1-1. Financial Accounting Versus Cost
Management: A
Systems Framework
Objective 1
A systems framework helps us understand the variety of topics that appear in the field of
cost management. It also facilitates our ability to understand the differences between
financial accounting and cost management. An accounting information system consists of
interrelated manual and computer parts and uses processes such as collecting, recording,
summarizing, analyzing, and managing data to transform inputs into information that is
provided to users.
The accounting information system within an organization has two major subsystems: (1) the
financial accounting information system and (2) the cost management accounting
information system. One of the major differences between the two systems is the targeted
user.
1-1a. Financial Accounting Information System
The financial accounting information system is primarily concerned with producing outputs
for external users. It uses well-specified economic events as inputs, and its processes follow
certain rules and conventions. For financial accounting, the nature of the inputs and the rules
and conventions governing processes are defined by the Securities and Exchange
Commission (SEC) and the Financial Accounting Standards Board (FASB). Among its
outputs are financial statements such as the balance sheet, income statement, and
statement of cash flows for external users (investors, creditors, government agencies, and
other outside users). Financial accounting information is used for investment decisions,
stewardship evaluation, activity monitoring, and regulatory measures.
1-1b. The Cost Management Information System
The cost management information system is primarily concerned with producing outputs for
internal users using inputs and processes needed to satisfy management objectives. The
cost management information system is not bound by externally imposed criteria that define
inputs and processes.
Instead, the criteria that govern the inputs and processes are set by people in the company.
The cost management information system has three broad objectives that provide
information for:
1. Costing out services, products, and other objects of interest to management
2. Planning and control
3. Decision making
The information requirements for satisfying the first objective depend on the nature of the
object being costed and the reason management wants to know the cost. For example,
product costs that satisfy the FASB rules are needed to value inventories for the balance
sheet and to calculate the cost of goods sold expense on the income statement. These
product costs include the cost of materials, labor, and overhead. In other cases, managers
may want to know all costs that are associated with a product for purposes of tactical and
strategic
profitability analysis. If so, then additional cost information may be needed concerning
product design, development, marketing, and distribution. For example, pharmaceutical
companies, such as AbbVie might want to associate research and development costs with
individual drugs or drug families. The desire for management to understand such cost
associations is logical given that the development of a single new drug can cost $2.6 billion
and faces a regulator approval rate of just 10 percent.
*
Cost information also is used for planning and control. It should help managers decide what
should be done, why it should be done, how it should be done, and how well it is being done.
For example, information about the expected revenues and costs for a new product could be
used as an input for target costing. At this stage, the expected revenues and costs may
cover the entire life of the new product. Thus, projected costs of design, development,
testing, production, marketing, distribution, and servicing would be essential information.
Finally, cost information is a critical input for many managerial decisions. For example, a
manager may need to decide whether to continue making a component internally or to buy it
from an external supplier. In this case, the manager would need to know the cost of
materials, labor, and other productive inputs associated with the manufacture of the
component and which of these costs would vanish if the product were no longer produced.
Also needed is information concerning the cost of purchasing the component, including any
increase in cost for internal activities such as receiving and storing goods. As illustrated by
this example, companies increasingly utilize a proactive cost management perspective to
improve resource allocation and investment decisions across the company.
Cost management has a much broader focus than that found in traditional costing systems.
It is concerned not only with how much something costs but also with the factors that drive
costs, such as cycle time, quality, and process productivity. Thus, cost management requires
a deep understanding of a firm's cost structure. Managers must be able to determine the
long- and short-run costs of activities and processes as well as the costs of goods, services,
customers, suppliers, and other objects of interest. Causes of these costs are also carefully
studied.
1-1c. Different Systems for Different Purposes
The financial accounting and cost management systems indicates us that different systems
exist to satisfy different purposes. As indicated, these two systems are subsystems of the
accounting information system. The cost management information system also has two
major subsystems: the cost accounting information system and the operational control
information system.
The objectives of these two subsystems correspond to the first and second objectives
mentioned earlier for the cost management information system (the costing and control
objectives). The output of these two cost systems satisfies the third objective (the
decision-making objective).
The cost accounting information system is a cost management subsystem designed to
assign costs to individual products and services and other objects
as specified by management. For external financial reporting, the cost accounting system
must assign costs to products in order to value inventories and determine cost of sales.
Furthermore, these assignments must conform to the rules and conventions set by the SEC
and the FASB. These rules and conventions do not require that all costs assigned to
individual products be causally related to the demands of individual products. Thus, using
financial accounting principles to define product costs may lead to under- and
overstatements of individual product costs. For reporting inventory values and cost of sales,
this may not matter. Inventory values and cost of sales are reported in the aggregate, and
the under- and overstatements may wash out to
the extent that the values reported on the financial statements are reasonably accurate.
