Friday, October 8, 2010


FINANCIAL VS. MANAGERIAL ACCOUNTING:  Early portions of this textbook dealt mostly with financial accounting.  Financial accounting is concerned with reporting to external parties such as owners, analysts, and creditors.  These external users rarely have access to the information that is internal to the organization, nor do they specify the exact information that will be presented.  Instead, they must rely on the general reports presented by the company.  Therefore, the reporting structure is well defined and standardized.  The methods of preparation and the reports presented are governed by rules of various standard-setting organizations.  Furthermore, the external users generally see only the summarized or aggregated data for an entity.
In contrast, managers of a specific business oftentimes need or desire far more detailed information.   This information must be tailored to specific decision-making tasks of managers, and its structure becomes more "free formed."  Such managerial accounting information tends to be focused on products, departments, and activities.  In this context, the management process is intended to be a broad reference to encompass marketing, finance, and other disciplines.  Simply simply: managerial accounting is about providing information in support of the internal management processes.  Many organizations refer to their internal accounting units as departments of strategic finance.  This title is perhaps more reflective of their wide range and scope of duties. 
Managerial accounting is quite different from financial accounting.  External reporting rules are replaced by internal specifications as to how data are to be accumulated and presented.  Hopefully, these internal specifications are sufficiently logical that they enable good economic decision making.  For example, specific reporting periods may be replaced with access to real-time data that enable quick responses to changing conditions.  And, forecasted outcomes become more critical for planning purposes.  Likewise, cost information should be disseminated in a way that managers can focus on (and be held accountable for!)  those business components ("segments") under their locus of control.
In short, the remainder of this book is about the ideas and methods that can be used to provide accounting information in direct support of the "broadly defined" role of managing a business organization.  If you aspire to work in strategic finance, the remainder of this book is your introductory primer.  But, for most readers -- those who must manage some part of an organization --  the remainder of this book is your guide to knowing how and when the management accountant's tools can be used to help you do your job better!
PROFESSIONAL CERTIFICATIONS IN MANAGEMENT ACCOUNTING:  You are likely familiar with the CPA (certified public accountant) designation; it is widely held and recognized.  The certification is usually accompanied by a state issued license to practice public accounting.  However, there are also CMA (certified management accountant) and CFM (certified financial manager) designations.  These are not "licenses," per se, but do represent significant competency in managerial accounting and financial management skills.  These certifications are sponsored by the Institute of Management Accountants.
THE ROLE OF MANAGEMENT:  I once saw a clever sign hanging on the wall of a business establishment: ''Managers are Paid to Manage -- If There Were No Problems We Wouldn't Need Managers."  This suggested that all organizations have problems, and it is management's responsibility to deal with them.  While there is some truth to this characterization, it is perhaps more reflective of a "not so impressive" organization that is moving from one crisis to another.  True managerial talent goes beyond just dealing with the problems at hand.
What does it mean to manage?  Managing requires numerous skill sets.  Among those skills are vision, leadership, and the ability to procure and mobilize financial and human resources.  All of these tasks must be executed with an understanding of how actions influence human behavior within, and external to, the organization.  Furthermore, good managers must have endurance to tolerate challenges and setbacks while trying to forge ahead.  To successfully manage an operation also requires follow through and execution.  But, each management action is predicated upon some specific decision.  Thus, good decision making is crucial to being a successful manager.
DECISION MAKING:  Some managers seem to have an intuitive sense of good decision making.   The reality is that good decision making is rarely done by intuition.  Consistently good decisions can only result from diligent accumulation and evaluation of information.  This is where managerial accounting comes in -- providing the information needed to fuel the decision-making process.  Managerial decisions can be categorized according to three interrelated business processes:  planning, directing, and controlling.  Correct execution of each of these activities culminates in the creation of business value.  Conversely, failure to plan, direct, or control is a roadmap to business failure.
The central theme to focus on is this: (1) business value results from good management decisions, (2) decisions must occur across a spectrum of activities (planning, directing, and controlling), and (3) quality decision making can only consistently occur by reliance on information.  Thus, I implore you to see the relevance of managerial accounting to your success as a business manager.  Let's now take a closer look at the components of planning, directing, and controlling.
PLANNING:  A business must plan for success.  What does it mean to plan?  It is about thinking ahead -- to decide on a course of action to reach desired outcomes.  Planning must occur at all levels.  First, it occurs at the high level of setting strategy.  It then moves to broad-based thought about how to establish an optimum "position" to maximize the potential for realization of goals.  Finally, planning must be undertaken from the perspective of thoughtful consideration of financial realities/constraints and anticipated monetary outcomes (budgets).
You have perhaps undergone similar planning endeavors.  For example, you decided that you desired more knowledge in business to improve your stake in life, you positioned yourself in a program of study, and you developed a model of costs (and future benefits).  So, you are quite familiar with the notion of planning!  But, you are an individual; you have easily captured and contained your plan all within your own mind.  A business organization is made up of many individuals.  And, these individuals must be orchestrated to work together in harmony.  They must share and understand the organizational plans.  In short, "everyone needs to be on the same page."
StrategyA business typically invests considerable time and money in developing its strategy.  Employees, harried with day-to-day tasks, sometimes fail to see the need to take on strategic planning.  It is difficult to see the linkage between strategic endeavors and the day-to-day corporate activities associated with delivering goods and services to customers.  But, this strategic planning ultimately defines the organization.  Specific strategy setting can take many forms, but generally includes elements pertaining to the definition of core values, mission, and objectives.
Core Values -- An entity should clearly consider and define the rules by which it will play.  Core values can cover a broad spectrum involving concepts of fair play, human dignity, ethics, employment/promotion/compensation, quality, customer service, environmental awareness, and so forth.  If an organization does not cause its members to understand and focus on these important elements, it will soon find participants becoming solely "profit-centric."  This behavior inevitably leads to a short-term focus and potentially illegal practices that provide the seeds of self destruction.  Remember that management is to build business value by making the right decisions; and, decisions about core values are essential. 
Earlier, reference was made to the CMA and CFM designations that can be earned from the Institute of Management Accountants (IMA).  You might find it interesting to follow this hyperlink to IMA's standards of ethical conduct for its members.
Mission -- Many companies attempt to prepare a pithy statement about their mission.  For example:
"At IBM, we strive to lead in the creation, development and manufacture of the industry’s most advanced information technologies, including computer systems, software, networking systems, storage devices and microelectronics.

We translate these advanced technologies into value for our customers through our professional solutions and services businesses worldwide."
