Topic 1

Introduction to Cost Accounting

Learning Objectives
1. Distinguish between financial, managerial and cost accounting;
2. Importance of mission statement to organizational strategy;
3. Understanding organization’s structure and business environment to perform
effectively in an organization;
4. Understand value chain and major value chain functions;
5. Importance of use of balance scorecard in assessing organization’s strategies; and
6. Source of ethical standards for cost accountants

LEARNING OBJECTIVE 1: DISTINGUISH BETWEEN FINANCIAL, MANAGERIAL AND COST

ACCOUNTING

Accounting is called the “dialect” of business. As such, accounting can be viewed as having
different dialects. The financial accounting dialect is often characterized as the primary
focus of accounting. Financial accounting is concentrated on the preparation and provision of
financial statements. Financial accounting information is typically historical, quantitative,
monetary and verifiable. Such information usually reflects activities of the whole
organization.

The second “dialect” of accounting is that of management and cost accounting.

Management accounting is concerned with providing information to parties inside an
organization so that they can plan, control operations, make decisions and evaluate
performance while cost accounting is directly concerned with the determination and use of
product or service costs.

Cost Accounting is an expanded phase of general or financial accounting which informs

management promptly with the cost of rendering a particular service, buying and selling a
product and producing a product. It is the field of accounting that measures, records and
reports information about costs.

All types of business entities – manufacturing, merchandising and service businesses –

requires information system which provide the necessary financial data. Because of the
nature of the manufacturing process, the information systems of manufacturing entities
must be designed to accumulate detailed cost data relating to the production process. Thus,
it is common today for small, medium and large manufacturing companies to have
structured costs accounting systems. These systems should show what costs were incurred
and where and how these costs were utilized. Cost accounting today is recognized as being
essential to efficient cooperation of business and industry.

Although cost accounting is developed originally in manufacturing business to satisfy

management’s need for product cost information, cost accounting information is useful for
all types of activities in all types of organizations. Cost accounting is essential not only for
profit-seeking entities but also for not-for-profit organizations such as governmental
agencies, churches and charities.

Financial Cost Accounting Managerial

Accounting Accounting
 Objective Record transactions Ascertainment, To assist the
and determine
allocation, accumulation management in
financial position and
and accounting for costs decision-making and
profit or loss policy formulation
Nature Concerned with
Concerned with both Deals with projection of
historical data past and present data for the future
recorded (historical in (futuristic in nature)
nature)
Principle Governed by GAAP Certain principles No set principles are
followed followed for recording followed
costs
Data used Qualitative aspects Only quantitative aspect Uses both quantitative
are not recorded is recorded and qualitative
concepts

Summary:
Financial accounting attempts to present some degree of precision in reporting historical
information while at the same time emphasizing verifiability and freedom from bias in the
information, relevance to the general user and some degree of timeliness in reporting which
is not as critical in managerial accounting. The timing of information and its relevance to the
decision on hand has greater significance to the internal decision-maker. Management is
more concerned on the timeliness of the information.

Cost Accounting can be viewed as the intersection

between financial and management accounting since it
addresses the informational demands of both financial
and management accounting by providing product or
service costs information to:
✔ External parties (stockholders,
creditors, regulatory bodies
and donors) for investment and credit decisions and for
reporting purposes; and
✔ Internal managers for planning, controlling, decision-making and evaluating
organizational performances.

For a manufacturing company, product cost consists of sum of all factory costs incurred to
make one unit of product and is developed in compliance with GAAP for financial reporting
purposes. In non-manufacturing companies, a service cost is more likely to be computed.
But product/service costs information can also be developed outside of the constraints of
GAAP to assist management in its needs for planning and controlling operations.

As companies expand operations, managers recognize that a single cost can no longer be
computed for a specific product or service. As a result, evolution of expanded accounting
databases, which include not only financial information but also cost and managerial
accounting information.

Cost accounting information is needed by both financial and management accountants.

