Solution manual cost and managerial accounting 3rd by barfield introduction to cost management systems

Chapter Introduction to Cost Management Systems Questions The production of any service or product requires inputs No product or service is produced without incurrence of costs The objective in incurring costs is to reap a reasonable return on those costs so that profits are generated Cost accounting data are becoming increasingly important because of the transference of power from producers to consumers With many equivalent, high-quality products and services competing for consumer dollars, producers have lost some ability to control their prices Now, the producers must concentrate on controlling costs to generate profits A secondary consideration in redesigning cost systems is the influence of advancing information technology With today’s high tech information systems, firms can acquire and manage more information at lower cost than ever before The only realistic method of evaluating whether costs are being effectively managed is to compare the benefits generated with the costs incurred This approach is equivalent to evaluating the costs incurred relative to the objectives that were to be accomplished from incurring the costs All control systems rely on information Information is needed regarding expected performance and actual performance An effective management information system gathers and disseminates both types of information A control system is a tool to aid managers in steering an organization to the achievement of its goals A control system has four components: a detector, an assessor, an effector, and a communications network A control system exists to keep an organization’s actual operations in line with its plans and strategies Multiple control systems are necessary because no single control system can be effective for all dimensions of performance For example, firms have activities related to purchasing, selling, operating, hiring, and contracting All of these and other areas will require control systems 25 26 Chapter Introduction to Cost Management Systems Organizations typically have goals and objectives for both the short and long terms Consequently, organizations must have control systems in place to ensure that both short- and longterm targets are achieved For businesses, one important short-term goal is to achieve profits, and a long-term-goal is to remain solvent and viable Managers might be willing to accept errors or miscalculations in information if the cost of getting more accurate information was too high or if the time spent obtaining more accurate information was too long Timeliness and cost are two important factors that managers must consider in determining when to acquire more accurate information Research and development: GAAP-based rules require these costs to be expensed as incurred For internal purposes, however, managers may want to match these costs with the benefits they generate: new products and services Product costs: For internal purposes, activity-based cost assignments may be used to better understand cost causality For external purposes, more traditional cost assignments may be used for compliance with GAAP and IRS requirements Life cycle considerations: For internal reporting purposes, costs may be maintained on a life-cycle basis to better associate cause and effect; for external reporting, the firm will likely use period-by-period reporting to be in compliance with GAAP 10 An integrated cost management system should relate the costs of business processes to the benefits they generate This information is useful in evaluating both the effectiveness and efficiency of the processes A CMS may generate other information useful in evaluating the effectiveness of processes such as their ability to improve product quality 11 No The primary purpose of a cost management system is to manage costs relative to strategies Thus, the intent is to control expenditures to maximize the achievement of goals that have been specified by shareholders, managers, and other organizational participants 12 Every organization is unique in its objectives, constraints, culture, strategies, and structure Because all of these variables are important determinants of the configuration of a cost management system, every organization requires a unique cost management system Chapter Introduction to Cost Management Systems 27 13 Organizational form influences the cost management system design in several ways For example, organizational form determines, in part, who in the organization is empowered to make decisions Also, the organizational form determines whether certain costs will be incurred (e.g., federal income taxes) and, whether those costs affect other costs such as the cost of acquiring public or private capital 14 Core competencies are activities a firm must execute well to survive Information useful in assessing core competencies would include benchmark data from competing firms or other firms, historical performance data, intelligence regarding actions likely to be taken by competitors, and measurement systems to capture performance in areas of core competencies 15 Centralized control is more appropriate in environments that are relatively static and in firms that have a shortage of managerial talent and constrained resources for developing effective control systems Decentralized control is more appropriate in organizations that are very dynamic and involved in diverse activities in which people closest to the action have the best information for making decisions Decentralization is also warranted in geographically dispersed firms that have the talent and resources to develop the necessary sophisticated control systems to make decentralization work effectively 16 A person’s answer to this question will likely hinge on how comfortable the person is with accepting