Such mission statements provide a snapshot of the organization and provide a focal point against which to match ideas and actions.  They provide an important planning element because they define the organization's purpose and direction.  Interestingly, some organizations have avoided "missioning," in fear that it will limit opportunity for expansive thinking.  For example, General Electric specifically states that it does not have a mission statement, per se.  Instead, its operating philosophy and business objectives are clearly articulated each year in the Letter to Shareowners, Employees and Customers. 
In some sense, though, GE’s logo reflects its mission: “imagination at work”.  Perhaps the subliminal mission is to pursue opportunity wherever it can be found.  As a result, GE is one of the world's most diversified entities in terms of the range of products and services it offers.
Objectives -- An organization must also consider its specific objectives.  In the case of GE:
"Imagine, solve, build and lead - four bold verbs that express what it is to be part of GE. Their action-oriented nature says something about who we are - and should serve to energize ourselves and our teams around leading change and driving performance."
The objective of a business organization must include delivery of goods or services while providing a return (i.e., driving performance) for its investors.  Without this objective, the organization serves no purpose and and/or will cease to exist. 
Overall, then, the strategic structure of an organization is established by how well it defines its values and purpose.  But, how does the managerial accountant help in this process?  At first glance, these strategic issues seem to be broad and without accounting context.  But, information is needed about the "returns" that are being generated for investors; this accounting information is necessary to determine whether the profit objective is being achieved.  Actually, though, managerial accounting goes much deeper.  For example, how are core values policed?  Consider that someone must monitor and provide information on environmental compliance.  What is the most effective method for handling and properly disposing of hazardous waste?  Are there alternative products that may cost more to acquire but cost less to dispose? What system must be established to record and track such material, etc.?  All of these issues require "accountability."   As another example, ethical codes likely deal with bidding procedures to obtain the best prices from capable suppliers.  What controls are needed to monitor the purchasing process, provide for the best prices, and audit the quality of procured goods?  All of these issues quickly evolve into internal accounting tasks.  And, the managerial accountant will be heavily involved in providing input on all phases of corporate strategy.
Positioning:  An important part of the planning process is positioning the organization to achieve its goals.  Positioning is a broad concept and depends on gathering and evaluating accounting information.
Cost/Volume/Profit Analysis and Scalability -- In a subsequent chapter, you will learn about cost/volume/profit (CVP) analysis.  It is imperative for managers to understand the nature of cost behavior and how changes in volume impact profitability.  You will learn about calculating break-even points and how to manage to achieve target income levels.  You will begin to think about business models and the ability (or inability) to bring them to profitability via increases in scale.  Managers call upon their internal accounting staff to pull together information and make appropriate recommendations.
Global Trade and Transfer -- The management accountant frequently performs significant and complex analysis related to global business activities.  This requires in-depth research into laws about tariffs, taxes, and shipping.  In addition, global enterprises may transfer inventory and services between affiliated units in alternative countries.  These transactions must be fairly and correctly measured to establish reasonable transfer prices (or potentially run afoul of tax and other rules of the various countries involved).  Once again, the management accountant is called to the task.
Branding/Pricing/Sensitivity/Competition -- In positioning a company's products and services, considerable thought must be given to branding and its impact on the business.  To build a brand requires considerable investment with an uncertain payback.  Frequently, the same product can be "positioned" as an elite brand via a large investment in up-front advertising, or as a basic consumer product that will depend upon low price to drive sales.  What is the correct approach?  Information is needed to make the decision, and management will likely enlist the internal accounting staff to prepare prospective information based upon alternative scenarios.  Likewise, product pricing decisions must be balanced against costs and competitive market conditions.  And, sensitivity analysis is needed to determine how sales and costs will respond to changes in market conditions.
As you can see, decisions about positioning a company's products and services are quite complex.  The prudent manager will need considerable data to make good decisions.  Management accountants will be directly involved in providing such data.  They will usually work side-by-side with management in helping them correctly interpret and utilize the information.  It behooves a good manager to study the basic principles of managerial accounting in order to better understand how information can be effectively utilized in the decision process.  With these sorts of topics in play, it is no wonder that the term "strategic finance" is increasingly used to characterize this profession.
Budgets:  A necessary planning component is budgeting.  Budgets outline the financial plans for an organization.  There are are various types of budgets. 
Operating Budgets -- A plan must provide definition of the anticipated revenues and expenses of an organization and more.  These operating budgets can become fairly detailed, to the level of mapping specific inventory purchases, staffing plans, and so forth.   The budgets, oftentimes, delineate allowable levels of expenditures for various departments. 
Capital Budgets -- Operating budgets will also reveal the need for capital expenditures relating to new facilities and equipment.  These longer-term expenditure decisions must be evaluated logically to determine whether an investment can be justified and what rate and duration of payback is likely to occur.
Financial Budgets --  A company must assess financing needs, including an evaluation of potential cash shortages.  These tools enable companies to meet with lenders and demonstrate why and when additional support may be needed.
The budget process is quite important (no matter how painful the process may seem) to the viability of an organization.  Several of the subsequent chapters are devoted to helping you better understand the nature and elements of sound budgeting.
DIRECTING:  There are many good plans that are never realized.  To realize a plan requires the initiation and direction of numerous actions.  Often, these actions must be well coordinated and timed.  Resources must be ready, and authorizations need to be in place to enable persons to act according to the plan.  By analogy, imagine that a composer has written a beautiful score of music -- the "plan."  For it to come to life requires all members of the orchestra, and a conductor who can bring the orchestra into synchronization and harmony.  Likewise, the managerial accountant has a major role in putting business plans into action.  Information systems must be developed to allow management to orchestrate the organization.  Management must know that inventory is available when needed, productive resources (man and machine) are scheduled appropriately, transportation systems will be available to deliver output, and on and on.  In addition, management must be ready to demonstrate compliance with contracts and regulations.  These are complex tasks.  They cannot occur without strong information resources.  A major element of management accounting is to develop information systems to support the ongoing direction of the business effort.
Managerial accounting supports the "directing" function in many ways.  Areas of support include costing, production management, and special analysis:
Costing:   A strong manager must understand how costs are captured and assigned to goods and services.  This is more complex than most people realize.  Costing is such an extensive part of the management accounting function that many people refer to management accountants as "cost accountants."  But, cost accounting is only a subset of managerial accounting applications.  With that in mind, let's focus on cost accounting.
Cost accounting can be defined as the collection, assignment, and interpretation of cost.  In subsequent chapters, you will learn about alternative costing methods.  It is important to know what products and services cost to produce.  The ideal approach to capturing costs is dependent on what is being produced.
