CHAPTER 1

INTRODUCTION TO COST MANAGEMENT

QUESTIONS FOR WRITING AND DISCUSSION

1. Cost management is concerned with competition means that companies

assigning costs and using are now competing with the best of
information for planning, controlling, the best. Accurate, timely, and
continuous improvement, and relevant accounting data are crucial
decision making. It encompasses in appropriately managing costs.
cost accounting and management Service industry growth has led to
accounting but has a broader focus the need for increased management
than the usual roles assigned to cost accounting information to improve
accounting and management productivity and quality. The
accounting. Cost accounting is advances in information technology
concerned with assigning costs to have led to the creation of integrated
various cost objects such as relational databases that allow a
products, services, and activities. variety of users to develop their own
Cost management broadens this reports based on their particular
focus by emphasizing accuracy of needs.
assignments based on causal
relationships. Management
accounting is concerned with
planning, controlling, and decision
making. Cost management broadens
this focus by emphasizing
continuous improvement and
expanding planning, control, and
decision making to include such
factors as processes, value chain,
life-cycle analyses, strategic
considerations, and environmental
costs.
2. Cost management differs from
financial accounting in the following
major ways: (1) an internal focus, (2)
an emphasis on the future, (3)
freedom from GAAP and other
mandatory rules, (4) a
multidisciplinary scope,
(5) an evaluation of individual
segments within the firm, and (6) the
provision of more detailed
information.
3. Factors affecting the focus and
practice of cost management are
global competition, service industry
growth, advances in information
technology, advances in the
manufacturing environment,
customer orientation, new product
development, total quality
management, time as a competitive
factor, and efficiency. Global

1
 It has also fostered the allows managers to identify and
implementation and use of more eliminate activities that do not add
sophisticated accounting systems value and thus reduce costs to the
such as activity-based costing. targeted level.
Customer orientation, new product
development, total quality
management, time as a competitive
factor, and efficiency require the
accountant to create and track
financial and nonfinancial measures
of customer satisfaction, quality
improvement, responsiveness, cycle
time, target costs, cost, and
productivity. Advances in the
manufacturing environment are
characterized by practices such as
the theory of constraints, just-in-time,
and automation. These changes are
affecting such practices as inventory
management and product costing.
4. Global business has led to an
increased need for more accurate
and timely account-ing information
as businesses find them-selves in
competition with other businesses
located around the world. The cost of
making bad decisions has increased
as global competition has increased;
thus, managers must have access to
more accurate cost data.
Additionally, managers may need
cost data from areas that have been
ignored in the past such as what it
costs customers to operate and
maintain a firm’s products.
5. Yes. PCs allow managers to access
accounting data, build their own
reports, and perform many of their
own analyses.
6. ERP software is designed to support
an
integrated information system,
allowing
managers from different functional
areas to have access to data from
other areas. This has enhanced the
ability to implement some of the
newer accounting systems such as
activity-based costing because ABC
needs to use data residing in other
functional areas.
7. Target costing allows managers to
plan for and manage the costs of
new products.
Activity-based management is a
complementary tool because it

2
 8. A flexible manufacturing system is a costs and revenues and thus provide
computerized system that allows signals to managers that allow them
different product lines to be
manufactured on the same to take corrective actions.
equipment. The equipment can be 15. Business ethics is concerned with
reconfigured simply by calling up
different programs. making the right choices and usually
9. The controller is responsible for both involves sacri-
internal and external accounting. ficing individual self-interest for the
These responsibilities usually include well-being of others. It is possible to
such diverse activities as taxes, SEC teach ethical behavior in virtually any
reports, cost accounting, budgeting, course. By introducing ethical
internal auditing, financial
accounting, and systems accounting. dilemmas in management
accounting, students can become
10. A line position has direct aware of the behavior that is
responsibility for carrying out the expected in the business world and,
basic missions of an organization. A in particular, for management
staff position has indirect accountants.
responsibilities for the basic missions
and provides a supportive role for 16. Yes. There is some evidence that
line activities. ethical behavior actually is good
business. It improves society, helps
11. For most organizations, the align individual goals with firm goals,
controller should be a member of the enhances a firm’s public image, and
top management staff. The controller even seems to be related to better
is the financial expert of an financial performance. The market
organization and can provide critical and consumers appreciate ethical
advice and insights. Furthermore, behavior and are willing to reward
the current tendency of having a those who adopt it.
cross-functional management team
increases the likelihood that the 17. Yes. As management accountants
controller will be included as part of become more informed about what
the management staff. behavior is acceptable and what is
not, we should expect increased
12. Planning establishes performance support for ethical behavior. The
standards, feedback compares code also recommends solutions to
actual performance with planned ethical dilemmas that might not have
performance, and control uses been obvious to the practicing
feedback to evaluate deviations from management accountant.
plans.
18. The three forms of certification are
13. Cost management has the role of the CMA, the CPA, and the CIA
providing information to help identify certificates. Although each
opportunities for improvement and certification can prove to be valuable
also provides an evaluation of the for management accountants, the
progress made in implementing the CMA designation is tailored to fit the
actions designed to create needs of management accountants.
improvement. The CPA designation has a public
14. Performance reports compare actual accounting orientation, and the CIA
costs and revenues with planned designation has an internal auditing

