CHAPTER 1 OVERVIEW OF COST MANAGEMENT AND STRATEGY INTRODUCTION The growing pressures of global competition, trade wars among countries, technological innovation and changes in business processes have made cost management much more important, critical and dynamic than ever before. Business managers: must think and act competitively and doing so requires a Strategy. Strategy is a set of policies, procedures and approaches to business that produce long-term success while strategic management involves the development of a sustainable competitive position. Strategic cost_management involves the development of cost management information to facilitate the principal management function which is strategic management. In today’s business environment, the development and use of information especially cost_management information is a critical factor in the effective management of a firm or organization. Cost_management information is the information that the manager needs to ° effectively manage the firm, profit-oriented as well as not-for-profit organization. This includes both financial information about cost and revenues as well as relevant nonfinancial information about productivity, quality and other key success” factors for the firm. Cost management is the practice of accounting in which the accountant develops and uses cost management information. For competitive success, it is not enough to emphasize only on financial information, This could lead manager to stress cost reduction (a financial measure) while ignoring or even lowering quality standards (a nonfinancial measure). This decision could be a critical mistake which could lead to the loss of customers and market share in the long run. If a firm is to compete successfully, importance should be given to nonfinancial and long-term measures of operating performance such as product and manufacturing advances, product quality and customer loyalty. Cost management information, is thus a value-added concept. It adds value by helping a firm be more competitive. Scanned with CamScanner4 Chapter | he success of every firm or Effective strategic management is very important toll : organization and is thus the pervasive theme of this book. / id production Strategic thinking involves anticipating changes. Ft ee er demal al processes are designed to accommodate expected changes In a as a result of Flexibility is important. The ability to make fast changes is critica’ HO the demand of the new management concepts of e-commerce, speed eueron are flexible manufacturing. Product life cycle — the time from the intr eee new product to its removal from the market — is expected to become ee oe shorter, Success in the recent past days or months is no longer a mé ‘shield ultimate success; the manager must be “driving” the firm by using the win ° not the rear-view mirror. The strategic emphasis also requires creative and integrative thinking, that is, the ability to identify and solve problems from a cross-functional view. The business functions are often identified as marketing, production, finance, and accounting / controllership. Instead of viewing a problem as a production problem, a marketing problem, or a finance and accounting problem, cross-functional teams view it from an integrative approach that combines skills from all functions simultaneously. The integrative approach is necessary in a dynamic and competitive environment. The firm’s attentions is focused on satisfying the customers’ needs; all of the firm’s resources, from all functions, are directed to that goal. USERS OF COST MANAGEMENT INFORMATION Cost management information is useful in all organizations: business firms, governmental units, and not-for-profit organizations. Business firms are usually categorized by industry, the main categories being merchandising, manufacturing, and service. Merchandising firms purchase goods for resale. Merchandisers that sell to other merchandisers are called wholesalers; those selling’ directly to consumers are retailers. Governmental and not-for-profit organization provide services, much like the firms in service industries. However, these organizations provide the services for ‘which no direct relationship exists between the amount paid and the services provided. Instead, both the nature of these services and the customers to receive them are determined by government or philanthropic organizations. The resources are provided by governmental units and/or charities. The services provided by these organizations are often called public goods to indicate that no typical market exists for them. Public goods have a number of unique characteristics, such as the impractically of limiting consumption to a single customer (clean water and police and fire protection are provided for all residents). Scanned with CamScannerOverview of Cost Management and Strategy 5 USES OF COST MANAGEMENT INFORMATION Cost management information is needed for each of the following management functions, namely: 1 Strategic Management Strategic management involves the development of a sustainable competitive position in which the firm’s competitive advantage spells continued success. A strategy is a set of goals and specific action plans that if achieved, provide the desired competitive advantage. Strategic management involes identifying and implementing these goals and action plans. Management must make sound strategic decisions regarding the choice of products, manufacturing methods, marketing techniques and channels and other long-term issues. The strategic emphasis requires an integrative approach which combines skills from all business function, namely, marketing, production, finance and accounting / controllership, is necessary in a dynamic and competitive environment. Due to increasing strategic issues, cost management has moved from a traditional role of product costing and operational control to a broader strategic focus: strategic cost management. Strategic cost management is the development ‘of cost management information to facilitate the principal management function, strategic management. Scanned with CamScannereee ee 6 3. Chapter | 2. Planning and Decision: naking Cost management information is needed to. Support Tecurring decision such as replacing and maintaining equipment, Managin Here budgeting ra materials purchases, scheduling rege S57 ‘ managing istrbtion of products io eistomen gr fik Planning and decision-making i cash flow management and ot just repair as equipment, when, to change a : begin new product development, Bf # marketing plan or when to Management and Operational Controt is foridentifvine : ‘ded to provide a fair and effective basis for identifying inefficient Operations and to reward and motivate the most effective manages. Operational Control takes place when mid-level mana; managers, regional managers) monitors the activities of operating-level managers and employers (e.g., production supervisions, department heads). Management control on the other hand, is the evaluation of mid- level manager by upper-level manager (e.g, Controller or the Chiet Financial Officer (CFO)). ges (€.g., product Reportorial and Compliance to Legal Requirements Reportorial and compliance responsibilities require management to comply with the financial reportin such as the Securities and Exch: Internal revenue (BIR), agencies. ig Fequirements to regulatory agencies ange Commission (SEC) Bureau of and other relevant: government authorities and ‘The financial statement preparation role has recently received a renewed new focus and interest as accounting scandals have shown how crucial and important accurate financial information is for investors, The financial statement information also sérves the other three management functions as this information is often an important part of planning and decision making, control and strategic’ management. Scanned with CamScannerOverview of Cost Management and Strategy 7 MANAGEMENT ACCOUNTANT’S ROLE IN STRATEGIC COST MANAGEMENT Cost Management is the practice of accounting in which the accountant develops and uses cost management information, This area of accountancy practice is performed by management accountants. Management accountants are the accounting professionals who develop and analyze cost management information and other accounting information. Management Accounting involves the application of appropriate techniques and concepts to economic data so as to assist management in establishing plans for reasonable economic objectives and in the making of rational decisions with a view toward achieving these objectives. It is the process of identification, measurement, accumulation, analysis, preparation, interpretation, and communication of financial information, which is used by management to plan, evaluate and control activities within an organization: It also comprises the preparation of financial reports for non-management groups such as shareholders, creditors, regulatory agencies and tax authorities. Management accountants (including cost accountants) are concerned with providing information to managers, that is, people inside’an organization who direct and control the operations. They provide a variety of reports. Some reports focus on how well managers and business units have performed while other reports provide timely and frequent updates on key indicators, analysis of business situation or opportunity and analytical reports that are needed to investigate specific problems. Management accountants at appropriate levels are involved actively in the process of managing the entity. The process includes making strategic, tactical and operating decisions and helping to coordinate the efforts of the entire organization. The management accountant participates, as part of management, in assuring that the organization operates as a unified whole in its long-run intermediate and short- run best interests. Management accounting is concerned primarily with providing information to internal managers who are charged with planning and controlling the operations of the firm and making a variety of management decisions. Generally, management accountants do the following task§: (a) Scorekeeping or data accumulation which enables both internal and external parties to evaluate organizational performance and position. Scanned with CamScanner8 Chapter 1 (b) Interpreti ieeitey cs ee ine of information that helps manager to Foor on conaaae cee Opportunities as well as inefficiencies. THis = oe ly associated with current planning and control and the analys!