Cost Accounting and Control

Module/Unit I: Part 2 - Introduction to Cost Management antonio jaramillo dayag

The term cost management is normally used for people engaged in businesses.
Unfortunately, that term has no uniform meaning. ______________________ therefore is
use to describe the approaches and activities of managers to use resources to
increase value to customers and to achieve organizational goals.

Cost management decisions comprise decisions such as whether to explore new markets,
implement new organizational processes, and change product designs. Information from
accounting systems helps managers to manage costs, but the information and the
accounting systems themselves are not cost management.

Cost management has a broad focus and is not only about reduction in costs. Cost
management includes decisions to incur additional costs.
Cost management in accounting:
 A form of management accounting that is designed to help business owners predict
how much business expenses. The purpose of this form of accounting is to avoid
going over budget so that businesses can hold onto as much of their revenues as
possible. It is the process of planning and controlling the budget of a business.

 Allows a business to predict impending expenditures to help reduce the chance of

going over budget. Cost management has a much wider focus than that found in
traditional-costing systems. It is not only concerned with how much something costs
but also with the factors that drive costs, such as product quality, and process
productivity.

The costs of activities and processes do not appear on the financial statements.
Knowing these costs and their primary causes is critical for companies engaging in such
tasks as continuous development, total quality management, productivity enhancement,
strategic cost management and environmental cost management

An important objective of a cost management system is the calculation of product costs

for external financial reporting.

Cost accounting provides the detailed cost information that management needs to control
current operations and plan for the future.

Three sectors of the economy wherein cost accounting needs to be needs to be applied:
1. ________________________companies purchase materials and components and
convert them into various finished goods. Examples are automotive companies such
as cellular phone producers, food-processing companies and computer companies.
2. _______________________companies purchase and then sell tangible products
without changing their basic form. This sector includes companies engaged in
retailing.
3. ____________________companies provide services (intangible products) - for example,
accounting firms, law firms, banks, transportation companies, mutual fund,
insurance, advertising, internet service providers and brokerage firms.

Management uses this information to decide how to allocate resources to the most efficient
and profitable areas of the business. All types of business entities - manufacturing,
merchandising, and service businesses - require accounting systems in cost
accumulation (actual/historical, normal costing and standard costing) to track their
activities.

For manufacturers, it is now common regardless of firm’s sizes to have cost accounting
systems that track the costs incurred to produce and sell their diverse product lines. While
the cost accounting principles and procedures discussed mostly emphasize manufacturers,
many of the same principles apply to service and merchandising businesses.
  For-profit service businesses, such as health clubs, accounting firms, and PBA
basketball teams, sell services rather than products.
 Merchandisers purchase finished goods for resale. They may be retailers, who sell
products to individuals for consumption, or wholesalers, who purchase goods from
manufacturers and sell to retailers.
 Not-for-profit entities such as universities/colleges, hospitals, voluntary health
and welfare organizations, and other not-for-profit entities such private and
community organizations, and trade associations, and some health care facilities,
provide services at little or no cost to the user.

What is Cost Accounting?

______________, often referred to as the language of business, provides much of that
necessary information. Accounting language has two primary “variations”:
 financial accounting, and
 management accounting.

Cost accounting is a bridge between financial and management accounting

_________________ refers to recording (of costs), classifying (manufacturing or non-

manufacturing), summarizing (or reporting) financial (quantitative) and nonfinancial
(qualitative or non-quantitative) information and interpreting the details of all cost
(materials, labor and overhead) aspects of company performance during a particular period
of time.

It is therefore, a system that records, summarizes, analyzes, and interprets the details of the
cost of materials, labor and overhead necessary to produce and sell an article or a product.

Modern cost accounting takes the perspective that collecting cost information is a function
of the management decisions being made. For example, calculating the cost of a product is a
cost accounting function that answers financial accounting’s inventory-valuation needs and
management accounting’s decision-making needs (such as deciding how to price products
and choosing which products to promote).

