Sustainable Management Accounting

Midterm

Accounting system

a formal mechanism for gathering, organizing, and communicating information about an organization’s activities

Liquidity

indicates whether a company will be able to reimburse its short-term debts. (If liquidity is low, a supplier may refuse to deal with the company, or at least refuse to sale on credit.)

Solvency

ability to reimburse long-term debts (same analysis as with liquidity)

Audited

external auditors are mandated to check whether companies communicate about actual, not fake, transactions and comply with the standards set to aggregate these transactions

Management accounting 

set of methods, techniques, and tools used for the production of relevant and timely information helping managers make decisions and making managers accountable for the decisions they make to ensure the best possible use of resources within the organization.

Role

core set of behavioral expectations tied to a social group or category that defines appropriate and permitted forms of behavior for group members

Scorekeeper

takes care of routine tasks which are mainly focused on internal financial reporting and traditional cost accounting (collects and records financial information, prepares standardized reports and sends these out periodically to internal recipients)

o   Most traditional

Watchdog

“corporate policeman” – controls whether managers achieve financial targets and adhere to internal management accounting policies (design internal control mechanisms and analyzes budget variances and deviates from internal management accounting policies —> directs attentions of managers to these “off things”)

Business partner

supports and enhances managerial decision making processes. Facilitates strategic or operational decision making purposes and pro actively collects and presents financial and non financial information for managers (working alongside management and participates as an equal member in decision making teams)

o   Collect info from both finance and non finance functions

o   More modern role

cost accounting system/costing system 

a set of rules, methods, and techniques used to estimate the resources consumed to produce an output or achieve a goal

cost objects

any output or goal for which resources were consumed and for which decision-makers desire a separate estimation of costs.(e.g: Product line, Products, Services, Projects)

3 distinct purposes for estimating the consumption of resources

• Resource allocation;

• Process optimization; and

• Asset valuation. - Our main focus

resource allocation

consists in deciding for which goals limited resources should be consumed.

process

the sequence of tasks and activities consuming resources (inputs like materials, labor, equipment) to produce an output (e.g. a product or service)

bottleneck

steps in the process which constrains the total production and forces other steps to remain idle for some period of time. (can result from constrained resources)

efficiency

refers to the quantity of resources consumed to obtain a result. The less resources are consumed to produce the same result, the more efficient a process is. Efficiency is often computed as output divided by input

step 5: asset valuation and reporting

consists in estimating the value, or monetary equivalent, of an asset (e.g., receivable, inventory, piece of equipment, etc.).- Once direct product costs have been traced and indirect product costs allocated to products, the units produced and the corresponding production costs are added to the inventory of each product. They stay there until they are sold (becoming a cost of goods sold above the gross margin) or scrapped (becoming an operating expense below the gross margin). By contrast, all the costs which cannot follow products in the inventory are expended in the income statement as costs of the period in which they were incurred (i.e., the period in which the resource is consumed, not paid for). Besides asset valuation, information is also used for process optimization and resource allocation.

economic value

way to assess a value - utility, discounted cash flows

market value

way to assess a value - price, opportunity cost

book value

way to assess a value - historical cost

invetorioability

based on whether the resources consumed were incorporated in products (manufacturing costs) and should therefore follow them in inventory

• Is the cost a product cost (goes into inventory) or a period cost (expensed immediately)?

traceability

whether the resources can be easily traced to a specific product

Can the resource be directly traced to a specific product?

1. If yes → classified as direct cost.

2. If no → becomes part of indirect costs.

steps of product costing process

1. cost recognition and accumulation

2. cost classification

3. computation of allocation rates

4. cost assignment

5. asset valuation and reporting

cost accumulation

the collection of costs in an organized way through an accounting system. It consists in collecting costs and classifying them based on a predefined set of categories indicating their nature and purpose. (can be difficult to determine when a cost occurred) 

cost

a consumption of resource, i.e. a transformation, destruction, or cession decreasing the value of an asset

-       con of definition: not specific – FA has more practical guideline for what is considered a cost

negative externality

a cost suffered by a third party as a consequence of the actions of the company. They are a destruction of resources caused by the company but of which someone else (the society, the planet) bears the costs.

