Chapter 15

Financial Management

Cost AccountingTraditions and Innovations

Barfield, Raiborn, Kinney

Learning Objectives (1 of 2)

• Explain why cost consciousness is important to all members of the organization

• Define committed costs and discretionary costs

• Describe how the benefits of discretionary cost expenditures are measured

• Identify when standards are applicable to discretionary costs

• Explain how a budget helps control discretionary costs

Learning Objectives (2 of 2)

• Describe how an activity-based budget differs from traditional budgets

• List the objectives of cash management

• (Appendix) Explain how program budgeting is used in not-for-profit entities

• (Appendix) Describe how zero-base budgeting is useful in cost control

Cost Control Systems

Provide information for planning and for determining the efficiency of activities

while they are being planned and after they are performed

Planning and Control ModelPLAN

EXECUTE

EVALUATE

RESPOND

PLANNING

CONTROL

Budgeting,Standard setting

Monitoring,Correcting

Providingfeedback

Costunderstanding

Cost containment,Cost avoidance

Costreduction

Before During After

ACTIVITY

COST CONSCIOUSNESS ATTITUDE

Why Costs Change• Cost Behavior

– Reaction of variable and mixed costs to changes in activity level

• Inflation/Deflation• Supply/Supplier Cost Adjustments

– Supply/demand adjustments

• Taxes• Regulatory Requirements• Quantity Purchased

Cost ContainmentCannot contain• inflation• tax• regulatory changes• supply and demand

adjustments

Use cost containment for • reduced competition• seasonality• quantities purchased

Interorganizational arrangements

Long-term or single-source contracts

Cost Avoidance and Reduction

• Avoidance - finding acceptable alternatives

• Reduction - lowering current costs– Benchmarks – Outsourcing– Consultants– Redesign operations

Implement Cost Control System

Investigate/understand types of costs

Communicate need for cost containment

Motivate employees (education/incentives)

Review results and consider improvements

View as long-run process

Fixed Costs

• Committed Costs plant assets and personnel structure– depreciation

– lease rentals

– property taxes

Cannot be reduced easily

• Discretionary Costs important but optional activities– employee travel– repairs and maintenance– advertising– research and development– employee training and

development

Controlling Committed Costs

• Compare expected benefits to expected costs

• Analyze operating leverage

• Perform postinvestment audit; compare actual to expected results

Discretionary Costs

• Vary in type and magnitude

• Vary in quality of performance

• Not easy to measure benefits in terms of money

Budgeting Discretionary Costs

• Perceived significance to the achievement of objectives and goals

• Expected level of operations

• Managerial negotiations

• Spend all of the appropriation, or

• Spend less than the appropriation

Measuring Benefits from Discretionary Costs

• Use surrogate measures– Reduction in unplanned downtime– Number of coupons clipped from ads– Reduction in number of customer complaints

• Compare discretionary costs to benefits to measure efficiency and effectiveness

Actual Result

Compared to

DesiredResult

Efficiency =Actual Output

Actual InputPlanned Output

Planned Input

Efficiency =Actual Input

Actual OutputPlanned Input

Planned Output

Effectiveness = Actual OutputPlanned Output

PreestablishedStandard

Discretionary Cost Measures

OR

Controlling Discretionary Costs

• To determine variances, compare actual to standards or budgeted amounts

• Use engineered costs – Costs that bear observable and known

relationship to a quantifiable activity base– Compute fixed or variable variances

Activity-Based Budgeting

Apply activity drivers to estimate the levels and costs of activities necessary to provide

the budgeted quantity and quality of production

Activity-Based Budgeting Steps

SelectFunction

IdentifyActivities

IdentifyActivityDrivers

EstimateDriver

Volume

IdentifyResources

EstimateCosts

Cash Management Issues

• Cash level– sufficient to cover all needs– low enough to allow for alternative uses of cash

• What variables influence the optimal level of cash?

• What are the sources of cash?

• What variables influence the cost of carrying cash?

Cash Management Issues

What variables influence the optimal level of cash?

• Uncertainty of timing of cash inflows and outflows

• Variability in cash requirements throughout the year

• Ability to arrange short-term financing

• Bond and loan covenants

Cash Management Issues

What are the sources of cash?

• Sale of equity or debt instruments

• Sale of unneeded or unproductive assets

• Normal operations– Reduce inventory – Increase A/R turnover– Decelerate payments

Cash Collection Cycle

Cash

Materials Inventory

Work in Process Inventory

Finished Goods Inventory

Accounts Receivable

Balance SheetCurrent Assets

Outflow

Inflow

Cash Management Issues

What variables influence the cost of carrying cash?

• Cost of borrowing and cost of issuing equity capital

• Opportunity costs of holding cash

Program Budgeting

• Use in government, not-for-profits, and service activities in for-profits

• Relates resource inputs to service outputs

• Define objectives in terms of output results, not quantity of input activities

• Analyze alternative activities that may achieve the objectives

• Use surrogate measures of output

?• When should results be measured?

• What results should be used as output measures? – Are all results equally important?

• What program actually caused the result?

• Did the program actually affect the target population?

Program Budgeting Questions

Zero-Base Budgeting

• Considers the priorities and alternatives for current and proposed activities in relation to organizational objectives

• Reevaluates activities– continue– eliminate– adjust funding

Questions

• What are committed costs and discretionary costs?

• How does a budget help to control discretionary costs?

• How does an activity-based budget differ from traditional budgets?