The original purpose of a cost accounting system was to control costs. This is still an
important function of cost management systems given the current global competitive
environment. Cost accounting provides the detailed cost information that management
needs to control current operations and plan for the future.

The main aim of cost accounting is to track the cost of production and fixed costs of
the company. This information is useful in reducing and controlling various costs. It is very
similar to financial accounting, but it is not reported at the end of the financial year.

The Role of Cost Accounting

In the past, the role of cost accounting was widely regarded as the calculation of the
inventory cost presented in the balance sheet and cost of goods sold figure in the income
statement. This view limits the broad range of information that managers need for decision-
making to nothing more than the product cost data that satisfy external reporting rules
such as generally accepted accounting principles and tax regulations. Such a restrictive
definition is inappropriate today and is certainly an inaccurate description of the uses of cost
accounting information.

Cost accounting furnishes management with necessary tools for planning and
controlling activities, improving quality and efficiency, and making both routine and
strategic decisions.

A Framework for Cost Management and Cost Accounting

Three features of cost accounting management and cost across a wide range of applications
are as follows:
1. Calculating the cost of products, services, and other cost objects
2. Obtaining information for planning and control and performance evaluation
3. Analyzing the relevant information for making decisions
Financial Accounting versus Cost Management Accounting

The accounting system has two major subsystems in an organization: the financial
accounting system and the cost management accounting system.

The major differences between the two accounting systems:

Financial Accounting Cost Management
Outputs for external users such as including for internal users using inputs and
investors, creditors (e.g., banks and processes needed to satisfy
suppliers), and government agencies management objectives.
Coverage nature of inputs and the rules and not bound by externally imposed
conventions governing process are criteria that defines inputs and
defined by IFRS (IASB) and US GAAP processes, The criteria govern the
(FASB) inputs and outputs are set by
personnel in the company
Usefulness for investment decisions, stewardship Has three broad objectives:
evaluation, monitoring activities and  Product costing
accounting regulations  Planning and control
 Decision-making
It should be emphasized that both the financial accounting and the cost management are
part of the total accounting information system. Unfortunately, the content of the cost
management is all too often driven by the needs of the financial accounting.

The reports of both financial accounting and cost management are frequently derived from
the same database, which was originally established to support the reporting requirements
of financial accounting. Many organizations need to expand this database, or create
additional databases, in order to satisfy more fully the needs of internal users.

Financial Accounting versus Management Accounting

Financial accounting and management accounting have different goals. On the other hand,
the major differences between financial accounting and managerial accounting:

Financial Accounting Management Accounting

Inherent record, classifies, summarizes and helps management to make effective
meaning analyzes the financial affairs decision
Primary users of external parties such as investors, internal users/parties such
information creditors (e.g., banks and suppliers), managers of the organization,
and government agencies employees
Scope/Focus/ pervasive / entire organization / focus much broader / focus on segments of
Aggregation of on business as a whole the organization such as division,
information department, product line as well as
the whole organization
Application show accuracy and fair presentation helps management take meaningful
of financial statements based. steps and strategize
Emphasis / Time historical-oriented / past data future-oriented using present and
Orientation past data
Measurement financial reports must be in need of management/internal
rules & accordance with GAAP measurement and reporting may
reporting not follow generally accepted
guiding accounting principles (GAAP)
principles
Source of data drawn from company’s system drawn from internal and external
(internal) sources
Measuring quantitative / financial (primarily quantitative (financial / monetary)
network/type of monetary by nature) and qualitative reports
information (nonfinancial / non-monetary) such
as defect rates, percentage of
products returned) by department
or product line
Dependence not dependent on management depends on financial accounting to
accounting make right decisions
Nature of objectivity, verifiability and reliability subjectivity and relevance
information
 Necessity of precision or accuracy (reliability) timeliness (relevance) over precision
information /
Emphasis of
reports
Statutory / legally mandatory to prepare financial has no statutory requirement
optional statements
requirement
Frequency / time prepared periodically such as prepared as needed by
coverage and quarterly, semi-annual or yearly management needs
nature of reports reports based on the company as a
/ Frequency of while
Reporting
Uses of Cost costing products such as cost of goods Budgeting, special decisions such as
Information sold (income statement account), make or buy or drop a product line,
finished goods, work-in-process and split-off point or process further, etc.
raw materials (balance sheet
accounts) using historical costing
Amount of detail compressed and simplified extensive and detailed
Purposes or end- for reportorial requirements for decision-making
result
Unifying model Assets = Liabilities + Equity no unifying model or equation
Financial Accounting versus Cost Accounting
All accounting systems are designed to provide information to decision makers. However, it
is convenient to classify accounting systems based on the primary user of the information.
The classification of accounting systems into financial and cost (or managerial) systems
captures this distinction between decision makers. The major differences between financial
and cost accounting:
Financial Accounting Cost Accounting
Users of the external (investors, creditors, internal (within the organization
information government agencies and tax such employees, managers, and
authorities) department heads )
Important comparability, decision relevance (for decision relevance (for managers),
criteria investors) timeliness
Who establishes external standard-setting group (IFRS managers / department heads
or defines the by IASB / US GAAP by FASB)
system
How to standard-based (rules-based) not designed in a vacuum or
determine standard based but relevance for
accounting decision-making for the company
treatment and the their business environment

