives, and Measures 596 Customer Perspective, Objectives, and Measures 598 Process Perspective, Objectives, and Measures 599 Learning and Growth Perspective 602

Linking Measures to Strategy 603

The Concept of a Testable Strategy 604 Strategic Feedback 605

Reporting Quality Costs 628

Quality Cost Reports 628 Distribution of Quality Costs: The Acceptable Quality View 628 Distribution of Quality Costs: Zero- Defects View 630 The Role of Activity-Based Cost Management 632

Quality Cost Information and Decision Making 633

Decision Making Contexts 633 Certifying Quality Through ISO 9000 635

Controlling Quality Costs 637

Choosing the Quality Standard 637 Types of Quality Performance Reports 639

Contents

CHAPTER 15 Productivity Measurement and Control 664

Productive Efficiency 665Partial Productivity Measurement 665

Partial Productivity Measurement Defined 666 Partial Measures and Measuring Changes in Productive Efficiency 667 Advantages of Partial Measures 668 Disadvantages of Partial Measures 668

Total Productivity Measurement 668

Profile Productivity Measurement 668 Profit-Linked Productivity Measurement 670 Price-Recovery Component 672

Measuring Changes in Activity and Process Efficiency 672

Activity Productivity Analysis 673 Process Productivity Analysis 675 Process Productivity Model 676 Quality and Productivity 679

CHAPTER 16 Environmental Costs: Measurement and Control 695

Defining, Measuring, and Controlling Environmental Costs 696

The Ecoefficiency Paradigm 696 Competing Paradigms 698 Environmental Costs Defined 699 Environmental Cost Report 700 Environmental Cost Reduction 702 An Environmental Financial Report 704

Environmental Costing 705

Environmental Product Costs 705 Unit-Based Environmental Cost Assignments 705 Activity-Based Environmental Cost Assignments 706

Life-Cycle Cost Assessment 707

Product Life Cycle 707 Assessment Stages 708

Strategic-Based Environmental Responsibility Accounting 711

Environmental Perspective 711 The Role of Activity Management 713

Part 4: Decision Making 734

CHAPTER 17 Cost-Volume-Profit Analysis 736

The Break-Even Point in Units 737

Operating-Income Approach 737 Contribution-Margin Approach 738 Profit Targets 739 After-Tax Profit Targets 740

Break-Even Point in Sales Dollars 741

Profit Targets 744 Comparison of the Two Approaches 745

Multiple-Product Analysis 745

Break-Even Point in Units 745 Sales Dollars Approach 748

Graphical Representation of CVP Relationships 749

The Profit-Volume Graph 749 The Cost-Volume-Profit Graph 749 Assumptions of Cost-Volume-Profit Analysis 751

Changes in the CVP Variables 753

Introducing Risk and Uncertainty 755 Sensitivity Analysis and CVP 759

CVP Analysis and Activity-Based Costing 759

Example Comparing Conventional and ABC Analysis 760 Strategic Implications: Conventional CVP Analysis versus ABC Analysis 761 CVP Analysis and JIT 762

CHAPTER 18 Activity Resource Usage Model and Tactical Decision

Making 781

Tactical Decision Making 782

The Tactical Decision-Making Process 782 Qualitative Factors 784

Relevant Costs and Revenues 785

Relevant Costs Illustrated 785 Irrelevant Cost Illustrated 786 Relevant Costs and Benefits in International Trade 786

Relevancy, Cost Behavior, and the Activity Resource UsageModel 788

Flexible Resources 788 Committed Resources 788

Illustrative Examples of Tactical Decision Making 790

Make-or-Buy Decisions 790 Keep-or-Drop Decisions 794 Order Decisions 797 Decisions to Sell or Process Further 799 Relevant Costing and Ethical Behavior 801

Special-CHAPTER 19 Pricing and Profitability Analysis 823

Basic Pricing Concepts 824

Demand and Supply 824 Price Elasticity of Demand 824 Market Structure and Price 825