Although financial accounting must be prepared in accordance with GAAP, management
must be prepared in accordance with management needs. Managers need information to
develop mission statements, implement strategy, control the value chain, measure and
assess personnel performance and set balance scorecard goals, objectives and targets.

LEARNING OBJECTIVE 2: IMPORTANCE OF MISSION STATEMENT TO ORGANIZATIONAL

STRATEGY

Organizational Strategy
Each organization (for profit or not) should have a mission statement that expresses the
purpose for which the organization exists, what the organization wants to accomplish and
how products and services be uniquely meet its targeted customers’ need. These statements
are used to develop the organization’s strategy or plan on how the firm will fulfill its goals
and objectives by deploying resources to create value for customers and shareholders.
Mission statements are modified over time to adapt to the ever-changing organizational
environment.

Each organization is unique; therefore, even

organizations engaged in selling similar
product or providing similar service have
unique strategies that influence an
organization’s strategy. These factors
include organizational structure, core
competencies, organizational constraints,
management style and organizational
culture and environment constraints.

Organizational strategy should be designed to help the firm achieve an advantage over its
competitors. Small organizations frequently develop only a single strategy, whereas large
organizations often design an overall strategy as well as individual strategies for each
organizational unit (such as division or a location). Unit strategies flow from the
organization’s overall strategy to ensure effective and efficient resource allocation that are
compatible with corporate goals.

Strategy decisions should reflect the organization’s core competencies. A core competency
is any critical function or activity in which an organization seeks a higher proficiency that its
competitors, making that function or activity the root of competitiveness and competitive
advantage. Technological innovation, engineering, product development and after-sales
service are examples of core competencies.

Regardless of the type of organization, managers are concerned with formulating strategy,
and cost accountants are charged with providing management with the information
necessary for making choices about and assessing progress toward, strategic achievement.
Most companies employ either cost leadership or a product (or service) differentiation
strategy. Cost leadership refers to a company’s ability to maintain its competitive edge by
undercutting competitor prices. Successful cost leaders sustain a large market share by
focusing almost exclusively on manufacturing products or providing services at a low cost
(Walmart, Volkswagen and Rent-a-Wreck). Product or service differentiation refers to a
company’s ability to offer superior quality products or more unique services than
competitors. Such products and services compete on quality and features and are generally
sold at a premium price (BMW, Beverly Hills Rent-a-Car). Successful company usually focus
on one strategy. However, some firms focus on more than one strategy simultaneously, but
one strategy is often more dominant.

Strategy Checklist
Checklist of questions are adopted by companies to help indicate whether their
comprehensive strategy is in place.
1. What are the most important factors in your organization’s operating environment?
2. What are your organization’s core competencies?
3. Have your organization’s core competencies become competitive advantage? If yes,
can these competitive advantages be maintained and how? If not, why has the
organization failed to capitalize on those core competencies?
4. What is your organization’s current position relative to your competitors?
5. What is your customers’ purchase or selection criteria? Are your products or services
designed to fit their criteria as well as or better than your competitor’s products or
services?
6. What is the organizational vision identified by your management, shareholders and
other internal and external stakeholders? Is the vision supported by identified goals
and objectives? Is the vision amenable to change in a changing environment?
7. Does your organization have the appropriate resources (financial, personnel and
technological) to fulfill its vision? If not, what else is needed and how can it be
obtained?
8. Have appropriate performance measurements have been established to determine if
progress is being made toward your organization’s mission and vision?
9. Are operating conditions continuously monitored to detect changes so that your
organization can adapt with flexibility and sensitivity, especially to new trends and
technology?

LEARNING OBJECTIVE 3. UNDERSTANDING ORGANIZATION’S

STRUCTURE AND BUSINESS ENVIRONMENT TO PERFORM EFFECTIVELY
IN AN ORGANIZATION

Organizational Structure
An organization is composed of people, resources other than people and
commitments that are acquired and arranged to achieve organizational
strategies and goals. The organization evolves from its mission, strategies,
goals and managerial personalities. Organizational structure reflects the
way in which authority and responsibility for making decisions are
distributed among personnel. Authority refers to the right of an individual or
team (usually by virtue of position/rank) to use resources to accomplish a
task or achieve an objective. Responsibility is the obligation of an individual
(or team) to accomplish a task or achieve an objective.