authority and the responsibility for using it Working in a decentralized environment gives an employee more autonomy but also more responsibility for results Certainly, some employees may be willing to sacrifice some freedom of choice to avoid that responsibility and, therefore, would prefer a more centralized environment 17 a Build mission: market share data, growth in product sales, data on geographic sales, cost of engineering design changes, and product life cycle cost data b Harvest mission: profit measurements, market share, cash flow, sales volume, and product line/geographic information c Hold mission: cash flow, profit measurements, market share, marketing and distribution costs, and market data such as competitor pricing 28 Chapter Introduction to Cost Management Systems 18 Organizational culture can be an effective control device A culture is a reflection of the values and practices that are acceptable or preferred by the company The mere existence of the culture deters certain undesirable practices and encourages others The culture can be perpetuated by hiring people who have values that are consistent with the culture In this manner, the culture is perpetuated and the employees have homogeneous beliefs regarding behaviors 19 AT&T operated in a regulated environment In such an environment, the company had no competitors and no incentive to be cost efficient in its operations Most decisions were made at the top, and employees were socialized to be followers rather than leaders With deregulation came the need for AT&T to be concerned about cost control In the Soviet Union all resource allocations were made by centralized managers (government officials) Perestroika resulted in the equivalent of decentralization Resource allocation was turned over to the private sector Also, many former government facilities were privatized and became private firms In both the AT&T case and the Soviet Union, the isolation from competitive forces was removed To survive, AT&T and the many privatized operations in the Soviet Union had to learn how to satisfy customers, or become marketfocused rather than internally focused With these changes, managers needed to acquire information about their customers and competitors In addition to understanding their markets, the managers needed to find ways to become more efficient To become more efficient, managers had to encourage employees to be costconscious and provide them with incentives to reduce costs Accordingly, information about employee performance was needed, aw well as information regarding supplier pricing, taxes, quality measurement, and customer-based performance 20 Confrontational competition involves a company seeking a temporary market advantage over its rivals To assess relative standing in a competitive dimension, such as product quality, a company necessarily must have information about its competitors—in this example, information about quality 21 The life-cycle stage determines which costs are important and which costs are controllable For example, in the design stage, no production costs are being incurred; so, a focus on production costs would be ineffective and inappropriate Instead, the focus should be on research and development costs and product design costs Similarly, in later stages of the product life cycle, no R&D expenses are being incurred,and thus, no focus should be given to them; rather, production and marketing costs should be the focus of attention Chapter Introduction to Cost Management Systems 29 22 Cost management has risen to the top of concerns because it has become a primary determinant of profitability Because competition is increasingly a contest among equals, the balance of power in the marketplace has been shifted to the consumer, who now has many choices of competitive products and services With many equivalent products competing for consumer dollars, the ability of any company to control price is diminished Companies must focus on reducing price to maintain market share; to achieve price reductions, companies must effectively manage costs 23 Core competencies for a typical college or university would include the areas of: student retention, student recruiting, student placement, faculty recruiting, cost management, faculty/student ratios, research productivity, generation of research grants, and fund raising Student answers will vary from those provided here 24 Productivity is the amount of output generated per employee Sales is the most likely measure of output To increase productivity, managers can increase the use of technology Technology allows more output to be produced with fewer employees Managers can also invest heavily in training to improve the skills of workers Higher-skilled workers are more productive than lower-skilled workers Managers can also simplify product designs and production processes to improve productivity and eliminate non-value-adding activities 25 Time-to-market is important in industries where economies of scale can be captured by the firm first-to-market Time-tomarket is important in automobile manufacturing (e.g., Chrysler and the minivan), electronics (e.g., Hewlett-Packard and the inkjet printer, Apple and the personal computer), and news reporting Industries in which time-to-market is less important include commodity goods (e.g., agricultural products, mining), very stable or mature industries (e.g., office furniture), and industries in which there is little competition based on product innovation (paper production) 26 Supply chains, or value chains, are increasingly the focus of cost management systems because managers are recognizing that many costs must be managed between firms, not just within firms By sharing information and ideas with its suppliers and customers, firms can develop effective cost management strategies for virtually all costs—not simply those it controls directly 