Cost Accounting and Control Module/Unit I: Part 2 - Introduction to Cost Management antonio jaramillo dayag The term cost management is normally used for people engaged in businesses. Unfortunately, that term has no uniform meaning. ______________________ therefore is use to describe the approaches and activities of managers to use resources to increase value to customers and to achieve organizational goals. Cost management decisions comprise decisions such as whether to explore new markets, implement new organizational processes, and change product designs. Information from accounting systems helps managers to manage costs, but the information and the accounting systems themselves are not cost management. Cost management has a broad focus and is not only about reduction in costs. Cost management includes decisions to incur additional costs. Cost management in accounting: A form of management accounting that is designed to help business owners predict how much business expenses. The purpose of this form of accounting is to avoid going over budget so that businesses can hold onto as much of their revenues as possible. It is the process of planning and controlling the budget of a business. Allows a business to predict impending expenditures to help reduce the chance of going over budget. Cost management has a much wider focus than that found in traditional-costing systems. It is not only concerned with how much something costs but also with the factors that drive costs, such as product quality, and process productivity. The costs of activities and processes do not appear on the financial statements. Knowing these costs and their primary causes is critical for companies engaging in such tasks as continuous development, total quality management, productivity enhancement, strategic cost management and environmental cost management An important objective of a cost management system is the calculation of product costs for external financial reporting. Cost accounting provides the detailed cost information that management needs to control current operations and plan for the future. Three sectors of the economy wherein cost accounting needs to be needs to be applied: 1. ________________________companies purchase materials and components and convert them into various finished goods. Examples are automotive companies such as cellular phone producers, food-processing companies and computer companies. 2. _______________________companies purchase and then sell tangible products without changing their basic form. This sector includes companies engaged in retailing. 3. ____________________companies provide services (intangible products) - for example, accounting firms, law firms, banks, transportation companies, mutual fund, insurance, advertising, internet service providers and brokerage firms. Management uses this information to decide how to allocate resources to the most efficient and profitable areas of the business. All types of business entities - manufacturing, merchandising, and service businesses - require accounting systems in cost accumulation (actual/historical, normal costing and standard costing) to track their activities. For manufacturers, it is now common regardless of firm’s sizes to have cost accounting systems that track the costs incurred to produce and sell their diverse product lines. While the cost accounting principles and procedures discussed mostly emphasize manufacturers, many of the same principles apply to service and merchandising businesses. For-profit service businesses, such as health clubs, accounting firms, and PBA basketball teams, sell services rather than products. Merchandisers purchase finished goods for resale. They may be retailers, who sell products to individuals for consumption, or wholesalers, who purchase goods from manufacturers and sell to retailers. Not-for-profit entities such as universities/colleges, hospitals, voluntary health and welfare organizations, and other not-for-profit entities such private and community organizations, and trade associations, and some health care facilities, provide services at little or no cost to the user. What is Cost Accounting? ______________, often referred to as the language of business, provides much of that necessary information. Accounting language has two primary “variations”: financial accounting, and management accounting. Cost accounting is a bridge between financial and management accounting _________________ refers to recording (of costs), classifying (manufacturing or nonmanufacturing), summarizing (or reporting) financial (quantitative) and nonfinancial (qualitative or non-quantitative) information and interpreting the details of all cost (materials, labor and overhead) aspects of company performance during a particular period of time. It is therefore, a system that records, summarizes, analyzes, and interprets the details of the cost of materials, labor and overhead necessary to produce and sell an article or a product. Modern cost accounting takes the perspective that collecting cost information is a function of the management decisions being made. For example, calculating the cost of a product is a cost accounting function that answers financial accounting’s inventory-valuation needs and management accounting’s decision-making needs (such as deciding how to price products and choosing which products to promote). The original purpose of a cost accounting system was to control costs. This is still an important function of cost management systems given the current global competitive environment. Cost accounting provides the detailed cost information that management needs to control current operations and plan for the future. The main aim of cost accounting is to track the cost of production and fixed costs of the company. This information is useful in reducing and controlling various costs. It is very similar to financial accounting, but it is not reported at the end of the financial year. The Role of Cost Accounting In the past, the role of cost accounting was widely regarded as the calculation of the inventory cost presented in the balance sheet and cost of goods sold figure in the income statement. This view limits the broad range of information that managers need for decisionmaking to nothing more than the product cost data that satisfy external reporting rules such as generally accepted accounting principles and tax regulations. Such a restrictive definition is inappropriate today and is certainly an inaccurate description of the uses of cost accounting information. Cost accounting furnishes management with necessary tools for planning and controlling activities, improving quality and efficiency, and making both routine and strategic decisions. A Framework