Every organization contains management and non-management line and staff personnel.
Line personnel work directly toward attaining organizational goals while staff personnel
give assistance and advice to line personnel. Relative to top accounting jobs, the treasurer
and controller are staff position. Treasurers are generally responsible for achieving short- and
long-term financing, investing and cash management goals while controllers are responsible
for delivering financial reports in conformity with GAAP to management. The CFO, who
oversees all financing activities of an organization, is considered a member of line personnel.

Organizational Constraints
A variety of organizational constraints may affect a firm’s strategy options. Most constraints
exist only in the short term because they can be overcome by existing business opportunities.
Four common organizational constraints are monetary capital, intellectual capital,
technology and environment. Although monetary capital can almost always be acquired
through debt (short- or long-term borrowings) or equity (common of preferred stocks) sales,
management should decide:
● Whether the capital can be obtained at a reasonable cost and/or
● A reallocation of current capital would be more efficient and effective

Intellectual capital encompasses all of an organization’s intangible assets: knowledge, skills

and information. Companies rely on their intellectual capital to create ideas for products or
services, to train and develop employees, and to attract or retain customers. As for
technology, companies must adopt emerging technologies to stay at the top of their industry
and achieve an advantage over competitors.

Environmental constraints also impact organizational strategies. An environmental

contstraints is any limitation caused by external cultural, fiscal (taxation structures),
legal/regulatory or political situations and by competitive market structures. One cultural
constraint that is becoming more prevalent in its effects on organizational strategy is
sustainability. More organizations are becoming aware of the need to integrate economic
longevity with ecological longevity, often referred to as the triple bottom line of people,
profits and planet. Some of the pressure for sustainability considerations comes from legal
requirements, while other pressure has been exerted by the internal and external
organizational stakeholders. Because environmental constraints cannot be directly controlled
by an organization’s management, they tend to be long- rather that short-run influences.

Going global, expanding core competencies and investing in new technology require
organizational change and an organization’s ability to change depends heavily on its
management style and organizational culture. Different managers exhibit different
preferences for interacting with the entity’s stakeholders, especially employees. Management
style is exhibited in decision-making process, risk taking, willingness to encourage change
and employee development, among other issues. Typically, management style is also
reflected in an organization’s culture: the basic number in which the organization interacts
with its business environment, the manner in which employees interact with each other and
with management and the underlying beliefs and attitude held by employees about the
organization. Culture plays a significant role in determining whether the communication
system tends to be formal or informal, whether authority is likely to be concentrated in
management or distributed throughout the organization, and whether organizational
members are experiencing feelings of well-being or stress.

LEARNING OBJECTIVE 4. UNDERSTAND VALUE CHAIN AND MAJOR VALUE CHAIN

FUNCTIONS
Value Chain
Strategic management’s foundation is the value chain, which is used to identify the
upstream and downstream organizational processes that lead to cost leadership or product
differentiation. The value chain is a set of value-adding functions or process that convert
inputs into products and services for company customers. The purpose of a value-chain
analysis is to increase production efficiency so that a company can deliver maximum value
for the least possible cost.

Components of a Value Chain

1. Research and Development – experimenting to reduce costs or improve quality.
2. Design – develop alternative product, service or process designs.
3. Supply – managing raw materials received from vendors. Companies often develop
long-term alliances with suppliers to reduce costs and improve quality.
4. Production – acquiring and assembling resources to manufacture a product or render a
service.
5. Marketing – promoting a product or service to current and prospective customers.
6. Distribution – delivering a product or service to a customer.
7. Customer service – supporting customers after the sale of a product or service.

