Introduction To Cost Management Systems: Cost Accounting: Foundations and Evolutions, 9e

Chapter 12:
Introduction to Cost
Management Systems
Cost Accounting:
Foundations and Evolutions, 9e
Kinney ● Raiborn
© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly
accessible website, in whole or in part.
Learning Objectives
■ Why do organizations have management control
systems?
■ What is a cost management system?
■ What are the organizational roles of a cost
management system?
■ What factors influence the design of a cost
management system?
■ What are the three groups of elements that comprise
a cost management system, and what are the
purposes of these elements?
■ What is gap analysis, and how is it used in the
evolution of a cost management system?
Relationship of Financial,
Management, and Cost Accounting
FINANCIAL COST MANAGEMENT

ACCOUNTING ACCOUNTING ACCOUNTING
Cost Accounting
■ Financial accounting ■ Management

❑ Uses cost accounting accounting
information for external ❑ Uses cost accounting
reporting information for internal
❑ Conforms to GAAP purposes
❑ Planning
❑ Highly aggregated ❑ Controlling
❑ Historical ❑ Decision making
❑ Performance evaluation
❑ Segmented
❑ Current
❑ Relevant for specific
purposes
Internal Information Flows
Planning
Control
Decision
Performance
External Information Flows
Intelligence
Competition
Government Suppliers
Creditors
Organization
Clients
Organizational
communications
Management Control Systems
■ Management Control Systems (MCS) help to

❑ Implement strategic and operating plans
❑ Provide a means for comparison of actual to planned
results for control purposes
■ The MCS
❑ Is not a mechanical process
❑ Requires judgment
❑ Is a black box—An operation whose exact nature cannot be
observed
❑ Guides the organization in designing and implementing
strategies to achieve organizational goals and objectives
MCS Components
■ Detector or sensor ■ Effector

❑ Measuring device that ❑ Device that alters behavior
identifies what is actually if the assessor indicates the
happening in the process need for doing so
being controlled ❑ Feedback
■ Assessor ■ Communications network
❑ Device for determining the ❑ Transmits information
significance of what is between
happening ■ the detector and the
■ Comparing the information assessor and
on what is actually ■ the assessor and the
happening with some effector
standard or expectation of
what should be happening
MCS Overview
Control device Assessor
Detector Effector
Entity being
controlled
MCS Processes
■ Information gathered
❑ Source documents (detectors) gather information
about sales
■ Comparisons made
❑ Comparisons are made to budget (assessor)
■ Communication occurs
❑ A variance report (effector) is issued
(communications network)
■ Changes made when necessary
❑ Encourages sales staff to increase sales volume
Cost Management Systems
■ A Cost Management System (CMS):
❑ May provide information that is more relevant to internal
users
❑ A CMS is part of the Management Information System
(MIS)
■ A structure of interrelated elements that collects,
organizes, and communicates data so managers may
plan, control, make decisions, and evaluate performance
■ Emphasizes satisfying internal demands for information
rather than external demands
❑ A CMS offers formal methods to plan and control an
organization’s cost-generating activities with major
challenges of
▪ Achieving profitability in the short run
▪ Maintaining a competitive position in the long run
CMS Overview
Short Run Long Run
Objective Organizational Survival

Efficiency
Focus Specific costs: Cost categories:

manufacturing, customers, suppliers,
service, marketing, products, distribution
administration channels
Information Timely, accurate, Periodic, reasonably
highly specific, accurate, broad focus,
Characteristics long term
short term
CMS Goals
▪ Develop product costs

▪ Assess product/service life-cycle
performance
▪ Improve understanding of processes and
activities
▪ Control costs
▪ Measure performance
▪ Allow pursuit of organizational strategies
CMS Goals: Develop Product Costs
▪ Develop product costs

❑ Use cost drivers (activities that have a direct
cause-and-effect relationship with costs)
❑ Trace costs when possible using
■ Bar coding
■ RFID (radio frequency identification)
❑ Use product costs to
■ Plan
■ Prepare financial statements
■ Assess individual product/service profitability
■ Assess period profitability
■ Establish prices for cost-plus contracts
■ Create a basis for performance measurements
CMS Goals: Assess Performance
■ Assess product/service life-cycle

performance
❑ Provides basis to relate costs incurred in one
stage of the life cycle to costs and profitability of
other stages
■ Strong investment in development and design stages
might reduce engineering changes and quality costs in
later stages
■ Inability to trace development and design costs to
related product/services might camouflage “disasters”
CMS Goals: Improve Understanding
■ Improve understanding of processes and

activities
❑ Understanding the process and reasons for cost
incurrence allows managers to make
cost-beneficial improvements in the production
and processing systems
CMS Goals: Control Costs
■ Control costs
❑ CMS provides information on activities and cost
drivers
■ In the case of spoilage, the CMS provides
❑ Number of spoiled units
❑ Cost of spoiled units
❑ Information to determine the cause of spoilage
CMS Goals: Assess Performance
■ Measure performance
❑ CMS allows managers to measure and evaluate
performance
■ Human performance
■ Equipment performance
■ Future investment opportunities
CMS Goals: Organizational
Strategies
■ Allow pursuit of organizational strategies
❑ CMS allows managers to
■ Effectively manage strategic resources
■ Determine core competences and organizational
constraints
■ Assess positive and negative financial and nonfinancial
factors of strategic and operational plans
Designing a CMS
ANALYZE
DETERMINE
desired outputs
PERFORM
gap analysis
Improve
ASSESS
gap reduction
CMS Design Influences
■ The design of the CMS is influenced by

