Acctg 4acc

Module 1
Basic Concepts

Learning Objectives
1. Describe the way managers use accounting information to create value in organizations.
2. Distinguish between the uses and users of cost accounting and financial accounting
information.
3. Explain how cost accounting information is used for decision making and performance
evaluation in organizations.
4. Identify current trends in cost accounting.
5. Understand ethical issues faced by accountants and ways to deal with ethical problems
that you face in your career.

How managers use accounting information to create value in organizations.

♦ Cost accounting helps manages achieve the maximum value for their organizations by
providing information for decision making and by measuring the effects of decisions on the
value creation of the organizations.

♦ Value chain is the set of activities that transforms raw resources into the goods and services
end users purchase and consume, and includes the treatment or disposal of any waste generated
by the end users.

Example 1: The value chain for gasoline industry may include the following.

Oil search and drilling

Oil refining

Gasoline distribution

Retail outlets

End users

Emission treatment
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 • The entire value chain consists of vendors and suppliers in the upstream and distributors
and customers in the downstream of an organization whose efficient coordination
depends on the information provided by the cost accounting system.

♦ Value-added activities are those that customers perceive as adding utility to the goods or
services they purchase.

• Research and development (R&D): The creation and development of ideas related to
new products, services, or processes.
• Design: The detailed development and engineering of products, services, or processes.

• Purchasing: The acquisition of goods and services needed to produce a good or service.

• Production: The collection and assembly of resources to produce a product or deliver a

service.

• Marketing and Sales: The process of informing potential customers about the attributes
of products or services and leads to their sale.

• Distribution: The process for delivering products or services to customers.

• Customer service: The support activities provided to customers concerning a product or

service.

♦ Value is created when an idea is established and continues to increase along the way. Each of
the value chain components adds value to the product or service.

• Administrative functions, such as human resource management and accounting, are

included in every business function of the value chain.

♦ Supply chain is the set of firms and individuals that sell goods and services to the firm.
Distribution chain is the set of firms and individuals that buy and distribute goods and services
from the firm.

• These suppliers and customers are on the firm’s boundaries.

• The supply chain and distribution chain are the parts of the value chain outside the firm.

♦ Value chain creates value for which the customer is willing to pay.

• Customers are concerned with the total cost of producing a product or service but not
with which firm in the supply chain incurred the cost.

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 • Firms must decide where in the value chain a value-added component is performed
most cost effectively.

♦ Cost accounting focuses on how the individual stages contribute to the value and how to work
with other managers to improve performance.

Differences Between Financial Accounting and Management Accounting

♦ Accounting systems provide information for decision makers. Depending on the perspectives
of the primary user of the information (outside versus inside the organization), the accounting
systems can be classified into financial and cost (or managerial) systems.

• Investors, creditors, government agencies, tax authorities, etc. are outside the
organization. Managers are inside the organization.

• Financial accounting is the field of accounting that reports financial position and
income according to accounting rules, which make financial accounting data comparable
across firms.

• Managers are interested in financial accounting information as well. But such

information is not sufficient for making operational decisions.

• Cost accounting is the field of accounting that measures, records, and reports
information about costs.

• Cost accounting information must be relevant for the particular decisions to be made by
managers in a particular business environment. This perspective shapes how a cost
accounting system is designed to provide good information and to add value to the
organization.

• Managers add value to the organization by the decisions they make, while accountants
add value by providing good information to managers making the decision.

• The major differences between financial and cost accounting are summarized as follows:

a.
Financial Managerial
• External focus • Internal focus
• Whole organization • Segments or divisions
• Historical • Current/projected
• Quantitative • Quantitative/qualitative
• Monetary • Monetary and nonmonetary
• Verifiable • Timely/reasonable estimate
• GAAP • Benefits exceed costs
• Formal recordkeeping • Formal and informal recordkeeping

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♦ External parties such as investors and creditors evaluate company and management
performance by using financial accounting information as governed by generally accepted
accounting principles (GAAP) and international financial reporting standards (IFRS).

• PFRS represent the rules, standards, and conventions that guide the preparation of
financial accounting statements for firms registered in the Philippines and IFRS in many
other countries and GAAP in the US, respectively.

• Financial accounting information thus prepared is consistent and comparable across

different companies, but may not be appropriate for managerial decision making.

• Cost data for managerial use within the organization are not constrained by GAAP or
IFRS. Instead, decision relevancy, which affects the future, determines the type of cost
information suitable for the problems at hand.

♦ Cost accounting information is in demand throughout the organization. Users of such

information must be identified and provided with best possible information for managerial
purposes.