parallel accounting systems

two sets of accounting systems – one for financial reporting (regulated) and one for internal management (flexible, alternative cost definitions).

step 2: cost classification

Build categories of costs based on inventoriability and traceability (step of product costing process)

matching principle

in FA states that costs incurred to generate revenues should be recognized as expenses in the same period as the revenues they generated

manufacturing costs

resources consumed to physically make products, are therefore assigned to these products, follow them first in the inventory and, when the products are sold, in the cost of goods sold.

period costs

resources consumed for purposes other than physically make products, and which therefore cannot follow them in the inventory. They are expended in the accounting period in which the resource consumption happened and was recognized

upstream period costs

are period costs incurred to prepare for production, for instance by designing products and production processes, or installing production lines

downstream period costs

are period costs incurred after or in parallel of the production process to advertise, sell, and deliver products, as well as general costs incurred to manage the company.

general administrative costs

include all costs associated with the general management of an organization, rather than with manufacturing or selling

selling costs

include all costs incurred to secure customers’ orders and deliver products to them.

absorption costing

a stock costing method, required for external reporting, in which all (and only) manufacturing costs are included as inventoriable costs. Product cost thus reflects the full costs of manufacturing the product. - assigns all manufacturing costs (including fixed ones like rent and linear of equipment depreciation) to products, even if those costs don’t change with how much you produce.

capacity costs

costs of acquiring in advance (i.e., before the work is done) resources necessary to make or deliver goods or services. They ensure that the company is able to achieve a desired level of production or to provide the desired level of service while maintaining product or service attributes, such as quality. These costs are incurred because the capacity is made available, not because the capacity is actually used.

variable costing

a method of stock costing in which all variable manufacturing costs, and only variable manufacturing costs, are added to the inventory. Capacity costs are excluded and treated as cost of the period in which they are incurred.

partial absorption costing

method of stock costing in which all variable manufacturing costs are added to the inventory, as well as the costs of the capacity effectively used during the period to manufacture products, but not the cost of the capacity remaining idle during that same period (Don’t assign fixed costs like maintenance or depreciation to products.)

cost of unused capacity

resources consumed to provide in advance a capacity of production or delivery and not used in the period during which these resources were available. E.g:

• Machine not used all day

• Extra staff hours not needed

• Factory space that stayed empty

full/total product costs

the sum of all the costs incurred to design, produce, sell, deliver, and eventually dispose a product. This kind of cost is the product of life-cycle costing

cost of quality

refers to the costs of prevention (cost incurred to reduce the likelihood of defects), appraisal (cost incurred to detect non-conform and defective products), non-conformance (to quality standards), internal failure (defects identified before shipping to customers), and external failure (incurred when a customer discovers a defect).

direct cost

cost which can technically be traced to a specific cost object in an economically feasible way. It is a a consumption of resource for a unique and well identified cost object which can therefore be uniquely, unequivocally, and directly assigned to this cost object.

indirect cost

a resource consumed by several cost objects which cannot be uniquely, unequivocally, and directly assigned to specific cost objects because of either an economic (it is too costly: reason 1) or a technical (is is impossible reason 2) reason.

o   Will have to go through several intermediate steps to assign them indirectly to the products

common cost

a resource consumed for several cost objects, which could technically be traced to each cost object, but not in an economically feasible way: the cost of tracing would exceed its benefit). – results from a decision not to trace which is judgement call

3 factors influencing decision to trace

1.     Materiality of the cost: the bigger the cost, the greater the risks associated with misassignment, the greater the benefits associated with better information, and the larger economies of scale in information production. Tracing is thus both more justifiable and more affordable.

 

2.     Availability of information gathering or tracing technologies: costs which used to be difficult to trace have become easy to trace by the introduction of new tracking technologies (e.g., bar-codes, GPS trackers, RFID chips, or dedicated meters).

