To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com
CHAPTER
16
MANAGING COSTS AND UNCERTAINTY
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?
©2011 Cengage Learning. All Rights Reserved. SM Cost Accounting 8th Edition by Raiborn and Kinney.
Visit http://downloadslide.blogspot.com to download more slides, ebooks, solution manual, and test bank.
To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com
Chapter 16: Managing Costs and Uncertainty
IM 2
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
©2011 Cengage Learning. All Rights Reserved. SM Cost Accounting 8th Edition by Raiborn and Kinney.
Visit http://downloadslide.blogspot.com to download more slides, ebooks, solution manual, and test bank.
To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com
Chapter 16: Managing Costs and Uncertainty
IM 3
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.
©2011 Cengage Learning. All Rights Reserved. SM Cost Accounting 8th Edition by Raiborn and Kinney.
Visit http://downloadslide.blogspot.com to download more slides, ebooks, solution manual, and test bank.
To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com
Chapter 16: Managing Costs and Uncertainty
IM 4
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.
c.
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.
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.
©2011 Cengage Learning. All Rights Reserved. SM Cost Accounting 8th Edition by Raiborn and Kinney.
Visit http://downloadslide.blogspot.com to download more slides, ebooks, solution manual, and test bank.
To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com
Chapter 16: Managing Costs and Uncertainty
f.
IM 5
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.
©2011 Cengage Learning. All Rights Reserved. SM Cost Accounting 8th Edition by Raiborn and Kinney.
Visit http://downloadslide.blogspot.com to download more slides, ebooks, solution manual, and test bank.
To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com
Chapter 16: Managing Costs and Uncertainty
IM 6
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
©2011 Cengage Learning. All Rights Reserved. SM Cost Accounting 8th Edition by Raiborn and Kinney.
Visit http://downloadslide.blogspot.com to download more slides, ebooks, solution manual, and test bank.
To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com
Chapter 16: Managing Costs and Uncertainty
IM 7
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.
v.

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.
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;
©2011 Cengage Learning. All Rights Reserved. SM Cost Accounting 8th Edition by Raiborn and Kinney.
Visit http://downloadslide.blogspot.com to download more slides, ebooks, solution manual, and test bank.
To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com
Chapter 16: Managing Costs and Uncertainty
IM 8