At the individual product level, however, distorted product costs can cause managers to
make significant decision errors. For example, a manager might erroneously deemphasize
and overprice a product that is, in reality, highly profitable. For decision making, accurate
product costs are needed. If possible, the cost accounting system should produce product
costs that simultaneously are accurate and satisfy financial reporting conventions. If not,
then the cost system must produce two sets of product costs: one that satisfies financial
reporting criteria and one that satisfies management decision-making needs.
The operational control information system is a cost management subsystem designed to
provide accurate and timely feedback concerning the performance of managers and others
relative to their planning and control of activities. Operational control is concerned with what
activities should be performed and assessing how well they are performed. It focuses on
identifying opportunities for improvement and helping to find ways to improve. A good
operational control information system provides information that helps managers engage in a
program of continuous improvement of all aspects of their businesses.
Product cost information plays a role in this process but, by itself, is not sufficient. The
information needed for planning and control is broader and
encompasses the entire value chain. For example, every profit-making manufacturing and
service organization exists to serve customers. Thus, one objective of an operational control
system is to improve the value received by customers. Products and services should be
produced that fit specific customer needs. (Note how this affects the design and
development system in the value chain.) Quality, affordable prices, and low post-purchase
costs for operating and maintaining the product are also important to customers.
A second, related objective is to improve profits by providing this value. Well-designed,
quality products that are affordable can be offered only if they also provide an acceptable
return to the owners of the company. Cost information concerning quality, different product
designs, and post-purchase customer needs is vital for managerial planning and control.
1-2. Factors Affecting the Use of Cost
Management
Objective 2
Worldwide competitive pressures, growth in the service industry, expansion of data analytics,
and advances in digital and manufacturing technologies have changed the nature of our
economy and caused many manufacturing and service industries to dramatically change the
way in which they operate.
Changes in these important factors, in turn, have prompted the development of innovative
and relevant cost management practices. For example, activity-based accounting systems
have been developed and implemented in many organizations. Additionally, the focus of cost
management accounting systems has broadened to enable managers to better serve the
needs of customers and manage the firm's business processes that are used to create
customer value.
Furthermore, cost management practices increasingly are informing decisions in important
emerging areas such as forensic accounting, enterprise risk management, and business
sustainability.
1-2a. Global Competition
Vastly improved transportation and communication systems have led to a global market for
many manufacturing and service firms. Several decades ago, firms neither knew nor cared
what similar firms in Japan, Brazil, India, Germany, Africa, and China were producing. These
foreign firms were not competitors because their markets were separated by geographical
distance.
Now, both small and large firms are affected by the opportunities and challenges offered by
global competition. Stillwater Designs, a small firm that designs and markets Kicker
speakers, has significant markets in Europe. The manufacture of the Kicker speakers is
mostly outsourced to Asian producers.
At the other end of the size scale, Apple, Google, Mars, Inc., Procter & Gamble, The
Coca-Cola Company, and Yum! Brands have developed sizable markets in China. For
example, Apple manufactures over 500,000 iPhones every day in a Chinese factory with
more than 200,000 employees and ships them around the world aboard massive Boeing 747
jets. For example, the 6,300-mile iPhone trek from Zhengzhou, China, to Anchorage, Alaska,
takes only three days.
Similarly, service providers, such as investment bankers
and management consultants, can communicate with foreign offices instantly.
Improved transportation and communication in conjunction with higher quality products that
carry lower prices have upped the ante for all firms. This global competitive environment has
increased the demand not only for more cost information but also for more accurate cost
information. Cost information plays a vital role in reducing costs, improving productivity, and
assessing product-line profitability.
1-2b. Growth in the Service Industry
The service industry—including financial services, transportation, technology, medical, and
travel—represents a significant and growing portion of the economy. For example, the global
financial services market is estimated at approximately $25 trillion. Furthermore, the service
industry now comprises approximately three quarters of the U.S. economy and employment.
Interestingly, new products oftentimes spur the use of new services in order to function as
customers desire, such as cars that utilize navigation services and smart televisions that
utilize streaming services. * Furthermore, the gig economy, which refers to the use of
short-term contracts to provide a service, represents one of the most impactful newer service
sectors. For example, many well-known startup service companies, such as Airbnb,
Instacart, and Uber, have arisen out of the gig economy. The significant growth in the service
industry has made managers in the industry more conscious of the need to have accurate
cost information for planning, controlling, continuous improvement, and decision making.