 

3.     Design of internal processes: if you dedicate a machine to a specific product (e.g., this tank is only used for cranberries smoothies, and this other one is only used for blueberries smoothies) they are easier to trace than if they are used by, and therefore common to, different products.

economies of scale

proportionate saving in costs gained by an increased level of production.

economies of scope

proportionate saving gained by producing two or more distinct goods, when the cost of doing so is less than that of producing each separately

cross subsidization

when resources consumed for some cost objects are mistakenly assigned to other cost objects. All costs are then distorted because some cost objects bear the cost of other cost objects. In other words, some products are over-costed while other products are under-costed.

step 4: cost assignment

consists in attributing costs to the cost objects consuming resources, in proportion of the resources they consumed. It is the general term which encompasses both cost tracing (assigning direct costs) and cost allocation (assigning indirect costs). step in product costing process

cost tracing

consists in assigning direct manufacturing costs to their respective cost objects.

cost allocation

consists in assigning indirect manufacturing costs to cost objects in proportion of their use of an allocation base (emptying cost pools into cost objects proportionally to their consumption of allocation bases).(has several steps) (part of product costing process step 3 computation of allocation rates)

cost pool

account where some indirect manufacturing costs are gathered (pooled together) and where they wait for the allocation to cost objects.

allocation rate

amount of cost which is allocated for a cost pool to a cost object for each unit of the allocation based that this cost object consumes. Formula: = Allocation amount from the cost pool / allocation base

allocation base

measure of activity used to allocate indirect manufacturing costs gathered in a cost pool to cost objects. It is supposed to provide a reasonable approximation of the relative consumption of the resources accumulated in this cost pool by the cost objects

cost allocation process

1. create cost pools

2. choose allocation bases

3. compute allocation rates

cost pool homogeneity

Group together indirect costs that are used in similar proportions by your products (cost objects).

Causality (choosing the right allocation base

Use an allocation base that drives or causes the cost in the pool

principle of cost pool homogeneity 

states that each cost pool should be homogenous, i.e., all the costs gathered in the same cost pool should be consumed in the same proportions by all cost objects.

cost driver

measure of activity (or capacity) which triggers a consumption of resources. A cost driver has a cause-and-effect relationship with these costs and, therefore, a change in cost driver causes a proportional change in the amount of resources consumed.

principle of allocation based on causality 

states that the cost driver of the costs gathered in a cost pool should be used as allocation base for this cost pool.

To implement principles of cost pool homogeneity and allocation based on causality

OR TO IDENTIFY COST DRIVER??

1. theoretical causation

2. empirical correlation

theoretical causation

i.e., a plausible causal relationship exists between the various costs to be pooled together and a measure of activity, their plausible cost driver, which will be used as allocation base.(ask whether different types of indirect manufacturing costs are likely to have the same purpose and the same underlying cause or cost driver.)

empirical correlation

i.e., an observed co-variation of these costs among themselves and with their cost driver, co-variation suggesting they systematically vary together in the same proportions. (if you have data, check whether these costs are indeed correlated with each other and with the assumed underlying cost driver)

single rate cost allocation system

uses a unique allocation base and allocation rate for each cost pool and ignores differences between capacity and activity.

due rate cost allocation system

splits any cost pool into two sub-pools, one for capacity costs and one for variable costs, each sub-pool having a different allocation rate

inventoriable costs

Stay in inventory until the product is sold.- delays their impact on operating income. In other words, when inventory increases, mis-classifying period costs as manufacturing costs temporarily improves operating income

period costs

Cannot be linked to inventory → go directly to the income statement in the period incurred. (Period costs are recorded when the resource is used, not necessarily when it is paid.)

weighted average cost (WAC)

value of the initial inventory plus production costs divided by the volume in the initial inventory plus the volume of production.

first in first out (FIFO)

the initial inventory leaves the company first, so the remaining inventory is valued at the unit cost of production of the period

last in first out (LIFO)

The latest production goes first, so the value of remaining inventory is more influenced by the value of the initial inventory.

earnings management

refers to all methods used by managers to manipulate reported earnings.

social costs

the monetized value of the damages to society caused by an incremental metric tonne of CO2 emissions

step 3: computation of allocation rates

needed for cost allocation

- A cost pool is an account where some indirect manufacturing costs are gathered (pooled together) and where they wait for the allocation to cost objects.