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.
c.
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.
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 cost-benefit relationship between the two; managers can judge this costbenefit 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
(Efficiency)
Outputs
(Effectiveness)
Objectives
Goals
Performance
©2011 Cengage Learning. All Rights Reserved. SM Cost Accounting 8th Edition by Raiborn and Kinney.
Visit http://downloadslide.blogspot.com to download more slides, ebooks, solution manual, and test bank.
To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com
Chapter 16: Managing Costs and Uncertainty
IM 9
d. Efficiency
i.
Efficiency is the process of performing tasks to produce the best yield at the lowest cost
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:
Actual Result
Efficiency
=
compared to
Desired Result
Actual Output
Planned Output
Actual Input
Planned Input
Actual Input
Planned Input
Actual Output
Planned Output
Planned Output
Preestablished
Actual Output
standard
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.
©2011 Cengage Learning. All Rights Reserved. SM Cost Accounting 8th Edition by Raiborn and Kinney.
Visit http://downloadslide.blogspot.com to download more slides, ebooks, solution manual, and test bank.
To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com
Chapter 16: Managing Costs and Uncertainty
v.
IM 10
The generalized cost variance analysis model can then be used:
AP × AQ
SP × AQ
Price Variance
SP × SQ
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:
Budgeted
Fixed Cost
Actual Cost
Spending Variance
Budgeted Fixed Cost x
Std Hours Allowed
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.
©2011 Cengage Learning. All Rights Reserved. SM Cost Accounting 8th Edition by Raiborn and Kinney.
Visit http://downloadslide.blogspot.com to download more slides, ebooks, solution manual, and test bank.
To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com
Chapter 16: Managing Costs and Uncertainty
c.
IM 11
An organization’s liquidity depends on having enough cash available to retire debts and other
obligations as they come due.
d. Firms hold cash to liquidate transactions, to cover unexpected events, and for speculation.
e. Cash levels should be sufficient to cover all needs but low enough to constrain opportunity
costs associated with alternative uses of the cash.
2. What Variables Influence the Optimal Level of Cash?
a. The actual level of cash maintained can differ from that necessary to meet the cash flow
requirements of the cash budget.
b. The level of confidence that managers have in the cash budget is a nonquantitative factor
that influences the desired cash balance.
c.
To avoid liquidity problems, managers of firms with high variability in the operating cycle must
hold more cash than managers of firms with very stable, predictable operating cycles.
d. Firms that would have difficulty arranging for short-term credit to cover unexpected cash
shortages are forced to carry extra cash to cover contingencies.
e. Also, securities ratings, particularly bond ratings, can induce firms to hold larger cash
balances than is justified based on all other considerations.
i.
Firms with debt may be obligated by loan covenants to maintain minimum levels of cash.
3. What are the Sources of Cash?
a. There are three usual sources for cash:
i.
sale of equity or debt securities and other shorter term instruments;
ii.
sale of assets no longer necessary or productive; and
iii. sales of goods and services.
b. Working capital is the excess of current assets over current liabilities.
i.
c.
The normal operating cycle begins with cash, extends to the purchase of materials, and
then to the exchange of those materials for receivables, and ultimately the collection of
the receivables brings cash back to the firm. Thus, the normal operating cycle is a cashto-cash cycle (See text Exhibit 16-9).
Effective management of the cash collection cycle can both reduce the demand for cash and
increase its supply.
i.
Accelerating the operating cycle will increase available cash.
ii.
Reducing the length of the operating cycle will reduce inventory and accounts receivable
and therefore increase cash.
iii. Cash can be increased by slowing down payments for inputs.
©2011 Cengage Learning. All Rights Reserved. SM Cost Accounting 8th Edition by Raiborn and Kinney.
Visit http://downloadslide.blogspot.com to download more slides, ebooks, solution manual, and test bank.
To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com
Chapter 16: Managing Costs and Uncertainty
IM 12
4. What Variables Influence the Cost of Carrying Cash?
a. The costs of borrowing or issuing equity capital rise and fall with inflation, the
creditworthiness of the borrower, and the availability of funds for lending.
i.
The higher these costs, the greater the incentive to minimize idle cash balances.
b. There is an opportunity cost associated with holding cash as excess cash can be invested in
productive projects or returned to investors.
5. Banking Relationships
a. Accounting and cash flow information are key determinants of loan eligibility, loan limits, and
credit terms.
b. From the bank's perspective, credit risk is a primary concern for determining whether, and
how much, a bank will lend to an entity and is a key input in determining the borrower's
interest rate. To assess credit risk, banks examine the borrower's:
i.
credit history;
ii.
ability to generate cash flow;
iii. quality of collateral;
iv. character of senior officers; and
v.
c.
operational plans and strategies.