3
 orientation. Only the CMA (3) management reporting, analysis,
designation specifically addresses and behavioral issues; and (4)
the professional requirements of a decision analysis and information
management accountant. systems. The parts reveal the
interdisciplinary nature of
19. The four parts are: (1) economics,
management accounting.
finance, and management; (2)
financial accounting and reporting;

4
 EXERCISES

1–1

a. FS g. CMS
b. FS h. FS
c. CMS i. CMS
d. CMS j. CMS
e. FS k. FS
f. CMS l. FS

1–2

1. Customers can be internal or external. Users of the component produced by

Milton’s department are his customers. This includes the Assembly
Department and the Rework Department. In a sense, those who buy the
calculators are his customers too—after all, the functionality of the calculator
is affected by the quality and reliability of its components.

2. Milton’s department is producing a low quality component. One out of every

100 units is a high defect rate and is causing a lot of rework. Being sensitive
would require a dramatic reduction in the defect rate. A reduction in the
defect rate would decrease cycle time, lower the rework rate, and decrease
costs. This creates the potential to increase value for external customers and
makes the life of internal customers much easier.

3. Cost management can provide information concerning quality—both financial

and nonfinancial. Defect rates can be tracked over time. Rework costs
attributable to defective components from Milton’s department can be
measured and tracked over time. Cycle time reductions due to improved
quality can be measured and reported. Product cost reductions attributable to
improved quality can be reported.
1–3

Companies have set up customer service telephone lines as a necessary part of

doing business. A mail-order business will find that many cusztomers prefer to
order merchandise over the phone rather than filling out an order form, finding a
stamp, and mailing it. Software companies find it necessary to have help lines
available to customers who may not be as technically sophisticated as a
computer programmer. Many of these customer service telephone lines are toll-
free. Costs include:

Direct costs:
The investment in office space and office furniture for the customer service
representatives.
The investment in telephones and queuing equipment.
The monthly cost of the phone service and the 800 number.
The salaries of the customer service representatives.

Indirect costs:
Cost of lost sales to competitors who do have this service if the company
chooses not to provide it.
Lost sales (no repeat orders) from frustrated customers who have difficulty
dialing in (overloaded lines) and who must remain on “hold” for an
inordinate amount of time.
Lower marketing costs in the long run as satisfied current customers
purchase additional items.
1–4

The manager is clearly making an unethical decision. The decision for

promotions has been made, and delaying the decision to promote deserving
employees is obviously unfair to them. Although the manager is not a cost or
management accountant, he is violating the ethical standard that required the
refusal of “any gift, favor (bonus), or hospitality that would influence their
actions.”

The manager’s decision is particularly egregious in that he is reducing the

salaries of others so that he may benefit. In effect, he is stealing from his
subordinates.

The dilemma arose because the manager wanted to manipulate income to

achieve the bonus. By basing reward on a short-run measure such as profits, the
manager has the incentive to manipulate earnings in the short run. Apparently, he
did not believe that any normal efforts to increase income would be successful.
An internal audit could be used to detect and deter such questionable behavior.
Furthermore, a company policy requiring managers to justify any delays in
promotions in writing to both the employees and higher management could
discourage behavior like the manager’s. The best control, however, is hiring
managers with the integrity to do the right thing even when faced with the
opportunity to cheat or steal.

