Financial Management

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Cost Accounting Traditions and Innovations Barfiel
d, Raiborn, Kinney
Chapter 15 Financial Management
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Learning Objectives (1 of 2)

• Explain why cost consciousness is important to
  all members of the organization
• Define committed costs and discretionary costs
• Describe how the benefits of discretionary cost
  expenditures are measured
• Identify when standards are applicable to
  discretionary costs
• Explain how a budget helps control discretionary
  costs

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Learning Objectives (2 of 2)

• Describe how an activity-based budget differs
  from traditional budgets
• List the objectives of cash management
• (Appendix) Explain how program budgeting is used
  in not-for-profit entities
• (Appendix) Describe how zero-base budgeting is
  useful in cost control

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Cost Control Systems

• Provide information for planning and for
  determining the efficiency of activities while
  they are being planned and after they are
  performed

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Planning and Control Model
PLAN
PLANNING
EXECUTE
RESPOND
CONTROL
EVALUATE
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ACTIVITY
Before
During
After
Budgeting, Standard setting
Monitoring, Correcting
Providing feedback
Cost understanding
Cost containment, Cost avoidance
Cost reduction
COST CONSCIOUSNESS ATTITUDE
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Why Costs Change

• Cost Behavior
• Reaction of variable and mixed costs to changes
  in activity level
• Inflation/Deflation
• Supply/Supplier Cost Adjustments
• Supply/demand adjustments
• Taxes
• Regulatory Requirements
• Quantity Purchased

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Cost Containment

• Cannot contain
• inflation
• tax
• regulatory changes
• supply and demand adjustments

• Use cost containment for
• reduced competition
• seasonality
• quantities purchased
• Interorganizational arrangements
• Long-term or single-source contracts

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Cost Avoidance and Reduction

• Avoidance - finding acceptable alternatives
• Reduction - lowering current costs
• Benchmarks
• Outsourcing
• Consultants
• Redesign operations

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Implement Cost Control System
Investigate/understand types of costs
Communicate need for cost containment
Motivate employees (education/incentives)
Review results and consider improvements
View as long-run process
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Fixed Costs

• Committed Costs plant assets and personnel
  structure
• depreciation
• lease rentals
• property taxes
• Cannot be reduced easily

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

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Controlling Committed Costs

• Compare expected benefits to expected costs
• Analyze operating leverage
• Perform postinvestment audit compare actual to
  expected results

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Discretionary Costs

• Vary in type and magnitude
• Vary in quality of performance
• Not easy to measure benefits in terms of money

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Budgeting Discretionary Costs

• Perceived significance to the achievement of
  objectives and goals
• Expected level of operations
• Managerial negotiations
• Spend all of the appropriation, or
• Spend less than the appropriation

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Measuring Benefits from Discretionary Costs

• Use surrogate measures
• Reduction in unplanned downtime
• Number of coupons clipped from ads
• Reduction in number of customer complaints
• Compare discretionary costs to benefits to
  measure efficiency and effectiveness

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Discretionary Cost Measures
Actual Result
Compared to
Desired Result
OR
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Controlling Discretionary Costs

• To determine variances, compare actual to
  standards or budgeted amounts
• Use engineered costs
• Costs that bear observable and known relationship
  to a quantifiable activity base
• Compute fixed or variable variances

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Activity-Based Budgeting

• Apply activity drivers to estimate the levels and
  costs of activities necessary to provide the
  budgeted quantity and quality of production

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Activity-Based Budgeting Steps
Identify Activities
Select Function
Identify Activity Drivers
Estimate Costs
Estimate Driver Volume
Identify Resources
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Cash Management Issues

• Cash level
• sufficient to cover all needs
• low enough to allow for alternative uses of cash
• What variables influence the optimal level of
  cash?
• What are the sources of cash?
• What variables influence the cost of carrying
  cash?

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Cash Management Issues

• What variables influence the optimal level of
  cash?
• Uncertainty of timing of cash inflows and
  outflows
• Variability in cash requirements throughout the
  year
• Ability to arrange short-term financing
• Bond and loan covenants

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Cash Management Issues

• What are the sources of cash?
• Sale of equity or debt instruments
• Sale of unneeded or unproductive assets
• Normal operations
• Reduce inventory
• Increase A/R turnover
• Decelerate payments

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Cash Collection Cycle
Balance Sheet Current Assets
Inflow
Cash
Outflow
Accounts Receivable
Materials Inventory
Work in Process Inventory
Finished Goods Inventory
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Cash Management Issues

• What variables influence the cost of carrying
  cash?
• Cost of borrowing and cost of issuing equity
  capital
• Opportunity costs of holding cash

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Program Budgeting

• Use in government, not-for-profits, and service
  activities in for-profits
• Relates resource inputs to service outputs
• Define objectives in terms of output results, not
  quantity of input activities
• Analyze alternative activities that may achieve
  the objectives
• Use surrogate measures of output

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Program Budgeting Questions
?

• When should results be measured?
• What results should be used as output measures?
• Are all results equally important?
• What program actually caused the result?
• Did the program actually affect the target
  population?

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Zero-Base Budgeting

• Considers the priorities and alternatives for
  current and proposed activities in relation to
  organizational objectives
• Reevaluates activities
• continue
• eliminate
• adjust funding

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Questions

• What are committed costs and discretionary costs?
• How does a budget help to control discretionary
  costs?
• How does an activity-based budget differ from
  traditional budgets?