Accountants must monitor the firm’s compliance with loan agreement covenants.
d. Trust is the important key to a good relationship between a bank and a borrower.
LO.7: How is technology reducing costs of supply chain transactions?
H. Supply Chain Management
1. General
a. Today, competition in markets is as much between supply chains as between individual firms.
i.
Thus, there is greater joint dependency among firms and their suppliers than existed in
earlier eras.
ii.
This dependency creates an incentive to share information and to manage costs across
customers and suppliers.
b. Text Exhibit 16–10 depicts three significant supply chain interactions and dependencies.
2. Information Technology and Purchasing
a. Today, firms increasingly use electronic exchanges of information and payments to reduce
purchasing transaction costs.
©2011 Cengage Learning. All Rights Reserved. SM Cost Accounting 8th Edition by Raiborn and Kinney.
Visit http://downloadslide.blogspot.com to download more slides, ebooks, solution manual, and test bank.
To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com
Chapter 16: Managing Costs and Uncertainty
i.
IM 13
These exchanges can involve the acquisition of significant resources such as direct
materials and indirect materials or nonoperating inputs such as office supplies.
3. Advances in Authorizing and Empowering Purchases
a. Today, firms are increasingly using e-procurement systems to purchase nonoperating inputs.
b. e-procurement systems are electronic B2B (business-to-business) buy-side applications that
control the requisitioning, ordering, and payment functions for inputs.
c.
One common configuration involves a large purchaser creating an electronic marketplace in
which the purchasing organization allows suppliers to make their electronic catalogs of
products and materials available on-line and the purchasing organization’s authorized
personnel then order inputs from those catalogs and pay for the purchases electronically.
d. Future versions of these systems will facilitate the exchange of information, such as product
specifications or drawings, with an expanded group of potential suppliers to increase
competition for both operating and nonoperating inputs.
LO. 8: Why is uncertainty greater in dealing with future events than with past events?
I.
Coping with Uncertainty
1. The world of management and cost accountants is split into two spheres separated by time.
a. The first sphere is the historical in which the accountant is concerned with accounting
accurately and fairly for events and activities that have already occurred.
b. The second sphere is futuristic, in which accountants deal with events and activities yet to
unfold.
2. The Nature and Causes of Uncertainty
a.
General
i.
Uncertainty in cost management may be attributed to cause and effect relationships and
unforeseen events.
b. Understanding Cause and Effect
i.
Uncertainty often arises from a lack of identification or understanding of cost drivers.
ii.
Some costs may be predicted with accuracy based on the relationship of the cost to the
cost driver, but rarely is the cost predicted perfectly because the entire cost is not related
to the cost driver.
iii. In the context of cost prediction and cost understanding, random refers to the fact that
some portion of the cost is not predictable based on the cost driver or that the cost is
stochastically, rather than deterministically, related to the cost driver.
c.
Occurrence of Unforeseen Events
i.
For example, the events of September 11, 2001, dealt a severe economic blow to most
industries in the United States but for the airline industry the impact of 9/11 was nearly
©2011 Cengage Learning. All Rights Reserved. SM Cost Accounting 8th Edition by Raiborn and Kinney.
Visit http://downloadslide.blogspot.com to download more slides, ebooks, solution manual, and test bank.
To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com
Chapter 16: Managing Costs and Uncertainty
IM 14
fatal as airlines lost 100 percent of their revenues for a brief period and a large portion of
revenues for an extended period after that disaster.
ii.
When firms plan for unforeseen events, it is impossible to know the severity of all
contingencies that could occur. Accordingly, no reasonable plan to deal with unforeseen
events will provide solutions for all possible occurrences.
LO.9: What are the four generic approaches to managing uncertainty?
3. Four strategies for dealing with uncertainty
a. There are four generic strategies for dealing with cost management uncertainties:
i.
First, uncertainty can be explicitly factored into estimates of future costs;
ii.
Second, costs can be structured to automatically adjust to uncertain outcomes;
iii. Third, options and forward contracts can be used to mitigate effects of uncertainty; and
iv. Fourth, insurance can be purchased to reimburse the firm in the event of unexpected
occurrences.
b. Explicitly Considering Uncertainty When Estimating Future Costs
i.
In the following equation, y is the cost or other item to be predicted (dependent variable);
a and b are, respectively, the intercept and slope in the prediction equation; and X is the
predictor variable (independent variable).
ii.
The least squares method is used to develop estimates of the values for a and b in the
prediction equation:
y = a + bX
iii. When alternative independent variables exist, least squares regression can help select
the independent variable that is the best predictor of the dependent variable.
iv. The coefficient of determination is the portion of the variance in the dependent variable
that is explained by the variance in the independent variable.
v.