❑ Organizational form, structure, and culture
❑ Organizational mission and core competencies
❑ Operations and competitive environment and
strategies
Organizational Form and Structure
■ Organizational form ■ Organizational structure

❑ Choice of form affects ❑ Distribute authority and
■ Cost of raising capital responsibility
■ Cost of operating business ❑ Centralized or decentralized
■ Cost of litigating decision making
■ Statutory authority to make ❑ Group subunits
decisions ■ Geographically
❑ Forms of the business ■ By similar missions (build,
include harvest, or hold)
■ Corporations ■ By natural product clusters
■ Partnerships ❑ Determine accountability for
■ LLPs cost management and
■ LLCs organizational control
❑ Determine the information
needed by the decision
maker
Organizational Culture
■ Organizational culture
❑ Underlying set of assumptions about the entity
and the goals, processes, practices, and values
that are shared by its members
❑ How people interact with each other
❑ Extent to which individuals take authority and
assume responsibility for organizational outcomes
Organizational Mission and Core
Competencies
■ Organizational mission ■ Core competencies
❑ Business mission provides ❑ Timeliness
a long-term goal toward ❑ Quality
which the organization ❑ Customer service
wishes to move
❑ Efficiency and cost control
■ Business mission regarding ❑ Responsiveness to change
competition
❑ The CMS gathers data and
❑ Avoid competition reports about core
■ Product Differentiation competencies
■ Cost Leadership
❑ Confront competition by
identifying and exploiting
temporary opportunities
■ Business mission in relation
to product life cycle
Operations and Competitive
Environment
■ Management needs to assess:
❑ Cost structure, including the proportion of fixed and
variable costs
❑ Level of technology costs, which tend to be fixed and
not susceptible to short-run control
❑ Production capacity
❑ Flexibility to respond to a change in short-term
conditions
Strategies
■ Strategies include: ■ Supplier relations
❑ Being first to market ❑ Form strategic alliances
■ Allows pricing flexibility ❑ Involve suppliers in product
■ Increases market share design and development
■ Large per-unit profit
❑ Link electronically
❑ Substantial reduction in product
costs ■ Integration of entire information
■ Develop new production system
processes ❑ Payroll
■ Capture learning curve effects ❑ Inventory valuation
■ Increase capacity utilization ❑ Budgeting
■ Create a focused factory
arrangement ❑ Costing
■ Design for manufacturability,
logistical support, reliability,
maintainability
CMS Purposes
■ A better CMS is essential to long-run

organizational survival and short-run
profitability
■ More sophisticated CMS are required as
❑ Cost of gathering, processing, and
communicating information decreases
❑ Quantity and intensity of competition
increases
CMS Elements: Motivational and
Reporting
■ Motivational elements ■ Reporting elements
❑ Performance ❑ Prepare financial
measurements statements
■ Quantitative or ❑ Implement responsibility
nonquantitative accounting system
■ Financial or nonfinancial ■ Performance reports for
■ Short term or long term subunits focusing on costs
❑ Reward structure and activities
■ Profit sharing
❑ Support of organizational
mission and competitive
strategy
CMS Elements: Information
■ Information elements
❑ Support budgeting process ❑ Focus on cost control
❑ Disclose cost drivers of ❑ Assess core competencies
activities ❑ Analyze make-or-outsource
❑ Reduce/eliminate decisions
non-value-added activities ❑ Relate cost to
❑ Emphasize managing costs product/process design
throughout the product life ❑ Focus on capital spending
cycle ❑ Minimize cost distortions
❑ Adapt to changing
competitive conditions
❑ Support of cost reduction
initiatives
Implementing CMS
■ Gap Analysis
❑ Identify gap to overcome
❑ Prioritize differences
❑ Develop and deploy improvements
❑ Repeat process to ensure continuous
improvement
Information Needs
<Information Available>
Gap to Overcome
Enterprise Resource Planning
■ For a truly integrated CMS

❑ Standardize information systems/replace legacy
systems
❑ Automate and integrate transfer of data among
systems
❑ Improve the quality of information
❑ Improve timeliness of information
■ Real-time, on-line reporting
Questions
■ Why do companies have MCS?

■ How does the external operating
environment affect the CMS?
■ What is gap analysis?
Potential Ethical Issues
■ Using the financial accounting system rather

than a CMS to support management
functions
■ Not balancing long and short-run concerns in
the design of the CMS
■ Using motivational elements to create high
payoffs for fraudulent behavior
■ Designing motivational elements that don’t
align with manager’s authority

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Chapter 12:

FINANCIAL COST MANAGEMENT

■ Financial accounting ■ Management

■ Management Control Systems (MCS) help to

■ Detector or sensor ■ Effector

Control device Assessor

Objective Organizational Survival

Focus Specific costs: Cost categories:

▪ Develop product costs

▪ Develop product costs

■ Assess product/service life-cycle

■ Improve understanding of processes and

■ The design of the CMS is influenced by

■ Organizational form ■ Organizational structure

■ A better CMS is essential to long-run

■ For a truly integrated CMS

■ Why do companies have MCS?

■ Using the financial accounting system rather

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