NOTE TO INSTRUCTOR: The students might address this situation from the
perspective of the employees who were delayed in their promotions. How should
they react?
1–5

1. The controller wants a written record of spoiled material in order to more

closely control it. From a behavioral perspective, the formal record keeping of
spoilage will make it seem more important to individuals on the factory floor.
If the company has a total quality management program in effect, keeping
track of spoilage can make it easier to note trends and ensure that spoilage is
being reduced over time. Additionally, the formal reporting of spoilage may
make it easier to pinpoint the areas in which spoilage occurs and may enable
management to improve the system to eliminate spoilage. Employees should
be made aware that the purpose of tracking spoilage is to eliminate it, not to
fix blame.
Besides, everybody doesn’t know what the spoilage rate is. Some people
think it is high, others think it is low. A written record of spoilage will prevent
a certain amount of pointless arguing about this. For example, the plant
manager will not be forced to rely on the production manager’s assessment
of spoilage as “practically none” or “not important.” Instead, both managers
can rely on the recorded spoilage to determine how much is occurring and
how it can best be reduced.

2. Bill correctly sees that keeping track of spoilage is additional work. This will
cost the plant in one way or another. Even if an additional worker need not be
hired, the workers who do record spoilage, by definition, will not be doing
something else. Bill should work together with the controller to see that the
costs of recording spoilage do not exceed the benefits. He should also
attempt to make the recording as easy as possible and concentrate on the
“expensive” spoilage. Finally, Bill’s remark indicates that workers may hide
spoilage to avoid responsibility. They may “steal” it and then dispose of it or
they may simply pass on a bad unit to the next process. Either approach is
costly and not in harmony with the goal of improving quality. These problems
can be avoided by training, education, and the installation of controls.
1–6

1. Planning. The management accountant gains an understanding of the impact

on the organization of planned transactions (i.e., analyzing strengths and
weaknesses) and economic events (both strategic and tactical) and sets
obtainable goals for the organization. The development of budgets is an
example of planning.
Control and evaluation. The management accountant ensures the integrity of
financial information, monitors performance against budgets and goals, and
provides information internally for decision making. Comparing actual
performance against budgeted performance and taking corrective action
where necessary is an example of control and evaluation.
Continuous improvement. The management accountant helps identify
opportunities for improvement , measures the projected costs and benefits,
and reports on the actual outcomes.
Decision making. The management accountant helps in the analysis of
various alternatives and helps to choose the optimum course of action.

2. A. Decision making; cost information on the gear is needed.

B. Continuous improvement: cost savings for rework and warranty activities.
C. Control and evaluation; a performance report triggered the investigation
that led to corrective action.
D. Decision making; cost information for a drop-or-keep decision is needed.
E. Decision making; accounting must forecast future cash flows and assess
quality and cycle time.
F. Planning and decision making; forecasts, cost-volume-profit analysis, and
cost information are needed.
G. Planning; forecasting of financial effects (specifically, a budgeted income
statement and a cash budget) is necessary.
H. Continuous improvement: cost information for setups and materials
waste.
1–7

Kambry Sorensen is staff. She is in a support role—she prepares reports and

helps explain and interpret them. Her role is to help the line managers more
effectively carry out their responsibilities.

Gabe Nabors is a line manager with direct responsibility for producing diagnostic
tests. One of the basic objectives of a hospital is to provide health-related
services (products). Thus, Gabe has direct responsibility for a basic objective and
holds a line position.

Leo Thayn is a line manager with direct responsibility for selling hospital services
to HMOs and clinics. Since marketing services is also a basic objective, Leo
holds a line position.
 PROBLEMS

1–8

Dear Lily,

I am pleased that you are considering taking an accounting course to

complement your hotel and restaurant major. You will find that a basic knowledge
of
accounting will stand you in good stead in dealing with the business aspects of
hotel management.

Financial accounting is primarily aimed at outside parties. It involves generating

financial statements that describe the assets and liabilities of a business and the
periodic income earned. You will find that banks, the IRS, and other local, state
and federal regulatory and licensing agencies will appreciate a good solid
financial accounting system.