The value of this statistic ranges between 0 and 1.

A value of 0 indicates the relationship between the predictor variable and the
dependent variable is completely random (i.e., the predictor variable is of no value in
predicting the dependent variable).

A value of 1 signifies that the variance of the independent variable explains
completely the variance of the dependent variable (i.e., the predictor variable is
ideal).
Text Exhibit 16–11 illustrates the hypothetical relationship of factory utility costs to two
alternative predictor variables: machine hours and plant production hours.
©2011 Cengage Learning. All Rights Reserved. SM Cost Accounting 8th Edition by Raiborn and Kinney.
Visit http://downloadslide.blogspot.com to download more slides, ebooks, solution manual, and test bank.
To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com
Chapter 16: Managing Costs and Uncertainty
IM 15
vi. Other statistical techniques such as computer simulations and more elaborate regression
models, which can include multiple independent variables as well as nonlinear
relationships between independent and dependent variables, can also be used to select
predictor variables.
c.

The goal in using more elaborate models is to reduce the prediction error and thereby
the effects of uncertainty on accuracy of predictions.

An example using an equation to predict annual factory maintenance costs is
provided in the text.
Structuring Costs to Adjust to Uncertain Outcomes
i.
ii.
Some industries are characterized by very high levels of fixed costs.

In the short run, the level of costs is very insensitive to the level of customer demand.

The result is that if demand spikes, profits soar, and if demand falters, profits drop
rapidly and quickly turn into losses.
Cost and revenue graphs are presented in text Exhibit 16–12 to illustrate two different
cost structures: one that is entirely variable and one that is entirely fixed.

The profits of the company with the fixed cost structure vary greatly with small
changes in volume while the profits of the company with the variable cost structure
change slowly as volume changes.

Although fixed and variable costs are not completely substitutable, most companies
have substantial opportunities to change their costs structures.
d. Using Options and Forward Contracts to Mitigate Price Risk
i.
ii.
Uncertainty of the cost of inputs arises from two sources: the quantity of the inputs
consumed and the price per unit of those inputs.

Although the quantity of inputs consumed is typically highly correlated with customer
demand and the volume of production, the prices of inputs can be influenced by
many other factors.

Thus, although the uncertainty surrounding quantity of input usage may best be
resolved by an improved understanding of volume drivers, other strategies will be
necessary to deal with price uncertainty.
Some companies operate in industries that are intensely competitive; if input prices
unexpectedly increase, these companies may be unable to increase prices sufficiently to
cover the increase in costs.
iii. These companies in particular need effective strategies for dealing with input price
uncertainty; two tools used in such strategies are options and forward contracts.

Options and forward contracts are agreements that give the holder the right to
purchase a given quantity of a specific input at a specific price at a specific time.