• At the production level, cost accounting information is used to control and improve
operations with high frequency.

• At the middle management level, deviations from the expectations (budgets) necessitate
investigation and corrective actions.

• At the executive level, cost accounting information is integrated into financial

information to assess the company’s overall success strategically and is provided on a
monthly, quarterly, or annual basis.

♦ The most serious problems with accounting systems appear to occur when managers attempt to
use accounting information that was developed for external reporting for decision making.

• Different uses of accounting information require different types of accounting

information.

♦ The goals of an organization are achieved through the decisions made by managers.

• Recurring themes:

(1) The manger’s job is to make decisions that determine the performance of the
organization.

(2) Accounting system is a primary source of information for managers to make

decisions.

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 (3) Accounting systems also provide information to the owners of the organization, who
are not managers, to evaluate the performance of the organization and the managers.

♦ Nonvalue-added activities are activities that do not add value to the goods or services from
the customer’s perspective. Examples include moving inventory around and reworking defective
units.

• Activities cause costs.

• These nonvalue-added activities should be identified and eliminated, therefore the costs
associated with them can also be eliminated. Cost reduction can be translated into lower
price and/or better service to customers.
• A well-designed accounting system can also identify nonvalue-added activities that
cross boundaries in the value chain.

♦ Cost-benefit analysis is the process of comparing benefits (often measured in savings or

increased profits) with costs associated with a proposed change within an organization.

• Managers should perform cost-benefit analyses to assess whether proposed changes in

an organization are worthwhile.

♦ Companies use the value chain and other information about the costs of activities to identify
strategic advantages in the market place.

• A company can proactively identify activities that customers value while providing
such activities at lower cost.

♦ When owners of a business are not also managers, both parties’ interests may not be properly
aligned. Accounting information system provides information to the owners about the
performance of the organization and the managers.

♦ Cost data can be used for decision making, for control and evaluation, and for preparing
budgets, among others.

• To evaluate the financial consequences of alternatives, estimates have to be made for

future costs, revenues, and/or assets based on past information.

• Identification of proper cost driver – factor that causes, or “drives,” costs – also helps
predict future results.

• Differential costs and revenues are costs and revenues that change in response to a
particular course of action. Items that do not change will not affect outcome, and are
therefore irrelevant to the decision.

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 • Responsibility center is a specific unit of an organization assigned to a manager who is
held accountable for its operations and resources.

• A budget shows a financial plan of the revenues and resources needed to carry out the
responsibility center’s tasks and meet financial goals.

• Managers are committed to the targets set in the budget as part of the planning process.
Later, a comparison of actual results with the budget at the end of each period determines
whether managers fulfill their responsibilities and whether changes can be made to
improve future operations.

♦ Cost accounting requires different accounting data for different decision purposes. “One size
fits all” does not apply to cost accounting.

FACTORS AFFECTING COST MANAGEMENT

1. Global competition – Vastly improved transportation and communications have led to a global
market for many manufacturing and service firms. For example, large U.S. companies such as
The Coca-Cola Company are developing sizable markets in China. This global focus highlights
the need for cost information to reduce costs, improve productivity, and assess product-line
profitability.
2. Growth of the service industry – Traditional manufacturing industries have declined in
importance. The service sector comprises approximately three-quarters of the world economy and
employment. Deregulation of many services such as airlines and utilities has increased
competition in the service industry.
3. Advances in information technology – Automation and integration increase the need for timely,
detailed information. Significant advances in technology include computer-integrated
manufacturing and the availability of personal computers, spreadsheet software, and graphics
packages.
4. Advances in the manufacturing environment – Manufacturing management approaches continue
to be utilized to quality, reduce inventories, eliminate waste, and reduce costs.
a. Theory of constraints – A method used to continuously improve manufacturing activities and
nonmanufacturing activities.
b. Just-in-time management – A demand-pull system that strives to produce a product only
when it is needed and only in the quantities demanded by customers.
c. Computer-integrated manufacturing – The automation of the manufacturing environment.
5. Customer orientation – Firms are concentrating on the delivery of value to the customer in order
to establish a competitive advantage.
6. New product development – A significant proportion of production costs are incurred during the
development and design stages. There is a high demand for more sophisticated cost management
tools related to new product development. Activity-based management is introduced as a system
that will allow management to identify and eliminate non-value-added activities to reduce life
cycle costs.
7. Total quality management – Continuous improvement and elimination of waste are the two
foundation principles that govern a state of manufacturing excellence. A philosophy of total
quality management has replaced the acceptable quality attitudes of the past.