Pricing Policies 826

Cost-Based Pricing 826 Target Costing and Pricing 828 Other Pricing Policies 829

The Legal System and Pricing 829

Predatory Pricing 829 Price Discrimination 830 Ethics 831

Measuring Profit 832

Reasons for Measuring Profit 832 Absorption-Costing Approach to Measuring Profit 834 Variable-Costing Approach to Measuring Profit 836

Profitability of Segments 839

Profit by Product Line 839 Divisional Profit 843 Customer Profitability 843 Overall Profit 845

Analysis of Profit-Related Variances 846

Sales Price and Price Volume Variances 846 Contribution Margin Variance 847 Market Share and Market Size Variances 848

The Product Life Cycle 849Limitations of Profit Measurement 852

CHAPTER 20 Capital Investment 878

Capital Investment Decisions 879Payback and Accounting Rate of Return: NondiscountingMethods 881

Payback Period 881 Accounting Rate of Return 883

Contents

The Net Present Value Method 883

The Meaning of NPV 884 Weighted Average Cost of Capital 884

An Example Illustrating Weighted Average Cost of Capital 885

Internal Rate of Return 885

Example with Uniform Cash Flows 885 IRR and Uneven Cash Flows 887

NPV versus IRR: Mutually Exclusive Projects 887

NPV Compared with IRR 888 Example: Mutually Exclusive Projects 890

Computing After-Tax Cash Flows 890

Inflationary Adjustments 892 Conversion of Gross Cash Flows to After-Tax Cash Flows 892

Capital Investment: Advanced Technology andEnvironmental Considerations 899

How Investment Differs 900 How Estimates of Operating Cash Flows Differ 900 An Example: Investing in Advanced

Technology 901 Salvage Value 902 Discount Rates 903

Appendix A: Present Value Concepts 905

Future Value 905 Present Value 906 Present Value of an Uneven Series of Cash Flows 906 Present Value of a Uniform Series of Cash Flows 907

Appendix B: Present Value Tables 908

CHAPTER 21 Inventory Management: Economic Order Quantity,

JIT, and the Theory of Constraints 929

Just-in-Case Inventory Management 930

Justifying Inventory 930 Economic Order Quantity: A Model for Balancing Acquisition and Carrying Costs 931 Calculating EOQ 932 When to Order or Produce 933 Demand Uncertainty and

Reordering 933 An Example Involving Setups 934 EOQ and Inventory Management 934

JIT Inventory Management 935

A Pull System 936 Setup and Carrying Costs: The JIT Approach 937 Due-Date Performance: The JIT Solution 938 Avoidance of Shutdown and Process Reliability: The JIT Approach 938 Discounts and Price Increases: JIT Purchasing versus Holding Inventories 941 JIT’s Limitations 941

Basic Concepts of Constrained Optimization 943

One Binding Internal Constraint 943 Internal Binding Constraint and External Binding Constraint 944 Multiple Internal Binding Constraints 944

Theory of Constraints 947

Operational Measures 947 Five-Step Method for Improving Performance 949

Glossary 967 Subject Index 979 Company Index 1003

Cost Management

Accounting and Control

P A R T 1

h t t p : / / h a n s e n s w l e a r n i n g c o m

1 Introduction To Cost Management

2 Basic Cost Management Concepts

3

Introduction to Cost Management

AFTER STUDYING THIS CHAPTER, YOU SHOULD BE ABLE TO:

1. List the similarities and differences between financial accounting and cost management

2. Identify the current factors affecting cost agement

man-3. Discuss the importance of the accounting systemfor internal and external reporting

4. Discuss the need for today’s cost accountant toacquire cross-functional expertise

5. Describe how management accountants functionwithin an organization

6. Understand the importance of ethical behaviorfor management accountants

7. Identify the three forms of certification available

to internal accountants

Financial Accounting versus Cost Management

The accounting information system within an organization has two major subsystems: a financial accountingsystem and a cost management accounting system One of the major differences between the two systems

is the targeted user Financial accountingis devoted to providing information for external users, ing investors, creditors (e.g., banks and suppliers), and government agencies These external users find theinformation helpful in making decisions to buy or sell shares of stock, buy bonds, issue loans and regula-tory acts, and in making other financial decisions Because the information needs of this group of external