Thus, the changes in the service sector add to the demand for innovative and relevant cost
management information.
1-2c. Advances in Information Technology and the Manufacturing Environment
Significant advances in information technology have led to advancements in the
manufacturing environment.
Enterprise resource planning (ERP) software can provide an integrated system capability—a
system that can run all the operations of a company and provide access to real-time data
from the various functional areas of a company spanning the entire value chain. Analyzing
this real-time data enables managers to continuously improve the efficiency of organizational
units and processes. Information can be captured and analyzed regarding product
movement through the factory, completed production, materials used, scrap generated, and
final product cost. The same real-time data usage occurs within service companies as well.
For example, UPS utilizes its multibillion-dollar investments in information technology to
provide customers with cutting-edge services, such as processing an astonishing 295 million
daily package tracking requests from customers.
As a result of these technological advances in information technology, cost accountants
have the flexibility to respond to the managerial need for more complex product costing
methods, such as activity-based costing (ABC). ABC software is classified as online analytic
software and facilitates improved decision making around areas such as cost estimation,
product pricing, and
planning and budgeting. This vast computing capability now makes it possible for
accountants to generate individualized reports on an as-needed basis.
Furthermore, manufacturing management approaches such as the theory of constraints and
just-in-time have allowed firms to increase quality, reduce inventories, eliminate waste, and
reduce costs. The theory of constraints is a method used to continuously improve
manufacturing and nonmanufacturing activities. Just-in-time (IT) manufacturing, strives to
produce a product only when it is needed and only in the quantities demanded by
customers. JIT is a critical part of a more comprehensive approach referred to as lean
manufacturing. Lean manufacturing is the persistent pursuit and elimination of waste that
simultaneously embodies respect for people. Waste is anything that does not add value to
the end user (customer). Depending on the nature of
the value streams created in lean manufacturing, a more accurate assessment of product
costs may result. The theory of constraints, just-in-time, and lean manufacturing can help
companies reduce lead times and inventories, and
therefore reduce costs.
1-2d. Cybersecurity and Data Privacy
The explosion in hacking and malware has led companies to emphasize data and
cybersecurity. Dedicated professionals identify threats and shore up company defenses
against them. The proliferation of these cyberthreats has also led to an increased emphasis
on data privacy as both internal company data and customer data must be guarded against
falling into the wrong hands. Cost and managerial accountants are important members of the
data security teams.
1-2e. Customer Orientation
Firms concentrate on the delivery of value to the customer with the objective of establishing
a competitive advantage. As such, companies increasingly utilize advances in digital
information technologies, including data analytics, to estimate the profitability of their current
and potential future customers.
The Kroger Company pays attention to who its customers are and which promotions lead to
higher sales. Its CEO, W. Rodney McMullen, stated in June 2023, "We also grew our
higher-income customer households, as they migrate from specialty retailers to Kroger.
These customers are extremely valuable because they are building larger baskets and
spending more per item. We see these customers buying premium Our Brands lines, more
fresh items and larger pack sizes, and as a result, they are more profitable." *
Interestingly,
using various data analytic techniques and cost management perspectives, Kroger
estimates that the value of a loyal customer is approximately eight times that of a non-loyal
customer when considered over time along the value chain. Accountants and managers
refer to a firm's value chain as the set of activities required to design, develop, produce,
market, and deliver products and services to customers. As a result, a key question to be
asked about any process or activity is whether it is important to the customer. The cost
management system must track information relating to a wide variety of activities important
to customers (e.g., product quality, environmental
performance, new product development, and delivery performance).
Customers now count the delivery of the product or service as part of the product. The cost
management system utilizes various techniques to provide insights on these activities. For
example, activity-based management identifies the activities produced at each stage of the
development process and assesses their costs. Target costing encourages managers to
assess the overall cost impact of product designs over the product's life cycle and
simultaneously provides incentives to make design changes to reduce costs. Companies
must compete not only in technological and manufacturing terms but also in terms of the
speed of delivery and response. Firms such as FedEx have exploited this desire by
identifying and developing a market the U.S. Postal Service could not serve.
Companies have internal customers as well. The staff functions of a company exist to serve
the line functions. The accounting department creates cost reports for production managers.
Accounting departments that are "customer driven" assess the value of the reports to be
sure that they communicate significant information in a timely and readable fashion. Reports
that do not measure up are dropped.