® vestigations of recurring routine internal accounting repo! situations in which management action may be required. sible courses 7 : ae (c) Problem-solving or quantification of the relative merits of pos: ji rocedure. THIS 'S of action as well as recommendations as to the best P commonly associated with non-recurring decisions. le the most value Three important guidelines h vig guidelines help management accountants ProvIC” 1 solving when scorekeeping provide the most value when scorekeeping, P! and attention directing (interpreting and reporting). ‘These are 1. Eimploy a cost-benefit approach hinical considerations and 2. Recognize behavioral as well as tec! 3. Use appropriate cost concepts for different purpose, Management accountants continually face resource-allocation di e or hire a new employee. The cost- whether to purchase a new software packag' benefit approach should be used in making these decisions: Resources should be spent if they are expected to better attain company goals in relation to the expected costs of those resources. The expected benefits from spending should exceed the be easy to quantify. d costs. The expected benefits and costs may not +h is useful for making resource-allocation cisions, such as expectet Nevertheless, the cost-benefit approac! decisions. Specifically, the management accountant provides a system, which allows management to receive the necessary information used in performing its administrative functions of: (a) planning which involves setting of goals for the firm, evaluating the various ways to meet the goals and picking out what appears to be the best way to meet the goals; (b) controlling which involves th i ; 1e evalu: ofa sth plained tales Me lation of whether actual performance (c) decision makin; ich ii 7g which involves de inati (eg, rel olves determination of, ‘tive i @ 8. relevant costs) for making important bisiness Uecaioes Aare ions. Scanned with CamScannerOverview of Cost Management and Strategy _9 Planning A key activity for all companies is planning. Planning involves identifying alternatives and selecting a course of actioni and specifying how the action will be implemented to further the organization’s objectives. The plan communicates a company’s goals to employees and specifies the Tesources needed to achieve them. The plans of management are often expressed formally in budgets. Cash budgets, capital budgets, and projected statements of firancial position are examples of contributions which accounting can make in resource planning while break-even analysis, projected income statements are examples of useful tools in profit planning. Control Control of organizations is achieved by evaluating the performarice of managers and the operations for which they are responsible.- The distinction between evaluating managers and evaluating the operations they control is important. Managers are evaluated to determine how their performance should be rewarded or punished, which in turn motivates them to perform at a high level. Based on an evaluation indicating good performance, a manager might receive substantial bonus compensation. An evaluation indicating a manager performed poorly might lead to the manager being fired. In part because evaluations of managers are typically tied to compensation and promotion opportunities, managers work hard to ensure that they will receive favorable evaluations. Cost variance analysis, financial statements analysis, gross profit variance analysis are some of the accounting control reports used to inform managers when activities which are part of their responsibility are deviating from the plan. The reports used evaluate the performance of managers and the operations they control are referred to as performance reports. Although there is no generally accepted method of preparing a performance report, such reports frequently involve a comparison of current period performance with performance in a prior period or with planned (budgeted) performance. Scanned with CamScanner10 Chapter 1 Performance reports may not provide definitive answers, but they are still extremely useful. Managers can use them to “flag” areas that need closer attention and to avoid areas that are under control. It would not seém necessary, for example, to investigate labor, rent, depreciation, or other Costs, because these costs are either equal to or relatively close to the planned level of cost. Typically, managers follow the principle of management by exception when using performance reports. This means that managers investigate departures from the plan tha appear to be exceptional; they do not investigate minor departures from the plan. Operations are evaluated to provide infor be changed (i.e., expanded, contracted, of an operation can be negative eve, responsible for the operation is basicall ™ation as to whether or not they should modified in some way). Af evaluation n when the evaluation of the manager ly positive Company plans often play an important role in the control process. Managers can compare actual results with planned results and decide if corrective action is necessary. If actual results differ from the plan, the plan may not have been followed Properly, the plan may have not been well thought out, or changing circumstances may have made the plan out of date. Figure 1-1 presents the major steps in the planning and control process. Once a lan has been made, actions are taken to implement it. These actions lead to results, which are compared with the original plan. Based on this evaluation, managers are rewarded (¢.g., given substantial bonuses or promoted if performance is judged to be good) or punished (e.g., given only a small bonus, given no bonus, or even fired if performance is judged to be poor). Also, based on the evaluation Process, operations may be changed. Changes may consist of expanding (e.g., adding a second shift), contracting (e.g., closing a production plant), or improving operations (¢.g., training employees to do a better job answering customer product inquiries). Changes may also consist of revising an unrealistic plan. Scanned with CamScanner oeOverview of Cost Management and Strategy _ 11 Figure 1-1: Planning and Control Process ——<—P Decisions to change Action taken to operations or revise implement plan Cmte > Decisions to reward or Comparison of planned Punish managers and actual results pte Thus, accounting serves management at all stages of the management process, from the formulation of objectives and so on up to the feedback of performance ‘information which in turn helps in the reformulation of objectives. ‘Decision Making As indicated in Figure 1-1, decision making is an integral part of the planning and control process — decisions are made to reward or punish managers, and decisions are made to change operations or revise plans. Should a firm add a new product? Should it drop an existing product? Should it manufacture a component used in assembling its major product or contract with another company to produce the component? What price should a firm charge for a new product? These questions indicate just a few of the key decisions that confront companies. And how well they make these decisions will determine future profitability and, possibly, the survival of the company. Recognizing the importance of making good decisions, we will devote all of Chapter 11 to the topic. Scanned with CamScanner12__ Chapter 1 information in summary, the management accountant develops east management iTS 4g for the Chief Financial Officer, other managers and employee te4™* manage the firm and make the firm more competitive an COUNTING AND COST .d successful. RELATIONSHIP BETWEEN COST AC MANAGEMENT set of provedures for recording and reporting facturing goods and performing service ae Tudes methods for recognizing: dl ssi ygsuch costs and comparing them with sta Cost accounting is a systematic measurements of the cost of manul aggregate and in detail. It inel allocating, aggregating and reportin costs. se is to provide ting. Its purpos Cost Management needs the output of cost account! say managers ath information which aids decision. There are no snc paar principles which: specify how management Caaied ae oa a ile sy’ ing and standar reported. While systems such as direct cos ard costing ott ing, each accountin; report should be tailored to the management accounting, €4( ig a jsion and the decision maker. The most effective systems Sapeenit id the accountant work together until the accountant manager-decision maker an understands the decision to be made and the manager understands the source of information that the accountant will report. information to choose strategy, to communicate it lement it. They use this information to coordinate ing and marketing a product or service. Managers use cost management i and to determine how best to imp! their decisions about designing, produci STRATEGIC DECISION AND THE COST MANAGEMENT ACCOUNTANT A company earns profit by attracting customers willing to pay for ee eae eee ee ie to the same goods and’services offered by other companies. The ke a ‘company’s success is creating value for customers while differentiating itself from its compan. Identifying how a company will do this is what strategy is all ait on a chosen strategy is only as good as how effectively it is ae Ha management accountant provides input that aids in developi gy, building resources and capabilities, and implementing siategy. Te inderstand the management acco role, we must first unde in f intant’s. r¢ i - le, first understand the Scanned with CamScannerCHAPTER 2 THE PROFESSIONAL ENVIRONMENT OF COST MANAGEMENT ORGANIZATION STRUCTURE AND THE MANAGEMENT ACCOUNTANT Many of the activities constituting the field of management accounting are interrelated and thus must be coordinated, ranked and implemented by the management accountant in such a fashion as to meet the objectives of the organization as perceived by him or her. A major function of the management accountant is that of tailoring the application of the process to the organization so that the organization’s objectives, short-term and long-term, are achieved effectively. Management accounting is intended to include persons involved in such functions as controllership, treasury, financial analysis, planning, and budgeting, cost accounting, internal audit, systems, and general accounting. Management accountants thus may have titles as controller, treasurer, budget analyst, cost analyst, and accountant, among others. The accounting