30 Chapter Introduction to Cost Management Systems 27 Feeder systems are the individual systems that provide the information to the cost management system, e.g., payroll system, accounts payable, accounts receivable These systems are very important to the design of a CMS because they determine the type, format, and amount of information gathered One primary consideration is the compatibility among the many feeder systems Additionally, when gap analysis is conducted, any additional information that is needed may be acquired from an existing feeder system 28 They are equally important as they are all integral to the design of an effective cost management system Only when all three elements are designed properly does the cost management system serve to effectively and efficiently implement the firm’s strategies 29 False To be successful, a firm must be solvent in the short run and profitable in the long run As long as a firm has enough cash to cover any negative cash flows, it can operate at a loss in the short term Often, short-term profits must be sacrificed to obtain long-term profits This is particularly true in industries that require large upfront investments in research and development to develop and introduce new products 30 Students should have little difficulty thinking of incidents where the relationship between behaviors and performance evaluation is evident Sometimes the behavior exhibited is positive, and sometimes it is negative For example, by grading based on class participation, a professor may get students to be more involved in class discussions By giving certain types of exams, a professor may encourage students to memorize facts By providing demerits for missing class, a professor may encourage a high level of class attendance By rewarding only research productivity, a university may encourage a professor to be uncaring about the quality of his or her teaching 31 Managers use multiple perspectives to design performance measures because they recognize there are different stakeholders in their organizations All of these stakeholders must be satisfied with the performance of the organization if the organization is to thrive For example, customers are interested in innovative, high-quality products and services that are delivered at a reasonable price If customers are not satisfied, they can take their dollars elsewhere and the company will fail Stockholders are interested in a satisfactory return on their investments Generation of profits, dividends, and appreciation in stock prices attract stockholders The failure to achieve these outcomes will leave the firm unable to attract the capital that is necessary to remain viable Chapter Introduction to Cost Management Systems 31 32 Gap analysis is a formal process in which the actual set of control and information systems of an organization are contrasted with the ideal set of such systems Any differences between the sets are labeled “gaps.” The purpose of gap analysis is to develop a strategy to close the gaps so that the actual systems in place come to resemble the ideal systems 33 CAM-I was a consortium organized to develop a framework for the design of cost management systems in advanced manufacturing settings One outcome of CAM-I was a set of principles for designing cost management systems Although compatible with existing cost accounting systems, the set of principles as a whole suggests a radical departure from traditional practices The practices focus management attention on organizational activities, product life cycles, integrating cost management and performance measurement, and integrating investment management and strategic management Chapter Introduction to Cost Management Systems 32 Exercises 34 Two observations arise from an examination of the data First, Firm Z is generating more profit per dollar of sales than is the average firm in the industry Although the average firm generates profit equal to 10 percent of sales ($0.096 ÷ $0.96), Firm Z’s profits are a whopping 26 percent of sales ($1.04 ÷ $4) Second, relative to its sales, Firm Z is spending much less on advertising, R&D, and investment in new facilities as indicated in the following table Spending as a Percentage of Sales Firm Z Industry Average Advertising 2% 17% R&D 8% 25% Facilities investment 10% 25% While one interpretation of the data is that Firm Z is much more profitable than the average firm in the industry because it is more effectively managing its costs, the opposite is likely true Firm Z is robbing from its future to increase the current level of profits Unless Firm Z starts investing much more heavily in the three areas featured in the problem, the firm will start to lose market share, sales will drop, and profits will decline dramatically 35 The problems cited in the article are serious but can be addressed with a comprehensive solution Although solutions can be devised for all firms, the solution crafted for any particular firm in the advertising industry may differ from the others The starting point in designing a solution would be to formally develop a company mission statement, determine a competitive strategy, and describe the market to be served Next, the organizational structure would be reviewed to ensure that it is appropriate for the strategy that is to be implemented Then, control systems can be designed that are tailored to the strategy, structure, and culture of the specific advertising firm As described in the article, most problems in the advertising industry relate to poor customer service This dimension of performance deserves special consideration in devising the cost management system The cost management system developed for any firm would need to include control components from all three categories of system elements: motivational, informational, and reporting A key to making the new systems effective would be to