Cost management is concerned with determining the costs of things like

products, services, and activities. It is also concerned with using financial and
non-financial information for planning, controlling, continuous improvement, and
decision making. For example, you will want to budget and control costs for a
hotel. You may want to determine the costs and revenues of different services.
For example, is it worthwhile to offer a Sunday brunch for hotel guests?

As you might guess, courses in both financial and cost management would be of
value. If you cannot afford the time to take both accounting courses, a good solid
background course in cost and management accounting would be best. Good
luck with your goal of becoming a hotel manager!

Sincerely,
1–9

At first glance, this seems simple. Couldn’t John simply mention that Patty had
already accepted a position as controller in another company? Since the decision
was a close one between the two, this information would likely tip the balance in
favor of John. However, there are some ethical issues to be considered. First, the
information that Patty gave was likely given in confidence, and John should not
disclose this confidential information without her permission. Second, disclosing
the confidential information may provide a personal benefit to John. Third, it may
be that Patty will change her mind about the position she has accepted
(assuming she can withdraw honorably from the acceptance) once she is
officially aware of the promotion. This decision and its consequences should be
Patty’s and not John’s. If I were John, I would leave the response to the
promotion entirely in Patty’s hands. Once offered the position, she may simply
indicate that she cannot accept it because she is committed to another job. This
may then cleanly open up the position for John.

1–10

1. Emily should not implement the suggested accounting procedures because

they conflict with generally accepted accounting principles, and violate
Sections I-2, I-3, III-4, III-6, and III-7 of the ethical code for management
accountants. It raises serious ethical questions in the areas of competence
and integrity; e.g., Emily is not able to “perform professional duties in
accordance with relevant laws, regulations, and technical standards” or
“prepare complete and clear reports.…”

2. Emily should discuss the problem with the next highest management level (if
the divisional manager’s mind cannot be changed). This could be, for
example, the corporate controller or the CEO. She could also discuss the
matter with an objective advisor to assess possible courses of action. In
some firms, ethical hotlines exist that will allow the dilemma to be analyzed. If
no resolution is obtained, then resignation may be called for.
1–11

The proposed changes violate the following ethical standards:

Competence. Top management’s request for Larry Stewart to account for the
company’s information in a manner that is not in accordance with generally
accepted accounting principles violates the standard to “perform professional
duties in accordance with relevant laws, regulations, and technical standards.”
Also, top management’s restriction on information disclosure has violated the
standard to “prepare complete and clear reports.…”

Confidentiality. Top management has violated the ethical standard of “refrain[ing]

from using…confidential information acquired in the course of their work for
unethical or illegal advantage…personally” (personal job security).

Integrity. Top management has violated the standard to “avoid actual or apparent
conflicts of interest and advise all appropriate parties [other shareholders] of any
potential conflict.”

The motivation for top management in this circumstance may be reinforced by

the favorable bonus situation, which is in violation of the standard to “refuse any
gift, favor [bonus], or hospitality that would influence their actions.”

By telling Stewart to restrict the disclosure of the changes, top management is

clearly in violation of the standard to “communicate unfavorable as well as
favorable information.…”

Objectivity. Top management’s restriction and distortion of Silverado’s financial

information violates the standard to “communicate information fairly and
objectively.”

To resolve the ethical dilemma, Larry Stewart should first determine if the
company has an established policy. If so, he should follow the prescribed
policies in resolving the ethical conflict. If there is no policy, then the specific
steps are:

A. To confront top management about the unethical behavior unless Stewart

feels that they are involved, in which case the problem should be presented
to the next higher level, the chairman of the Board of Directors. If this fails,
then the issue can be taken to the Audit Committee and the Board of
Directors.

B. To clarify relevant concepts by confidential discussion with an objective

advisor to obtain possible courses of action.

C. To resign and submit an informative memorandum to the chairman of the

Board of Directors, if all levels of internal review have been exhausted and the
conflict still exists.
1–12

By discussing the possible sale of Emery’s common stock with members of the
trouble-shooting team, Gus Swanson has violated the following standards of
ethical conduct.

Confidentiality. Swanson has disclosed confidential information acquired in the

course of his work that he has not been authorized to share with peers and others
within the organization. In addition, he has not informed subordinates of the
confidential nature of the information nor has he attempted to prevent the further
distribution of this information.

