Chapter 28: Management Accounting System Design

Financial Accounting Prepared in accordance with GAAP primarily for interested outside users such as shareholders, bondholders, banks, and other creditors. Built around basic equation: Assets = Liabilities + Owners’ Equity.

Purposes of Management Accounting 3 principal purposes each of which requires a different cost construct: Measurement. Control. Solving of alternative choice problems.

Types of Information: Measurement Requires full cost of cost objects. Full cost = direct + fair share of indirect. Most pervasive cost objects: goods and services produced and sold. However, full cost could be used for any cost object. Small number of companies use variable instead of full costs. Full costs used to arrive at prices and analyze economic performance of business segments (e.g., product lines).

Types of Information: Control Collects cost incurred in responsibility centers. Specific manager is accountable for each responsibility center’s performance. Actual inputs and outputs are compared to planned inputs and outputs. Variances are identified, investigated and actions are taken. Behavioral considerations are at least as important as accounting considerations.

Types of Information: Alternative Choice Problems Data not found in management accounting systems. Relevant data vary with specific problem: Costs and revenues that differ under one choice or another. Short-run problems: contribution analysis. Longer run or capital budgeting problems: PV analysis of cash inflows and outflows.

Cost Categories: Accounting Treatment Costs as incurred either reduce retained earnings (expensed) or increase assets (capitalized). Costs that are expensed as incurred are period costs. Capitalized costs are expensed in various ways: Product costs are expensed according to the matching concept when product is sold. Property, plant, and equipment, other than land, (intangibles) are depreciated (amortized) over their useful life.

Cost Categories: Ability to Trace to Cost object Direct costs are costs that are traced to or caused by a single cost object. Indirect costs are associated with 2 or more cost objects jointly. Direct vs. indirect cost is only meaningful when related to a specific cost object. E.g., plant manger is direct to plant but indirect to each product (unless plant makes only one product). Indirect production costs = production overhead costs = factory overhead costs = overhead costs.

Cost Categories: Cost Element Type of cost (e.g., material, labor, and supplies).

Cost Categories: Behavior with Respect to Volume Variable: an item of cost whose total amount varies proportionately with volume. Non-variable or fixed: Total cost of these items does not vary with volume. Semi-variable: Total costs vary less than proportionately with volume. Step function: Costs that increase in chunks as volume is increased.

Cost Categories: Time Perspective Historical: actual costs at time of transaction. Standard (usually per unit amounts): at current cost levels at time set. Budget: at future costs estimated at time that budget is set.

Cost Categories: Degree of Managerial Influence Controllable cost: an item of cost that a responsibility center manager can significantly influence the amount. Non-controllable: an item of cost that is not significantly influenced by the responsibility center manager.

Cost Categories: Ability to Budget “Right” Amounts Engineered cost: the right or proper amount to spend for some activity can be predetermined; such as direct material content of a product. Discretionary (= programmed = managed) cost: the proper amount to spend is a matter of judgment. Committed cost: a cost that is an inevitable consequence of a past decision. Can be budgeted with certainty. Sunk cost such as depreciation on equipment purchased in the past.

Cost Categories: How They Change With Respect to Specified Conditions Differential (= incremental = avoidable) costs: costs that are different under one set of circumstances than under another set.

Accounting Database Captured from source documents: Vendor invoices, billing documents. Constitute operating information.

Level of Detail Chart of accounts: complete set of accounts in accounting system. Must satisfy: All required types of management accounting. Financial accounting. Tax accounting.

Cost Accounting System Choices Job costing vs. process costing. Actual costs vs. standard costs. Choices of volume measures, allocation bases. One/multiple cost accounting systems. Integrated/several databases.

Considerations in Management Control Systems Availability of accounting information to support full cost and differential analyses. Behavioral considerations are at least as important as responsibility accounting information. Every practice must be held up to the goal congruence test by asking these questions: What action will it motivate managers to take in their own perceived self-interest? Will this action be in the best interests of the organization?

Common Mistakes in Management Control Assume unfavorable variances imply poor management performance. Not pay attention or commend managers for favorable performance.