function is usually “staif”, with responsibility for providing line managers and also other staff managers, with specialized services. This includes advice and help in the areas of budgeting, controlling, pricing and special decisions. Line authority is the authority to command action or give orders to subordinates. Line managers are directly responsible for attaining the objectives of the business firm as efficiently as possible, Sales and production managers typically have line authority. Staff authority is the authority to advise but not command others; it is exercised laterally or upward. Staff managers give support, advice and service to line departments. Examples of staff authority are found in personnel, purchasing, engineering and accounting. Except for exercising line authority over his department, the chief accounting officer usually the controller generally fills the staff role in his company as contrasted with the line roles of sales ahd production executives. Theoretically, Scanned with CamScanner22 Chapter 2 followed by the line fe “ 4 res to be the controller transmits the best accounting procedu through a manual of i suc ‘ people to the President who will communica is delegated authority from instructions. In practice however, the controller how to-apply these procedures, n top line ianagement to direct the line people ore the right 10 command. action, i i This is known as functional authority which specialty. laterally or downwardywith regard to specific function or iat ILLER 0) THE CHIEF FINANCIAL OFFICER AND THE CONTR‘ finance director in many he financial operations of ganizations, but The chief financial officer (CFO) — also called the countries — is the éxecutive responsible for overseeing t in an organization. The responsibilities of the CFO vary amo) 1s they usually include the following areas: | information for-reperts to ip - i iding financial © Controllership — includes providing 4 overseeing the over all managers and reports to shareholders an operations of the accounting system. © - Treasury — includes banking and_short- and | investments, and management of cash. _ © Risk management — includes managing the financial risk of and exchange-rate changes and derivatives management. i ““e” “Taxation —-includes income taxes, sales taxes, and international tax-~—~ planning. es ¢ Internal audit — includes reviewing and-analyzing financial and other records to attest to the integrity of the organization’s financial reports and to adherence to its policies and procedures. — ong-term financing, In some organizations, the CFO is also responsible for information systems. In other organizations, an officer of equivalent rank to the CFO — called the chief information officer — is responsible for information systems, The controller (also called the chief accounting officer) is the financial exec ti primarily responsible for management accounting and financial -accounti ae book focuses on the controller as the chief manageitient:accountin ing. This Modern controllets do not do any controlling in terms of line author eee: their own departments. Yet, the modern concept of controllershi 2 Ee : the controller does control in a special sense. That is, by reporti ip maintains that relevant data (problem-solving and attention-directing roles) ie eee rd ler exerts a force or influence that impels management tows it A decisions... - * ard making better-informed “Scanned with CamScannerThe Professional Environment of Cost Management _23 Figure 2-1 is an illustrative organization chart of the CFO and the corporate controller of an apparel company Figure 2-1: Reporting Relationships for the CFO and the Corporate Controller Chairman Chief Executive Officer Board of Directors (CEO) President Chief Operating Officer (COO) Chief Financial Officer (CFO) Controller | Treasurer The Controller as the Top Management Accountant Controllership is the practice of the established science of control which is the process by which management assures itself that the resources are procured and utilized according to plans in order to achieve the company’s objectives. In most organizations, the top managerial accounting position is held by the controller. The controller provides reports for planning and evaluating company activities (e.g., budgets and performance reports) and provides the information needed to make management decisions (e.g., decisions related to construction of a new factory or decisions related to adding or dropping a product). The controller also has responsibility for all financial accounting reports and tax filings with the Bureay of Internal Revenue and other taxing agencies, as well as coordinating the activities of the firm’s external auditors. Scanned with CamScanner24 Chapter 2 the controller’s office is wart for d é sation cht c e controller is cost A simplified illustration of the organization Tring to the cont such shown in Figure 2-2. Note that one ofthe avefacturing companios nave ‘cha accounting, ee medium-sized and large manu ciliate management decisions department. Cost accountants estimate - stag inventory. and develop cost information for purposes of ¥ Ifone wants a high. ent team. The controller is an integral part ofthe fopmanseeMe”- Leg not only strong level career in management accounting, he/she W") tives, These skill accounting skills but also skills required of all eet ills, solid interpersonal skills include excellent written and oral eS ak ‘im ‘competes. and a deep knowledge of the industry in which the anagem iss controller’s office The controller’s authority is basically staff authority in sath own department, gives advice and service to other departments. Hav de miaintainiedtha he has line authority. In the moder concept of controllership it is ma interpreting the controller does control in a special sense. That is, by reporting ie HiaeeracaL relevant data, the controller exerts a force or influence that impels management toward logical decisions consistent with objectives. Figure 2-2: A Typical Organization Chart Showing the Functions of the Controller Controller te Budgeting and 5. 7 Financial Financial Analysis Reporting | a and Special Studies Cost Management Systems Development Taxation Reporting Scanned with CamScannerThe Professional Environment of Cost Management _ 25 Basic Functions of Controllership The basic principal functional responsibilities and acti ies of controllership may be categorized as follows: 1. Planning. Establish and maintain an integrated plan of operation consistent with the company’s goals and objectives, both short and long term, analyzed and revised, as required, communicated to all levels of management, with appropriate systems and procedures installed. 2. Control. Develop and revise standards against which to measure performance and provide guidance and assistance to other members of management in insuring conformance of actual results to standards. 3. Reporting. Prepare, analyze, and interpret financial results for utilization by management in the decision-making process, evaluate the data with reference to company and unit objectives; prepare and file external reports as required to satisfy government regulatory bodies, shareholders, financial institution, customers, and the general public. 4. Accounting. Design, establish, and maintain general and cost accounting systems at all company levels, including corporate, divisional, plant, and unit to properly record all financial transactions in the books of accounts and records in accordance with sound accounting principles with adequate internal control. 5. Other Primary Responsibilities. Manage and supervise such functions as taxes, including interface with the respective taxing authorities and agents; maintain appropriate relationships with internal and external auditors; develop and maintain systems and procedures; develop record retention programs; supervise assigned treasury functions; institute investor and financial public relations programs; office management; and direct other assigned functions. As circumstances warrant, there may be many deviations from the basic functions just described. It should be pointed out that the controller’s efforts should not be diluted and render him less effective by assigning to him unrelated functions ofan operational nature. The financial planning and control functions are too important to the success of the business enterprise to burden the controller with activities that others can perform. Scanned with CamScannerll 26 Chapter 2 Qualifications of the Controller would are and finance with an L. An excellent technical foundation 1 oe ecounting principles. + Understanding and thorough knowled8e° ssanizing, and control, 2. An understanding ofthe principles of PINT, the company competes 3, A general understanding of the industry im WoT and the social, economic, and political forces in viading, its technologies 4. A thorough understanding of the company, ich and environment. » products, polices, objectives histor, FEAST soment and a basic 5. The ability to communicate with all levels of mal tated to engineerin understanding of the other functional problems rel aa Ig, production, procurement, industrial relations, and marl i = si formmati 6. The ability to express ideas clearly in writing or in making We presentations. 7. The ability to motivs The qualifications of an effective controller ate others to achieve positive action and results. The controller may have the technical capability and be able to lay out the assigned tasks as well as supervise and direct his personnel, but he must also have integrity and the ability to communicate if he is to succeed. He must be fair, reasonable, and sincere with all concerned if he is to be recognized for the importance of the controllership function. As in any executive position, the controller must be able to work with people at all levels, have respect for the ideas and opinions of others, and have the resourcefulness, to meet all challenges. . THE CHIEF FINANCIAL OFFICER AND THE TREASURER Although organizational structures vary from firm of firm, the role of finance is assigned to the Chief of Financial Offi i F i Syne ae icer (CFO) or the Vice President-Finance The. financial vice-president’s key subordinates are the Treasurer and the i an Controller. This book has extensivel i previous section, ely dealt with the role of the Controller in the Scanned with CamScannereo The Professional Environment of Cost Management 27 Treasurership Treasurership is concerned with the acquisition, financing and management of assets of a business concern to maximize the wealth of the firms for its owners. In addition to the position of the controller, many companies have a position called treasurer. The dreasurer-has custody of cash and funds invested in various marketable securities. In addition to money management duties, the treasurer is generally responsible for maintaining relationships with investors, banks,-and other creditors, Thus,’ the treasurer plays a major role in managing cash and marketable securities, preparing cash forecasts and obtaining financing from banks and other lenders. Both the controller and the treasurer report to the chief financial officer (CFO) who is the senior executive responsible for both accounting and financial operations. In most firms the treasurer has the following responsibilities: 1. Funds Procurement : This involves raising of funds in accordance with the firms planned capital structure. This responsibility may require negotiating for loans, short-term or long-term, issuing equity of debt instruments at the best terms and conditions possible. . 