Chapter 12:

Introduction to Cost
Management Systems
Cost Accounting:
Foundations and Evolutions, 8e
Kinney Raiborn

Learning Objectives

Why do organizations have management control

systems?
What is a cost management system?
What are the organizational roles of a cost
management system?
What factors influence the design of a cost
management system?
What are the three groups of elements that
comprise a cost management system, and what are
the purposes of these elements?
What is gap analysis, and how is it used in the
evolution of a cost management system?

Relationship of Financial,
Management, and Cost Accounting

FINANCIAL
ACCOUNTING

COST
MANAGEMENT
ACCOUNTIN ACCOUNTING
G

Cost Accounting

Financial accounting

Uses cost accounting

information for external
reporting
Conforms to GAAP
Highly aggregated
Historical

Management
accounting

Uses cost accounting

information for internal
purposes

Planning
Controlling
Decision making
Performance evaluation

Segmented
Current
Relevant for specific
purposes

Cost Management Systems

When cost accounting is shaped and dominated by

financial accounting needs, the information
generated may be of limited value to managers
A Cost Management System (CMS):

May provide information that is more relevant to internal users

A CMS is part of the Management Information System (MIS)
A structure of interrelated elements that collects, organizes,
and communicates data so managers may plan, control, make
decisions, and evaluate performance
Emphasizes satisfying internal demands for information rather
than external demands
A CMS offers formal methods to plan and control an
organizations cost-generating activities with major challenges of
Achieving profitability in the short run
Maintaining a competitive position in the long run

Internal Information Flows

Planning
Control
Decision
Performance

External Information Flows

Intelligence
Competition
Government

Suppliers

Creditors

Organization

Organizational
communications

Client
s

Management Control Systems

Management Control Systems (MCS) help to

Implement strategic and operating plans

Provide a means for comparison of actual to planned results for
control purposes

The MCS is part of the MIS

An MCS

Is not a mechanical process

Requires judgment
Is a black boxAn operation whose exact nature cannot be
observed
Guides the organization in designing and implementing strategies
to achieve organizational goals and objectives

MCS Components

Detector or sensor

Measuring device that

identifies what is actually
happening in the process
being controlled

Assessor

Device for determining the

significance of what is
happening

Comparing the information

on what is actually
happening with some
standard or expectation of
what should be happening

Effector

Device that alters behavior

if the assessor indicates the
need for doing so
Feedback

Communications network

Transmits information
between

the detector and the

assessor and
the assessor and the
effector

MCS Overview
Control device

Assessor

Effector

Detector

Entity being
controlled

MCS Processes

Information gathered

Comparisons made

Comparisons are made to budget (assessor)

Communication occurs

Source documents (detectors) gather information

about sales

A variance report (effector) is issued

(communications network)

Changes made when necessary

Encourages sales staff to increase sales volume

CMS Overview
Short Run
Objective
Focus

Information
Characteristics

Long Run

Organizational
Efficiency

Survival

Specific costs:
manufacturing,
service, marketing,
administration

Cost categories:
customers, suppliers,
products, distribution
channels

Timely, accurate,
highly specific,
short term

Periodic, reasonably
accurate, broad focus,
long term

CMS Goals

Develop product costs

Assess product/service life-cycle
performance
Improve understanding of processes and
activities
Control costs
Measure performance
Allow pursuit of organizational strategies

CMS Goals: Develop Product Costs

Develop product costs

Use cost drivers (activities that have a direct cause-andeffect relationship with costs)
Trace costs when possible using

Bar coding
RFID (radio frequency identification)

Use product costs to

Plan
Prepare financial statements
Assess individual product/service profitability
Assess period profitability
Establish prices for cost-plus contracts
Create a basis for performance measurements

CMS Goals: Assess Performance

Assess product/service life-cycle
performance

Provides basis to relate costs incurred in one

stage of the life cycle to costs and profitability of
other stages

Strong investment in development and design stages

might reduce engineering changes and quality costs in
later stages
Inability to trace development and design costs to
related product/services might camouflage disasters

CMS Goals: Improve Understanding

Improve understanding of processes and
activities

Understanding the process and reasons for cost

incurrence allows managers to make costbeneficial improvements in the production and
processing systems