establish accountability consistent with the organizational authority structure Chapter Introduction to Cost Management Systems 33 To be accountable, each manager in the advertising agency must be assigned certain responsibilities Each manager’s performance should be measured relative to benchmarks that are specific for a given type of responsibility Then, a reward system must be established that provides monetary and other benefits that are based on the comparison of actual and benchmark performance If designed appropriately, the performance and reward systems will convince managers to be much more attentive to the needs and demands of their customers Additionally, information systems would be developed to ensure that each manager received the data necessary to fulfill their responsibilities competently 36 The presentation should, at a minimum, discuss the following points: • the corporation is relatively more expensive to launch than the other organizational forms • the general partnership is the least expensive to form • outside capital is easier to raise in the corporate form because of the limited liability protection offered to shareholders along with the well-developed secondary markets for publicly-traded stocks • separation of ownership and management is most difficult in the general partnership form It is probably easiest to achieve in the corporate form • only the corporation is subject to income taxes The other entity forms can be taxed as pass-through entities • only the general partnership exposes the investors to unlimited liability The other forms offer at least limited liability to investors 37 No solution provided 38 No solution provided 34 Chapter Introduction to Cost Management Systems 39 The old adage “you get what you measure” applies to the use of accounting information The major points that should be raised in the discussion are: • Accounting information will promote goal achievement only if the measurements are highly correlated with the goals Alternatively, goal congruence problems will be created if the accounting information captures performance dimensions that are not highly correlated with goal achievement The use of nonfinancial performance measures may serve to strengthen the tie between accounting information and goals • Only if the accounting information is accurate will it serve to promote goal congruence and goal achievement • Only if the accounting information is used as a basis to both measure performance and reward employees will it be relevant Even if accounting information is highly correlated with organizational goals, managers and employees will ignore the information unless it directly affects their welfare It will affect their welfare if their evaluation, pay, and promotion are based on accounting measurements 40 No solution provided 41 If a firm fails to achieve its goals and objectives, there are two possible causes related to topics in this chapter First, the strategy itself could have been flawed (because, for example, the organization lacked the necessary resources to execute the strategy) Second, the control systems may have been inadequate to ensure that the strategy was successfully implemented The fact that Corel demonstrated a distinct change in its approach to management of its costs, in this case, indicates the company changed its strategy The original strategy was to use a low-price approach to capture market share from Microsoft However, the company lacked the necessary financial resources to maintain this strategy The company changed to a strategy of becoming a niche player (formally, this strategy is sometimes called compression of competitive scope) rather than the dominant player in the industry The main niche the company seeks to serve is the current owners of Corel software—individuals and firms who have previously indicated a preference for Corel products With the change in strategy, the company no longer needed to spend massively on advertising and promotion to attract a broader clientele Consequently, the company slashed these costs and that allowed profits to increase Students will have different answers Chapter Introduction to Cost Management Systems 35 Cases 42 Although the specific company selected will determine the solution to this case, some generic actions can be taken by most firms With regard to customers and suppliers, some typical costs that could be reduced by having better sharing of information include Costs related to producing products that have no current buyers These costs include obsolescence, spoilage, theft, insurance, storage, and property taxes Costs related to non-value-adding features Customers purchase products to satisfy specific needs If a product contains features for which no specific customer need is satisfied, then costs are incurred without any benefit being obtained Coordination costs relating to order taking and order filling as well as distribution Through better communication with customers and suppliers, costs related to sales, billing, accounts collection, cash movement, and freight can be reduced Quality costs By sharing information with suppliers about the quality of the suppliers’ outputs, suppliers can take actions to improve the quality of their products Product design and manufacturing costs By sharing preliminary product design data with customers and suppliers, less expensive components may be identified and more efficient production processes may be developed Promotion costs By better understanding how to reach customers to give them information about new products, costs of marketing and promotion can be reduced 43 a Procter & Gamble’s decision was based on the high cost of distributing and redeeming coupons These costs could be avoided if the firm elected to discontinue use of coupons as a promotion tool The cost savings represent the benefits to be realized There are two major