Solution manual cost accounting 8th by kinney chapter 16

Terminology Appropriation: a predetermined maximum allowable expenditure Coefficient of determination: the portion of the variance in the dependent variable cost explained by the movem

Learning Objectives

After reading and studying Chapter 16, you should be able to answer the following questions:

1 What are the functions of a cost control system?

2 What factors cause costs to change from period to period or to deviate from expectations?

3 What are the generic approaches to cost control?

4 What are the two primary types of fixed costs, and what are the characteristics of each?

5 What are the typical approaches to controlling discretionary fixed costs?

6 What are the objectives managers strive to accomplish in managing cash?

7 How is technology reducing costs of supply chain transactions?

8 Why is uncertainty greater in dealing with future events than with past events?

9 What are the four generic approaches to managing uncertainty?

MANAGING COSTS AND UNCERTAINTY

CHAPTER

16

Terminology Appropriation: a predetermined maximum allowable expenditure

Coefficient of determination: the portion of the variance in the dependent variable (cost) explained by

the movement in the independent variable, the value of which ranges between 0 and 1

Committed costs: costs associated with plant assets and the human resources

Cost avoidance: the practice of finding acceptable alternatives to high-cost items and/or not spending

money for unnecessary goods and services

Cost consciousness: a company-wide employee attitude toward the topics of understanding costs

changes, cost containment, cost avoidance, and cost reduction

Cost containment: the practice of minimizing period-by-period increases in per-unit variable and total

fixed costs

Cost control system: the set of formal and/or informal tools and methods designed to manage

organizational costs

Cost reduction: the practice of lowering current costs, especially those that may be in excess of what is

necessary

Discretionary cost: a cost that arises from a management decision to fund an activity at a specified

amount for a specified period of time; a cost that can be reduced to zero in the short run if necessary

Engineered cost: a cost that has been found to bear an observable and known relationship to a

quantifiable activity base

e-procurement systems:electronic B2B (business-to-business) buy-side applications controlling the requisitioning, ordering, and payment functions for inputs

Forward contracts: agreements that give the holder the right to purchase a given quantity of a specific

input at a specific price at a specific time

Hedging: the use of options and forward contracts to manage price risk

Option: (see forward contracts)

Price elasticity: a numerical measure of the relationship of supply or demand to price changes

Random: in the context of cost prediction and cost understanding, refers to the fact that some portion of

the cost is not predictable based on the cost driver or the cost is stochastically rather than

deterministically related to the cost driver

Uncertainty:doubt or lack of precision in specifying future outcomes; arises from lack of complete knowledge about future events

Working capital: total current assets minus total current liabilities

Lecture Outline

LO.1: What are the functions of a cost control system?

A Introduction

1 This chapter explains some of the key contributions of accounting and finance to business

organizations

a Topics include cost control systems and general cost management strategies, the

responsibilities and tools of the treasury function (e.g., cash management, financial risk management, and supply chain management), and methods and tools for dealing with

uncertainty in budgeting and cost management

B Cost Control Systems

1 A cost control system is a set of formal and/or informal tools and methods designed to manage

organizational costs

2 An effective cost control system must perform at three points: before an event, during an event,

and after an event (See text Exhibit 16-1.)

a As shown in the exhibit, some of the cost control methods found in practice includes budgets, variance analysis, and responsibility reports

3 The general planning and control model in text Exhibit 16–2 emphasizes that control is part of a

management cycle that begins with planning

4 A good control system encompasses not only planning and control functions but also the idea of cost consciousness

a Cost consciousness refers to a company-wide employee attitude toward the topics of

understanding cost changes, cost containment, cost avoidance, and cost reduction (See text

Exhibit 16-3)

b Managers alone cannot control costs

LO.2: What factors cause costs to change from period to period or to deviate from expectations?

C Understanding Cost Changes

1 General

a Cost control is first exercised when the budget is prepared, but budgets can be properly prepared only when the reasons for periodic cost changes are understood and cost control cannot be achieved without an understanding of why costs may differ between periods or from the budgeted amounts

2 Cost Changes Because of Volume Changes

a A flexible budget can compensate for changes in variable costs due to activity level changes

by providing expected variable costs at the actual activity level

b With a flexible budget, managers can make valid budget-to-actual cost comparisons to determine whether costs were properly controlled

c For costs to be controlled effectively, cost drivers must be determined as accurately as possible

3 Cost Changes Because of Inflation/Deflation

a Fluctuations in the value of money, called general price-level changes, cause the prices of goods and services to change

i In the United States, the Consumer Price Index (CPI) is the most often cited measure of general price-level changes

ii Inflation and deflation indexes by industry or commodity can be examined to obtain more accurate information about inflation/deflation effects on prices of particular inputs, such

as energy resources

b Some companies include price-escalation clauses in sales contracts to cover the inflation occurring from order to delivery (especially in industries having production activities that require substantial lead times)

