Solution manual cost accounting 8th by kinney chapter 12

SM Cost Accounting 8th Edition by Raiborn and Terminology Black box: an operation whose exact nature cannot be observed Cost management system CMS: a set of formal methods developed for

Learning Objectives

After reading and studying Chapter 12, you should be able to answer the following questions:

1 Why do organizations have management control systems?

2 What is a cost management system?

3 What are the organizational roles of a cost management system?

4 What factors influence the design of a cost management system?

5 What are the three groups of elements that comprise a cost management system, and

what are the purposes of these elements?

6 What is gap analysis and how is it used in the evolution of a cost management system?

INTRODUCTION TO COST MANAGEMENT SYSTEMS CHAPTER

12

©2011 Cengage Learning All Rights Reserved SM Cost Accounting 8th Edition by Raiborn and

Terminology Black box: an operation whose exact nature cannot be observed

Cost management system (CMS): a set of formal methods developed for planning and controlling

an organization’s cost-generating activities relative to its short term objectives and long term

strategies

Cost structure: the relative composition of an organization’s fixed and variable costs and, thus, how

costs change relative to changes in production or sales volume

Enterprise resource planning (ERP) systems: packaged business software systems usually

involving a large number of separate modules that collect data from individual processes in the firm (sales, shipping, distribution, and so forth) and assemble that data in a form accessible by all

managers

Gap analysis: the study of the differences between two information systems, often a current system

and a proposed system

Management control system (MCS): an information system that helps managers gather

information about actual organizational occurrences, make comparisons against plans, effect changes when they are necessary, and communicate among appropriate parties; it should serve to guide organizations in designing and implementing strategies so that organizational goals and objectives are achieved

Management information system (MIS): a structure of interrelated elements that collects,

organizes, and communicates data to managers to help them plan, control, make decisions, and evaluate performance

Organizational culture: the underlying set of assumptions about the entity and the goals,

processes, practices, and values that its members share

Organizational form: an entity’s legal nature (for example, sole proprietorship, partnership,

corporation)

Profit sharing: an incentive payment to employees that is contingent on the level of organizational

profit generated

Radio frequency identification (RFID): a process that uses exceptionally small “flakes” of silicon to

transmit a code for the item to which it is attached; used for bar code readers

Lecture Outline

LO.1: Why do organizations have management control systems?

A Introduction

1 A fundamental concern of managers is identifying levers that affect organizational costs and benefits

2 Managers use models and information systems to improve their understanding of costs and benefits and to identify drivers of costs and revenues

3 Even though directly linked to the managerial functions of planning, controlling, decision making, and performance evaluation, cost accounting information is frequently found to be of limited value to managers because that information is shaped by the more dominant

financial reporting demands

4 In designing cost accounting systems, the general internal use of information and the

specific application of information to manage costs are receiving increased attention

5 This chapter introduces management information and control systems, which offer a

foundation and context for understanding the roles of the cost management system (CMS),

a system first introduced in Chapter 2

a The chapter also discusses concepts and approaches to designing information systems that support the internal use of accounting and other information to manage costs, giving particular emphasis to the main factors that determine the structure and success of a CMS, the factors that influence the design of such a system, and the elements that compose the system

B Introduction to Management Information and Control Systems

1 A Cost Management System (CMS) is part of an overall management information and control system

2 Text Exhibit 12-1 illustrates the types of information needed in an organization to meet the

requirements of individuals in performing their managerial functions as well as requirements

of external parties in performing their investment and credit-granting functions

3 A management information system (MIS) is a structure of interrelated elements used to

collect, organize, and communicate data to managers so they can plan, control, make decisions and evaluate performance

a The emphasis in an MIS is satisfying internal demands for information rather than external demands

b In most modern organizations, the MIS is computerized for ease of access to

information, reliability of input and processing, and ability to simulate outcomes of alternative situations

©2011 Cengage Learning All Rights Reserved SM Cost Accounting 8th Edition by Raiborn and