Costing Methods -- In some settings, costs may be captured by the "job costing method."  For example, a custom home builder would likely capture costs for each house constructed.  The actual labor and material that goes into each house would be tracked and assigned to that specific home (along with some matching amount of overhead), and the cost of each home can be expected to vary considerably.
Some companies produce homogenous products in continuous processes.  For example, consider the costing issues faced by the companies that produce the lumber, paint, bricks or other such homogenous components used in building a home.  How much does each piece of lumber, bucket of paint, or stack of bricks cost?  These types of items are produced in continuous processes where costs are pooled together during production, and output is measured in aggregate quantities.  It is difficult to see specific costs attaching to each unit.  Yet, it is important to make a cost assignment.  To deal with these types of situations, accountants might utilize "process costing methods."
Now, let's think about the architectural firms that design homes.  Such organizations need to have a sense of their costs for purposes of billing clients, but the firm's activities are very complex.  An architectural firm must engage in many activities that drive costs but do not produce revenues.  For example, substantial effort is required to train staff, develop clients, bill and collect, maintain the office, print plans, visit job sites, consult on problems identified during construction, and so forth.  The individual architects are probably involved in multiple tasks and projects throughout the day; therefore, it becomes difficult to say exactly how much it costs to develop a set of blueprints for a specific client!  The firm might consider tracing costs and assigning them to activities (e.g., training, client development, etc.).  Then, an allocation model can be used to attribute activities to jobs, enabling a reasonable cost assignment.  Such "activity-based costing" (ABC) systems can be used in many settings, but are particularly well suited to situations where overhead is high, and/or a variety of products and services are produced.
Costing Concepts -- In addition to alternative methods of costing, a good manager will need to understand different theories or concepts about costing.  In a general sense, the approaches can be described as "absorption" and "direct" costing concepts.  Under the absorption concept, a product or service would be assigned its full cost, including amounts that are not easily identified with a particular item.  Overhead items (sometimes called "burden") include facilities depreciation, utilities, maintenance, and many other similar shared costs.  With absorption costing, this overhead is schematically allocated among all units of output.  In other words, output absorbs the full cost of the productive process.  Absorption costing is required for external reporting purposes under generally accepted accounting principles.  But, some managers are aware that sole reliance on absorption costing numbers can lead to bad decisions.  As a result, internal cost accounting processes in some organizations focus on a direct costing approach.  With direct costing, a unit of output will be assigned only its direct cost of production (e.g., direct materials, direct labor, and overhead that occurs with each unit produced).  You will study the differences between absorption and direct costing, and consider how they influence the management decision process.  It is one of the more useful business decision elements to understand -- empowering you to make better decisions.  Future chapters will build your understanding of these concepts.
In review, to properly direct an organization requires a keen sense of the cost of products and services.  Costing can occur under various methods and theories, and a manager must understand when and how these methods are best utilized to facilitate the decisions that must be made.  Large portions of the following chapters will focus on these cost accounting issues.
Production:   As you would suspect, successfully directing an organization requires prudent management of production.  Because this is a hands-on process, and frequently entails dealing with the tangible portions of the business (inventory, fabrication, assembly, etc.), some managers are especially focused on this area of oversight.  Managerial accounting provides numerous tools for managers to use in support of production and production logistics (moving goods through the production cycle to a customer).
To generalize, production management is about running a "lean" business model.  This means that costs must be minimized and efficiency maximized, while seeking to achieve enhanced output and quality standards.  In the past few decades, advances in technology have greatly contributed to the ability to run a lean business.  Product fabrication and assembly have been improved through virtually error free robotics.  Accountability is handled via comprehensive software that tracks an array of data on a real-time basis.  These enterprise resource packages (ERP) are extensive in their power to deliver specific query-based information for even the largest organizations.  B2B (business to business) systems enable data interchange with sufficient power to enable one company's information system to automatically initiate a product order on a vendor's information system.  Looking ahead, much is being said about the potential of RFID (radio frequency identification).  Tiny micro processors are embedded in inventory and emit radio frequency signals that enable a computer to automatically track the quantity and location of inventory.  M2M (machine to machine) enables connected devices to communicate necessary information (e.g., electric meters that no longer need to be read for billing, etc.) without requiring human engagement.  These developments are exciting, sometimes frightening, but ultimately enhance organizational efficiency and the living standards of customers who benefit from better and cheaper products.  But, despite their robust power, they do not replace human decision making.  Managers must pay attention to the information being produced, and be ready to adjust business processes to respond.
Production is a complex process requiring constant decision making.  It is almost impossible to completely categorize and cover all of the decisions that will be required.  But, many organizations will share similar production issues relating to inventory management and responsibility assignment tasks.
Inventory -- For a manufacturing company, managing inventory is vital.  Inventory may consist of raw materials, work in process, and finished goods.  The raw materials are the components and parts that are to be processed into a final product.  Work in process consists of goods under production.  Finished goods are the completed units awaiting sale to customers.  Each category will require special consideration and control.
Failure to properly manage any category of inventory can be disastrous to a business.  Overstocking raw materials or overproduction of finished goods will increase costs and obsolescence.  Conversely, out-of-stock situations for raw materials will silence the production line at potentially great cost.  Failure to have finished goods on hand might result in lost sales and customers.  Throughout subsequent chapters, you will learn about methods and goals for managing inventory.  Some of these techniques carry popular acronyms like JIT (just-in-time inventory management) and EOQ (economic order quantity).  It is imperative for a good manager to understand the techniques that are available to properly manage inventory.
Responsibility Considerations -- Enabling and motivating employees to work at peak performance is an important managerial role.  For this to occur, employees must perceive that their productive efficiency and quality of output are fairly measured.  A good manager will understand and be able to explain to others how such measures are determined.  Your study of managerial accounting will lead you through various related measurement topics.  For instance, direct productive processes must be supported by many "service departments" (maintenance, engineering, accounting, cafeterias, etc.).  These service departments have nothing to sell to outsiders, but are essential components of operation.  The costs of service departments must be recovered for a business to survive.  It is easy for a production manager to focus solely on the area under direct control, and ignore the costs of support tasks.  Yet, good management decisions require full consideration of the costs of support services.  You will learn alternative techniques that managerial accountants use to allocate responsibility for organizational costs.  A good manager will understand the need for such allocations, and be able to explain and justify them to employees who may not be fully cognizant of why profitability is more difficult to achieve than it would seem. 