Management Accounting versus Cost Accounting

The distinction between cost accounting and management accounting is not so clear-cut,
and we often use these terms interchangeably. Those items that not so clear-cut are
following:
Cost Accounting Management Accounting
Primary ascertainment of cost of producing a provide information to managers for
objective product / assist the management in setting goals and future activity for
cost control and decision-making its efficiency and effective
performance / provide necessary
information to the management in
the process of its planning,
controlling, and performance
evaluation, and decision-making
Information quantitative information quantitative and qualitative
information
Accounting there are specific rules and procedure no specific rules and procedures
information for preparing
Scope limited to cost data wider area of operation like tax,
budgeting, planning and
forecasting, analysis, etc.
 Cost aspect related to ascertainment, allocation, associated with impact and effect
and distribution aspect of cost
Planning short-range planning long and short range planning, for
which it uses high-level techniques
such as probability structure,
sensitive analysis etc.
Aims reducing extra expenditure, aims at the planning of policies and
eliminating unnecessary costs and strategy formulation setting goals,
controlling various costs
Cost Accounting System
In cost accounting system, the emphasis is on operating profit, the excess of operating
revenues over the operating costs incurred to generate those revenues. This figure differs
from net income, which is operating profit adjusted for interest, income taxes, extraordinary
items, and other adjustments required to comply with GAAP or other regulations such as tax
laws.

Relationship of Cost Accounting to Financial Accounting and Management

Accounting
Financial accounting is often characterized as the primary focus of accounting. It is
concentrated on the preparation of financial statements: the balance sheet, the statement of
comprehensive income (including income statement), statement of cash flows and changes
in equity. It is designed to provide information about the firm to external users. External
users include investors, creditors, government authorities, regulators, customers,
competitors, suppliers, labor unions, and so on. It is based on standards or rules. It is
dedicated to processing information about historical, monetary transactions

Management accounting focuses on the information needs of an organization’s internal

managers, needs that are related to the planning, controlling, and decision-making
functions of those managers. Managerial accounting systems do not require rules.
Cost accounting is a subset of both financial and managerial accounting (refer to Figure
1-1). It provides information on the determination of product or service cost that is used on
the balance sheet and income statement. Some information generated by cost accounting is
used in management accounting and some in financial accounting. Thus, cost essentially
links financial and management accounting.

None of these accounting areas is more important than the other; each simply provides
different information for different needs. Thus, the determination of “importance” lies with
the user and the user’s purposes.