Generically, the use of options and forward contracts to manage price risk is known
as hedging.
©2011 Cengage Learning. All Rights Reserved. SM Cost Accounting 8th Edition by Raiborn and Kinney.
Visit http://downloadslide.blogspot.com to download more slides, ebooks, solution manual, and test bank.
To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com
Chapter 16: Managing Costs and Uncertainty
IM 16
iv. Text Exhibit 16–13 lists items that are commonly hedged.
e. Insuring Against Occurrences of Specific Events
i.
Insurance involves a contract in which one party (an insurer) in exchange for a payment
(premium) agrees to reimburse a second party (an insured) for the costs of certain
occurrences.
ii.
Whereas other strategies for dealing with uncertainty largely address uncertainty about
costs deriving from quantity and price variability, insurance is purchased to cope with
uncertainty about occurrences of specific events.
iii. Events usually insured against are those that, in the absence of insurance, would
dramatically increase costs such as fire, flood, loss of revenues from business
interruption, etc.
©2011 Cengage Learning. All Rights Reserved. SM Cost Accounting 8th Edition by Raiborn and Kinney.
Visit http://downloadslide.blogspot.com to download more slides, ebooks, solution manual, and test bank.
To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com
Chapter 16: Managing Costs and Uncertainty
IM 17
Multiple Choice Questions
1. (LO.1) Select the response that shows the correct order of the steps in a cost control system.
a. Evaluate → Plan → Respond → Execute
b. Evaluate → Plan → Execute → Respond
c. Plan → Execute → Respond → Evaluate
d. Plan → Execute → Evaluate →Respond
2. (LO.1) Preparing variance reports for a division is a cost control method for which of the following
control points?
a. After an event
b. During an event
c. Before an event
d. All of the above
3. (LO.2) Cost changes may be attributed to which of the following factors?
a. Volume changes
b. Inflation
c. Supply/supplier cost adjustments
d. All of the above
4. (LO.3) Cost containment is not possible for:
a. reduced supplier competition.
b. supply and demand adjustments.
c. quantities purchased.
d. seasonality.
5. (LO3.) The practice of finding acceptable alternatives to high-cost items or not spending money
for unnecessary goods or services is referred to as:
a. cost reduction.
b. cost management.
c. cost avoidance.
d. cost containment.
6. (LO.4) Committed costs:
a. may be partially controlled by comparing actual and expected results from plant asset
investments.
b. include costs such as maintenance and advertising.
c. are usually not measurable in monetary terms.
d. are generated by activities that vary in type and magnitude from day to day.
7. (LO.4) Discretionary costs are:
a. costs such as depreciation and staff salaries.
b. those management decides to incur in the current period to enable the company to achieve
objectives other than the filling of orders placed by customers.
c. governed mainly by past decisions that established the current levels of operating and
organizational capacity and that only change slowly in response to small changes in capacity.
d. unaffected by current managerial decisions.
8. (LO.5) Discretionary costs are generally budgeted on the basis of all of the following factors
except:
a. the upcoming period’s expected level of operations.
b. the previous period’s actual costs.
c. the related activity’s perceived significance to achieving the organization’s goals.
d. the ability of managers to effectively negotiate during the budgetary process.
©2011 Cengage Learning. All Rights Reserved. SM Cost Accounting 8th Edition by Raiborn and Kinney.
Visit http://downloadslide.blogspot.com to download more slides, ebooks, solution manual, and test bank.
To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com
Chapter 16: Managing Costs and Uncertainty
IM 18
9. (LO.6) Which of the following is not a reason firms hold cash?
a. To cover unexpected events
b. For speculation
c. To liquidate transactions
d. All of the above are reasons why firms hold cash.
10. (LO.6) Which of the following variables influences the cost of carrying cash?
a. Cost of borrowing
b. Cost of issuing equity capital
c. Opportunity cost of holding cash
d. All of the above
11. (LO.7) Purchases of indirect materials and nonoperating inputs such as office supplies are
increasingly being accomplished using an e-procurement system. Which of the following
functions is typically not included in such a system?
a. Payment function
b. Requisitioning function
c. Forecasting function
d. Ordering function
12. (LO.8) A decision maker is operating in an environment in which all the facts surrounding a
decision are known exactly, and each alternative is associated with only one possible outcome.
The environment is known as:
a. conflict.
b. risk.
c. uncertainty.
d. certainty.
13. (LO.9) All of the following are strategies for dealing with uncertainty except:
a. explicitly considering uncertainty when estimating future costs.
b. installing new information technology.
c. structuring costs to adjust to uncertain outcomes.
d. insuring against occurrences of specific events.
14. (LO.9) What coefficient of correlation results from the following data?
X
1
2
3
4
5
Y
10
8
6
4
2
a. - 1
b.
0
c. +1
d. +100
15. (LO.9) In regression analysis, which of the following correlation coefficients represents the
strongest relationship between the independent and dependent variables?
a. - .50
b.
.00
c.
.50
d. 1.00
©2011 Cengage Learning. All Rights Reserved. SM Cost Accounting 8th Edition by Raiborn and Kinney.
Visit http://downloadslide.blogspot.com to download more slides, ebooks, solution manual, and test bank.
To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com
Chapter 16: Managing Costs and Uncertainty
IM 19
Multiple Choice Solutions
1.
d
2.
a
3.
d
4.
b
5.
c
6.
a
7.
b (CMA Adapted)
8.
b
9.
d
10.
d
11.
c
12.
d (CMA Adapted)
13.
b
14.
b (CMA Adapted)
15.
d (CMA Adapted)
©2011 Cengage Learning. All Rights Reserved. SM Cost Accounting 8th Edition by Raiborn and Kinney.
Visit http://downloadslide.blogspot.com to download more slides, ebooks, solution manual, and test bank.