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 8. Time as a competitive element – Time is a crucial element in all phases of the value chain, and
world-class firms reduce time to market by compressing design, implementation, and production
cycles.
9. Efficiency – Cost is a critical measure of efficiency. Activity-based costing and profit-linked
productivity measurement are introduced as methods to evaluate the overall financial effect of
productivity changes.

Current trends in cost accounting.

♦ Cost accounting undergoes dynamic changes over time to accommodate shifting managerial
emphases and decision contexts in all stages of the value chain, from research and development
(R&D), design, purchasing, production, marketing, distribution, all the way to customer service.

• In the development stage, companies partner with suppliers to ensure cost-efficient

designs and materials for products.

• Design for manufacturing (DFM) is the concept that manufacturing cost and complexity
need to be considered in the design of the product.

• The tradeoff between complex design for a more desirable product and difficult and
expensive manufacturing process can be manifested through cost accounting methods
such as activity-based costing (ABC) – a costing method that first assigns costs to
activities and then assigns them to products based on the products’ consumption of
activities.

• Activity-based costing provides more detailed and accurate cost information than
traditional costing methods and enables managers to make more informed decisions,
leading to activity-based management that identifies and eliminates nonvalue-added
activities.

• In purchasing, performance measures (metrics that indicates how well an individual,

business unit, product, or firm is working) are used to evaluate performance of key
suppliers and business partners.

• Benchmarking is the continuous process of measuring a company’s own products,

services, and activities against best practices either inside or outside the organization.
Continuous improvement sets the performance standard ever higher to achieve better
results throughout the supply chain.

• Just-in-time (JIT) method may be used in production or purchasing where each unit is
purchased or produced just in time for its use. Cost accountants develop unique treatment
for the just-in-time environment while deemphasizing the need for inventory valuation.

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 • Lean accounting is a cost accounting system that provides measures at the work cell or
process level and minimizes wasteful or unnecessary transaction processes. Lean
accounting provides support for lean manufacturing techniques.

• Customer relationship management (CRM) is a system that allows firms to target

customers by assessing customer revenues and costs. Marketing managers use cost
accounting data to better manage different customer groups based on their profitability.

• In the distribution stage, managers frequently consider activities for outsourcing, with
which one or more of the firm’s activities will be performed by another firm or individual
in the supply or distribution chain for improved efficiency and cost savings.

• Total quality management (TQM) is a management method by which the

organization seeks to excel on all dimensions, with the customer ultimately defining
quality.

• Cost of quality (COQ) is a system that identifies the costs associated with producing
low quality items, including rework, returns, and lost sales.

• Enterprise resource planning (ERP) systems represent the information technology

that links the various systems of the enterprise into a single comprehensive information
system. By integrating purchasing, production, human resources, and finance, managers
hope to avoid lost orders, duplication of effort, and costly studies to determine what the
current state of the enterprise is.

• All these tools are meant to add value to the organization. They also provide
opportunities for people interested in cost accounting to contribute to the organization.

• Organizational structure
a. Authority is the right (usually by virtue of position or rank) to use resources to
accomplish a task or achieve an objective. It is the power to direct others to perform
or not perform activities
b. Responsibility is the obligation to accomplish a task or achieve an objective.
c. Line managers work directly toward attaining organizational goals. They are often
held responsible for achieving targeted balanced scorecard measures or budgeted
operating income for their divisions or geographic regions. Examples would include
managers in production, sales, and distribution.
d. Staff employees give assistance and advice to managers. Examples include
employees in marketing, engineering, accounting, and finance.
e. Organizational Chart – shows an entity’s principal management position. It helps to
define authority, responsibility and accountability and is essential in developing a
cost accounting system.

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♦ Key financial players in an organization and their activities include:

• Chief financial officer (CFO): The top financial personnel and usually a senior vice
president; in charge of the entire accounting and finance function of a company.

• Treasurer: The person responsible for managing liquid assets (such as cash and short-
term investments); conducting business with banks and other financial institutions;
overseeing public issues of stock and debt.

• Controller: The person in charge of accounting functions, including planning, decision

making, designing information systems and incentive systems, and helping managers
make operating decisions.

• Internal auditors: Part of an internal audit department that ensures compliance with laws,
regulations, and company policies and procedures; provides consulting and auditing
services within the firm; also assists external auditors examining external financial
reports and reviewing companies’ internal control systems; often reports directly to the
audit committee of the Board of Directors as “whistle blowers.”

• Cost accountants: A group of people who record, measure, determine, and analyze costs;
work with financial and operational managers to provide relevant information for
decisions.

♦ People from engineering, production, marketing, finance, and accounting often work together
in cross-functional teams to solve problems.