2. Banking and Custody of Funds This involves direct management of cash and cash equivalents and maintenance of good relations with banks and other non-bank institution. 3. Investment of Funds This involves management of the company’s placements and securities or purchase of debtor equity-instruments such rdinary or preference shares in other corporate entities. This responsibility also includes analysis __ of decisions related to investment in property, plant and equipment. 4. Operating Responsibilities related to (a) Credit and Collection (b) Inventory Management —">"—(e) Corporate pension and retirement fund (d) Investor Relations (e) Insurance (f) Compliance with legal and regulatory provisions relating to funds procurement, use and distribution as well as coordination of the finance function with,accounting function. Scanned with CamScanner28 Chapter 2 NT ACC (QUNTANTS ETHICAL STANDARDS FOR MANAGEME . ae int ethical behavior jn sod regarding concerns have been raised ee unethical can au el hive gations and S f society, including In recent years, many ents 0! virtually all SeB religion. Although these business and in public life. Alle been directed toward managers in virtue and evel government, business, charitable organizations, ‘tention, it is doubtful that they of f the nation. After all, allegations and scandals have received a lot 1 fiber o the m represent a wholesale breakdown of the moral ‘tremain untainted PI day that hundreds of millions of transactions are conducted every 4aY f iation of what is and is not Nevertheless, it is important to have ait pe rt ly, the Institute of Seay . Fortunatel; acceptable behavior in business aie yr States has developed avery useful Mani its (IMA) of the iti Mangement cr of cal Conti odds ‘Management Accounting and Financial Manageme" Even is eal s were specifically developed for management accountants, they have loader application. Code of Conduct for Management Accountants tants (IMA) issued the Standards of Ethical nt Accounting and Financial Management. ‘These standards are presented in Figure 2-3. There are two parts to the standards. ‘The first part provides general guidelines for ethical behavior. In a nutshell, the management accountant has ethical responsibilities in four broad areas namely 1. to maintain a high level of professional competence, The Institute of Management Account Conduct for Practitioners of Manageme! 2. to treat sensitive matters with confidentiality, 3. to maintain personal integrity, and 4, to be objective in all disclosing. The second part of the standards gives specific guidance cot it 4 paiva ncernin; it Id be done if an individual finds evidence of ethical misconduct Stas organization. The ethical standards provide sound, practical advi ; . ice for mat and managers. They require professional behavior, ecpaclal ae Sao of interest. They require management accountants to bring bi i ing conflict attention of their supervisors, and to work competently. ig bad news to the Scanned with CamScannerThe Professional Environment of Cost Management _29 Most of the rules in the ethical standards are motivated by a very practical consideration ~ if these rules were not generally followed in business, then the economy could come to a halt. The following are examples of the consequences of not abiding by the standards: 1. Suppose employees could not be trusted with confidential information. Top managers would therefore be reluctant to distribute confidential information within the company. This could result to decisions being made based on incomplete information and could lead to deterioration of operations. Suppose employees accept bribes from suppliers. Then contracts would tend to go to suppliers who pay the highest bribe rather than to the most competent suppliers. Would you like to fly.in an airplane whose wings were made by the subcontractor who was willing to pay the highest bribe to a purchasing agent? Suppose the CEOs or presidents of companies routinely lied in their annual reports to shareholders and grossly distorted financial statements. If the basic integrity of the company’s financial statement could not be relied on, investors and creditors would have little basis for making informed decisions. Rational investors would suspect the worst and would pay less for securities issued by companies. As a result, less funds would be available for productive investments and many firms might be unable to raise any funds at all. This ultimately, would lead to slower economic growth, fewer goods and services, and higher prices. As these examples suggest, if ethical standards were not generally adhered to, there would be undesirable consequences for everyone. Following ethical rules such as those in the Standards of Ethical Conduct for Practitioners of Management Accounting and Financial Management is not just a matter of being “nice”; it is absolutely essential for the smooth functioning of an advanced market economy. Scanned with CamScanner30 Chapter 2 ractitioners of Managemen, it Figure 2-3: Standards of Ethical Accounting and Financia i jent have an obligatioy to the public, their profession, the organization they SeN2 7 ication, the Institute the highest standards of ethical conduct. In recognition Ot dards of ethical condi of Management Accountants has promulgated ‘the followit ; eogement aheiciee for prectitonesofmnaganent zzouring 9/0207 eral to actieig the these standards, both domestically and internationally, 'S ella Objectives of Management Accounting. Practitioners of man jalualle ee financial management shall not commit acts contrary to these st ee Y condone the commission of such acts by others within their organ! 5 inting and financial management Competence. Practitioners of management accou have a responsibility to: it Maintain, an ped level of professional competence by ongoing of their knowledge and skills, i Perform their professional duties in aocordance with relevant laws, regulations, and technical standards. ‘ 7 Prepare complete and clear reports and recommendations after appropriate analysis of relevant and reliable information. development Confidentiality. Practitioners of management accounting and financial management have a responsibility to: + Refrain from disclosing confidential information acquired in the course of their work except when authorized, unless legally obligated to do so. Inform subordinates as appropriate regarding the confidentiality of information acquired in the course of their work and monitor their activities to assure the maintenance of that confidentiality. Refrain from using or appearing to use confidential information acquired in the course of their work for unethical or illegal advantage either personally or through third parties. Integrity. Practitioners of management accounting and financial management have a responsibility to: + Avoid actual or apparent conflicts of interest and advise all appropriate parties of any potential conflict, + Refrain from engaging in any activity that would prejudice their ability to carry out their duties ethically. + Refuse any gift, favor, or hospitality that would influence or would appear to influence their actions. Scanned with CamScannerThe Professional Environment of Cost Management 31 . Refrain from either actively or passively subverting the attainment of the organization's legitimate and ethical objectives. + Recognize and communicate professional limitations or other constraints that would preclude responsibility judgment or successful performance of an activity . Communicate unfavorable as well as favorable information and professional judgments or opinions, + Refrain from engaging in or supporting any activity that would discredit the profession. Objectivity. Practitioners of management accounting and financial management have a responsibility to: + Communicate information fairly and objectively. + Disclose fully all relevant information that could reasonably be expected to influence an intended user’s understanding of the reports, comments, and recommendations presented. Resolution of Ethical Conflict. In applying the standards of ethical conduct, Practitioners of management accounting and financial management may encounter problems in identifying unethical behavior or in resolving an ethical conflict. When faced with significant ethical issues, practitioners of management accounting and financial management should follow the established policies of the organization bearing on the tesolution of such conflict. If these policies do not resolve the ethical conflict, such practitioner should consider the following courses of action: + Discuss such problems with the immediate superior except when it appears that the superior is involved, in which case the problem should be presented initially to the next higher managerial level. If a satisfactory resolution cannot be achieved when the problem is initially presented, submit the issues to the next higher managerial level. If the immediate superior is the chief executive officer, or equivalent, the acceptable reviewing authority may be a group such as the audit committee, executive committee, board of directors, board of trustees, or owners. Contact with levels above the immediate superior should be initiated only with the superior's knowledge, assuming the superior is not involved. Except where.legally prescribed, communication of such problems to authorities or individuals not employed or