4 Cost Changes Because of Supply/Supplier Cost Adjustments

a The relationship between the availability of a good or service and the demand for that item affects its selling price

b The relationship between price changes and supply and demand changes varies across products

i Price elasticity is a numerical measure of the relationship of supply or demand to price

changes Price elasticities can be calculated for specific products using historical data

on price changes and supply and demand changes

ii If price elasticity is low, then a large change in price will lead to only a small change in supply or demand; alternatively, if price elasticity is high, a large change in price leads to

a large change in supply or demand

c Specific price-level changes are also caused by advances in technology; as a general rule,

as suppliers advance the technology of producing a good or performing a service, the cost of that product or service to producing firms declines

d Alternatively, additional production or performance costs are typically passed on by suppliers

to their customers as part of specific price-level changes; such costs can be within or outside the supplier’s control

e The number of suppliers of a product or service can also affect selling prices; as the number

of suppliers increases in a competitive environment, price tends to fall

f Sometimes, cost increases are caused by higher taxes or additional regulatory requirements; complying with these regulations can increase costs In response, companies can:

i pass along the costs to customers as price increases to maintain the same income level;

ii decrease other costs to maintain the same income level; or

iii accept a decline in net income

5 Cost Changes Because of Quantity Purchased

a Companies may receive discounts for bulk purchases

b Involvement in group purchasing arrangements can make quantity discounts easier to obtain

LO.3: What are the generic approaches to cost control?

D Cost Containment

1 General

a Cost containment is the practice of minimizing, to the extent possible, period-by-period

increases in per-unit variable and total fixed costs

b Cost containment is not possible for inflation adjustments, tax and regulatory changes, and supply and demand adjustments

c Costs that rise due to reduced supplier competition, seasonality, and quantities purchased are subject to cost containment activities

d Purchasing agents must remember that the supplier offering the lowest bid is not necessarily the best supplier to choose Other factors such as quality, service, and reliability are

important

e A company can circumvent seasonal cost changes by postponing or advancing purchases

f As to services, it is often possible for employees to repair rather than replace items that have seasonal cost changes

2 Cost Avoidance and Cost Reduction

a Cost avoidance is the practice of finding alternatives to high cost items and/or not spending

money for unnecessary goods or services Managers should always be searching for ways

to eliminate unnecessary expenditures

b Cost reduction refers to the practice of lowering current costs, especially those that may be

in excess of what is necessary

i Benchmarking is especially important for identifying excessive costs

ii Companies can reduce costs by outsourcing rather than by maintaining internal

departments

iii Sometimes money must be spent (e.g., research and development) to generate cost savings

iv Some companies look outside the organization for guidance on how and where to cut costs

c Managers may adopt the following five-step method of implementing a cost control system

(See text Exhibit 16-4.):

i understand the types of costs incurred by the organization;

ii communicate the need for cost consciousness to all employees;

iii educate employees in cost control techniques, encourage them to suggest ways to control costs, and motivate them to embrace the concepts;

iv generate reports that indicate actual results, compare budget to actual, and calculate variances; and

v develop a view that the cost control system is a long-run process, not a short-term solution

d A cost-benefit analysis should be performed before a commitment is made to incur a cost

LO.4: What are the two primary types of fixed costs, and what are the characteristics of each?

E Committed Fixed Costs

1 All fixed costs (and the activities that create them) can be categorized as either committed or discretionary, with the difference between the two categories being primarily the time period for

which management obligates itself to the activity and the cost

2 Committed costs are costs associated with plant assets and the human resources that an

organization must have to operate

a The amount of committed costs is dictated by long-run management decisions

b Committed costs include depreciation, lease rentals, property taxes, and staff salaries

3 One method of controlling committed costs is to compare expected benefits of plant assets (or human resources) with expected costs of such investments

4 A second method of controlling committed costs involves performing a postinvestment audit of capital expenditures

5 The benefits from committed costs generally can be predicted and commonly are compared with actual results in the future

F Discretionary Costs

1 General

a A discretionary cost is one that a decision maker must periodically review to determine if it

continues to be in accord with ongoing policies

i A discretionary fixed cost reflects a management decision to fund a particular activity at a specified amount for a specified period of time

ii Discretionary costs relate to company activities that are important but whose level of funding is subject to judgment

iii Discretionary costs are usually service-oriented and include employee travel, repairs and maintenance, advertising, research and development, and employee training and

development

iv There is no "correct" amount of these expenditures and the amount of benefit created can be determined only subjectively

 Discretionary costs are generated by activities that vary in type and magnitude from day-to-day and whose benefits are often not measurable in monetary terms In addition, performance quality can also vary according to the task and employee skill levels involved

 Because of these two factors—varying activities and varying quality levels—

discretionary costs are not usually susceptible to the precise measures available to plan and control variable production costs or the cost-benefit evaluation techniques available to control committed fixed costs

 Since the benefits of discretionary cost activities cannot be assessed definitively, these activities are often among the first to be cut when profits are lagging

v Thus, proper planning for discretionary activities and costs can be more important than subsequent control measures

LO.5: What are the typical approaches to controlling discretionary fixed costs?