Company managers communicate organizational strategy to all members in the value chain
so that the strategy can be effectively implemented. The communication network needed for
coordination among internal functions is designed in part with input from cost accountants
who integrate information needs of managers for each value chain function.

LEARNING OBJECTIVE 5. IMPORTANCE OF USE OF BALANCE SCORECARD IN ASSESSING

ORGANIZATION’S STRATEGIES

Accounting information helps managers to measure dimension of performance that are

important in accomplishing strategic goals. In the past, management spent significant time
analyzing historical financial data to assess whether the organizational strategy is effective.
Today, firms use a variety of information to determine not only how the organization has
performed but also how it is likely to perform in the future. Historical financial data reflects
lag indicators or outcomes that resulted from past actions, such as installing a new
production process or implementing a new software system. Unfortunately, lag indicators are
often recognized and assessed too late to significantly improve current or near-future
actions. In contrast, lead indicators project future outcomes and thereby help assess
strategic progress and guide decision making before lag indicators are known.

Lag and lead indicators can be developed for many performance aspects and to assess
strategy congruence. The balance scorecard (BSC) is a framework that translates an
organization’s strategy into clear and objective performance measures (both leading and
lagging) that focus on customers, internal business process, employees and shareholders.
Thus, the BSC provides a means by which actual business outcomes can be evaluated
against performance targets.
 The BSC includes short- and long-term, internal and external,
and financial and non-financial measures to balance
management’s view and execution of strategy. BSC has four
perspectives and each perspective has a unique set of goals and
measures.
● Learning and growth,
● Internal business,
● Customer value, and
● Financial performance

Learning and growth – focuses on using organization’s intellectual capital to adapt to

changing customer needs or to influence new customers’ needs and expectations through
product or service innovations. This perspective addresses whether a company can continue
to progress and be seen by customers as adding value.

Internal business – focuses on those things that the organization must do well to meet
customer needs and expectations. This perspective concentrates on issues such as employee
satisfaction, product quality control and cost management.

Customer value – addresses how well the organization is doing relative to important
customer criteria such as speed (lead time), quality, service and price (both purchase and
after purchase). Customers must believe that, when a product or service is purchased, the
value received was worth the price paid.

Financial performance – addresses the concerns of stockholders and other stakeholders

about profitability and organizational growth. A performance measurement in this
perspective might address the savings provided from outsourcing decisions.

Sample Balance Scorecard and Perspectives

LEARNING OBJECTIVE 6. SOURCE OF ETHICAL STANDARDS FOR COST ACCOUNTANTS

Professional Ethics
Most business participate in the global economy, which encompasses the international trade
of goods and services, movement of labor and flows of capital and information. The world
has essentially become smaller through technology advances, improved communication
capabilities and trade agreements that promote international movement of goods and
services among countries. Multinational corporation managers must achieve their
organization’s strategy within global structure and under international regulations while
exercising ethical behavior.

In business, managers need to attain their financial targets by concentrating on acquiring a

targeted market share and achieving desired levels of customer satisfaction. However,
executives at many companies have exhibited unethical method in trying to “make their
numbers.” Earnings management is any accounting method or practice used by managers
or accountants to deliberately “adjust” a company’s profit to meet a predetermined internal
or external target. Earnings management allows a company to meet earnings estimates,
preserve a specific earnings trend, convert a loss to a profit, increase management
compensation (tied to stock performance) or hide illegal transactions. When the boundaries
of reason are exceeded in applying accounting principles, companies are said to be engaging
in aggressive accounting. Such aggression may range from simply stretching the limits of
legitimacy all the way to outright fraud. Worldcom, Enron, Tyco and HealthSouth are but a
few of the many companies whose managers faced criminal penalties from acting unethically
within the parameters of their jobs. Some of the aggressive accounting practices that have
been exposed involved in the manipulation of cost accounting information.