In addition, techniques must be utilized to capture the cost of quality -- or perhaps better said, the cost of a lack of quality.  Finished goods that do not function as promised entail substantial warranty costs, including rework, shipping (back and forth!), and scrap.  There is also an extreme long-run cost associated with a lack of customer satisfaction.
Understanding concepts of responsibility accounting will also require you to think about attaching inputs and outcomes to those responsible for their ultimate disposition.  In other words, a manager must be held accountable, but to do this requires the ability to monitor costs incurred and deliverables produced by circumscribed areas of accountability (centers of responsibility) .  This does not happen by accident and requires extensive systems development work, as well as training and explanation, on the part of management accountants.
Analysis:  Certain business decisions have recurrent themes:  whether to outsource production and/or support functions, what level of production and pricing to establish, whether to accept special orders with private label branding or special pricing, and so forth.
Managerial accounting provides theoretical models of calculations that are needed to support these types of decisions.  Although such models are not perfect in every case, they are effective in stimulating correct thought.  The seemingly obvious answer may not always yield the truly correct or best decision.  Therefore, subsequent chapters will provide insight into the logic and methods that need to be employed to manage these types of business decisions.
CONTROLLING:  Things rarely go exactly as planned, and management must make a concerted effort to monitor and adjust for deviations.  The managerial accountant is a major facilitator of this control process, including exploration of alternative corrective strategies to remedy unfavorable situations.  In addition, a recent trend (brought about in the USA by financial legislation most commonly known as Sarbanes-Oxley or SOX) is for enhanced internal controls and mandatory certifications by CEOs and CFOs as to the accuracy of financial reports.  These certifications carry penalties of perjury, and have gotten the attention of corporate executives -- leading to greatly expanded emphasis on controls of the various internal and external reporting mechanisms.
Most large organizations have a person designated as "controller" (sometimes termed "comptroller").  The controller is an important and respected position within most larger organizations.  The corporate control function is of sufficient complexity that a controller may have hundreds of support personnel to assist with all phases of the management accounting process.  As this person's title suggests, the controller is primarily responsible for the control task; providing leadership for the entire cost and managerial accounting functions.  In contrast, the chief financial officer (CFO) is usually responsible for external reporting, the treasury function, and general cash flow and financing management.  In some organizations, one person may serve a dual role as both the CFO and controller.  Larger organizations may also have a separate internal audit group that reviews the work of the accounting and treasury units.  Because internal auditors are reporting on the effectiveness and integrity of other units within a business organization, they usually report directly to the highest levels of corporate leadership.  As you can see, "control" has many dimensions and is a large task!
Monitor:  Let's begin by having you think about controlling your car (aka "driving")!  Your steering, acceleration, and braking are not random; they are careful corrective responses to constant monitoring of many variables -- other traffic, road conditions, destination, and so forth.  Clearly, each action on your part is in response to you having monitored conditions and adopted an adjusting response.  Likewise, business managers must rely on systematic monitoring tools to maintain awareness of where the business is headed.  Managerial accounting provides these monitoring tools, and establishes a logical basis for making adjustments to business operations.
Standard Costs -- To assist in monitoring productive efficiency and cost control, managerial accountants may develop "standards."  These standards represent benchmarks against which actual productive activity is compared.  Importantly, standards can be developed for labor costs and efficiency, materials cost and utilization, and more general assessments of the overall deployment of facilities and equipment (the overhead).
Variances -- Managers will focus on standards, keeping a particularly sharp eye out for significant deviations from the norm.  These deviations, or "variances," may provide warning signs of situations requiring corrective action by managers.  Accountants help managers focus on the exceptions by providing the results of variance analysis.  This process of focusing on variances is also known as "management by exception."
Flexible tools -- Great care must be taken in monitoring variances.  For instance, a business may have a large increase in customer demand.  To meet demand, a manager may prudently authorize significant overtime.  This overtime may result in higher than expected wage rates and hours.  As a result, a variance analysis could result in certain unfavorable variances.  However, this added cost was incurred because of higher customer demand and was perhaps a good business decision.  Therefore, it would be unfortunate to interpret the variances in a negative light.  To compensate for this type of potential misinterpretation of data, management accountants have developed various flexible budgeting and analysis tools.  These evaluative tools "flex" or compensate for the operating environment in an attempt to sort out confusing signals.  As a business manager, you will want to familiarize yourself with these more robust flexible tools, and they are covered in depth in subsequent chapters.
Scorecard:  The traditional approach to monitoring organizational performance has focused on financial measures and outcomes.  Increasingly, companies are realizing that such measures alone are not sufficient.  For one thing, such measures report on what has occurred and may not provide timely data to respond aggressively to changing conditions.  In addition, lower-level personnel may be too far removed from an organization's financial outcomes to care.  As a result, many companies have developed more involved scoring systems.  These scorecards are custom tailored to each position, and draw focus on evaluating elements that are important to the organization and under the control of an employee holding that position.  For instance, a fast food restaurant would want to evaluate response time, cleanliness, waste, and similar elements for the front- line employees.  These are the elements for which the employee would be responsible; presumably, success on these points translates to eventual profitability.
Balance -- When controlling via a scorecard approach, the process must be carefully balanced.  The goal is to identify and focus on components of performance that can be measured and improved.  In addition to financial outcomes, these components can be categorized as relating to business processes, customer development, and organizational betterment.  Processes relate to items like delivery time, machinery utilization rates, percent of defect free products, and so forth.  Customer issues include frequency of repeat customers, results of customer satisfaction surveys, customer referrals, and the like.  Betterment pertains to items like employee turnover, hours of advanced training, mentoring, and other similar items.  If these balanced scorecards are carefully developed and implemented, they can be useful in furthering the goals of an organization.  Conversely, if the elements being evaluated do not lead to enhanced performance, employees will spend time and energy pursuing tasks that have no linkage to creating value for the business.
Improvement -- TQM is the acronym for total quality management.  The goal of TQM is continuous improvement by focusing on customer service and systematic problem solving via teams made up of front-line employees.  These teams will benchmark against successful competitors and other businesses.  Scientific methodology is used to study what works and does not work, and the best practices are implemented within the organization.  Normally, TQM-based improvements represent incremental steps in shaping organizational improvement.  More sweeping change can be implemented by a complete process reengineering.  Under this approach, an entire process is mapped and studied with the goal of identifying any steps that are unnecessary or that do not add value.  In addition, such comprehensive reevaluations will, oftentimes, identify bottlenecks that constrain the whole organization.  Under the theory of constraints (TOC), efficiency is improved by seeking out and eliminating constraints within the organization.  For example, an airport might find that it has adequate runways, security processing, luggage handling, etc., but it may not have enough gates.  The entire airport could function more effectively with the addition of a few more gates.  Likewise, most businesses will have one or more activities that can cause a slow down in the entire operation.  TOC's goal is to find and eliminate the specific barriers.