2 Controlling Discretionary Costs

a General

i Budget appropriations, which are predetermined amounts or rates for each budget item,

serve as a basis for comparison with actual costs

b Budgeting Discretionary Costs

i Funding levels for discretionary costs should be set only after both discretionary cost activities have been prioritized and cash flow and income expectations have been reviewed

ii Discretionary costs are typically budgeted on the basis of three factors:

 the related activity’s perceived significance to the achievement of objectives and goals;

 the upcoming period’s expected level of operations; and

 managerial negotiations during the budgetary process

iii Managers are expected to spend the full amount of their appropriations within the

specified time frame for some discretionary costs, while the “less is better” credo is appropriate for other discretionary cost activities

 The cost of preventive maintenance is often cited as an example of a cost where

“less is not better.”

iv If revenues, profits, or cash flows are reduced, funding for discretionary expenditures should be evaluated, not simply in reference to reduced operations but also relative to activity priorities

v The difference in management attitude between committed and discretionary costs has to

do with the ability to measure the benefits provided

 Benefits of committed fixed costs can be measured on a before and after basis through the capital budgeting and postinvestment audit processes

 The benefits from discretionary fixed costs are often not distinctly measurable in monetary terms, or they may not even be identifiable

c Measuring Benefits from Discretionary Costs

i Companies often assume that the benefits—and the activities—are unimportant since benefits from some activities traditionally classified as discretionary cannot be adequately measured

ii These types of activities produce quality products and services in the long run; therefore, before reducing or eliminating expenditures in these areas, managers should attempt to recognize and measure the benefits through the use of surrogate, nonmonetary

measures

 Such an effort requires time and creativity (See text Exhibit 16-5.)

iii The comparison of input costs and output results can help to determine if there is a reasonable benefit relationship between the two; managers can judge this cost-benefit relationship by how efficiently inputs (represented by costs) were used and how effectively those resources (again represented by costs) achieved their purposes These relationships can be seen in the following model:

Inputs Outputs Objectives Goals (Efficiency) (Effectiveness)

Performance

d Efficiency

from the resources available; the degree to which a satisfactory relationship occurs when comparing outputs to inputs

ii Effectiveness is a measure of how well the firm’s objectives and goals are achieved;

compares actual output results to desired results; the successful accomplishment of an objective

iii Efficiency and effectiveness can be determined as follows:

Efficiency =

or alternatively

Efficiency =

Effectiveness =

e Effectiveness

i Determination of an activity's effectiveness is unaffected by whether the designated output measure is stated in monetary or nonmonetary terms

ii Measurement of effectiveness does not require the consideration of inputs, but

measurement of efficiency does

iii The relationship between discretionary costs and desired results is inconclusive at best, and the effectiveness of such costs can be inferred only from the relationship of actual to desire output

f Control Using Engineered Costs

i Some discretionary activities are repetitive enough to allow the development of standards similar to those for manufacturing costs

ii An engineered cost is a cost that has been found to bear an observable and known

relationship to a quantifiable activity base

iii Discretionary cost activities that can be categorized as engineered costs are normally

geared to a performance measure relative to work accomplished

iv A company can compare actual cost against standard cost each period after obtaining a fairly valid estimate of what costs should be based on a particular activity level for the cost driver volume

v The generalized cost variance analysis model can then be used:

Price Variance Efficiency Variance

Total Inspection Cost Variance

vi The company may prefer the following type of fixed overhead variance analysis if quality inspection cost becomes a discretionary fixed cost:

Spending Variance Volume Variance

Total Inspection Cost Variance vii The method of variance analysis and thus cost control must be appropriate to the cost category and management information needs

 Managers should always consider whether the activity itself and, therefore, its cost incurrence were sufficiently justified

 Postincurrence audits of discretionary costs are often important in determining an expenditure's value

g Control Using the Budget

i Monetary control is accomplished through the use of budget-to-actual comparisons once

discretionary cost budget appropriations have been made (See text Exhibits 16-6, 16-7, and 16-8 for a case study)

ii Actual results are compared to expected results and explanations should be provided for the variances

iii To ensure variable cost variances are useful, flexible budgeting procedures must be used

iv Explanations for variances can often be found by recognizing cost consciousness

attitudes

LO.6: What are the objectives managers strive to accomplish in managing cash?

G Cash Management

1 General

a Cash is the most important and challenging resource to manage

b The cash budget and pro forma cash flow statement provide managers information about the amounts and timing of cash flows