includ-C H

A P

T E R

users are so diverse and the information must be so highly reliable, the financial

ac-counting system is designed in accordance with clearly defined acac-counting rules and

formats, or generally accepted accounting principles (GAAP) Cost management

pro-duces information for internal users Specifically, cost management identifies, collects,

measures, classifies, and reports information that is useful to managers for determining

the cost of products, customers, and suppliers, and other relevant objects and for

plan-ning, controlling, making continuous improvements, and decision making

Cost management has a much broader focus than that found in traditional costingsystems It is not only concerned with how much something costs but also with the

factors that drive costs, such as cycle time, quality, and process productivity Thus, cost

management requires a deep understanding of a firm’s cost structure Managers must

be able to determine the long- and short-run costs of activities and processes as well as

the costs of goods, services, customers, suppliers, and other objects of interest Causes

of these costs are also carefully studied

The costs of activities and processes do not appear on the financial statements Yet,knowing these costs and their underlying causes is critical for companies engaging in

such tasks as continuous improvement, total quality management, environmental cost

management, productivity enhancement, and strategic cost management

Cost management encompasses both the cost accounting and the management counting information systems Cost accounting attempts to satisfy costing objectives for

ac-both financial and management accounting When cost accountingis used to comply

with a financial accounting objective, it measures and assigns costs in accordance with

GAAP When used for internal purposes, cost accounting provides cost information

about products, customers, services, projects, activities, processes, and other details that

may be of interest to management The cost information provided plays an important

support role for planning, controlling, and decision making This information need not,

and often should not, follow GAAP

Management accountingis concerned specifically with how cost information andother financial and nonfinancial information should be used for planning, controlling,

continuous improvement, and decision making Management accounting has an

over-all objective of making sure that organizations make effective use of resources so that

value is maximized for shareholders and customers and other interested shareholders

Porsche,Stihl,DaimlerChrysler,and other German companies view management

ac-counting as a distinct discipline and typically employ as many or more staff in

man-agement accounting as in financial accounting.1

It should be emphasized that both the cost management information system andthe financial accounting information system are part of the total accounting informa-

tion system Unfortunately, the content of the cost management accounting system is

all too often driven by the needs of the financial accounting system The reports of both

cost management and financial accounting are frequently derived from the same

data-base, which was originally established to support the reporting requirements of

finan-cial accounting Many organizations need to expand this database, or create additional

databases, in order to satisfy more fully the needs of internal users For example, a firm’s

profitability is of interest to investors, but managers need to know the profitability of

individual products The accounting system should be designed to provide both total

profits and profits for individual products The key point here is flexibility—the

ac-counting system should be able to supply different data for different purposes

Factors Affecting Cost Management

Over the last 25 years, worldwide competitive pressures, deregulation, growth in the

service industry, and advances in information and manufacturing technology have

List the ties and differ- ences between financial account- ing and cost management.

similari-O BJ

EC TIV E 1

1 Paul A Sharman, “German Cost Accounting,” Strategic Finance (December 2003): 30–38.

Identify the rent factors affecting cost management.

cur-O BJ

EC TIV E 2

changed the nature of our economy and caused many manufacturing and service dustries to dramatically change the way in which they operate These changes, in turn,have prompted the development of innovative and relevant cost management practices.

in-For example, activity-based accounting systems have been developed and implemented

in many organizations Additionally, the focus of cost management accounting systemshas been broadened to enable managers to better serve the needs of customers andmanage the firm’s business processes that are used to create customer value A firm canestablish a competitive advantage by providing more customer value for less cost thanits competitors To secure and maintain a competitive advantage, managers seek to im-prove time-based performance, quality, and efficiency Accounting information must beproduced to support these three fundamental organizational goals

Global Competition

Vastly improved transportation and communication systems have led to a global marketfor many manufacturing and service firms Several decades ago, firms neither knew norcared what similar firms in Japan, France, Germany, and Singapore were producing