for Cost Management and Cost Accounting Three features of cost accounting management and cost across a wide range of applications are as follows: 1. Calculating the cost of products, services, and other cost objects 2. Obtaining information for planning and control and performance evaluation 3. Analyzing the relevant information for making decisions Financial Accounting versus Cost Management Accounting The accounting system has two major subsystems in an organization: the financial accounting system and the cost management accounting system. The major differences between the two accounting systems: Outputs Coverage Usefulness Financial Accounting Cost Management for external users such as including investors, creditors (e.g., banks and suppliers), and government agencies nature of inputs and the rules and conventions governing process are defined by IFRS (IASB) and US GAAP (FASB) for internal users using inputs and processes needed to satisfy management objectives. not bound by externally imposed criteria that defines inputs and processes, The criteria govern the inputs and outputs are set by personnel in the company Has three broad objectives: Product costing Planning and control Decision-making for investment decisions, stewardship evaluation, monitoring activities and accounting regulations It should be emphasized that both the financial accounting and the cost management are part of the total accounting information system. Unfortunately, the content of the cost management is all too often driven by the needs of the financial accounting. The reports of both financial accounting and cost management are frequently derived from the same database, which was originally established to support the reporting requirements of financial accounting. Many organizations need to expand this database, or create additional databases, in order to satisfy more fully the needs of internal users. Financial Accounting versus Management Accounting Financial accounting and management accounting have different goals. On the other hand, the major differences between financial accounting and managerial accounting: Inherent meaning Primary users of information Scope/Focus/ Aggregation information of Application Emphasis / Time Orientation Measurement rules & reporting guiding principles Source of data Measuring network/type of information Dependence Nature information of Financial Accounting record, classifies, summarizes and analyzes the financial affairs external parties such as investors, creditors (e.g., banks and suppliers), and government agencies pervasive / entire organization / focus on business as a whole show accuracy and fair presentation of financial statements based. historical-oriented / past data financial reports must accordance with GAAP be in drawn from company’s system (internal) quantitative / financial (primarily monetary by nature) not dependent on management accounting objectivity, verifiability and reliability Management Accounting helps management to make effective decision internal users/parties such managers of the organization, employees much broader / focus on segments of the organization such as division, department, product line as well as the whole organization helps management take meaningful steps and strategize future-oriented using present and past data need of management/internal measurement and reporting may not follow generally accepted accounting principles (GAAP) drawn from internal and external sources quantitative (financial / monetary) and qualitative reports (nonfinancial / non-monetary) such as defect rates, percentage of products returned) by department or product line depends on financial accounting to make right decisions subjectivity and relevance Necessity of information / Emphasis of reports Statutory / optional requirement Frequency / time coverage and nature of reports / Frequency of Reporting Uses of Cost Information Amount of detail Purposes or endresult Unifying model precision or accuracy (reliability) timeliness (relevance) over precision legally mandatory to prepare financial statements has no statutory requirement prepared periodically such as quarterly, semi-annual or yearly reports based on the company as a while prepared as management needs costing products such as cost of goods sold (income statement account), finished goods, work-in-process and raw materials (balance sheet accounts) using historical costing compressed and simplified for reportorial requirements Budgeting, special decisions such as make or buy or drop a product line, split-off point or process further, etc. Assets = Liabilities + Equity no unifying model or equation needed by extensive and detailed for decision-making Financial Accounting versus Cost Accounting All accounting systems are designed to provide information to decision makers. However, it is convenient to classify accounting systems based on the primary user of the information. The classification of accounting systems into financial and cost (or managerial) systems captures this distinction between decision makers. The major differences between financial and cost accounting: Users of the information Important criteria Who establishes or defines the system How to determine accounting treatment Financial Accounting external (investors, creditors, government agencies and tax authorities) comparability, decision relevance (for investors) external standard-setting group (IFRS by IASB / US GAAP by FASB) Cost Accounting internal (within the organization such employees, managers, and department heads ) decision relevance (for managers), timeliness managers / department heads standard-based (rules-based) not designed in a vacuum or standard based but relevance for decision-making for the company and the their business environment Management Accounting versus Cost Accounting The distinction between cost accounting and management accounting is not so clear-cut, and we often use these terms interchangeably. Those items that not so clear-cut are following: Primary objective Cost Accounting ascertainment of cost of producing a product / assist the management in cost control and decision-making Information quantitative information Accounting information there are specific rules and procedure for preparing Scope limited to cost data Management Accounting provide information to managers for setting goals and future activity for its efficiency and effective performance / provide necessary information to the management in the process of its planning, controlling, and performance evaluation, and decision-making quantitative and qualitative information no specific rules and procedures wider area of operation like tax, budgeting, planning and forecasting, analysis, etc. Cost aspect Planning