- An allocation base is a measure of activity used to allocate indirect product costs gathered in a cost pool to cost objects. It is supposed to provide a reasonable approximation of the relative consumption of the resources accumulated in this cost pool by the cost objects.

- An allocation rate is the amount of cost which is allocated for a cost pool to a cost object for each unit of the allocation based that this cost object consumes.

- Principles for allocating costs in cost pools: Cost pool homogeneity and causality

step 1: cost recognition and accumulation

The collection of costs in an organized way through an accounting system. It consists in collecting costs and classifying them based on a predefined set of categories indicating their nature and purpose. For example: Wages, depreciations, etc. (nature) and cost pool or cost object to which it is related (purpose

what is a cost in FA

-        Depreciation over time for equipment.

-        Damage to assets (e.g., damaging a Picasso painting).

-        Actual use of prepaid services or employee labor.

-        Impairment: If asset value drops (e.g., painting loses value), the loss is recognized—due to conservatism in accounting (you recognize potential losses, not potential gains).

what is not a cost in FA

• Buying equipment or inventory (you exchange one asset—cash—for another).

• Paying back loans or debts (you're reducing liabilities, not consuming resources).

• Paying dividends (redistribution of profits, not consumption).

• Externalities (e.g., environmental damage) are not recognized as costs in financial accounting—only in management accounting

cost estimation

consists in assessing the parameters of a linear cost function to predict total cost and its variations

product (or service) costing

designed to measure, value, and record the amount of resources which were consumed for a product or provide a service. It focuses on the purpose of the resource consumption (for what was a resource consumed?).

cost behavior

is a description of how a cost changes in relationship to a measure of activity called cost driver. (costs do not all have the same relationship with the level of activity)

variable costs

costs proportional to the level of activity

linear variable

when the cost per unit of cost driver is constant. It is strictly proportional to the level of activity.

concave variable

when the cost per unit of cost driver decreases as the activity increases. It is less than proportional to the level of activity.

convex variable

when the cost per unit of cost driver increases as the activity increases. It is more than proportional to the level of activity

step costs

constant within any range of activity but increase by discrete amounts when activity exceeds that range of activity.

step variable costs

step costs which are fixed over a narrow range of activity.( Treated like variable costs — small errors are okay and considered "good enough.") (smaller steps)

step fixed costs

step costs which are fixed over a wide range of activity (Require adjusting the cost function at different activity levels — this leads to defining a relevant range (a range where the cost function stays valid) (bigger steps)

fixed costs

costs which are not proportional to the volume of activity.

capacity fixed costs

costs related to resources acquired in advance, before the actual level of activity is known, and which are consumed whatever the actual level of activity

discretionary fixed costs

costs which are not proportional to the volume of activity, but over which managers have discretion (i.e., they decide over them).

mixed costs/semi-variable

costs that have both a variable and a fixed component.

cost function

equations describing how total cost changes with changes in activity for a specified period and within a range of activity (Most often: TC = VC*Q + FC)

linearity assumption

relationship between two variables can be approximated by a straight line characterized by a constant slope (UC^d) and intercept (FC_p).

steps of the cost estimation process

1. Data collection and preparation

2. Cost estimation

3. Cost prediction, cost control, and model validation

Activity based Costing (ABC)

helps by grouping cost drivers into 4 levels (cost hierarchy)
1. Unit level activities - cost increases with number of units

2.Batch level activities - cost increases with number of batches

3.Product level activities - cost depends on how many different products, not how many are made

4.Facility level activities - cost linked to number of locations or departments

Theoretical causation

there must be an economically plausible causal relationship between the measure of activity as cause and the cost as consequence; and

Empirical correlation

the measure of activity and the cost must be highly statistically correlated

relevant range

range of cost driver over which a specific linear relationship between cost and cost driver is valid. In other words, it is a range of activity over which the unit variable cost UC^d and the amount of fixed costs FC_p can be assumed constant.

engineering approach

assess the value of the resources (e.g.,materials, labor) theoretically consumed for every additional unit of cost driver(s) as well as other costs not related to volumes. (basically estimate from scratch)