These foreign firms were not competitors since their markets were separated by graphical distance Now, both small and large firms are affected by the opportunities of-fered by global competition Stillwater Designs, a small firm that designs and marketsKicker speakers, has significant markets in Europe The manufacture of the Kicker speak-ers is mostly outsourced to Asian producers At the other end of the size scale, Procter

geo-& Gamble,The Coca-Cola Company,andMars, Inc., are developing sizable markets

in China Automobiles, currently being made in Japan, can be in the United States intwo weeks Investment bankers and management consultants can communicate with for-eign offices instantly Improved transportation and communication in conjunction withhigher quality products that carry lower prices have upped the ante for all firms Thisnew competitive environment has increased the demand not only for more cost infor-mation but also for more accurate cost information Cost information plays a vital role

in reducing costs, improving productivity, and assessing product-line profitability

Growth of the Service Industry

As traditional industries have declined in importance, the service sector of the economyhas increased in importance The service sector now comprises approximately three-quarters of the U.S economy and employment Many services—among them account-ing services, transportation, and medical services—are exported Experts predict that thissector will continue to expand in size and importance as service productivity grows Dereg-ulation of many services (e.g., airlines and telecommunications in the past and utilities inthe present) has increased competition in the service industry Many service organizationsare scrambling to survive The increased competition has made managers in this industrymore conscious of the need to have accurate cost information for planning, controlling,continuous improvement, and decision making Thus, the changes in the service sectoradd to the demand for innovative and relevant cost management information

Advances in Information Technology

Three significant advances relate to information technology One is intimately connectedwith computer-integrated applications With automated manufacturing, computers areused to monitor and control operations Because a computer is being used, a consid-erable amount of useful information can be collected, and managers can be informedabout what is happening within an organization almost as it happens It is now possi-ble to track products continuously as they move through the factory and to report (on

a real-time basis) such information as units produced, material used, scrap generated,and product cost The outcome is an operational information system that fully inte-grates manufacturing with marketing and accounting data

Enterprise resource planning (ERP) softwarehas the objective of providing anintegrated system capability—a system that can run all the operations of a company andprovide access to real-time data from the various functional areas of a company Usingthis real-time data enables managers to continuously improve the efficiency of organi-zational units and processes To support continuous improvement, information that istimely, accurate, and detailed is needed.

Automation and integration increase both the quantity (detail) and the timeliness

of information For managers to fully exploit the value of the more complex tion system, they must have access to the data of the system—they must be able to ex-tract and analyze the data from the information system quickly and efficiently This, inturn, implies that the tools for analysis must be powerful

informa-The second major advance supplies the required tools: the availability of personalcomputers (PCs), online analytic programs (OLAP), and decision-support systems(DSS) The PC serves as a communications link to the company’s information system,and OLAP and DSS supply managers with the capability to use that information PCsand software aids are available to managers in all types of organizations Often, a PCacts as a networking terminal and is connected to an organization’s database, allowingmanagers to access information more quickly, do their own analyses, and prepare many

of their own reports The ability to enhance the accuracy of product costing is nowavailable Because of advances in information technology, cost accountants have theflexibility to respond to the managerial need for more complex product costing meth-ods such as activity-based costing (ABC)

ABC software is classified as online analytic software Online analytic applicationsfunction independently of an organization’s core transactions but at the same time aredependent on the data resident in an ERP system.2ABC software typically interfaceswith DSS software and other online analytic software to facilitate applications such ascost estimating, product pricing, and planning and budgeting This vast computing ca-pability now makes it possible for accountants to generate individualized reports on anas-needed basis Many firms have found that the increased responsiveness of a con-temporary cost management system has allowed them to realize significant cost savings

by eliminating the huge volume of internally generated monthly financial reports.The third major advance is the emergence of electronic commerce Electronic com- merce (e-commerce) is any form of business that is executed using information andcommunications technology Internet trading, electronic data interchange, and bar cod-ing are examples of e-commerce Internet trading allows buyers and sellers to come to-gether and execute transactions from diverse locations and circumstances Internet tradingallows a company to act as a virtual organization, thus reducing overhead Electronic data interchange (EDI)involves the exchange of documents between computers usingtelephone lines and is widely used for purchasing and distribution The sharing of in-formation among trading partners reduces costs and improves customer relations, thusleading to a stronger competitive position EDI is an integral part of supply chain man-agement (value-chain management) Supply chain managementis the management ofproducts and services from the acquisition of raw materials through manufacturing, ware-housing, distribution, wholesaling, and retailing The emergence of EDI and supply chainmanagement has increased the importance of costing out activities in the value chain anddetermining the cost to the company of different suppliers and customers