So far, this chapter has provided snippets of how managerial accounting supports organizational planning, directing, and controlling.  As you can tell, managerial accounting is surprisingly broad in its scope of involvement.  Before looking at these topics in more detail in subsequent chapters, become familiar with some key managerial accounting jargon and concepts.  The remainder of this chapter is devoted to that task.
PRODUCTION COSTS:  Companies that manufacture a product face an expanded set of accounting issues.  In addition to the usual accounting matters associated with selling and administrative activities, a manufacturer must deal with accounting concerns related to acquiring and processing raw materials into a finished product.  Cost accounting for this manufacturing process entails consideration of three key cost components that are necessary to produce finished goods:
(1)  Direct materials include the costs of all materials that are an integral part of a finished product and that have a physical presence that is readily traced to that finished product.  Examples for a computer maker include the plastic housing of a computer, the face of the monitor screen, the circuit boards within the machine, and so forth.  Minor materials such as solder, tiny strands of wire, and the like, while important to the production process, are not cost effective to trace to individual finished units.  The cost of such items is termed "indirect materials."  These indirect materials are included with other components of manufacturing overhead, which is discussed below.
(2)  Direct labor costs consist of gross wages paid to those who physically and directly work on the goods being produced.  For example, wages paid to a welder in a bicycle factory who is actually fabricating the frames of bicycles would be included in direct labor.  On the other hand, the wages paid to a welder who is building an assembly line that will be used to produce a new line of bicycles is not direct labor.  In general, indirect labor pertains to wages of other factory employees (e.g., maintenance personnel, supervisors, guards, etc.) who do not work directly on a product.  Indirect labor is rolled into manufacturing overhead.
(3)  Manufacturing overhead includes all costs of manufacturing other than direct materials and direct labor.  Examples include indirect materials, indirect labor, and factory related depreciation, repair, insurance, maintenance, utilities, property taxes, and so forth.  Factory overhead is also known as indirect manufacturing cost, burden, or other synonymous terms.  Factory overhead is difficult to trace to specific finished units, but its cost is important and must be allocated to those units.  Normally, this allocation is applied to ongoing production based on estimated allocation rates, with subsequent adjustment processes for over- or under-applied overhead.  This is quite important to product costing, and will be covered in depth later.
Importantly, nonmanufacturing costs for selling and general/administrative purposes (SG&A) are not part of factory overhead.  Selling costs relate to order procurement and fulfillment, and include advertising, commissions, warehousing, and shipping.  Administrative costs arise from general management of the business, including items like executive salaries, accounting departments, public and human relations, and the like.
Accountants sometimes use a bit of jargon to describe certain "combinations" of direct materials, direct labor, and manufacturing overhead:
Prime Costs = Direct Labor + Direct Material
Conversion Costs = Direct Labor + Manufacturing Overhead
Prime costs are the components that are direct in nature.  Conversion costs are the components to change raw materials to finished goods.
PRODUCT COSTS:  Now, another way to look at manufacturing costs is to think of them as attaching to a product.  In other words, products result from the manufacturing process and "product costs" are the summation of direct materials, direct labor, and factory overhead.  This is perhaps easy enough to understand.  But, how are such costs handled in the accounting records?
To build your understanding of the answer to this question, think back to your prior studies about how a retailer accounts for its inventory costs.  When inventory is purchased, it constitutes an asset on the balance sheet (i.e., "inventory").  This inventory remains as an asset until the goods are sold, at which point the inventory is gone, and the cost of the inventory is transferred to cost of goods sold on the income statement (to be matched with the revenue from the sale).
By analogy, a manufacturer pours money into direct materials, direct labor, and manufacturing overhead.  Should this spent money be expensed on the income statement immediately?  No!  This collection of costs constitutes an asset on the balance sheet ("inventory").  This inventory remains as an asset until the goods are sold, at which point the inventory is gone, and the cost of the inventory is transferred to cost of goods sold on the income statement (to be matched with the revenue from the sale).  There is little difference between a retailer and a manufacturer in this regard, except that the manufacturer is acquiring its inventory via a series of expenditures (for material, labor, etc.), rather than in one fell swoop.  What is important to note about product costs is that they attach to inventory and are thus said to be "inventoriable" costs.
PERIOD COSTS:  Some terms are hard to define.  In one school of thought, period costs are any costs that are not product costs.  But, such a definition is a stretch, because it fails to consider expenditures that will be of benefit for many years, like the cost of acquiring land, buildings, etc.  It is best to relate period costs to presently incurred expenditures that relate to SG&A activities.  These costs do not logically attach to inventory, and should be expensed in the period incurred.
It is fair to say that product costs are the inventoriable manufacturing costs, and period costs are the nonmanufacturing costs that should be expensed within the period incurred.  This distinction is important, as it paves the way for relating to the financial statements of a product producing company.  And, the relationship between these costs can vary considerably based upon the product produced.  A soft drink manufacturer might spend very little on producing the product, but a lot on selling.  Conversely, a steel mill may have high inventory costs, but low selling expenses.  Managing a business will require you to be keenly aware of its cost structure.
CATEGORIES OF INVENTORY:  Unlike retailers, manufacturers have three unique inventory categories:  Raw Materials, Work in Process, and Finished Goods.  Below is the inventory section from the balance sheet of an actual company:
For this company, observe that finished goods is just a small piece of the overall inventory.  Finished goods represent the cost of completed products awaiting sale to a customer.  But, this company has a more significant amount of raw materials (the components that will be used in manufacturing units that are not yet started) and work in process.  Work in process is the account most in need of clarification.  This account is for goods that are in production but not yet complete; it contains an accumulation of monies spent on direct material (i.e., the raw materials that have been put into production), direct labor, and applied manufacturing overhead.
Your earlier studies should have ingrained these formulations: Beginning Inventory + Purchases = Cost of Goods Available for Sale, and Cost of Goods Available for Sale - Ending Inventory = Cost of Goods Sold. If you need a refresher, look at Chapter 5.  Of course, these relations were necessary to calculate the cost of goods sold for a company with only one category of inventory.
For a manufacturer with three inventory categories, these "logical" formulations must take on a repetitive nature for each category of inventory.  Typically, this entails a detailed set of calculations/schedule for each of the respective inventory categories.  Don't be intimidated by the number of schedules, as they are all based on the same concept.