Aims related to ascertainment, allocation, and distribution short-range planning reducing extra expenditure, eliminating unnecessary costs and controlling various costs associated with impact and effect aspect of cost long and short range planning, for which it uses high-level techniques such as probability structure, sensitive analysis etc. aims at the planning of policies and strategy formulation setting goals, Cost Accounting System In cost accounting system, the emphasis is on operating profit, the excess of operating revenues over the operating costs incurred to generate those revenues. This figure differs from net income, which is operating profit adjusted for interest, income taxes, extraordinary items, and other adjustments required to comply with GAAP or other regulations such as tax laws. Relationship of Cost Accounting to Financial Accounting and Management Accounting Financial accounting is often characterized as the primary focus of accounting. It is concentrated on the preparation of financial statements: the balance sheet, the statement of comprehensive income (including income statement), statement of cash flows and changes in equity. It is designed to provide information about the firm to external users. External users include investors, creditors, government authorities, regulators, customers, competitors, suppliers, labor unions, and so on. It is based on standards or rules. It is dedicated to processing information about historical, monetary transactions Management accounting focuses on the information needs of an organization’s internal managers, needs that are related to the planning, controlling, and decision-making functions of those managers. Managerial accounting systems do not require rules. Cost accounting is a subset of both financial and managerial accounting (refer to Figure 1-1). It provides information on the determination of product or service cost that is used on the balance sheet and income statement. Some information generated by cost accounting is used in management accounting and some in financial accounting. Thus, cost essentially links financial and management accounting. None of these accounting areas is more important than the other; each simply provides different information for different needs. Thus, the determination of “importance” lies with the user and the user’s purposes. Interrelationship of Financial Accounting, Cost Accounting and Management Accounting Cost accounting is viewed as the common denominator or intersection between financial accounting and management accounting. Cost accounting addresses the informational demands of both financial and management accounting by providing product or service information to: external parties (stockholders, creditors, regulatory authorities and donors) for investment and credit decisions for reporting purposes, and internal managers for planning, controlling, decision-making and performance evaluation on an organization. Figure 1-1: Relationship of Financial, Management, and Cost Accounting (Uses of Product Cost Data in Financial and Management Accounting) Financial Accounting (for inventory costing purposes in the financial statements) Cost Accounting (product cost information) Managerial Accounting (for special reports to management for decision-making purposes It is important to remember that information from the cost accounting system is just a means to an end; the final products are for financial accounting for financial statement presentation and management accounting for managerial. Cost accounting is for: Financial accounting for preparing financial statements, and Managerial accounting looking for the best information in understanding how the information is used in decision making For a manufacturing company, product cost consists of the sum of all factory costs incurred to make one unit of product and is developed in compliance with GAAP (generally accepted accounting principles) for financial reporting purposes. In nonmanufacturing companies–service business or not-for-profit entities, a service cost is more likely to be computed. But product/service cost information can also be developed outside of the constraints of GAAP to assist management in needs for planning and controlling operations. The following are items that provide the relationship of cost accounting to financial accounting and management accounting: 1. Cost accounting provides information for financial accounting and management accounting 2. Cost accounting attempts to satisfy costing objectives for both financial and management accounting. 3. Reports such as balance sheets, income statements, and statements of cash flows are common wherein costing of products is provided by cost accounting system. 4. Cost accounting includes those parts of both financial and management accounting that collect and analyze cost information. 5. Cost accounting provides the product cost data for inventory costing in the financial statements (financial accounting) and required for special reports to management (management accounting). Professional Associations and Agencies (United States) Financial accounting has been subject to the regulations of professional associations and government agencies to a greater extent than cost accounting. Investors, creditors, and external users do not have access to as much information about the company as management does, and thus these external users must be protected. Cost accounting has been influenced in varying degrees by professional associations and government agencies. In some cases, the influence was direct; in other cases the influence was indirect. Direct Influence The following professional associations and government agencies are listed in descending order – in terms of the direct influence they had on the field of cost accounting. 1. National Association of Accountants. This professional association, founded in 1919 (then called the National Association of Cost Accountants), later, the name was changed to National Association of Accountants (NAA) in 1957. Thereafter, in 1991 the group changed its name to what is now the Institute of Management Accountant (IMA). NAA has had the greatest impact to date on the field of cost accounting and it played a major role in developing new and sophisticated procedures in the cost and management field. Its publications, which are practice-oriented, are the leading source of current information for cost and management accountants. An important development is the Institute of Management Accounting (IMA) (established in 1972), charged with developing the Self-Study Program and awarding the Certificate in Management Accounting. 2. Cost Accounting Standards Board (CASB) – refer to discussion below. 