Integrity. By discussing this information, Swanson has engaged in an activity that

would discredit his profession and prejudice his ability to carry out his duties
ethically.

Objectivity. Swanson has violated the requirement to communicate all

information fairly and objectively.

Competence. Swanson has an obligation to perform his duties in accordance with

relevant laws and regulations. By discussing the information he overheard,
Swanson may have violated laws regulating the use of inside information.
1–13

1. Assuming the controller did not inform the CEO and CFO of the situation, the
ethical considerations of the controller’s apparent lack of action, as covered
in the Standards of Ethical Conduct for Management Accountants, are as
follows:
Competence. Management accountants have a responsibility to perform their
professional duties in accordance with the relevant laws, regulations, and
technical standards and to prepare complete reports after appropriate
analyses of relevant and reliable information. The controller’s apparent lack
of
action regarding the overstatement of inventory and lack of provision for
potential purchase commitment losses do not comply with generally
accepted accounting principles.
Integrity. Management accountants have a responsibility to avoid conflicts of
interest, refrain from engaging in any activity that would prejudice their ability
to carry out their duties ethically, refrain from subverting the organization’s
legitimate and ethical objectives, and refrain from engaging in any activity
that would discredit their profession.
Objectivity. Management accountants have a responsibility to communicate
information fairly and objectively and to fully disclose information that could
influence an intended user’s understanding of the reports.

2. The recommended course of action that Marian Nevins should take, as

described in Standards of Ethical Conduct for Management Accountants, is
as follows:
Consult company policies and procedures regarding ethical conflict. If the
company does not have adequate procedures in place to resolve the conflict,
then Nevins should discuss the problem with her immediate superior, the
controller. However, as the controller is apparently involved in the matter and
she has already spoken to him, it would not be necessary to inform him that
she is taking the situation to the CFO.
Since the issue is still not resolved, she should consult the next higher level
of management, the CFO, particularly since he or she will be one of the
signers of the representation letter.
During this process, Nevins could clarify relevant concepts by confidential
discussion with an objective advisor to obtain an understanding of possible
courses of action. (The IMA maintains a toll-free ethics hotline for members
experiencing ethical conflicts.)
If the issue remains unresolved, Nevins should continue to take the problem
to the next higher levels of authority which may include the audit committee,
executive committee, and/or the board of directors.
1–13 Concluded

If the ethical conflict still exists, after exhausting all levels of internal review,
Nevins should resign and submit an informative memorandum to an
appropriate representative of the organization.
Except where legally prescribed, communication of these issues to outsiders
(the media, regulatory bodies, etc.) by Nevins is not considered appropriate.

3. The actions that Heart Health Procedures can take to improve the ethical
situation within the company include:
Setting the tone at the top for control consciousness of the people in the
organization.
Establishing an audit committee within the board of directors and providing
an avenue for communication free of reprisals within the company.
Adopting performance-based, long-term financial incentive plans.
 COLLABORATIVE LEARNING EXERCISE

1–14

Potential questions Queen Isabella might have asked during the eight-month
voyage are listed. (F) refers to a financial accounting type of question; (CM) refers
to a cost management type of question.

Months 1–3:
How are you progressing? Have you sighted land yet? (CM)
How has the weather been? Are the winds favorable? (CM)
Are there any problems on the ships? (CM)
What distance have you covered? Are your supplies adequate? (CM)
How are provisions holding out? (F, CM)

Month 4:
What is the terrain like? (CM) Is the land inhabited? (CM)
What are the inhabitants like? Warlike? Peaceful? (CM)
Have you found gold and precious stones? Other valuables (e.g., spices)?
How much? (F)
Did you claim the land for Spain? (F, CM)
What resources are available in the new land? Timber and stone to build
government buildings? (F, CM)
Is there a good harbor? Are there nearby lands? (CM)
What is your assessment of the potential for long-term colonization? (F, CM)
Are the three ships in good condition? The sailors? (CM)

Months 5–8:
What kind of progress have you made? (CM)
Are you at the same stage you would have expected based on your voyage
out? (CM)
How has the weather been? Are the winds favorable? (CM)
Have you lost any ships or cargo? (F) Are there any problems on the ships?
(CM)
How are provisions holding out? (CM)
When do you expect to be back in Spain? (CM)
 CYBER RESEARCH CASES

Answers will vary.