costs of discontinuing the use of coupons The first is the potential loss of existing customers The second is the cost of alternative promotion mechanisms that would be used to replace the coupons b The market strategy may be to compete more on the basis of price and less on the basis of product differentiation By spending less on product promotion, the company will have a lower breakeven point, and by lowering the price, it may recoup some of the loss in profits per unit through an increase in the volume of sales Chapter Introduction to Cost Management Systems 36 44 a The implied mission is either hold or harvest The reduction in costs such as R&D suggests that the mission has become survival b Across-the-board cuts would be a logical approach to cost cutting only if all organizational units have the same mission Across-the-board cuts would likely have a much more detrimental long-term effect on units with a build mission than other units By implementing major cuts to units with a build mission, a company may be severely harming its future Across-the-board cuts are typically imposed in lieu of specifying specific costs to be cut By imposing across-the-board cuts, top managers are implying that no activities are more crucial than any other activities to the company’s profitability and survival This is strong evidence that the company is not managing its cost relative to its strategy c A better system of cost management would relate all activities to customer value Those activities generating high value relative to cost would not have been cut Additionally, the mission of each subunit would have been considered in identifying which costs to cut Those subunits with a build mission would likely be protected from cost-cutting to some extent Also, the company would consider which core competencies could be damaged by cost cutting measures and would take steps to make certain that those competencies are protected from effects of severe cost cutting Chapter Introduction to Cost Management Systems 45 37 The following are the major problems in the Residential Products Division: • The mission of the division is not defined, nor is the broader strategy of the firm • Green has no incentive to invest in assets that will foster future growth Her compensation is a fixed salary and a bonus based on annual profit The bonus scheme does not encourage growth This is aggravated by the fact that Green is 53 years old and may be contemplating retirement in the not-too-distant future • The division’s growth is stagnant, and market share is slipping Further, the division does not seem to have a major presence in the growth sector of the market, ornamental products • The division is not exploiting information technology Although it has some computerized systems, there is no apparent integration of systems • The division is obviously not customer-focused It has no customer service department and apparently no out-of-office sales staff to promote products • The annual operating budget is the only major control tool used by upper management Some actions that could be taken to address the problems in the Residential Products Division follow • Develop a mission statement for the division that is consistent with the strategy of the firm A strategic plan should also be compiled • Develop an integrated cost management system for the firm The control systems need to be consistent with the strategy of the firm and the mission of the division From the strong growth rate of the industry, some incentives need to be developed to encourage growth in market share and sales Even if the mission is hold rather than grow, there is opportunity for the division to regain lost market share • An integrated cost management system needs to be developed The system should include incentive elements, reporting elements, and information elements Informational elements should allow Green and other managers to obtain the information they need to make the division grow For example, the division needs to develop the capability to determine what characteristics (quality, features, etc.) customers desire in garage door hardware and other products, the ability to monitor actions of competitors, and the necessary information to evaluate cost control efforts • Culturally and structurally, the division needs to become more customer-focused Structurally, the division can establish a customer service department and develop an external sales force to gather information from customers Culturally, the division can become more customer focused by Chapter Introduction to Cost Management Systems 38 • developing incentives for employees Customer-related incentives could be based on measures of quality, lead time, product innovation, and customer service Structurally, at the corporate level, the company may need to consider more decentralization of control Using the operating budget as the only major control tool may place limits on actions that Green and her managers can take to improve operations With decentralization of control, corporate management could develop new reporting elements for the cost management system that would facilitate growth in the Residential Products Division Chapter Introduction to Cost Management Systems 46 39 a The strategy implied in the news article is differentiation through higher levels of quality customer service than those offered by competitors The quote “it can cut a lot of costs without gutting the sales staff” implies that the sales function is staffed at a high level relative to the industry b The challenge at Nordstrom’s is to make the organization more efficient without destroying either the company culture, which is customer-oriented, or the high level of customer service Assuming the corporate strategy of competing through differentiation based on higher-quality service is maintained, the following approach might be