Cost Accounting Notes

Value Creation in Organizations

• Cost accounting aims to assist managers in maximizing value for their organizations through efficient decision-making.
• The value chain, which includes activities from R&D to customer service, transforms raw resources into goods and services. Efficient coordination with vendors, suppliers, distributors, and customers is essential.
• Firms must decide where each value-added component can be performed most cost effectively.

Using Cost Information to Increase Value

• Cost information adds value when it improves managerial decisions.
• Cost accounting emphasizes understanding individual stages' contribution to value.

Accounting Systems

• Accounting systems are classified as financial or cost (managerial) based on the primary users of information.
• Financial accounting serves external decision-makers like investors and creditors, focusing on comparability across firms, governed by GAAP and IFRS.
• Cost accounting serves internal managers, prioritizing relevance over comparability and focusing on future costs.

Cost Accounting, GAAP and IFRS

• Financial data for external reporting adheres to GAAP or IFRS, while managerial cost data need not comply.
• Management defines its own cost information, relevant for decision-making.

Customers of Cost Accounting

• Customers are the focus; cost information is a product for managers at production, middle management, and executive levels.
• Misuse of cost accounting information often arises from using data developed for external reporting for internal decision-making.

Framework for Assessing Cost Accounting Systems

• Managerial decisions drive organizational performance, aided by accounting system information.
• Accounting systems help owners evaluate organizational and managerial performance.

The Manager’s Job Is to Make Decisions

• Managers are decision-makers relying on accounting systems for information.
• The effectiveness of decisions depends on the quality of information provided by the accounting system.

Finding and Eliminating Activities That Don’t Add Value

• Organizations identify and eliminate nonvalue-added activities to reduce costs.
• Cost-benefit analysis is used to assess the worth of proposed changes.
• Strategic opportunities are identified by eliminating nonvalue-added activities to gain a cost advantage or improve customer service.

Owners Use Cost Information to Evaluate Managers

• Cost information informs owners about organizational and managerial performance.

Cost Data for Managerial Decisions

• Estimating cost differences among alternatives is crucial, identifying cost drivers.
• Cost accounting involves predicting future costs; past data helps predict future events.
• Differential costs and revenues change based on actions.

Costs for Control and Evaluation

• Responsibility centers have budgets to guide operations and meet goals.
• Different decisions require different cost data.

Trends in Cost Accounting

• Advances in IT and emphasis on cost control drive changes in cost accounting.
• Cost accounting is integrated throughout the value chain, requiring collaboration between managers and cost accountants.
• This includes R&D, design, purchasing, production (e.g., JIT methods), marketing (e.g., CRM), distribution (e.g., outsourcing), and customer service (e.g., COQ systems).

Enterprise Resource Planning

• ERP systems link various organizational activities by integrating information.

Creating Value in the Organization

• All managers use cost accounting information.

Choices: Ethical Issues for Accountants

• Accountants face ethical dilemmas and must maintain integrity, objectivity, and confidentiality.
• Professional codes of ethics exist, and the Sarbanes-Oxley Act of 2002 addresses corporate governance problems.

Cost Accounting and Other Business Disciplines

• Cost accounting is interdisciplinary, overlapping with other business areas.

Introduction to Cost Accounting

• Cost accounting systems provide information for informed managerial decisions and are tailored to specific company needs.

What Is a Cost?

• A cost is a sacrifice of resources, including cash or assets, to acquire goods or services.
• Cost is distinct from expense.

Outlay Costs vs. Opportunity Costs

• Outlay Cost: A past, present, or future cash outflow.
• Opportunity Cost: The forgone benefit from the best alternative use of a resource.
• Operating profit is the excess of operating revenues over operating costs.

Presentation of Costs in Financial Statements

• Cost information appears in financial statements for internal management use. Service, retail, wholesale, and manufacturing organizations differ in their statements.

Service Organizations

• Labor costs are most significant.

Retail and Wholesale Companies

• COGS tracks costs of tangible goods.

Manufacturing Companies

• Manufacturing firms track various manufacturing costs.
• Product Costs: Costs assigned to production units, recognized when sold.
• Period Costs: Nonmanufacturing costs expensed as incurred.
• Direct Manufacturing Costs: Product costs easily identified with units.
• Indirect Manufacturing Costs: All other product costs.