Interrelationship of Financial Accounting, Cost Accounting and Management

Accounting
Cost accounting is viewed as the common denominator or intersection between financial
accounting and management accounting. Cost accounting addresses the informational
demands of both financial and management accounting by providing product or service
information to:
 external parties (stockholders, creditors, regulatory authorities and donors) for
investment and credit decisions for reporting purposes, and
 internal managers for planning, controlling, decision-making and performance
evaluation on an organization.
Figure 1-1: Relationship of Financial, Management, and Cost Accounting (Uses of
Product Cost Data in Financial and Management Accounting)

Financial Accounting Managerial Accounting

(for inventory costing Cost Accounting (for special reports to
purposes in the (product cost management for
financial statements) information) decision-making
purposes
It is important to remember that information from the cost accounting system is just a
means to an end; the final products are for financial accounting for financial statement
presentation and management accounting for managerial.

Cost accounting is for:

 Financial accounting for preparing financial statements, and
 Managerial accounting looking for the best information in understanding how the
information is used in decision making

For a manufacturing company, product cost consists of the sum of all factory costs
incurred to make one unit of product and is developed in compliance with GAAP (generally
accepted accounting principles) for financial reporting purposes.

In nonmanufacturing companies–service business or not-for-profit entities, a

service cost is more likely to be computed. But product/service cost information can also be
developed outside of the constraints of GAAP to assist management in needs for planning
and controlling operations.

The following are items that provide the relationship of cost accounting to
financial accounting and management accounting:

1. Cost accounting provides information for financial accounting and management

accounting
2. Cost accounting attempts to satisfy costing objectives for both financial and
management accounting.
3. Reports such as balance sheets, income statements, and statements of cash
flows are common wherein costing of products is provided by cost accounting
system.
4. Cost accounting includes those parts of both financial and management accounting
that collect and analyze cost information.
5. Cost accounting provides the product cost data for inventory costing in the
financial statements (financial accounting) and required for special reports to
management (management accounting).

Professional Associations and Agencies (United States)

Financial accounting has been subject to the regulations of professional associations and
government agencies to a greater extent than cost accounting. Investors, creditors, and
external users do not have access to as much information about the company as
management does, and thus these external users must be protected.

Cost accounting has been influenced in varying degrees by professional associations and
government agencies. In some cases, the influence was direct; in other cases the influence
was indirect.

Direct Influence

The following professional associations and government agencies are listed in descending
order – in terms of the direct influence they had on the field of cost accounting.

1. National Association of Accountants. This professional association, founded in

1919 (then called the National Association of Cost Accountants), later, the name was
changed to National Association of Accountants (NAA) in 1957. Thereafter, in 1991
the group changed its name to what is now the Institute of Management Accountant
(IMA). NAA has had the greatest impact to date on the field of cost accounting and it
played a major role in developing new and sophisticated procedures in the cost and
management field. Its publications, which are practice-oriented, are the leading
source of current information for cost and management accountants. An important
development is the Institute of Management Accounting (IMA) (established in 1972),
charged with developing the Self-Study Program and awarding the Certificate in
Management Accounting.
 2. Cost Accounting Standards Board (CASB) – refer to discussion below.

3. Financial Executive Institute (FEI). This professional association was

established in 1931 as the Controller’s Institute of America. It is a national
organization whose members are the top financial officers in their companies. A
financial executive, according to the FEI, is a person responsible for the
administration of the assets of a firm. The actual title may be controller/comptroller,
treasurer, vice-president of finance, generally depending on the size of the company.
The cost accountant generally reports to the financial executive through the
controller/comptroller.

Indirect Influence

The following accounting professional associations/board had an important indirect

influence on the field of cost accounting.

1. American Institute of Certified Public Accountants [AICPA, United States

(US)].
2. Financial Accounting Standards Board (United States)/International
Accounting Standards Board (IASB)
3. American Accounting Association

Cost Accounting Standards

Management accountants can use different costs and different information for different
purposes, because their discipline is not required to adhere to generally accepted
accounting principles when providing information for managers’ internal use.

No similar accounting board exists to define universal management accounting standards.

However, a public sector board called the Cost Accounting Standards Board (CASB) was
established in 1970 by the U.S. Congress to promulgate uniform cost accounting standards
for defense contractors and federal agencies.