1-2f. Total Quality Management
Continuous improvement and elimination of waste are the two foundation principles that
govern a state of manufacturing excellence. Manufacturing excellence is the key to survival
in today's world-class competitive environment. Producing products and services that
actually perform according to specifications and with little waste are the twin objectives of
world-class firms. A philosophy of total quality management, in which managers strive to
create an environment that will enable organizations to produce defect-free products and
services, has replaced the acceptable quality attitudes of the past. The emphasis on quality
applies to services as well as products.
The message is clear. Pursuing an objective of high quality promises major benefits. Cost
management supports this objective by providing crucial information concerning
quality-related activities and quality costs. Savings associated with quality initiatives can be
reported as well. Managers need to know which quality-related activities add value and
which ones do not. They also need to know what quality costs are and how they change
over time.
1-2g. Data Analytics
Cost management provides significant value to organizations through its unique ability to
analyze relevant financial and nonfinancial information and provide reliable insights that
improve strategic and operational decision making across the organization. Organizations
rely on employees from different functional areas to perform various cost management
analyses. As studied throughout this book, these organizational decisions rely on numerous
cost management analyses, including hospital breakeven point, new chief executive officer
selection, restaurant margin of safety, existing product profit and loss, research and
development cost allocation, special order offer, store operating hours, new geographic
service line launch cost, risk response net benefit, grocery store product placement, and
capital project return on investment.
However, conducting cost management analyses that provide value-adding decision insights
increasingly requires an understanding of and comfort with the rapidly growing role of data
analytics within these analyses. *, * Oftentimes these analyses utilize very large data
sets—data sets so large that they exceed the ability of commonly used software to capture
and analyze the relationships (hence, the big data label that has become popular). Analyzing
these big data sets can provide significant insights that help companies to reduce costs,
improve quality, decrease cycle times, detect fraudulent activity,
and enhance decision making. Software for analyzing big data sets has been developed by
companies such as Oracle and SAP; moreover, software such as Microsoft Power BI and
Tableau provide similar analytical capabilities for individuals, small businesses, and large
businesses.
Although defined formally in Chapter 2, data analytics generally refers to the practice of
identifying and analyzing appropriate data and then communicating the resulting insights to
help improve organizational decision making. For example, executives increasingly expect
their accountants to utilize data analytics in forecasting the financial consequences of
various decisions. * The Institute of Management Accountants' Competency Framework
more specifically describes the growing importance of data analytics as accountants work to
effectively "extract, transform, and analyze data to gain insights, improve predictions, and
support decision making." * Additionally, as companies externally disclose increasing
amounts of financial and nonfinancial business sustainability performance data (e.g.,
regarding economic, environmental, social, regulatory, and political issues), management
accounting must consider data visualization challenges regarding how best to communicate
data such that internal decision makers and key external stakeholders understand the
"complete story" of the organization's performance. For example, as explained in the
Competency Framework, data analytics plays an increasingly large role in a number of
important traditional and emerging management accounting analyses, including the
following:
Forecasting—Using analytical tools and data mining techniques to discover key and relevant
trends, both historical and predictive in nature
• Budgeting—Projecting the amount and timing of financial and operational resources
required to allow the organization to achieve its long-term strategic goals
• Extraction—Identifying, transforming, and querying the data necessary to conduct
important financial analyses that often involve multiple data sets and information systems
• Governance-Considering the degree of accuracy, decision relevance, and security of the
increasing amount and types of data used in various financial estimates, including those
involving enterprise risk
management issues
Visualization-Determining how best to present complex analytical tools and organizational
performance results in a manner that is transparent and understandable to investors and
other key stakeholders
In summary, the growing presence of data analytics continues to increase significantly the
responsibilities and importance of cost management. Chapter 2 discusses data analytics in
more detail, including a framework that specifically applies the growing role of data analytics
to cost management analyses.
1-2h. Forensic Accounting
Accountants increasingly provide important inputs used in resolving organizations' various
legal disputes, including civil and fraud cases. These inputs consist primarily of accounting
measures of the economic consequences resulting from such disputes. For example, a
business might use cost behavior concepts to measure what its cost would have been if a
supplier trucking company had not violated the terms of its product delivery agreement. As
another example, a business might use product profitability information to determine
damages after a competitor illegally interferes with its product sales activity over some
period of time. Therefore, experts define forensic accounting as the action of identifying,
recording, settling, extracting, reporting, and verifying past financial data or other accounting
activities for settling current or prospective legal disputes or using such past financial data
for projecting future financial data to settle legal disputes.