Three major categories of product costs:

• Direct Materials
• Direct Labor
• Manufacturing Overhead (factory burden)
• Prime Costs are direct costs, including direct materials and labor.
• Conversion Costs convert direct materials into final products (direct labor and manufacturing overhead).
• Nonmanufacturing costs include marketing and administrative costs.

Cost Allocation

• Cost allocation assigns costs from shared facilities or services to different departments or cost objects.
• Cost Object: Any end to which a cost is assigned.
• Cost Pool: Collection of costs to be assigned.
• Cost Allocation Rule: Method for assigning costs.
• Direct Cost: Easily related to a cost object.
• Indirect Cost: Not easily related to a cost object.

Details of Manufacturing Cost Flows

• Manufacturing involves steps like receiving materials, processing, and finishing goods.
• Inventory accounts include Direct Materials Inventory, Work-in-Process Inventory, and Finished Goods Inventory.

Inventoriable Costs

• Costs added to inventory accounts.
• Costs flow through income and balance sheet accounts.
• The cost of goods manufactured and sold statement presents manufacturing costs.

Cost of Goods Manufactured and Sold

• Direct Materials: Beginning + Purchases - Ending
• Work in Process: Beginning + Direct Materials + Direct Labor + Manufacturing Overhead - Ending
• Finished Goods: Beginning + Goods Manufactured - Ending

Cost Behavior

• Cost behavior deals with how costs react to changes in activity levels, classified as fixed, variable, semivariable, and step costs.
• Fixed Costs: Remain unchanged within the relevant range.
• Variable Costs: Change proportionally with volume.
• Relevant Range: Activity range where cost is fixed or variable.
• Semivariable Cost: Has fixed and variable components.
• Step Cost: Increases with volume in steps.

Components of Product Costs

• Includes manufacturing and nonmanufacturing costs.
• Full Absorption Cost: GAAP Standard that includes all inventoriable costs for external financial reporting

Misleading Unit Fixed Costs

• Fixed costs per unit are misleading since they are valid only at one volume.

Profitability Ratios

• Gross Margin = Revenue - COGS
• Contribution Margin = Sales - Variable Costs

Gross Margin versus Contribution Margin

• Full Absorption Costing: Follows GAAP/IFRS. Includes all costs of product to get COGS that affects Gross Margin
• Variable Costing: Only includes variable product costs
• Managerial Costing: Includes product costs that management allocates

Developing Financial Statements for Decision Making

• Financial Models can be altered in order to promote better decision making among upper management of the firm.

Cost-Volume-Profit Analysis

• CVP analysis examines revenue, cost, and volume relationships to inform decisions.

Profit Equation

• $Operating \ profit = Total \ revenues - Total \ costs$
• $Total \ revenue = Price * Units \ of \ output \ produced \ and \ sold$
• $Total \ costs = (Variable \ costs \ per \ unit * Units \ of \ output) + Fixed \ costs$
• $X = F/(P–V )$
• Managers consider whether costs are fixed or variable, focusing on cost behavior rather than financial accounting classifications.

Finding Break-Even and Target Volumes

• Break-even volume and the calculation of it is critical for business profit planning models.

Break-Even Volume in Units

• $Break-even \ volume (in \ units) = Fixed \ costs / Unit \ contribution \ margin$

Break-Even Volume in Sales Dollars

• $Contribution \ margin \ ratio = Unit \ contribution \ margin / Sales \ price \ per \ unit$
• $Break-even \ volume \ sales \ dollars = FixedCosts / (Sales \ CM)$

Target Volume in Units

• $Target \ volume (units) = (Fixed \ costs + Target \ profit) / Contribution \ margin \ per \ unit$

Target Volume in Sales Dollars

• $Target \ volume (sales \ dollars) = (Fixedcosts + Targetprofit)/Contributionmarginratio$
• The relationships among cost, volume, and profit can be graphically illustrated.

Profit-Volume Model

• Profit-volume analysis relates profit and volume directly.
• $Operating \ Profit= TR -TC$

Use of CVP to Analyze the Effect of Different Cost Structures

• Cost structure refers to the proportion of fixed and variable costs in an organization.
• Operating leverage describes the extent of fixed costs in the cost structure.

Margin of Safety

• Margin of safety is how many sales are over the