utilized This approach assumes that control systems at Nordstrom’s will not be rebuilt from scratch but will merely be “fine tuned” to achieve higher profitability Develop a target for the amount by which costs are to be cut Compare the costs of Nordstrom’s to those of its closest competitors in as many categories as possible The objective of this step is to understand which costs should be targeted for reduction After identifying which categories of costs are significantly higher at Nordstrom’s relative to competitors, determine which costs could be reduced while impacting customer service the least In this step, it is important to understand how each cost category relates to customer service Obtaining direct input from consumers could be helpful in more specifically defining the dimensions of customer service that separate Nordstrom’s from its competitors The deepest cuts in costs should be in the categories that have the least impact on customer service and the value derived by customers from shopping at Nordstrom’s Develop target amounts by which each cost category is to be cut The sum of all targeted amounts should match the amount stated in step Chapter Introduction to Cost Management Systems 40 47 Determine who has responsibility for the costs identified in steps and Develop the necessary motivational elements to create an incentive for cost reduction for the individuals identified in step Evaluate the informational and reporting elements to be certain the information and feedback systems will support the cost reduction activities a GAAP-based rules for reporting earnings require most costs related to developing and promoting new products to be expensed as incurred However, the products being introduced may have a life cycle of five years or so Accordingly, it would be appropriate to capitalize the research and development costs and amortize them over the life cycle of the products Since GAAP rules don’t allow capitalization, the research and development and promotion costs get expensed before the revenues from the new vehicles are realized This has the effect of depressing current profits but also, perhaps, overstating future profits b It would appear that there are motivational elements in Kellogg’s cost management system that encourage growth Managers are demonstrating a willingness to invest in future products even though doing so has the effect of moderately depressing current reported profits Managers would be very reluctant to act in this manner if their incentives were tied solely to current profitability Reality Check 48 a Ordinarily, the cost management system [CMS] design team creates its design within the context of decisions made by a strategic planning team Usually, the strategic planning team recommends and management gains company consensus regarding vision, mission, and major company goals and objectives However, in small companies, teams are sometimes charged with a broader responsibility than for one particular issue b Students will often suggest maximizing profits, maximizing stockholder wealth, or maximizing customer satisfaction The truth is that these goals are mutually supportive c Ignoring the satisfaction of any particular stakeholder such as stockholders, managers or customers can have a disastrous effect on the remaining stakeholders Therefore, a balance must be achieved in a manner that considers the well being of all of these stakeholders simultaneously Chapter Introduction to Cost Management Systems 49 50 41 a The sharing of information allows employees to better understand how they are expected to contribute to the organization In short, they see how their roles relate to the roles of others By better understanding their roles, employees can identify ways to improve their job tasks in ways that will increase the output volume or quality of others as well as improving their own output volume and quality b Sharing information removes the threat from both managers and employees that one individual can use private information to exploit another individual Further, the sharing of information allows employees to view issues from the perspective of managers, and vice versa The result is that all individuals are likely to develop a similar perspective of the business Rather than employees and managers having polarized views of issues, each group will have an appreciation of the concerns of the other The result should be an increase in cooperation Employer-provided health-care plans are common in the United States and other industrialized countries However, it is difficult to develop an ethics-based rationale for this common arrangement It can easily be argued that because the amount of healthcare coverage provided tends to be the same for all employees of a particular class, health-care provision is less motivational than other forms of compensation It is, at best, loosely tied to performance Instead of providing health-care coverage, employers could simply reallocate the funds expended for health-care to its employees in a manner that provides a tighter linkage between pay and performance Many would argue that this would result in a fairer allocation of resources, which would benefit employees and other stakeholders 42 Chapter Introduction to Cost Management Systems ... configuration of a cost management system, every organization requires a unique cost management system Chapter Introduction to Cost Management Systems 27 13 Organizational form influences the cost management. .. them; rather, production and marketing costs should be the focus of attention Chapter Introduction to Cost Management Systems 29 22 Cost management has risen to the top of concerns because it... all costs—not simply those it controls directly 30 Chapter Introduction to Cost Management Systems 27 Feeder systems are the individual systems that provide the information to the cost management