SCHEDULE OF RAW MATERIALS:  Focusing first on raw material, a company must determine how much of the available supply was transferred into production during the period.  The schedule at right illustrates this process for Katrina's Trinkets, a fictitious manufacturer of inexpensive jewelry.
The amounts in the schedule are all "made up" to support the example, but in a real world scenario, the beginning and ending inventory amounts would be supported by a physical inventory and the purchases determined from accounting records.  Or, Katrina might utilize a sophisticated perpetual system that tracks the raw material as it is placed into production.  Either way, the schedule summarizes the activity for the period and concludes with the dollar amount attributed to direct materials that have flowed into the production cycle.  This material transferred to production appears in the schedule of work in process that follows.
SCHEDULE OF WORK IN PROCESS:  The following schedule presents calculations that pertain to work in process. Pay attention to its details, noting that (1) direct materials flow in from the schedule of raw materials, (2) the conversion costs (direct labor and overhead) are added into the mix, and (3) the cost of completed units to be transferred into finished goods is called cost of goods manufactured. The amounts are assumed, but would be derived from accounting records and/or by a physical counting process. 
SCHEDULE OF COST OF GOODS MANUFACTURED:  The schedules of raw materials and work in process are often combined into a single schedule of cost of goods manufactured.  This schedule contains no new information from that presented above; it is just a combination and slight rearrangement of the separate schedules.
SCHEDULE OF COST OF GOODS SOLD:  The determination of cost of goods sold is made via an examination of changes in finished goods: 
THE INCOME STATEMENT:  An income statement for a manufacturer will appear quite similar to that of a merchandising company.  The cost of goods sold number within the income statement is taken from the preceding schedules, and is found in the income statement at right.
All of the supporting schedules that were presented leading up to the income statement are ordinarily "internal use only" type documents.  The details are rarely needed by external financial statement users who focus on the income statement.  In fact, some trade secrets could be lost by publicly revealing the level of detail found in the schedules.  For example, a competitor may be curious to know the labor cost incurred in producing a product, or a customer may think that the finished product price is too high relative to the raw material cost (e.g., have you ever wondered how much it really costs to produce a pair of $100+ shoes?).
REVIEWING COST FLOW CONCEPTS FOR A MANUFACTURER:  Review the following diagram that summarizes the discussion thus far.  Notice that costs are listed on the left -- the "product costs" have a blue drop shadow and the "period costs" have a pink drop shadow.  Further,

Thursday, September 30, 2010


Chapter 17 provided an introduction to product costing.  You were exposed to the schedule of cost of goods manufactured and the basic cost flow of a manufacturer.  In that preliminary presentation, most cost data (e.g., ending work in process inventory, etc.) were "given."  In addition, Chapter 18 showed how cost data are used in making important business decisions.
COST DATA DETERMINATION:  How does one determine the cost data for products and services that are the end result of productive processes?  The answer to this question is more complex than you might suspect.  Multiple persons, parts, and processes may be needed to bring about a deliverable output.  Think about an automobile manufacturer; what is the dollar amount of "cost" for the hundreds of cars that are in various stages of completion at the end of a month?  After studying this chapter, and the next, you will have a better sense of how business information systems are used to generate these all-important cost data.
This chapter focuses on the job costing technique, and the next chapter will look more closely at process costing and other options.  At the outset, note that job costing is best suited to those situations where goods and services are produced upon receipt of a customer order, according to customer specifications, or in separate batches (as a result, many companies will refer to this costing method as the job order costing method).  For example, a ship builder would likely accumulate costs for each ship produced.  An aircraft manufacturer would find this method logical.  Construction companies and home builders would naturally gravitate to a job costing approach.  Each job is somewhat unique.  Materials and labor can be readily traced to each job, and the cost assignment logically follows.
CONCEPTUALIZING JOB COSTING:  Begin to develop an understanding of job costing by thinking about a simple illustration.  Jack Castle owns an electrical contracting company, Castle Electric.  Jack provides a variety of products and services to clientele.  Jack has four employees, maintains a neat (rented) shop, a broad inventory of parts and equipment, and a fleet of five service trucks.  On a typical day, Jack will arrive at the shop early and line out the day's work assignments for his four electricians.  Around 8:00 a.m., his electricians begin to arrive, and he gives them their assignments, as well as the necessary parts and equipment they will need.  They are then dispatched to the various job sites.
One of Jack's electricians is Donnie Odom.  On July 14, Donnie arrived at the shop at 8:00 a.m.  He first spent thirty minutes getting his assignments and loading a service truck with necessary items to complete the day's work.  His three tasks for the day included:
Job A:  Cleaning and reconnecting the electrical connections and replacing a flood light atop a billboard (materials required include one lamp at $150).
Job B:  Replacing the breakers on an old electrical distribution panel at an office building (materials required include 20 breakers at $20 each).
Job C:  Pulling wire for a new residence under construction (materials required include 500 feet of wire at $0.14 per foot).
Donnie successfully completed all three tasks on July 14.  He spent 1 hour on the billboard, 2 hours on the electrical panel, and 3 hours on the residential installation.  The other 2 hours of his 8-hour day were spent on indirect job administration and travel.  During the day, Donnie also used a roll of electrical tape ($3) and a box of wire nuts (60 nuts at $0.05 each).  Donnie is paid $18 per hour.  Donnie drove the truck 100 miles on July 14, and he used a variety of tools, ladders, and other specialized equipment.  Jack is paid $25 per hour, and he does not usually work on any specific job.  Instead, his time is spent doing spot inspections of work, getting permits, managing inventory, and tending to the various other tasks associated with these jobs. 
Now, the "job costing" question is:  How much did it "cost" to change the light on the billboard, etc.?
The job cost included the direct costs of the job; specifically, Donnie's direct labor time (1 hour) and the direct material (one lamp at $150).  But, the job could not have gotten done without the shop, equipment, trucks, indirect labor time, Jack's efforts, tape and wire nuts, and so forth.  These latter items constitute the indirect costs, or overhead, for the job.  How then, are we to assign costs to a specific job?
TRACKING DIRECT LABOR:  A logical starting point for job costing is to track the direct labor to specific jobs.  Donnie, and the other electricians, fill out a time report documenting time spent on each job, as well as the time spent on tasks that cannot be traced to a specific job:
Not only will this time sheet form the basis for payroll, but it will also allow cost assignment to specific jobs.  The direct labor for the billboard task (Job A) was one hour of Donnie's time (at $18 per hour).  The "direct labor" for Job A will be compiled by reference to the above time sheet.