engaged by the organization is not considered appropriate. Clarify relevant ethical issues by confidential discussion with an objective advisor (e.g., IMA Ethics Counseling Service) to obtain a better understanding of possible courses of action. Consult your own attorney as to legal obligations and rights conceming the ethical conflict. Ifthe ethical conflict still exists after exhausting all levels of internal review, there may be no other recourse on significant matters than to resign from the organization and Scanned with CamScannerSe Clot P resentative Of the e pees Chapter 2 and 102 0 he ethical confit, it may mative mem “gon the nat lve sn, depending to submit an info ization. After resign@0° i organization. After ty ther parties iation of Accountants, al riate to i iso be approp! nis formerly ement Accounting, 32 al Assoc 7 Tpattute of Mk fanag | =jpattute of Management Account. Obj of Me fama on enagerer Accountt we revised Im 1997 | sieteent No. 18, New Youu ot June COMPANY CODE OF CONDUCT Steines . «af function in an ed market Ethical standards serve ¢ VOY import ee ical standards, material living izes the importance of economy. Without widespread adherence a pears would fall. A former f CMA emphi ethics in business: : ae can + a pratt Suppliers like to sell to ership. Communities are more deal honestly and fairly with ction effectively, all of the “Employees like to like to deal with an ethically relial firms with which they can have a real partn likely to cooperate with organizations that them. If the business community is to fun ‘players need to act ethically.” ” It is unfortunate though, that some companies place so much emphasis on short- term profits that may make it seem like the only way to get ahead is to act unethically. Those who engage in unethical behavior often j more of the following reasons: ustify their actions with one or (1) the organization expects unethical behavior, (2) everyone else is unethical, and/or (3) behaving unethically is the only way to get ahead, - To counter the first justification for unethical behavi i ape oma ei soe of soit. These cree peal oben suppliers and the rd responsi ies to its employees, its cust i its guidelines rather than ts in which the company operates, Cod aa ad behavior in a specific eae ee epeeitie do’s and don'ts oO es strong customer ‘end em re Companies with a strong code fe meena Beet ployee loyalty. While liar: of ethics can create , their victories are often short-term. Com, sand cheats may win on t i ies i fi term find that it pays to treat all of their constituents pon n business for the long nestly and loyally. Scanned with CamScannerThe Professional Environment of Cost Management 33 TYPICAL ETHICAL CHALLENGES Ethical issues can confront management accountants in many ways. Here are two examples: © Case A. Roger Cruz, a management accountant, knows that reporting a loss for a software division will result in yet another series of layoffs, and has concerns about the commercial potential of software for which R&D costs are currently being capitalized as an asset rather than being shown as an expense for internal reporting purposes. The division manager argues that the new product will be successful and profitable but presents little evidence to support her argument. The last two products from this division have been unsuccessful. The management accountant has many friends in the division and wants to avoid a personal confrontation with the division manager. © Case B: A packaging supplier, bidding for a new contract, offers the management accountant of the purchasing company an all-expense paid weekend to the Boracay Resort. The supplier does not mention the new contract when giving the invitation. The accountant is not a personai friend of the supplier. He knows cost issues are critical in approving the new contract and is concemed that the supplier will ask for details about bids by competing packaging companies. _ In both cases, the management accountant is faced with an ethical dilemma. Case A involves competence, objectivity, and integrity. The management accountant should request that the division manager provide credible evidence that the new product is commercially viable. If the manager does not provide such evidence, expensing R&D costs in the current period is appropriate. Case B involves confidentiality and integrity. Ethical issues are not always clear-cut. The supplier in Case B may have no intention of raising issues associated with the bid. However, the appearance of a conflict of interest in Case B is sufficient for many companies to prohibit employees from accepting “favors” from suppliers. Figure 2-3 includes the IMA’s guidance on “Resolution’ of Ethical Conflict.” The accountant in Case B should discuss the invitation with his immediate supervisor. If the visit is approved, the supplier should be informed that the invitation has been officially approved subject to his following corporate policy (which includes the confidentiality of information). Scanned with CamScanner: hapter L 34 Chapter 2 wrERNATIONAL LEVE) TH! CODES OF CONDUCT ON ntants (IFAC) in which i, : ou . e In July 1990, the International Federation of Ace the “Guidelines on Ethies fy, Philippines through the PICPA is @ member he activities of alll professiong Professional Accountants” which S0V8" °F whether they.are practicing a accountants throughout the world; tie service OF employed as inter it : din 20 ‘ements in matters dealing wi accountants, Ina outing tia Tasemens ope con th competence, objectivity, independence, and confdenttt Win’ ke fe Outlines the accountants ethical responsibilities in ee a and commissions, advertising and solicitor the artvolved, the IFAC a border activities. Where cross-border activit arise thn the ike ' ments are ical requirements must be followed if these requirements 2 Fe requirements of the country in which the wo i ion Commission approve The Board of Accountancy of the Professional Regulation Comm proved i Ethics for Professional Accountants in the implementation of the Revised Code © the Philippines effective January 1, 2016. INTERNATIONAL CERTIFICATIONS The three certifications available to management accountants are as follows: Certificate of Management Accounting (CMA) Certificate in Public Accounting (CPA) Certificate in Internal Auditing (CIA) OMA. A Certified Management Accountant is one who has passed the rigorous qualifying examination, has met an experience requirement, and participates in continuing’ educations. The CMA Certificate is granted by the Institute Management Accountants (IMA). - CPA. A Certified Public Accountant is one who has met the pre-qualification educational requirements, passed the CPA licensure examinations given by the Professional Regulatory Board of Accountancy and has satisfied all other legal and regulatory requirements of a public accountant, The CPAs main responsibility is to provide assurance concerning the reliability of the j ion ¢ in i firm’s financial statements, Vertis information contain in the Scanned with CamScanneree The Professional Environment of Cost Management _35 CIA. Since one of the management control responsibilities of the management accountant is to develop effective systems to detect and prevent errors and fraud in the accounting records, it is common for the management accountant to have strong ties to the control-oriented organization such as.the Institute of Internal Auditors (IIA) granting Certification in Internal Auditing (CIA). To attain the Status of Certified Internal Auditor an individual must pass a comprehensive examination designed to erisure technical competence and have the required number of years of work experience. INSTITUTE OF MANAGEMENT ACCOUNTANTS (IMA) Management accountants have gained status in recent years as they now spend more time analyzing a company’s operations and less with the problems of recording and computing costs of products. The Institute of Management * Accountants (IMA), the principal organization of management accountants in the United States, has instituted a program to provide certifications for management accountants and financial managers. The Certified Management Accountant (CMA) examination was first given in 1972. A listing of the required subject areas in the CMA examination indicates the breadth of knowledge expected of the professional management accountant. The examination consists of the following four parts: Economics, Finance, and Management; Financial Accounting, and Reporting; Management Reporting, Analysis and Behavioral Issues; and Decision Analysis and Information Systems. The Certified in Financial Management (CFM) examination was first given in 1996. The CFM examination is similar to the CMA examination with one major difference: the Financial Accounting and Reporting section is replaced with Corporate Financial Management. The IMA also promulgated a code of ethics for management accountants, with is discussed in the previous section. The Institute of Management Accounting (IMA) is a professional organization that publishes the monthly magazine Strategic Finance. Since 1973, the IMA has conducted a comprehensive examination to test the knowledge a management accountant must have to be successful in ‘a complex and fast-changing business world. More than 3,000 individuals take the exam each year. Those who pass the exam are issued a Certificate in Management Accounting and are proud to indicate the designation CMA on resumes and business cards. For details on student and professional memberships in the IMA and for information on the CMA examination, visit the IMA Web site. Scanned with CamScanner36 Chapter 2 rds of et! ical conducy nda t developmet te call to discuss ethical oa isthe One of contributions of the IMA is a ‘hese ethical standards, i er and maintenance of an ethics hotline ON ie to revi conflicts. One may also visit the IMA website af ACCOUNTANTS PHILIPPINE ASSOCIATION OF MANAGEME (PAMA) tants (NAA) «tion of Accountants PAMA was established in 197238 the Nations) association tee was foun ee Philippine Chapter, Inc. Itis affiliated Witt and vofessional activities that primarily to provide its members wit! eluetionl a4 POST es and methods, supplement in the knowledge of ma acc held to present relevant Monthly technical meetings, seminars and orn cram private and and current topics by leading speakers a veri a v the exchange of ideas educational sectors. The open forum provides the Publication of technical and experi ee : xperiences among the participants and the speakers. Pt jateri fo , materials is also part of the Association S efforts to service its members. agement To propagate and professionalize Management Accounting in'the pune PAMA conducts the Certificate in Management Accounting (CMA) Program institute of Management through its continuing education arm, the Philippine I ‘Accounting (PIMA). Basic. objectives of the program are: as a recognized profession by 1. To establish management accounting t accountant and the underlying identifying the role of the management body of knowledge, and by outlining a course of study by which. such knowledge can be acquired. 