Potentially, the CASB could be the most influential force in the cost accounting field if its
standards were adopted by a significant number of companies for nongovernment work.
The CASB are legally required in cost systems for government contracts, but not in the cost
system of a government contractor for nongovernment work.

The CASB issues 20 Cost Accounting Standards (of which one has been withdrawn) from its
inception until it was dissolved / terminated in 1980 because US congress believed the
board’s purpose had been accomplished; however, the board’s standards became part of all
major procurement regulations and remained in effect. Congress reestablished the CASB in
1988 as an independent board.

The board’s objectives are to

 Increase the degree of uniformity in cost accounting practices among government
contractors in like circumstances;
 Establish consistency in cost accounting practices in like circumstances by each
individual contractor over time; and
 Require contractors to disclose their cost accounting practices in writing.

Although CASB standards do not constitute a comprehensive set of rules, compliance is

required for companies bidding on or pricing cost-related contracts.

An organization important to the practice of management and cost accounting is the

Institute of Management Accountants, or the IMA. The IMA is a voluntary membership
organization of accountants, finance specialists, academics, and others. It sponsors two
major certification programs: Certified Management Accountant (CMA) and Certified in
Financial Management (CFM).

The IMA also issues directives on the practice of management and cost accounting called
Statements on Management Accounting, or SMAs. The SMAs, unlike the pronouncements of
the CASB, are not legally binding standards, but they undergo a rigorous developmental
and exposure process that ensures their wide support.

An organization similar to the IMA is the Society of Management Accountants of Canada,

which also issues guidelines on the practice of management accounting. These Management
Accounting Guidelines (MAGs), like the SMAs, are not requirements for organizational
accounting, but are merely suggestions. Although the IMA, Cost Accounting Standards
Board, and Society of Management Accountants of Canada have been instrumental in
standards development, much of the body of knowledge and practice in management
accounting has been provided by industry practice and economic and finance theory.

Thus, no “official” agency publishes generic management accounting standards for all
companies, but there is wide acceptance of (and, therefore, authority for) the methods
presented in the text. The development of cost and management accounting standards and
practices indicates that management accountants are interested and involved in
professional recognition. Another indication of this movement is the adoption of ethics codes
by both the IMA and the various provincial societies in Canada.

Professional Certification for Management Accountant

A variety of certifications are available to management accountants. Three of the major

certifications available are:
1. Certificate in Management Accounting,
2. Certificate in Public Accounting, and
3. Certificate in Internal Auditing.

Each certification offers particular advantages to a cost or management accountant. In each

case, an applicant must meet specific educational and experience requirements and pass a
qualifying examination to become certified. Thus, all three certifications offer evidence that
the holder has achieved a minimum level of professional competence. Furthermore, all
three certifications require the holder to engage in continuing professional education in
order to maintain certification. Because certification reveals a commitment to professional
competency, most organizations encourage their management accountants to be certified.

The Certificate in Management Accounting

In 1974, the Institute of Management Accountants (IMA) developed the Certificate in

Management Accounting to meet the specific needs of management accountants. A
Certified Management Accountant (CMA) has passed a rigorous qualifying examination,
has met an experience requirement, and participates in continuing education.

One of the key requirements for obtaining the CMA certificate or designation is passing a
qualifying examination. Four areas are emphasized:
1. economics, finance, and management;
2. financial accounting and reporting;
3. management reporting, analysis, and behavioral issues; and
4. decision analysis and information systems.

The parts to the examination reflect the needs of management accounting and underscore
the earlier observation that management accounting has more of an interdisciplinary flavor
than other areas of accounting.

One of the main purposes of creating the CMA program was to establish management
accounting as a recognized, professional discipline, separate from the profession of public
accounting. Since its inception, the CMA program has been very successful. Many firms
now sponsor and pay for classes that prepare their management accountants for the
qualifying examination, as well as provide other financial incentives to encourage
acquisition of the CMA certificate.