4 The accounting function is charged with the task of providing information to interested external parties such as creditors and suppliers relative to payments and purchases as well

as to the government for mandatory reporting to regulatory agencies

5 Managers use internally and externally generated information to manage their organizations

6 The MIS is part of the management control system

a As illustrated in text Exhibit 12-2, a control system has the following four primary

components:

i a detector or sensor, which is a measuring device that identifies what is actually

happening in the process being controlled;

ii an assessor, which is a device for determining the significance of what is happening

Usually, significance is assessed by comparing the information on what is actually happening with some standard or expectation of what should be happening;

iii an effector, which is a device that alters behavior if the assessor indicates the need

for doing so This device is often called “feedback;” and

iv a communications network, which transmits information between the detector and

the assessor and between the assessor and the effector

b A management control system is not merely a mechanical process, it also requires the application of judgment

i Thus, a management control system can be referred to as a black box, which is

defined as an operation whose exact nature cannot be observed

LO 2: What is a cost management system?

C Defining a Cost Management System

1 A cost management system (CMS) consists of a set of formal methods developed for

planning and controlling an organization’s cost-generating activities relative to its short term objectives and long term strategies

2 An effective CMS helps managers face two major challenges:

a achieving profitability In the short-run; and

b maintaining a competitive position in the long-run

3 Text Exhibit 12-3 illustrates the organizational role of a cost management system which is

providing information useful for managing the organization’s core competencies

4 Text Exhibit 12-4 summarizes the differences in the information requirements for

organizational success in the short-run and long-run

5 Text Exhibit 12-5 illustrates how a CMS should integrate information from all areas of the

firm and provide managers faster access to more cost information that is relevant, detailed, and appropriate for short-and-long-term decision making

LO.3: What are the organizational roles of a cost management system?

D The Roles of a Cost Management System

1 A CMS can be viewed as having six primary goals:

a to develop reasonably accurate product costs, especially through the use of cost drivers;

b to assess product/service life-cycle performance;

c to improve understanding of processes and activities;

d to control costs;

e to measure performance; and

f to allow the pursuit of organizational strategies

2 A CMS should primarily provide the means of developing accurate product or service costs

a Thus, the system must be designed to use cost driver information to trace costs to products and services

b Traceability has been made easier by improved information technology, including bar

coding and radio frequency identification (RFID), which uses exceptionally small

“flakes” of silicon to transmit a code for the item to which it is attached

3 The product/service costs generated by the CMS constitute the input to managerial

processes and such costs are used to plan, prepare financial statements, assess individual product/service profitability and period profitability, establish prices for cost-plus contracts, and create a basis for performance measurements

4 The financial accounting system does not reflect life-cycle information

a The CMS should provide information about the life-cycle performance of a product or service Without life-cycle information, managers will not have a basis to relate costs incurred in one part of the life cycle to costs and profitability of other parts

5 A CMS should help managers understand business processes and organizational activities

so that they can make cost-beneficial improvements in production and processing systems

6 The cost accounting system’s original purpose was to control costs, and in today’s global competitive environment, that is still an important function

a A cost can be controlled only when the related activity is monitored, the cost driver is known, and the information is available

7 The information produced by a CMS should help managers measure and evaluate

performance

8 To maintain its competitive position, a firm must generate information necessary to define and implement its organizational strategies Therefore, the CMS must be flexible

©2011 Cengage Learning All Rights Reserved SM Cost Accounting 8th Edition by Raiborn and

LO.4: What factors influence the design of a cost management system?

E Designing a Cost Management System

1 The CMS must be tailored to the unique characteristics of the firm

a Some overriding factors important in designing a CMS are shown in text Exhibit 12-6

and described in the text

2 Organizational form, structure, and culture

a An entity’s legal nature is reflected in its organizational form A firm may operate in the

form of a corporation, a general partnership, a limited partnership, a limited liability partnership (LLP), and a limited liability company (LLC)

b Organizational structure refers to how authority and responsibility for decision making

are distributed in an entity

i Although the current competitive environment is conducive to a high degree of delegation, top managers usually retain authority over operations that can be performed more economically centrally because of scale economies

ii In designing the organizational structure, top managers normally try to group subunits either geographically or by similar missions or natural product clusters These aggregation processes provide effective cost management because of proximity or similarity of the subunits under a single manager’s control

iii Text Exhibit 12-7 describes the three generic missions that business subunits can

pursue (build, harvest, or hold)