2. To foster higher educational standards in the field of management accounting. 3. To assist employees, educators and students by establishing an objective measure of an individuals’ knowledge and competence in the field of management accounting. Scanned with CamScannerCHAPTER 3 CONTEMPORARY BUSINESS ENVIRONMENT AND STRATEGIC FOCUS OF COST MANAGEMENT CONTEMPORARY BUSINESS ENVIRONMENT The business environment in recent years has been characterized by increasing competition and relentless drive for continuous improvement. These changes include (1) an increase in global competition; (2) advances in manufacturing technologies; (3) advances in information technologies, the Internet, and e- commerce; (4) a greater focus on the customer; (5) new forms of management organization; and (6) changes in the social, political, and cultural environment of business. As businesses turned global and product lines expanded, operations have become more complex, forward-looking companies saw a tremendous need for management oriented data‘ that was separate from financial-oriented data. Corporate executives are now using cost data to chart successful futures for their companies. Adapting management accounting system to better meet management's needs for information is crucial to an organization’s survival when competing in global markets. Global conipetitors now have relatively free access to markets around the world. As a result, domestic markets on virtually every country face greater challenges from foreign competition. With increased reliance on global markets, companies need not only respond quickly to changing market conditions but also tailor products to different consumer tastes and demands and this has to be done at a level that assures profit and gives satisfactory returns to shareholders. In today’s automated environment management accountants use their management control systems to support and reinforce manufacturing and other operating strategies. It is in this light that one learns to appreciate the role of a management accountant which is more of an influencing role rather than just an informing role. The change in the business environment in at least the last two decades where organization have to transform themselves to become more competitive, have profound effect in the practice of management accounting. Of particular importance are the changes in business, especially the increase in global competition and the changes in management techniques, that have created the need for a new, strategic approach to management and to cost management. Scanned with CamScanner56 Chapter 3 ‘The Global Business Environment jevelopment that drive a a .; in the contemporary the ke: trade are Rs arkets and tr iness ohaNGeS "Fit organization, The growth of international mé ary for-prO the extensive changes in the canter and not-for? apid growth of business envit .. Profit-oriente eit a consumer: SE eau are all affected significamyy other continues. The 's and regulators mpetition e increasing trade i col : d_ increase e al, e- multinationy nities for growth and economic independence an goods are traded growing number of alliance among | iy that the 0PP « i jus dicate clear! ality agreements among countries int oe low-208 y caners and profitability lie in global markets. SON a business i 7 . benefited. Manager». ities are pursued in worldwide, most consumers are o ativl ;: 2 iction act? investors benefit kewise when sues and Prod foreign countries. * need cost management itive and firms ; a als ued financial and nonfinancial ffectively- Global business environment is very information to sustain competitiveness. a information about doing business and competing © Advances in Manufacturing Technologies Firms around the world adopt new. manufacturing technologies to remain competitive in the face of the increased global competition. Many firms adopt methods applied in some Japanese manufacturing firms that produced si ignificant cost and quality improvements using quality teams, and statistical quality control. thod in order to reduce the cost and Some firms include just-in-time inventory met! waste of maintaining large levels of raw materials and unfinished product. A key competitive edge that forms have is the ability.to deliver the product or service faster than the competition. This is known as speed-to-market. Advances in Information Technologies, The Internet and E-Commerce The increasing use of information technology, the internet and e-commerce is perhaps the most fundamental of all business changes in recent years. This new economy is manifested in the rapid growth of Internet-based firms (the dot-com’s: such as Amazon, eBay, and E-trade) and the increased use of the Int " business data processing, communication, and sales. These techi 10 ate resulted in the growing focus in cost management by reducin thet iG process transaction, thereby expanding the indvidel’s aecese ty ine within the firm, the,industry and the business environment acu ae ee le world. Scanned with CamScannerContemporary Business Environment and Strategic Focus of Cost Management _ 57 A Greater Focus on Customers To succeed in this era, customer value is the key focus that businesses of all types must be concerned with. A key change in increased customer demand for product functionality and quality. As.business firms seek to.add new features and new Products as quickly as possible, shorter product life cycle thereby increasing the overall intensity of competition. The new business process focuses on customer satisfaction, Producing value for the customer has changed the orientation of managers from low-cost Production of large quantities to quality, service, faster delivery and the ability to respond to the customer's desire for specific feature. Today, many of the critical success factors are customer oriented. Cost management practices are also changing, cost management reports now include specific measures of customer preference and customer satisfaction. The value of a product or service to the customer is affected by such diverse attributes as product price, quality, functionality, user-friendlia Service, warranty and maintenance costs. By managing acti customer value, the firms can establish a competitive advantage by creating better customer value for the same or lower cost than that of competitors. Cost information plays an important part in, the process called strategic cost management. Generally, firms chose a strategic position corresponding to one of two general strategies: (a) cost leadership, and (b) superior product through differentiation. A focus on customer value means that the management accounting system should produce information about both realization and sacrifice. The system should be able to measure various attributes of customer value, Successful pursuit of cost leadership and/or differentiation strategies requires an understanding of a firm’s value chain (intemal) and supply chain (external). Scanned with CamScanner58__ Chapter 3 : —— New Forms of Management Organization in marketing Management organization has changed in response to the are ba value, the and manufacturing. Because of the focus on customer satisfact : performance to emphasis has shifted from financial and profit-based meas ‘Paty, time to customer-related, nonfinancial performance measures such #8 QT spe of delivery and service. Similarly, the hierarchical command-and-cor anieihat organization is being replaced by a more flexible organs. Ins response tO encourages teamwork and coordination among business Hees jnclude reports that these changes, cost management praotices areialen chan reports reflect the are useful to cross-functional teams of managers; the rating and financial multinational roles of these teams and include a variety of oper ‘and production information: product quality, unit cost, customer satis sad Inarketing in the bottlenecks. The changes in management organization environment of business are summarized in Figure 3-1. Environments Figure 3-1: Comparison of Prior and Contemporary Business Pm ‘Contemporary Business Prior Business Environment Environment Management Organization : it ti t exclusively financial | Financial and operating we pape fan data, the firm's strategic ue success factors fi ic idand | Network-based Management Hierarchical, comman ork-b izational structure | control organization forms, oa teamwork focus — employee has more responsibility and control, coaching rather than command and control Management focus Emphasis on the short term, Emphasis on the long ‘short-term performance term, focus on critical measures and compensation, | success factors, Concem for sustaining the commitment to the long- current stock price, short term success of the firm, tenure and high mobility of top including adding ‘ Managers : shareholder value Scanned with CamScannera Contemporary Business Environment and Strategic Focus of Cost Management _ 59 Manufacturing Basis of compensation Standardization, economies | Quality, functionality, of scale _- customer satisfaction Manufacturing process High volume, long production | Low volume, short Tuns, significant levels of in- | production runs, focus on process and finished reducing inventory levels inventory and other non-value-added activities and costs Manufacturing Assembly-line automation, Robotics, flexible technology isolated technology manufacturing systems, ; applications integrated technology applications connected by networks Required labor skills Machine-paced, low-level Individually and team- skills paced, high-level skills Emphasis on quality Acceptance of a normal or Goal of zero defects usual amount of waste ‘ Marketing Products Relatively few variations, long | Large number of product life cycles variations, short product life cycles Markets Largely domestic Global Changes in the Social, Political, And Cultural Environment of Business Significant changes have