Although any type of accounting information potentially can be relevant to the measurement
of economic consequences, management accounting—including cost management
information—is particularly relevant to these measurements. However, the court (i.e., the
judge, jury, and attorneys on both sides) often is not sophisticated in understanding and
applying accounting information to case issues. Fortunately, forensic accounting experts are
uniquely able to provide the court with relevant and reliable cost management and other
accounting information to meet its needs. Therefore, it
is essential that forensic accountants provide the court with knowledge and insight into the
relevant accounting issues in an attempt to help it reach a fair and reasonable case decision.
In so doing, forensic accountants are expected to clearly and concisely explain why they
selected particular accounting information, how they arrived at their accounting
measurements, and how such measures should be interpreted.
More specifically, forensic accountants provide accounting measurement services in several
different but related areas: (1) fraud investigations (i.e., finding fraud and measuring the cost
of resulting damages, preventing or minimizing fraud, and testifying in fraud cases); (2)
litigation support (i.e., litigation consulting, preparing expert opinion reports, and testifying at
trials or in other formats); and (3) performing business valuations (i.e., both adversarial and
non-adversarial). Each of these dispute areas frequently relies on the estimation of certain
costs, typically generated by using various data analytic techniques, to assess the nature
and amount of the dispute's economic consequences. Examples of common disputes
include whether the terms of a service contract have been violated by one of the contracting
parties, the financial consequences resulting from an injury to an employee using an
improperly serviced machine, and the amount of lost sales resulting from a company failing
to provide essential parts as called for in the customer contract. In order to estimate the
appropriate amount of damages within each dispute, a forensic accountant must determine
what accounting information is
relevant to the situation, the correct financial amount of any relevant accounting information,
and how the relevant accounting information should be used or interpreted in resolving the
dispute. Therefore, this book provides examples where appropriate of how cost
management insights inform important forensic accounting analyses.
1-2i. Business Sustainability
Companies operate in an increasingly complex and interconnected global business
environment. As such, the decisions made by companies have increasingly wide and deep
footprints for their stakeholders, including investors, customers, suppliers, regulators,
employees, nongovernmental agencies, and communities. As a result, stakeholders seek
more information regarding a company's various activities beyond the financial statements
and other information traditionally contained with a 10-K annual report.
Business sustainability refers to a company's ability to create value over the long term by
measuring performance, managing risks, and communicating
effectively to key stakeholders in a manner that consistently reflects the achievement of its
strategy. Therefore, stakeholders increasingly desire information that can help them assess
the company's business sustainability performance, which a growing number of investors
interpret as a leading indicator of future financial performance. In response to these
stakeholder requests, companies voluntarily disclose varying but significant types and
amounts of qualitative and quantitative information regarding their business sustainability
performance. For example, KPMG survey evidence finds that over 90 percent of the world's
largest companies choose to disclose business sustainability information to some degree. *
These business sustainability disclosures pertain to numerous issues, including the
company's employee safety at overseas clothing manufacturing plants; compliance with
Environmental Protection Agency rules on air, soil, and water pollution; status regarding
product and service innovation efforts; carbon emissions across product and service life
cycles; supplier selection processes; and employee engagement endeavors. Companies
typically include these disclosures in an annual corporate sustainability report (CSR), also
referred to as a responsibility or citizenship report. Ideally, the items disclosed within a CSR
should link clearly to the company's strategy and reflect its most important risks and
opportunities. For example, a large delivery company, such as Amazon, UPS, or FedEx,
should focus relatively heavily on measuring, managing, and publicly disclosing its activities
involving carbon emissions, whereas a public university should instead focus relatively
heavily on campus safety or student job placement upon graduation. As business
sustainability performance and disclosures often involve cost management expertise, this
book provides examples where appropriate to demonstrate the growing importance of cost
management within business sustainability.
1-3. The Role of the Management Accountant
Objective 3
World-class firms are those that are at the cutting edge of customer support.
They know their market and their product. They strive continually to improve product design,
manufacture, and delivery. These companies can compete with the best of the best in a
global environment. The titles of employees who perform important cost management
analyses vary widely across organizations and include management accountants, internal
auditors, finance personnel, corporate accountants, consultants, risk managers, and
advisors. However, regardless of their title, accountants also can be termed world class.
Those who merit this designation are intelligent and well prepared. They not only have the
education and training to accumulate and provide financial information, but also stay up to
date in their field and in 3 business. In addition, world-class accountants must be familiar
with the customs and financial accounting rules of the countries in which their firm operates.
1-3a. Line and Staff Positions
The role of cost and management accountants in an organization is one of support and
teamwork. They assist those who are responsible for carrying out an organization’s basic
objectives. Positions that have direct responsibility for the basic objectives of an organization
are referred to as
line positions. In general, individuals in line positions participate in activities that
produce and sell their company’s product or service. Positions that are supportive in
nature and have only indirect responsibility for an organization’s basic objectives are
called staff positions.