In 2002, as a result of many large financial frauds, the US Congress passed the
Sarbanes-Oxley Act of 2002 (SOX). This act holds chief executive officers (CEOs) and chief
financial officers (CFOs) personally accountable for their organization’s financial reporting. In
addition, the accounting profession promotes high ethical standards for accountant through
several of its professional organizations. The IMA administer the CMA exam, which is focused
on the professional expertise acquired by accounting and financial management
professionals. The CMA credential demonstrates expertise in financial planning, analysis,
control, decision support and professional ethics. CMAs are required to adhere to IMA’s
Statement of Ethical Professional Practice. This set of standards focuses on competence,
confidentiality, integrity and credibility. Adherence to these standards helps management
accountants attain a high level of professionalism, thereby facilitating the development of
trust from people inside and outside the organization.

✔ Competence – individuals will develop and maintain the skills needed to practice
their profession. For instance, cost accountants working in companies involved in
government contracts must be familiar with both GAAP and CASB standards.
✔ Confidentiality – individual will refrain from disclosing company information to
inappropriate parties (such as competitors).
✔ Acting with integrity means that individuals will not participate in organizationally or
professionally discreditable actions. Integrity, for example, could preclude cost
accountants from accepting gifts from suppliers because such gifts could bias (or be
perceived to bias) the accountant’s ability to fairly evaluate the suppliers and their
products.
✔ Credibility – individuals will provide full, fair and timely disclosure of all relevant
information. For example, cost accountants should not intentionally miscalculate
product cost data to materially misstate a company’s financial position or results of
operations.

Cost and management accountants may find that others within the organization have acted
illegally or immorally; such actions could include financial fraud, theft, environmental
violations or employee discriminations.
Competence
Each member has a responsibility to:
Maintain an appropriate level of professional expertise by continually developing
  knowledge and skills.
Perform professional duties in accordance with relevant laws, regulations and ethical
  standards.
Provide decision support information and recommendations that are accurate, clear,
  concise and timely.
 Recognize and communicate professional limitations or other constraints that would
  preclude responsible judgment or successful performance of an activity.

Confidentiality
Each member has a responsibility to:
  Keep information confidential expect when disclosure is authorized or legally required.
Inform all relevant parties regarding appropriate use of confidential information. Monitor
  subordinates' activities to ensure compliance.
  Refrain from using confidential information for unethical or illegal advantage.

Integrity
Each member has a responsibility to:
Mitigate actual conflict of interest. Regularly communicate with business associates to
  avoid apparent conflicts of interest.
  Advise all parties of potential conflicts.
  Refrain from engaging in any conduct that would prejudice carrying out duties ethically.
  Abstain from engaging in or supporting any activity that might discredit the profession.

Credibility
Each member has a responsibility to:
  Communicate information fairly and objectively.
Disclose all relevant information that could reasonably expected to influence an intended
  user's understanding of the reports, analyses or recommendations.
Disclose delays or deficiencies in information, timeliness, processing or internal controls
  in conformance with the organization policy and/or applicable law.

Resolution of Ethical Conflicts

In applying the Standards of Ethical Professional Practice, you may encounter problems
identifying unethical behavior or resolving an ethical conflict. When faced with ethical issues,
you should probably follow your organization’s established policies on the resolution of such
conflict. If these policies do not resolve the ethical conflict, you should consider the following
courses of action:
● Discuss the issue with your immediate supervisor except when it appears that the
supervisor is involved. In that case, present the issue to the next level. If you cannot
achieve the satisfactory resolution, submit the issue to the next management level. If
your immediate supervisor is the chief executive officer (CEO) 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 your superior’s
knowledge, assuming he or she is not involved. Communication of such problems to
authorities or individuals not employed or engaged by the organization is not
considered appropriate, unless you believe there is a clear violation to the law.
● Clarify relevant ethical issues by initiating a confidential discussion with an IMA Ethics
Counselor or other impartial advisor to obtain a better understanding of possible
courses of action.
● Consult your own attorney as to legal obligations and rights concerning ethical
conflicts.

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