taken place in the social, political, and cultural environments that affect business. Although the nature and extent of these changes vary a great deal from country to country, they include a more ethically and racially diverse workforce, a renewed sense of ethical responsibility among managers and employees, and an increased deregulation of business by the national government. The new business environment requires firms to be flexible and adaptable and to place greater responsibility in the hands of a more highly skilled workforce. Additionally, the changes tend to focus the firm factors outside the production of its product or provision of its service to the ultimate consumer and the global society in which the costumer lives. Scanned with CamScanner60 Chapter 3 STRATEGIC FOCUS OF COST MANAGEMENT pected change in, the Janning and practices. Jhnologies when \d customer A competitive firm incorporates the emerging and xi contemporary environment of business into its business PI This firm is customer-driven, uses advanced manufacturing r° appropriate, anticipates the effect of changes in regulatory policies an tastes, and recognizes its complex social, political and cultural environment. nt focuses that accountal other management cost control and Guided by strategic or long-term thinking, the focusing on make the company successfull rather than just financial measure. Cost management should focus identification of those measures that are critical t management systems should cons not on the measurement per — but on the 10 the firm’s success. sider the Phases of the development of cost following: are basic transaction reporting systems: second stage, cost management systems | reporting. The objective is reliable the usefulness for cost management Stage 1: Cost management system: Stage 2: .. As they develop into the s focus on external financial financial reports; accordingly, is limited. Stage 3: -Cost management systems track key operating data and develop more accurate and relevant cost information for decision making; cost management information is developed. Strategically relevant cost management information is an integral Stage 4: part of the system. Stages 1 and 2 of cost system ‘development focus on the management accountant’s measurement and reporting role. Stage 3 shifts to operational control. Stage 4, the accountant becomes an integral part of management, not just a management reporter buta full business partner, with the skills of identifying, summarizing and reporting critical factors necessary for the firm’s success. Critical Success Factors (CSFs) are measures of tho ; s ar se aspects, of the firm’s performance essential to its competitive advantage and, therefore, to its success. Many ofthese critical suecess factors are financial, but many are nonfinancial. The 's for any given firm depend on the nature of the competition it faces. a Scanned with CamScannerContemporary Business Environment and Straregte Focus of Cost Management “61 COST MANAGEMENT AND ACCOUNTING SYSTEMS The term cost management is widely used in businesses today. Unfortunately, there is no uniform defini aoe ition. We use cost management to describe the approaches and activities of managers in short-run and long-run planning and control decisions that increase value for customers and lower costs of products and services. For example, managers make decisions regarding the amount and kind of material being used, changes of plant processes, and changes in product designs. Information from accounting systems helps managers make such decisions, but the information and the accounting systems themselves are not cost management. ~ Cost management has a broad focus. For example, it includes — but it not confined to the continuous reduction of costs. The planning and control of costs is usually inextricably linked with revenue and profit planning. For instance, to enhance Tevenues and profits, managers often deliberately incur additional costs for advertising and product modifications. Cost management is not practiced in isolation. It’s an integral part of general management strategies and their implementation. Examples include programs that enhance customer satisfaction and quality, as well as programs that promote “blockbuster” new product development. WHEN SHOULD THE INTERNAL ACCOUNTING SYSTEM BE CHANGED? The succeeding sections will analyze organizational innovations. These innovations illustrate that internal accounting systems are an integral-part of the organization’s architecture. When managers change the architecture of their organization by decentralizing decision rights and empowering employees via TQM programs because the firm’s business strategy changes, accounting systems are likewise modified. Similarly, when JIT production systems are installed, accounting system changes follow. However, there were no organization changes associated with productivity measurement systems and these accounting systems were not widely implemented. There is no such thing as the ideal management accounting system. Each organization has different circumstances that lead ‘to different management accounting decisions. Also, accounting must continually deal with trade-offs among external users wanting information describing fim performance and internal users wanting information for decision making and control. Surviving organizations must meet the demands of changing technologies and markets by Scanned with CamScanner62 Chapter 3 = s structures and organizational architectures. Because less revising their” busin constant state of change, the accounting organizational architectures are ina system must regularly adapt. in signs that indicate that the internal accounting system is not Mie WoO tig is dysfunctional behavior on the part of managers because i of poorly chosen performance measures. Managers will make decisions to positively influence performance measures. If those performance measures are not consistent with the goals of the organization, management will make decisions that do not coincide with the organization’s goals. Another sign of problems with the accounting system is poor operating decisions. If product mix and pricing decisions based on management accounting are not adding to the organizational value, then the accounting system is either providing inaccurate estimates of opportunity costs and/or creating dysfunctional incentives, Often changes in customers’ organizational architectures cause suppliers to change their architecture (and accounting systems). If your major customers are modifying their organizational architectures, they are likely responding to This text will emphasize the dual role of internal accounting systems for decisi i making and control. Because the internal accounting system is perfor eee separate roles (it is also being used for taxes and financial eae ), fade ote between these roles must be made. In ite decision-making role. the Meccan system is the first place managers turn to help th i fe : However, accounting numbers are nx nit cue pore cost Scanned with CamScannerContemporary Business Environment and Strategic Focus of Cost Management __ 63 INTEGRATIVE FRAMEWORK Succeeding chapters of this book will describe and analyze cost management accounting systems, Besides being used for both decision making and control, these accounting systems support external reporting for shareholders, taxes, and government regulations. Thus, one of the central themes of this text is that trade- offs arise when the accounting system is designed for multiple purposes. In addition to providing a better understanding of the internal uses of accounting system, this book reinforces the importance of viewing the accounting system as part of the firm’s organizational architecture. This analytic structure will help readers better understand, use, and design future accounting systems as well as other systems that evaluate and reward performance and partition decision rights. Figure 3-2 shows the integrative framework for understanding how the accounting system is used in the firm’s organizational architecture. Starting at the top, two external factors (technological innovation and market conditions) affect the firm’s business strategy. The business strategy then interacts with the firm’s organizational architecture to provide incentives for managers and employees. These incéntives affect the actions taken, which in turn affect the value of the firm. Thus, Figure 3-2 emphasizes that external factors like technology and market conditions affect investments, organizational architecture, incentives, actions, and ultimately the value of the firm. - Figure 3-2 provides two important observations: 1. Changes in the accounting system rarely occur in a vacuum. Accounting system changes generally occur at the same time as changes in the firm’s business strategy and other organizational changes, particularly with regard to the partitioning of decision rights and the performance evaluation and reward systems. 