• Value is added by
(1) bringing a variety of expertise and perspectives to a problem,
(2) ensuring that the product is appropriate for its customer base,
(3) giving production a chance to formulate an efficient production process,
(4) obtaining financing for the project, and
(5) determining whether the project is economically feasible.

The Role of Cost Accounting:

Cost accounting furnishes management with the necessary tools for planning and
controlling activities, improving quality and efficiency and making both routine and strategic
decisions. The collection, presentation and analysis of information regarding costs and benefits
helps management accomplish the following tasks:
1. Creating and executing plans and budgets for operating under expected competitive
and economic conditions.
2. Establishing cost methods that permit control of activities, reduction of costs and
improvement of quality
3. Controlling physical quantities of inventory, and determining the cost of each product
or service produced for the purpose of pricing and evaluating the performance of a
product, department or division.

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 4. Determining company costs and profit for an annual accounting period or a shorter
period. This includes determining the cost of inventory and cost of goods sold
according to external reporting rules
5. Choosing among two or more short-run or long-run alternatives that might alter
revenues or costs.

Ethical issues faced by accountants and ways to deal with ethical problems
that you face in your career.

♦ Cost assignment to activities, products, projects, corporate units, and people, as the result of
the design of cost systems, affects price, reimbursement, and pay, among others. It has the
potential to be misused to defraud customers, employees, or shareholders.

♦ Accounting information is used to evaluate the performance of managers. Accountants who

prepare the numbers are under constant pressure to make accounting choices that will influence
performance reports.

• Both the preparers and users of cost information need to be aware of the incentives
created by performance measurement systems and how those incentives may lead to
unethical (or even illegal) conduct.

• Professional organizations such as the Institute of Management Accountants (IMA),

Institute of Internal Auditors (IIA) and the American Institute of Certified Public
Accountants (AICPA) have developed codes of ethics to help their members maintain the
highest levels of ethical conducts and resolve ethical dilemmas. Many businesses also use
these codes to train their employees and to demonstrate their commitment to certain
business practices with respect to their customers and as a guide for their employees. The
Philippine Institute of Certified Pubic Accountants have also adopted this Code of Ethics.

STANDARDS OF ETHICAL CONDUCT FOR MANAGEMENT ACCOUNTANTS

Accountants have a responsibility to:
1. COMPETENCE
a. Maintain an appropriate level of professional competence by on-going
developments of their knowledge and skills
b. Perform their professional duties in accordance with relevant laws, regulations
and technical standards
c. Prepare complete and clear reports and recommendations after appropriate
analysis of relevant and reliable information.

2. CONFIDENTIALITY
a. Refrain from disclosing confidential information acquired in the course of their
work except when authorized, unless legally obligated to do so

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 b. Inform subordinates as appropriate regarding the confidentiality of information
acquired in the course of their work and monitor their activities to assure the
maintenance of their confidentiality
c. Refrain from using or appearing to use confidential information acquired in the
course of their work for unethical or illegal advantage either personally or
through third parties.
3. INTEGRITY
a. Avoid actual or apparent conflicts of interest and advise all appropriate parties
of any potential conflict.
b. Refrain from engaging in any activity that would prejudice their ability to carry
out their duties ethically
c. Refuse any gift, favor or hospitality that would influence or would appear to
influence their actions
d. Refrain from either actively or passively subverting the attainment of the
organization’s legitimate and ethical objectives
e. Recognize and communicate professional limitations or other constraints that
would preclude responsible judgement or successful performance of an activity
f. Communicate unfavorable as well as favorable information and professional
judgments or opinions
g. Refrain from engaging in or supporting any activity that would discredit the
profession
4. OBJECTIVITY
a. Communicate information fairly and objectively
b. Disclose fully all relevant information that could reasonably be expected to
influence an intended user’s understanding of the reports, comments and
recommendations presented

• IMA code of ethics discusses the steps cost accountants should take when faced with an
ethical conflict, including
(1) discuss the conflict with the immediate superior, or, if the conflict involves the
superior, the next level in authority, (2) clarify the relevant issues and concepts by
discussions with a disinterested party, and (3) consult an attorney about rights and
obligations.

References:

Lanen, W.N. (2017). Fundamentals of cost accounting. (5e). New York, N.Y.: Mc Graw-Hill Education
Blocher, E.J., Stout, D.E., Juras, P. E. Cost management. New York, N.Y.: Mc Graw-Hill Education
Vanderbeck,E.J. & Mitchell M.R. (2017). Principles of cost accounting. 17th edition. Australia: Cengage

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