Advances in the Manufacturing Environment

Manufacturing management approaches such as the theory of constraints and time have allowed firms to increase quality, reduce inventories, eliminate waste, and re-

just-in-2 R Shaw, “ABC and ERP: Partners at Last?” Management Accounting (November 1998): 56–58.

duce costs Automated manufacturing has produced similar outcomes The impact ofimproved manufacturing technology and practices on cost management is significant.

Product costing systems, control systems, allocation, inventory management, cost ture, capital budgeting, variable costing, and many other accounting practices are be-ing affected

Just-in-Time Manufacturing

A demand-pull system, just-in-time (JIT) manufacturingstrives to produce a uct only when it is needed and only in the quantities demanded by customers Demand,measured by customer orders, pulls products through the manufacturing process Eachoperation produces only what is necessary to satisfy the demand of the succeeding op-eration No production takes place until a signal from a succeeding process indicatesthe need to produce Parts and materials arrive just in time to be used in production

prod-JIT manufacturing typically reduces inventories to much lower levels (theoretically

to insignificant levels) than those found in conventional systems, increases the sis on quality control, and produces fundamental changes in the way production is or-ganized and carried out Basically, JIT manufacturing focuses on continual improvement

empha-by reducing inventory costs and dealing with other economic problems Reducing ventories frees up capital that can be used for more productive investments Increasingquality enhances the competitive ability of the firm Finally, changing from a traditionalmanufacturing setup to JIT manufacturing allows the firm to focus more on qualityand productivity and, at the same time, allows a more accurate assessment of what itcosts to produce products

in-Computer-Integrated Manufacturing

Automation of the manufacturing environment allows firms to reduce inventory, crease productive capacity, improve quality and service, decrease processing time, andincrease output Automation can produce a competitive advantage for a firm The im-plementation of an automated manufacturing facility typically follows JIT and is a re-sponse to the increased needs for quality and shorter response times As more firmsautomate, competitive pressures will force other firms to do likewise For many manu-facturing firms, automation may be equivalent to survival

in-The three possible levels of automation are (1) the stand-alone piece of equipment,(2) the cell, and (3) the completely integrated factory Before a firm attempts any level

of automation, it should first do all it can to produce a more focused, simplified ufacturing process For example, most of the benefits of going to a completely inte-grated factory can often be achieved simply by implementing JIT manufacturing

If automation is justified, it may mean installation of a computer-integrated ufacturing (CIM) system CIM implies the following capabilities: (1) the products are

man-designed through the use of a assisted design (CAD) system; (2) a assisted engineering (CAE) system is used to test the design; (3) the product is manu-factured using a computer-assisted manufacturing (CAM) system (CAMs usecomputer-controlled machines and robots); and (4) an information system connects thevarious automated components.

computer-A particular type of Ccomputer-AM is the flexible manufacturing system Flexible turing systems are capable of producing a family of products from start to finish usingrobots and other automated equipment under the control of a mainframe computer.This ability to produce a variety of products with the same set of equipment is clearlyadvantageous

manufac-Customer Orientation

Firms are concentrating on the delivery of value to the customer with the objective ofestablishing a competitive advantage Accountants and managers refer to a firm’s value chain as the set of activities required to design, develop, produce, market, and deliverproducts and services to customers As a result, a key question to be asked about anyprocess or activity is whether it is important to the customer The cost managementsystem must track information relating to a wide variety of activities important to cus-tomers (e.g., product quality, environmental performance, new product development,and delivery performance) Customers now count the delivery of the product or service

as part of the product Companies must compete not only in technological and ufacturing terms but also in terms of the speed of delivery and response Firms like Fed- eral Expresshave exploited this desire by identifying and developing a market the U.S Post Officecould not serve

man-Companies have internal customers as well The staff functions of a company exist

to serve the line functions The accounting department creates cost reports for duction managers Accounting departments that are “customer driven” assess the value

pro-of the reports to be sure that they communicate significant information in a timely andreadable fashion Reports that do not measure up are dropped