2. Alterations in the firm’s organizational architecture, including changes in the accounting system, are likely to occur in response to changes in the firm’s business strategy caused by external shocks from technology and shifting market conditions. Scanned with CamScanner64 Chapter 3 Figure 3-2: The determinants of business strategy, organizational innovation architecture, and firm value Technological Business strategy. Asset structure Customer base Nature of knowledge creation Organizational architecture ‘Separation of decision management from decision control Performance reward and punishment system Decision rights partitioning Centralization/decentralization Performance evaluation system Accounting system Nonfinancial systems Compensation policy Promotion policy ¥ Incentives and actions ve Firm value Scanned with CamScanner, Contemporary Business Environment and Strategic Focus of Cast Management _ 65 Three significant managerial implications are derived from these two observations. First, before implementing an accounting or other organizational change, it is important to understand what is driving the change. Second, an accounting system should not be adopted merely because other firms are doing so; they may be reacting to a different set of extemal shocks. Third, an accounting system should not be changed without concurrent, consistent changes in the way decision rights . are partitioned as well as in the performance reward systems. All three parts of the organization’s architecture must be internally consistent and coordinated. Scanned with CamScannerCHAPTER 4 STRATEGY; DEVELOPING A COMPETITIVE ‘GEMENT CONTEMPORARY COST M TECHNIQUES DEVELOPING A COMPETITIVE STRATEGY A strategy is a set of policies, procedures and approaches to business that produce long-term success, Finding a strategy begins with determining the purpose and long-range direction or on in other words, the mission of the company. The mission is developed into specific performance objectives which are then implemented by specific corporate or company’s strategies, that is, specific actions to achieve the objectives that will fulfill the mission. A firm succeeds by implementing a strategy- Strategy specifies how an organization matches its own capabilities with the opportunities in the market place to accomplish its objectives. In other words, strategy describes how a compete will compete and the opportunities its employee should seek and pursue. Companies follow one of two broad strategies. Some companies such as Jollibee, Pure Gold and Cebu Pacific Airline compete on the basis of providing a quality product or service at low prices. This is also known as “Cost Leadership” strategy. Other companies such as Rustan’s Department Store and BGC Shangri-La Hotel compete on their ability to offer unique products or services that are often priced higher than the products or services of competitors. This is known as “Product Differentiation” strategy, Deciding between these strategies is a big part of what managers do. Management, accountants work closely with managers in formulating strategy by providing information about the sources of competitive advantage — for example, the cost, productivity, or efficiency advantage of their company: relative to competitors or the premium prices a company can charge relative to the costs of adding features that make its products or services distinctive. The management accountant also helps formulate a strategy by answering questions such as: ed Scanned with CamScannerDeveloping a Competitive Strategy; Contemporary Cost Management Techniques _7 * Who are our most important customers? * How sensitive are their purchases to price, quality, and service? Who are our most important suppliers? What substitute products exists in the marketplace, and how do they differ from our product in terms of price and quality? * Is the industry demand growing or shrinking? * Is there overcapacity? Strategic cost management is often used to describe Cost Management that specifically focuses on strategic issues such as these. STRATEGIC MEASURES OF SUCCESS Firms use cost management to support their strategic goals. The strategic cost management system develops strategic information, including both financial and non-financial information. ‘ Financial performance measures iriclude among others a, growth in sales and earnings b. cash flows c. stock price They show the impact of the firm’s policies and procedures in the firm’s current financial position and therefore, its current return to the shareholders. Non-financial measures of operation include among others market share product quality customer satisfaction growth opportunities pese The nonfinancial factors show the firm’s current and potential competitive position as measured from three additional perspective, namely: 1. the customer 2. internal business process and 3. innovation and learning Strategic financial and nonfinancial measures of success are also commonly called: Critical Success Factors (CSFs) Scanned with CamScannera 72__Chapter f Success (Critical rapter 4 cial Measures © Figure 4-1 shows the Financi Success Factors) Sales Profitability Liquidity Market value Figure 4-1: Financial and No! CF Success Factors and How to Measure pease CSF jow Financial Meas f Success, a duct groups, sales trend, maar Level of sales in cle oe oduct, sales forecast al and Nonfinan es of success Or Critical ur nfinancial Meas percent of sales from aa from operations, eamings trend, dividend a ir flow, interest coverage, frend in cash flow, v , ee ie inventory tumover, receivables turnover, credit ratings Share price Customer satisfaction Dealer and distributor Marketing and selling Timeliness of delivery Quality Non-Financiz ‘of Success Customer Factors : Financial Measures Customer retums and complaints, customer Survey th of dealer and distributor Coverage and streng! eg., number of dealers per channel relationships, state or region eo Trends in sales performance, training, market research activities; measured in hours or peso On-time delivery performance, time from order to customer receipt Customer complaints, warranty expense Internal Business Process Quality Productivity Flexibility Equipment readiness, Safety Number of defects, number of returns, customer survey, amount of scrap, amount of rework, field service reports, warranty claims, vendor quality defects Cycle time (ftom raw materials to-finished product); labor efficiency; machine efficiency; amount of waste, rework, and scrap pete time, cycle time owntime, operator experi i it maintenance activities poets a Number of accidents, effects and accidents Scanned with CamScannerDeveloping a Competitive Strategy: Contemporary Cost Management Techniques 73 Learning and Innovation Product innovation Timeliness of new product Skill development Number of design changes number of new patents oF copyrights, skills of research and development staff Number of days over or under the announced ship date Number of training hours, amount of skill performance improvement Employee morale Employee turnover, ‘number of complaints, employee survey Competence Rate of turnover, training, experience, adaptability, financial and operating performance measures Other factors Government relations Number of violations, community service activities Without strategic information, the firm is likely to stray from its competitive course, to make strategically wrong manufacturing and marketing decisions, to choose the wrong products or the wrong customers. Some of the consequences of a lack of strategic information are shown in Figure 4-2. Figure 4-2: Consequences of Lack of Strategic Information Decision making based on intuition Lack of clarity about direction and goals Lack of clear and favorable perception of the firm by customers and ‘suppliers Incorrect investment decisions; choosing products, markets or manufacturing processes inconsistent with strategic goals + Inability to effectively benchmark competitors, resulting in lack of knowledge about more effective competitive strategies Failure to identify most profitable products, customer and markets Scanned with CamScannerpee Charen deg es ee COMPETITIVE STRATEGIES i fully oF as resu For a firm to sustain a competitive position, it must rr al) = market forces.arrive at one of the tivo competitive statestes Cost Leadership and Product Differentiation Cost Leadership This is a competitive strategy in which a firm succeeds in oe aaa or services at the lowest cost in the industry. A firm that is a cost leader makes sustainable profits at lower prices, thereby limiting the growth of competitions in the industry through its success in price wars and undermining the profitability of competitors which must meet the firm’s low price. Product Differentiation The differentiation strategy is implemented by creating a perception among consumers that the product or service is unique in some important way, usually by being of higher quality, features or innovation. This perception allows the firm to charge higher prices and outperform the competition in profits without reducing cost significantly. Most industries, including automobile, consumer electronics, and industrial equipment, have differentiated firms. The appeal of differentiation is especially strong for product lines which the perception of quality and image is important, as in cosmetics, jewelry and automobiles. Tiffany, Rolex, Ferrari and BMW are good examples of firms that emphasize differentiation. Distinctive Aspects of the Two Competitive Strategies ‘Aspect Cost Leadership Differentiation Strategic target Broad cross section ofthe | Focused section of the market market Basis of competitive || Lowest cost in the industry Unique product or service advantage Product ine Limited selection Wide varity, diferentating features Production emphasis | Lowest possible cost with Innovation in differentiating high qualty and essential | products produc features Markets emphasis | Lowprice * Premium price and innovaive, differentiating features Scanned with CamScannerDeveloping a Competitive Strategy: Contemporary Cost Management Techniques 75 Looking more closely at differentiated firms, the keys CSFs and execution issues are in marketing and product development — developing customer loyalty and brand recognition, emphasizing superior and unique products, and developing and using detailed and timely information about customer needs and behavior. This is where the marketing and product development within the firm provide leadership and the management accountants support these efforts by gathering, analyzing, and reporting the relevant information. Other Strategic Issues A firm succeeds by adopting and effectively implementing one of the strategies explained earlier. Recognize that although one strategy is generally dominant, a firm is most likely to work hard at process improvement throughout the firm, whether cost leader or differentiator, and on occasion to employ both of the strategies at the same time. However, a firm following both strategies is likely to succeed only if it achieves one of them significantly. A firm that does not achieve at least one strategy is not likely to be successful. This situation is what Michael calls “getting stuck in the middle”. A firm that is stuck in the middle is not able to sustain a competitive advantage. For example, giant retailer Makati Supermarket been stuck in the middle between trying to compete with Pure Gold on cost and price, and with style conscious target on differentiation. Scanned with CamScanner76 Chapter 4 CONTEMPORARY Cost MANAGEMENT TECHNIO ment the firm’s broad Strategy UES imple Managers common! lowing tools to ii rs: and to facilitate te ctenen of success on critical > cad ing, ae GET, total quality management, process reensinees cement. thio S customization, balanced scorecard, ativty-based costing ane MET Tg sof constraints (TOC), life eyele costing, target costing, COMPRES TS and manufacturing, automation, ecommerce and the value_

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