3. Financial Executive Institute (FEI). This professional association was established in 1931 as the Controller’s Institute of America. It is a national organization whose members are the top financial officers in their companies. A financial executive, according to the FEI, is a person responsible for the administration of the assets of a firm. The actual title may be controller/comptroller, treasurer, vice-president of finance, generally depending on the size of the company. The cost accountant generally reports to the financial executive through the controller/comptroller. Indirect Influence The following accounting professional associations/board had an important indirect influence on the field of cost accounting. 1. American Institute of Certified Public Accountants [AICPA, United States (US)]. 2. Financial Accounting Standards Board (United States)/International Accounting Standards Board (IASB) 3. American Accounting Association Cost Accounting Standards Management accountants can use different costs and different information for different purposes, because their discipline is not required to adhere to generally accepted accounting principles when providing information for managers’ internal use. No similar accounting board exists to define universal management accounting standards. However, a public sector board called the Cost Accounting Standards Board (CASB) was established in 1970 by the U.S. Congress to promulgate uniform cost accounting standards for defense contractors and federal agencies. Potentially, the CASB could be the most influential force in the cost accounting field if its standards were adopted by a significant number of companies for nongovernment work. The CASB are legally required in cost systems for government contracts, but not in the cost system of a government contractor for nongovernment work. The CASB issues 20 Cost Accounting Standards (of which one has been withdrawn) from its inception until it was dissolved / terminated in 1980 because US congress believed the board’s purpose had been accomplished; however, the board’s standards became part of all major procurement regulations and remained in effect. Congress reestablished the CASB in 1988 as an independent board. The board’s objectives are to Increase the degree of uniformity in cost accounting practices among government contractors in like circumstances; Establish consistency in cost accounting practices in like circumstances by each individual contractor over time; and Require contractors to disclose their cost accounting practices in writing. Although CASB standards do not constitute a comprehensive set of rules, compliance is required for companies bidding on or pricing cost-related contracts. An organization important to the practice of management and cost accounting is the Institute of Management Accountants, or the IMA. The IMA is a voluntary membership organization of accountants, finance specialists, academics, and others. It sponsors two major certification programs: Certified Management Accountant (CMA) and Certified in Financial Management (CFM). The IMA also issues directives on the practice of management and cost accounting called Statements on Management Accounting, or SMAs. The SMAs, unlike the pronouncements of the CASB, are not legally binding standards, but they undergo a rigorous developmental and exposure process that ensures their wide support. An organization similar to the IMA is the Society of Management Accountants of Canada, which also issues guidelines on the practice of management accounting. These Management Accounting Guidelines (MAGs), like the SMAs, are not requirements for organizational accounting, but are merely suggestions. Although the IMA, Cost Accounting Standards Board, and Society of Management Accountants of Canada have been instrumental in standards development, much of the body of knowledge and practice in management accounting has been provided by industry practice and economic and finance theory. Thus, no “official” agency publishes generic management accounting standards for all companies, but there is wide acceptance of (and, therefore, authority for) the methods presented in the text. The development of cost and management accounting standards and practices indicates that management accountants are interested and involved in professional recognition. Another indication of this movement is the adoption of ethics codes by both the IMA and the various provincial societies in Canada. Professional Certification for Management Accountant A variety of certifications are available to management accountants. Three of the major certifications available are: 1. Certificate in Management Accounting, 2. Certificate in Public Accounting, and 3. Certificate in Internal Auditing. Each certification offers particular advantages to a cost or management accountant. In each case, an applicant must meet specific educational and experience requirements and pass a qualifying examination to become certified. Thus, all three certifications offer evidence that the holder has achieved a minimum level of professional competence. Furthermore, all three certifications require the holder to engage in continuing professional education in order to maintain certification. Because certification reveals a commitment to professional competency, most organizations encourage their management accountants to be certified. The Certificate in Management Accounting In 1974, the Institute of Management Accountants (IMA) developed the Certificate in Management Accounting to meet the specific needs of management accountants. A Certified Management Accountant (CMA) has passed a rigorous qualifying examination, has met an experience requirement, and participates in continuing education. One of the key requirements for obtaining the CMA certificate or designation is passing a qualifying examination. Four areas are emphasized: 1. economics, finance, and management; 2. financial accounting and reporting; 3. management reporting, analysis, and behavioral issues; and 4. decision analysis and information systems. The parts to the examination reflect the needs of management accounting and underscore the earlier observation that management accounting has more of an interdisciplinary flavor than other areas of accounting. One of the main purposes of creating the CMA program was to establish management accounting as a recognized, professional discipline, separate from the profession of public accounting. Since its inception, the CMA program has been very successful. Many firms now sponsor and pay for classes that prepare their management accountants for the qualifying examination, as well as provide other financial incentives to encourage acquisition of the CMA certificate.