In an organization whose basic mission is to produce and sell laser printers, the vice
presidents of manufacturing and marketing, the factory manager, and the assemblers are all
line positions. The vice presidents of finance and human resources, the cost accountant, and
the purchasing manager are all staff positions.
The partial organization chart, laid out in Exhibit 1.1, illustrates the organizational positions
for production and finance. Because one of the basic objectives of the organization is to
produce, those directly involved in production hold line positions. Although management
accountants such as controllers and cost accounting managers may exercise considerable
influence in the organization, they have no authority over the managers in the production
area. The managers in line positions are the ones who set policy and make the decisions
that impact production. By supplying and interpreting accounting information, however,
accountants can have significant input into policies and decisions. Accountants also
participate in project teams that are involved in decision making.
The Controller
The controller, the chief accounting officer, supervises all accounting departments. Because
of the critical role that management accounting plays in the operation of an organization, the
controller is often viewed as a member of the top management team and encouraged to
participate in planning, controlling, and decision-making activities. As the chief accounting
officer, the controller has responsibility for both internal and external accounting
requirements. This charge may include direct responsibility for internal auditing, cost
accounting, financial accounting (including Securities and Exchange Commission [SEC]
reports and financial statements), systems accounting (including analysis, design, and internal
controls), budgeting support, economic analysis, and taxes. The duties and organization of the
controller’s office vary from firm to firm. In some companies, the internal audit department
may report directly to the financial vice president; similarly, the systems department may
report directly to the financial vice president or even to another staff vice president. A
possible organization of a controller’s office is also laid out in Exhibit 1.1.
The Treasurer
The treasurer is responsible for the finance function. Specifically, the treasurer raises capital
and manages cash (banking and custody), investments, and investor relations. The treasurer
may also be in charge of credit and collections as well as insurance. As laid out in Exhibit
1.1, the treasurer reports to the financial vice president.
1-3b. Information for Planning, Controlling, Continuous Improvement,
and Decision Making
The cost and management accountant is responsible for generating financial information
required by the firm for internal and external reporting. This involves responsibility for
collecting, processing, and reporting information that will help managers in their planning,
controlling, and other decision-making activities.
Planning
The detailed formulation of future actions to achieve a particular end is the management
activity called
planning. Planning therefore requires setting objectives and identifying methods to achieve
those objectives. A firm may have the objective of increasing its short- and
long-term profitability by improving the overall quality of its products. By improving
product quality, the firm should be able to reduce scrap and rework, decrease the number of
customer complaints and the amount of warranty work, reduce the resources currently
assigned to inspection, and so on, thus increasing profitability. This is accomplished by
working with suppliers to improve the quality of incoming raw materials, establishing quality
control circles, and studying defects to ascertain their cause.
Controlling
The processes of monitoring a plan’s implementation and taking corrective action as needed
are referred to as
controlling. Control is usually achieved with the use of feedback. Feedback is information
that can be used to evaluate or correct the steps that are actually being taken to implement a
plan. Based on the feedback, a manager may decide to let the implementation continue as is,
take corrective action of some type to put the actions back in harmony with the original plan,
or do some midstream replanning.
Feedback is a critical facet of the control function. It is here that accounting once again plays
a vital role. Accounting reports that provide feedback by comparing planned (budgeted) data
with actual data are called
performance reports. Exhibit 1.2 presents a performance report
that compares budgeted sales and cost of goods sold with the actual amounts for the month
of August. Deviations from the planned amounts that increase profits are labeled “favorable,”
while those that decrease profits are called “unfavorable.” These performance reports can
have a dramatic impact on managerial actions—but they must be realistic and supportive of
management plans. Revenue and spending targets must be based (as closely as possible) on
actual operating conditions.
Continuous Improvement
In a dynamic environment, firms must continually improve their performance to remain
competitive or to establish a competitive advantage. A company pursuing continuous
improvement has the goal of performing better than before and better than competitors. In
practical terms,
continuous improvement is increasing overall efficiency by reducing waste, improving
quality, and reducing costs. Cost management supports continuous improvement by providing
information that helps identify ways to improve and then reports on the progress of the
methods that have been implemented. It also plays a critical role by developing a control
system that locks in and maintains any improvements realized.
Decision Making
The process of choosing among competing alternatives is
decision making. Decisions can be improved if information about the alternatives is gathered
and made available to managers. One of the major roles of the accounting information system
is to supply information that facilitates decision making. This pervasive managerial function
is an important part of both planning and control. A manager cannot plan without making
decisions. Managers must choose among competing objectives and methods to carry out the
chosen objectives. Only one of numerous mutually exclusive plans can be chosen. Similar
comments can be made concerning the control function.