 Subunits pursuing a “build” mission use more cash than they generate Such subunits invest cash today with an expectation of future returns These are the high growth oriented subunits of the firm

 At the other extreme, subunits pursuing a “harvest” mission are expected to generate excess cash and have a much shorter investment horizon

 Between the build and harvest missions is the hold mission which applies to those subunits that are pursuing a balance between growth and profit generation

iv The extent to which managers delegate also determines who will be held

accountable for cost management and organizational control Thus, the CMS must provide relevant and timely information to persons who are making decisions

c Organizational culture refers to the underlying set of assumptions about an entity and

the goals, processes, practices, and values its members share

i For example, a well-designed CMS is instrumental in providing a foundation for companies with an organizational culture that emphasizes cost savings and continuous improvement

3 Organizational mission and core competencies

a Knowledge of the organization’s mission and core competencies are essential in

designing a CMS

i The mission provides a long-term goal toward which the organization wishes to move

b In pursuing their mission, companies can either avoid or confront competition

i Differentiation is the most common approach to avoiding competition

 Differentiation involves the avoidance of competition by attempting to be more

adept in some way than other entities

 Products can be differentiated based on quality, functionality, and markets served

ii Another way to avoid competition is to establish a position of cost leadership by becoming the low cost producer or provider; competition is held in abeyance because prices can be set that emphasize the cost efficiencies

iii Confrontation is a strategy in which companies still try to differentiate their products

by introducing new features or try to develop a price leadership position by dropping prices

c Text Exhibit 12-8 illustrates how the strategy of the firm, together with the life cycle

stages of products, determines what a firm must do well to be successful at any point in time

i The exhibit also illustrates how the information requirements of managers change over time as the life cycle evolves and therefore depend on the strategy being pursued

d An organization can clarify its mission by identifying core competencies

i Core competencies are the operational dimensions that are key to an organization’s survival

ii Most organizations consider timeliness, quality, customer service, efficiency and cost control, and responsiveness to change as five critical competencies

iii Once competencies are identified, the CMS can be designed to gather information related to measurement of those items and to generate output about those

competencies in forms that are useful to interested parties

4 Operations and Competitive Environment and Strategies

a Managers can assess internal specifics related to the design of a CMS once the

organizational “big picture” has been established

b The firm’s cost structure is a primary consideration

©2011 Cengage Learning All Rights Reserved SM Cost Accounting 8th Edition by Raiborn and

i Cost structure has traditionally been defined in terms of relative proportions of fixed

and variable costs and, thus, how costs change relative to changes in production or sales volume

ii The percentage of fixed (or long-term variable) costs within organizational cost structures has increased dramatically in recent years mostly due to the increased use of automated technology

iii The cost management implications of this shift in cost structure are significant Fewer costs are susceptible to short-run control so cost management efforts are increasingly directed toward the long run

iv The management of fixed costs is partially a matter of capacity management: high capacity utilization (if accompanied by high sales volumes) allows a firm to decrease its unit fixed costs in following a low-cost production strategy

v A firm has less flexibility to implement short-term actions to effect a change in the level of fixed or long-term variable costs when such costs have increased due to higher levels of technological investment

c In pursuing either a differentiation or cost leadership strategy, the management of high technology costs requires beating competitors to the market with new products

d A company that is first to market may be able to set a price that provides the opportunity

to obtain a large market share which may lead to an industry position of cost leadership

i Time to market is critical in the high-tech industry because profitability depends o selling an adequate number of units at an acceptable price before competitors surface

ii Faster time to market and shorter product life cycles are pushing companies into more frequent product transitions, requiring managers to confront the potential rewards and challenges associated with product introductions and phase outs