TRACKING DIRECT MATERIALS:  Jack keeps detailed records of the material released to each job.  When Donnie gathered up the light bulbs, breakers, wire, tape, and wire nuts on the morning of the 14th, some system needed to be in place to "check out" this material.  The document that is used for this process is called a "materials request"  or "materials requisition" form.  This form will show what material is leaving the available raw materials stock and being put into production.  Sometimes a separate form is prepared for each item, and sometimes a running list similar to the following is used:
This form provides essential documentation to safeguard and track inventory; a manager that fails to control and monitor inventory does so at great peril!  It also reveals that the "direct material" for the billboard task (Job A) was $150 (the light bulb).  The wire nuts and tape that might have been used on the billboard will be dealt with as overhead which is discussed later.
Before moving on to overhead, you need to know one more thing about a "materials requisition" form; although the illustrated form lists the material cost, that will not always be the case.  Sometimes, a business will not be particularly interested in letting employees see cost information, or cost information may not be readily available.  In either case, the form will instead include a part or serial number.  A subsequent clerical task will be to identify the cost of the particular parts that were put into production.  Great care must always be taken to match the right cost to the right item, and in the right quantity.  For example, the 500 feet of wire may be on one roll, but it is priced by the foot, and the quantity should be 500 feet, not 1 roll; the job cost calculation would be incorrect if only $0.14 were assigned to one roll of wire!
TRACKING OVERHEAD:  Jack would have a huge task if he tried to daily trace all items of overhead.  For instance:
  • How hard would it be to track the "indirect material"?  How many wire nuts were used on the billboard?  How many inches of electrical tape were used?  What was the cost of these items?
  • What about indirect labor?  Donnie spent two hours on job-related administration and travel issues for the six hours of direct labor time on the 14th.  Should the cost of the 2 hours be spread over the three jobs equally, pro-rata based on hours, or some other basis?  On the 15th, Donnie may spend the entire day on the residential wiring job and have little administrative and travel time.  How does this impact the cost per hour of output on the 15th versus the 14th?  What about Jack's time?  He is supervising 4 electricians.  Should the cost of  his time be allocated 1/4 to each, or based on some other formula?
  • Then, one must consider the cost of rent, equipment, trucks, and so forth.  Donnie needed a ladder to scale the billboard.  A ladder will eventually wear out -- but how much is the "ladder cost" for one trip up and down a billboard?  Now, repeat this question for every item of cost incurred in running Castle Electric.
Tracking overhead is tricky.  One way this is done is by using a predetermined overhead rate.  Assume Jack sat down at the beginning of the year with his accountant.  Together they carefully considered all of the production overhead that was anticipated during the year -- the cost of Jack's time, the rent, the cost of vehicles, insurance, taxes, utilities, indirect labor, indirect materials, depreciation of long-lived assets, and so forth.  The expected total came to $150,000.  Jack figures that his four electricians will work a total of 7,500 direct labor hours during the year.  By comparing these two numbers ($150,000 and 7,500 hours), it is now possible to "model" that overhead is $20 per direct labor hour.  The "overhead application rate" is thus determined.
Now, two things should be made clear.  First, overhead application is arbitrary.  Jack decided to apply overhead based on direct labor hours; this is a common choice, but not the only choice.  Some other systematic and rational approach could have been developed.  Ordinarily, one would try to establish some correlation between the application base and overall cost incurrence.  For instance, feet of wire used (instead of direct labor hours) could have been selected as the application base; but, feet of wire would be hard to defend since two of Donnie's three jobs did not use any wire and would not be assigned any of the business overhead!  The point is that some logical method needs to be used to attach overhead costs to output, but no single choice is absolute.  Cost allocation necessarily involves some degree of arbitrary methodology; this is neither bad nor good, it is just reality.  In some ways, costing is more of an "art" than "science" -- despite its outward appearance of mathematical precision.
Second, expect differences between the actual overhead and the amount applied to production.  For instance, Jack will likely discover that actual overhead is more or less than $150,000.  Jack will also find that his electricians will probably work more or less than the anticipated 7,500 hours.  When all is said and done, Jack will need to deal with the actual cost.  The difference between the amount of overhead applied to production (i.e., direct labor hours X the $20 per hour rate) and the actual amount spent must be accounted for!  We will see how to deal with this later in the chapter.
JOB COST SHEET:  The preceding information can be logically transferred to a job cost sheet that is a compilation of cost data for a specific job:
The direct labor information found on the job cost sheet is taken from Donnie Odom's daily time sheet (a cross-reference is created of "DTS.07.14.X5.DO" to indicate "daily time sheet of July 14, 20X5, for Donnie Odom").  In similar fashion, Donnie's material requisition form was used as the source document for compiling the direct material information.  Some type of cross-referencing system needs to be developed to allow one to trace specific cost allocations to their source documents.  Overhead was applied directly to the job cost sheet based upon the predetermined overhead application scheme of $20 per direct labor hour.
EXPANDING THE ILLUSTRATION:  The next graphic shows separate job cost sheets for all three of Donnie's jobs.  All direct material and direct labor must be transferred to specific jobs.  As alluded to earlier, the indirect labor (admin hours) and indirect material is not directly transferred to a specific job; its cost is instead represented through the applied overhead.
ANOTHER EXPANSION OF THE ILLUSTRATION:  Thus far, the illustration has focused only on Donnie's activities.  He had relatively simple assignments on the 14th and was able to complete three separate jobs by himself.  But, remember that Jack has three other electricians and many other jobs.  Some of these jobs may require multiple employees and extend over days and weeks.  One such job was the new home of Aba Obekie.  This job took two electricians (Andy Axom and Bev Bentson) three full days to complete.  The resulting job cost sheet appeared as follows:
DATABASE VERSUS SPREADSHEET:  Jack could maintain some or all of his job costing system manually.  Or, he could use an electronic spreadsheet to prepare reports similar to those just illustrated.  However, there is another more powerful tool -- the electronic database.  A number of commercial packages are available.  Generalizing, data are entered via a user friendly input form that includes a number of predetermined "slots" for entering desired information.  For instance, below is a data entry form for entering Donnie's time and material for the 14th:
The benefit of the database approach is that information is only entered once; it need not be transferred to other forms.  The computer files can be queried in many ways -- beyond just preparing a job cost report.  For instance, Jack could use the customized reports feature to find all jobs on which billboard light bulbs were used during the past 18 months, determine the total direct labor hours of any employee for a selected time interval, identify how many jobs were performed for a selected client, and on and on!  Such databases provide a powerful management tool.