1-3c. Certification
A variety of certifications are available to management accountants. Three of the major
certifications available are a Certificate in Management Accounting, a Certificate in Public
Accounting, and a 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.
1-3d. 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. The exam consists of two parts: (1) Technology and Analytics and
(2) Strategic Financial Management. Each part has a four-hour examination and consists of
100 multiple-choice questions, as well as two essays. The exam features an increasing
emphasis on data governance, technology-enabled finance transformation, data analytics,
ethics, and strategic decision making.
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.
1-3e. The Certificate in Public Accounting
The Certificate in Public Accounting is the oldest certification in accounting. Unlike the
CMA designation, the purpose of the Certificate in Public Accounting is to provide evidence
of a minimal professional qualification for external auditors. The responsibility of external
auditors is to provide assurance concerning the reliability of the information contained in a
firm’s financial statements. Only
Certified Public Accountants (CPAs) are permitted (by law) to serve as external
auditors. CPAs must pass a national examination and be licensed by the state in
which they practice. Although the Certificate in Public Accounting does not focus as
heavily on management accounting as the CMA, many management accountants
hold it because of its widespread recognition across business.
1-3f. The Certificate in Internal Auditing
Another certification available to internal accountants is the Certificate in Internal Auditing.
The forces that led to the creation of this certification in 1974 are similar to those that
resulted in the CMA program. As an important part of the company’s control environment,
internal auditors evaluate and appraise various activities within the company. While internal
auditors are independent of the departments being audited, they do report to the top
management of the company. Since internal auditing differs from both external auditing and
management accounting, many internal auditors felt a need for a specialized certification. To
attain the status of a
Certified Internal Auditor (CIA), an individual must pass a comprehensive
examination designed to ensure technical competence and have two years’ work
experience.
1-4. Accounting and Ethical Conduct
Objective 4
Business ethics is learning what is right or wrong in the work environment and
choosing what is right. Well-known and staggering ethical breakdowns, such as the
one that occurred at Wells Fargo involving millions of fake customer accounts and
billions of dollars in corporate fines, serve as stark reminders of the constant need
for organizations to behave ethically. Business ethics could also be described as the
science of conduct for the work environment. Principles of personal ethical behavior
include concern for the well-being of others, respect for others, trustworthiness and
honesty, fairness, doing good, and preventing harm to others. For professionals such
as accountants, managers, engineers, and physicians, ethical behavior principles
can be expanded to include concepts such as objectivity, full disclosure,
confidentiality, due diligence, and avoiding conflicts of interest.
1-4a. Benefits of Ethical Behavior
Attention to business ethics can bring significant benefits to a company. Companies with a
strong code of ethics can create strong customer and employee loyalty. Observing ethical
practices now can avoid later litigation costs. Companies in business for the long term find
that it
pays to treat all of their constituents honestly and fairly. Furthermore, a company that values
people more than profit and is viewed as operating with integrity and honor is more likely to
be a commercially successful and responsible business. These observations are supported by
a number of studies concerning ethics and financial performance. These studies find that
there is a positive correlation between ethical performance and economic performance.
, Simply put, being ethical pays.
1-4b. Standards of Ethical Conduct for Management Accountants
Organizations and professional associations often establish a code of ethics or standards of
conduct for their managers and employees. All firms subject to the Sarbanes-Oxley Act must
disclose whether they have established a code of ethics for senior financial officers and, if
not, must explain why. Although a code of ethics is not mandated by law, it certainly is
encouraged strongly.
In addition to establishing a code of ethics, most companies have established ethics training
programs and whistle-blower hotlines or other mechanisms for employees to report ethical
behavioral breakdowns within their company. However, while important, the mere presence
of such ethical codes, training programs, and reporting mechanisms certainly does not
guarantee highly ethical behavior. Therefore, investors and other key stakeholders
increasingly expect companies to measure and disclose evidence of highly ethical behavior.
As discussed earlier in the chapter, the majority of companies voluntarily report various
measures of business sustainability performance, some of which include evidence of ethical
behavior. For example, Cleveland Clinic, one of the top-rated hospitals in the world,
enthusiastically discloses its frequent inclusion by the Ethisphere Institute as one of the
World’s Most Ethical Companies.
The Institute of Management Accountants (IMA) has established ethical standards for
management accountants. Management accountants are subject to this professional code and
have been advised that “they shall not commit acts contrary to these standards nor shall they
condone the commission of such acts by others in their organizations.”