New Product Development

A high proportion of production costs are committed during the development and sign stage of new products The effects of product development decisions on other parts

de-of the firm’s value chain are now widely acknowledged This recognition has produced

a demand for more sophisticated cost management procedures relating to new productdevelopment—procedures such as target costing and activity-based management Tar- get costing encourages managers to assess the overall cost impact of product designsover the product’s life cycle and simultaneously provides incentives to make designchanges to reduce costs Activity-based managementidentifies the activities produced

at each stage of the development process and assesses their costs Activity-based agement is complimentary to target costing because it enables managers to identify theactivities that do not add value and then eliminate them so that overall life cycle costscan be reduced

man-Total Quality Management

Continuous improvement and elimination of waste are the two foundation principlesthat govern a state of manufacturing excellence Manufacturing excellence is the key tosurvival in today’s world-class competitive environment Producing products and servicesthat actually perform according to specifications and with little waste are the twin ob-jectives of world-class firms A philosophy of total quality management, in which man-agers strive to create an environment that will enable organizations to produce defect-freeproducts and services, has replaced the acceptable quality attitudes of the past

The emphasis on quality applies to services as well as products Boeing Aerospace Support (AS) provides maintenance and training support for Boeing aircraft From

1999 to 2003, AS significantly improved the quality of its services From 1998 to 2003,the “exceptional” and “very good” responses on customer satisfaction surveys increased

by more than 23 percent On-time delivery of maintenance services was about 95 cent For one program, the turn-around time was about three days for AS, while itscompetitors were taking up to 40 days for the same services As a consequence of theimproved quality, AS more than doubled its revenues from 1999 to 2003 (especiallyimpressive given that the market growth was flat during this period) The company alsoreceived the 2003 Malcolm Baldrige National Quality Award in the service category.3The message is clear Pursuing an objective of improving quality promises majorbenefits Cost management supports this objective by providing crucial information con-cerning quality-related activities and quality costs Managers need to know which quality-related activities add value and which ones do not They also need to know what qualitycosts are and how they change over time

per-Time as a Competitive Element

Time is a crucial element in all phases of the value chain Firms can reduce time to ket by redesigning products and processes, by eliminating waste, and by eliminatingnon-value-added activities Firms can reduce the time spent on delivery of products orservices, reworking a product, and unnecessary movements of materials andsubassemblies

mar-Decreasing non-value-added time appears to go hand-in-hand with increasing ity With quality improvements, the need for rework decreases, and the time to pro-duce a good product decreases The overall objective is to increase customerresponsiveness

qual-Time and product life cycles are related The rate of technological innovation hasincreased for many industries, and the life of a particular product can be quite short

Managers must be able to respond quickly and decisively to changing market tions Information to allow them to accomplish this goal must be available Hewlett- Packard has found that it is better to be 50 percent over budget in new productdevelopment than to be six months late This correlation between cost and time is apart of the cost management system

condi-Efficiency

While quality and time are important, improving these dimensions without sponding improvements in financial performance may be futile, if not fatal Improvingefficiency is also a vital concern Both financial and nonfinancial measures of efficiencyare needed Cost is a critical measure of efficiency Trends in costs over time and mea-sures of productivity changes can provide important measures of the efficacy of con-tinuous improvement decisions For these efficiency measures to be of value, costs must

corre-be properly defined, measured, and accurately assigned

Production of output must be related to the inputs required, and the overall nancial effect of productivity changes should be calculated Activity-based costing andprofit-linked productivity measurement are responses to these demands Activity-basedcosting is a relatively new approach to cost accounting that provides more accurate andmeaningful cost assignments By analyzing underlying activities and processes, elimi-nating those that do not add value, and enhancing those that do add value, dramaticincreases in efficiency can be realized

fi-3 As reported at http://www.nist.gov/public_affairs/releases/2003baldrigewinners.htm on May 5, 2004.