iii Reducing time to market is one way a company can cut costs Text Exhibit 12-9

describes other techniques

e Expeditious time to market requires a short development stage in the product life cycle Thus, getting to market quickly and profitably may require a compromise between

product innovation and superior product design

i A firm may have to incur costs associated with design flaws (such as the cost of engineering changes) that could have been avoided if more time had been allowed during development

f Time to market is important because of the competitive advantages it offers and

because of compressed product life cycles The faster a product gets to market, the

greater market share that can be captured Text Exhibit 12-10 demonstrates the

relationship between time to market and market share

g Supplier relationships constitute another aspect of an organization’s operating

environment Many companies that have formed strategic alliances with suppliers have found such relationships to be effective cost control mechanisms

h The need to integrate an organization’s current information system is another operating environment consideration in the design of a CMS The “feeder” systems (such as payroll, inventory valuation, budgeting, and costing) that are in place should be

evaluated to determine answers to the following questions:

i What input data are being gathered and in what form?;

ii What outputs are being generated and in what form?;

iii How do the current systems interact with one another and how effective are those interactions?;

iv Is the current chart of accounts appropriate for the cost management information desired?; and

v What significant information issues (such as yield, spoilage, and cycle time) are not presently being addressed by the information system and could those issues be integrated into the current feeder systems?

i With knowledge of the previous information, management must analyze the cost-benefit tradeoffs that relate to the design of the CMS

i As the costs of gathering, processing, and communicating information decrease, or

as the quantity and intensity of competition increase, more sophisticated cost management systems are required

ii As companies focus on customer satisfaction and their product and service offerings expand, the generation of better cost information is essential to long-run

organizational survival and short-run profitability

j Proper incentives and reporting systems must be incorporated into the CMS to motivate managers to make decisions that are consistent with organizational strategies

LO.5: What are the three groups of elements that comprise a cost management system, and what are the purposes of these elements?

F Determine Desired Components of CMS

1 A CMS is composed of three primary elements: motivational elements, informational

elements, and reporting elements as detailed in Text Exhibit 12-11

2 Motivational elements

a Performance measures are chosen to be consistent with organizational goals and objectives and to “drive” managers toward designated achievements

i These measurements may be quantitative or nonquantitative, financial or

nonfinancial, and short-term or long-term

b The motivational elements create a linkage between the internal information systems and the performance of the firm as perceived by the stockholders

©2011 Cengage Learning All Rights Reserved SM Cost Accounting 8th Edition by Raiborn and

i Text Exhibit 12-12 indicates how this linkage typically is operationalized

c The motivational elements can also create dysfunctional behaviors if they create

performance pressure on managers that is too intense

i Among possible dysfunctional behaviors is the intentional misstatement of

transactions and accruals by managers to distort the performance measurements of the accounting system

d Firms develop internal controls to protect the integrity of financial reports and to

safeguard assets

i The Sarbanes-Oxley Act of 2002 (Section 404) requires companies to establish and maintain an adequate system of internal controls over financial reporting and report

on any material weaknesses within that system

e The performance measurement system should be designed to:

i support the organization’s mission and competitive strategies;

ii motivate employees and managers to act in the best interest of the organization and its subunits; and

iii help recruit and retain qualified employees

f Different forms of rewards have different incentive effects and can reflect different time orientations

i Longer-term incentives generally encourage managers to be more long-term

oriented in their decisions

ii Short-term incentives encourage managers to focus on the near future

g Performance rewards for top managers may consist of both short-term (e.g., cash) and long-term incentives (e.g., stock options)

h The rewards for subunit managers should be based on the specific subunit’s mission

i For example, managers of subunits charged with a “build” mission should receive long-term incentives and be evaluated based on longer-term performance measures while managers of subunits charged with a “harvest” mission must be more oriented

to the short term

i Today’s companies experiment with a variety of incentives as carrots to induce

employees and managers to act in the best interest of shareholders

i Profit sharing refers to compensation that is contingent on the level of

organizational profit generated

j Performance measurement selection and the reward structure are significant since managers evaluate decision alternatives based on how the outcomes may impact the selected performance measurement and reward criteria