The standards and the recommended resolution of ethical conflict are presented in
Exhibit 1.3. The code has five major divisions: competence, confidentiality, integrity,
credibility, and resolution of ethical conflict.
To illustrate an application of the code, suppose that the vice president of finance has
informed Adrianna Nunez, a divisional controller, that the division’s accounting staff will be
reduced by 20 percent within the next four weeks. Furthermore, Adrianna Nunez is instructed
to refrain from mentioning the layoffs because of the potential uproar that would be caused.
One of the targeted layoffs is a cost accounting manager who happens to be a good friend.
Adrianna Nunez also knows that her good friend is planning to buy a new sports utility
vehicle within the next week. Adrianna is strongly tempted to inform her friend so that she
can avoid tying up cash that she may need until a new position is found. Would it be unethical
for Adrianna to share her confidential information with her friend? This situation is an
example of an ethical dilemma. Informing the friend would violate II-1, the requirement that
confidential information must not be disclosed unless authorized. Resolution of the conflict
may be as simple as chatting with the vice president, explaining the difficulty, and obtaining
permission to disclose the layoff.
LO1
Explain how cost management differs from financial accounting.
•
Management accounting differs from financial accounting primarily in its targeted users.
Management accounting information is intended for internal users, whereas financial
accounting information is directed toward external users.
•
Management accounting is not bound by the externally imposed rules of financial reporting.
•
Management accounting provides more detail than financial accounting, and it tends to be
broader and multidisciplinary.
LO2
Identify factors and trends affecting the use of cost management.
•
These factors and trends include:
•
More intense global competition
•
Growth in the service industry
•
Advances in digital information technology and the manufacturing environment
•
Focus on customer orientation
•
Total quality management
•
Expansion of the use of data analytics
•
Emergence of forensic accounting
•
Increase in interest in business sustainability
•
Many traditional management accounting practices will be altered because of the revolution
taking place among many manufacturing firms.
•
Deregulation and growth in the service sector of our economy are also increasing the demand
for management accounting practices.
LO3
Describe how management accountants function within an organization.
•
Management accountants are responsible for:
•
Identifying
•
Collecting
•
Measuring
•
Analyzing
•
Preparing
•
Interpreting
•
Communicating information used by management to achieve the basic objectives of the
organization
•
Management accountants need to be sensitive to the information needs of managers.
•
Management accountants serve as staff members of the organization and are responsible for
providing information; they are usually intimately involved in the management process as
valued members of the management team.
•
Three major certifications available to internal accountants are: the CMA, the CPA, and the
CIA.
LO4
Understand the importance of ethical behavior for management accountants.
•
Management accounting aids managers in their efforts to improve the economic performance
of the firm.
•
Unfortunately, some managers have overemphasized the economic dimension and have
engaged in unethical and illegal actions. Many of these actions have relied on the
management accounting system to bring about and even support that unethical behavior.
•
To emphasize the importance of the ever-present constraint of ethical behavior on
profit-maximizing behavior, this text presents ethical issues in many of the problems
appearing at the end of each chapter.
•
The CMA certificate is designed especially for management accountants. The prestige of the
CMA certificate or designation has increased significantly over the years and is now well
regarded by the industrial world.
•
The CPA certificate is primarily intended for those practicing public accounting; however,
this certification is also highly regarded and is held by many management accountants.
•
The CIA certificate serves internal auditors and is also well respected.
Problem 1-10 Ethical Issues
Objective 4
Emily Henson, controller of an oil exploration division, has just been approached by Tim
Wilson, the divisional manager. Tim told Emily that the projected quarterly profits were
unacceptable and that expenses need to be reduced. He suggested that a clean and easy way
to reduce expenses is to assign the exploration and drilling costs of four dry holes to those of
two successful holes. By doing so, the costs could be capitalized and not expensed, reducing
the costs that need to be recognized for the quarter. He further argued that the treatment is
reasonable because the exploration and drilling all occurred in the same field; thus, the
unsuccessful efforts really were the costs of identifying the successful holes. “Besides,” he
argued, “even if the treatment is wrong, it can be corrected in the annual financial statements.
Next quarter’s revenues will be more and can absorb any reversal without causing any severe
damage to that quarter’s profits. It’s this quarter’s profits that need some help.”
Emily was uncomfortable with the request because generally accepted accounting principles
do not sanction the type of accounting measures proposed by Tim.
Required:
1.​ Using the code of ethics for management accountants, recommend the approach that
Emily should take.
2.​ Suppose Tim insists that his suggested accounting treatment be implemented. What
should Emily do?