CMS Goals: Control Costs

Control costs

CMS provides information on activities and cost

drivers

In the case of spoilage, the CMS provides

Number of spoiled units

Cost of spoiled units
Information to determine the cause of spoilage

CMS Goals: Assess Performance

Measure performance

CMS allows managers to measure and evaluate

performance

Human performance
Equipment performance
Future investment opportunities

CMS Goals: Organizational

Strategies
Allow pursuit of organizational strategies

CMS allows managers to

Effectively manage strategic resources

Determine core competences and organizational
constraints
Assess positive and negative financial and nonfinancial
factors of strategic and operational plans

Designing a CMS
ANALYZE

DETERMINE
desired outputs

PERFORM
gap analysis
Improve
ASSESS
gap reduction

CMS Design Influences

The design of the CMS is influenced by

Organizational form, structure, and culture

Organizational mission and core competencies
Operations and competitive environment and
strategies

Organizational Form and Structure

Organizational form

Choice of form affects

Cost of raising capital

Cost of operating business
Cost of litigating
Statutory authority to make
decisions

Organizational structure

Forms of the business

include

Corporations
Partnerships
LLPs
LLCs

Distribute authority and

responsibility
Centralized or decentralized
decision making
Group subunits

Geographically
By similar missions (build,
harvest, or hold)
By natural product clusters

Determine accountability for

cost management and
organizational control
Determine the information
needed by the decision
maker

Organizational Culture

Organizational culture

Underlying set of assumptions about the entity

and the goals, processes, practices, and values
that are shared by its members
How people interact with each other
Extent to which individuals take authority and
assume responsibility for organizational outcomes

Organizational Mission and Core

Competencies

Organizational mission

Business mission provides a

long-term goal toward which
the organization wishes to
move

Business mission regarding

competition
Avoid competition
Product Differentiation
Cost Leadership
Confront competition by
identifying and exploiting
temporary opportunities
Business mission in relation
to product life cycle

Core competencies

Timeliness
Quality
Customer service
Efficiency and cost control
Responsiveness to change
The CMS gathers data and
reports about core
competencies

Operations and Competitive

Environment

Management needs to assess:

Cost structure, including the proportion of fixed and

variable costs
Level of technology costs, which tend to be fixed and
not susceptible to short-run control
Production capacity
Flexibility to respond to a change in short-term
conditions

Strategies

Strategies include:

Being first to market

Allows pricing flexibility

Increases market share

Large per-unit profit

Substantial reduction in product
costs

Develop new production

processes

Capture learning curve effects

Increase capacity utilization

Create a focused factory

arrangement

Design for manufacturability,

logistical support, reliability,
maintainability

Supplier relations

Form strategic alliances

Involve suppliers in product
design and development
Link electronically

Integration of entire information

system

Payroll
Inventory valuation
Budgeting
Costing

CMS Purposes

A better CMS is essential to long-run

organizational survival and short-run
profitability
More sophisticated CMS are required as
Cost of gathering, processing, and
communicating information decreases
Quantity and intensity of competition
increases

CMS Elements: Motivational and

Reporting

Motivational elements

Performance
measurements

Reward structure

Quantitative or
nonquantitative
Financial or nonfinancial
Short term or long term
Profit sharing

Support of organizational
mission and competitive
strategy

Reporting elements

Prepare financial
statements
Implement responsibility
accounting system

Performance reports for

subunits focusing on costs
and activities

CMS Elements: Information

Information elements

Support budgeting process

Disclose cost drivers of
activities
Reduce/eliminate nonvalue-added activities
Emphasize managing costs
throughout the product life
cycle
Adapt to changing
competitive conditions
Support of cost reduction
initiatives

Focus on cost control

Assess core competencies
Analyze make-or-outsource
decisions
Relate cost to
product/process design
Focus on capital spending
Minimize cost distortions

Implementing CMS

Gap Analysis

Identify gap to overcome

Prioritize differences
Develop and deploy improvements
Repeat process to ensure continuous
improvement
Information Needs
<Information Available>
Gap to Overcome

Enterprise Resource Planning

For a truly integrated CMS

Standardize information systems/replace legacy

systems
Automate and integrate transfer of data among
systems
Improve the quality of information
Improve timeliness of information

Real-time, on-line reporting

Questions
Why do companies have MCS?
How does the external operating
environment affect the CMS?
What is gap analysis?

Potential Ethical Issues

Using the financial accounting system rather

than a CMS to support management
functions
Not balancing long and short-run concerns in
the design of the CMS
Using motivational elements to create high
payoffs for fraudulent behavior
Designing motivational elements that dont
align with managers authority