MOVING BEYOND THE CONCEPTUAL LEVEL:  Thus far, we have looked at a simple and understandable illustration of job costing.  What this illustration fails to show is:
  • The sophistication of the information systems that are used to track job costs in a larger organization.
  • The debits and credits that are needed to track the accumulation and application of costs within a company's general ledger system.
  • The ultimate disposition of the difference between applied and actual overhead.
Each of these issues will be dealt with in the following sections of this chapter.  As you proceed to study this material, you may find yourself becoming consumed by the details.  If so, take a deep breath and think again about Jack Castle; consider that all we are doing is applying Jack's costing model to a more robust business environment.
THE INFLUENCE OF TECHNOLOGY:  Jump on an internet search engine, and look for "factory automation", "bar code scanners", or "RFID".  Spend some time at the websites of companies like Oracle or SAP.  It is an eye opening experience!  There is a revolution in manufacturing technology, where robots and machines have resulted in quantum leaps in productivity and quality.  What your tour of the internet will reveal is a similar revolution in the deployment of technology to enable job costing for those same environments.
DIRECT MATERIAL:  Give some thought to the computer that you used to examine the suggested websites.  It was likely produced as the direct result of someone's specific order.  If you have ordered a computer, you know that you must choose components relating to memory, hard drives, monitors, sound systems, and on and on.  Literally hundreds of combinations are possible.  Therefore, each computer represents a unique job, and it will have a unique cost depending on the installed options.  You may have seen a video of a computer factory where the units are zipping along an assembly line at an amazing rate.  How can cost data be captured for each unit?  It would be impractical to deploy the basic system introduced for Jack Castle.  How many people would it take to track all of the components, and how could they avoid errors?  The key is to utilize the logic within Jack's system, but deploy it in a cost-effective and accurate way.  As a result, companies are increasingly reliant on devices that capture identification data for each significant part that goes into a manufactured product.  If you were to open up the housing on your computer, you would quickly note that many of the expensive parts within have serial numbers, barcodes, or other unique identifiers attached to them.  These ID's were probably mechanically scanned into a database that matches them with the serial number of the finished computer unit.  As a result, a computer manufacturer can probably tell you exactly which memory chips, hard drives, etc. are installed in the computer you are using.  This is helpful for warranty processing, product recalls, and other inventory management issues.  But, that same data can be matched with raw materials purchase records to produce a listing of direct material cost for each unit produced.  This is exactly what Donnie's material requisition process did earlier in this chapter, but at warp speed, with great precision, and little human intervention.
DIRECT LABOR:  Technology is also used to track and log time to specific jobs via various forms of “login clocks.”  Note that the information being tracked is essentially the same as what Donnie was providing to Jack via the daily time sheet, but with added efficiency, accuracy, and control.  In addition to monitoring job cost, a manager must also safeguard corporate resources.  Here, technology can play a key role.  Newer systems require biometric validation (like finger print IDs and logging) of employees working on a project.  These tools are used to make sure that employees who claim time working on a job are in fact present and working on the job!  Such systems can also be used to limit access to direct material inventory.  Rather than allowing free access to an inventory storage area, or providing a human "guard," technology can control who comes and goes, and what they take with them when they leave.
Some products are produced via an assembly line approach where each worker performs a specific task.  Only a certain amount of time is available for each task, as the line keeps moving.  Depending on the product, each employee might perform the same operation on 50, 100, or more units per hour.  It would take more time to measure and record the labor for each job than it takes to perform the labor task itself.  In this type of environment, cost is usually assigned to jobs based on the average or standard time for each activity.  In essence, if an employee is expected to work on 60 units per hour, one minute of direct labor time/cost would be assigned to each unit for the employee's specific task.  In a subsequent chapter, you will learn more about standards and managing variances from those standards.
OVERHEAD AND COST DRIVERS:  The application of overhead to specific jobs is mostly an exercise in algebra.  Jack applied overhead at the rate of $20 for each hour of direct labor.  A similar mathematical exercise is used to apply overhead in the highly automated factory environment.  Some predetermined scheme is used to apply the overhead to production.
However, in a highly mechanized environment, one must give careful thought to the "cost driver."  The cost driver is the factor that is viewed as causing costs to be incurred within an organization; it is best viewed only in an abstract context, as there are too many individual variables for any single factor to fully explain all cost incurrence.  For Jack Castle's business, direct labor hours were viewed as the primary cost driver and the basis for assigning overhead.  Labor hours may not be the most significant cost driver in a mechanized setting.  Machine hours, number of direct material bar code scans, fuel consumption, spot-welds, or number of assembly steps could each provide a potentially logical base for allocating overhead.  This choice must be logical, as it will govern the allocation of total overhead costs to individual products.
It is a bit frightening to consider that product pricing, CVP analysis, inventory values, decisions to discontinue a product, and so forth are dependent upon costing information that is driven by arbitrary overhead allocation choices.  This underscores the importance of careful methodology in correctly identifying cost drivers.  To do otherwise could result in costing some products too high and others too low.  This might lead to overproduction of unprofitable products and discontinuance of profitable lines.  How is this possible?  Suppose a computer manufacturer allocated overhead based on the installation of RAM memory chips.  As a result, a machine with 2 GB of memory would absorb twice as much overhead as a machine with 1 GB.  This is probably not a good idea; there is little difference in the production process needed to manufacture the two machines (save and except the difference in direct material cost for memory chips).  The faulty overhead allocation could cause management to conclude that the 2 GB machines were too costly to produce, while the 1 GB machines seem a relative bargain.  In short, the amount of memory is probably not the leading cost driver.
Management accountants have long fretted about the overhead allocation problem.  With so much at stake, quite a lot of thought has been put into ways to improve this effort.  In the next chapter, you will discover "activity-based costing."  ABC seeks to overcome some of the issues just described by dividing production into its component processes ("activities") and more closely associating overhead with each unique process.   But, ABC has its own limitations, so do not be too quick to dismiss the merits of the overhead allocation approach introduced in this chapter.
Thus far, the illustrations of job costing have focused on forms, spreadsheets, databases, and technology to accumulate job cost information.  In a sophisticated electronic environment, that information can be seamlessly transferred to a company's general ledger system.  In the alternative, one may still need to transcribe the cost flow information via a series of entries.  Either way, it is imperative to not only understand how job cost data are measured, but also how they impact a company's general ledger and resulting financial statements.
DIRECT MATERIALS:  Begin by considering how a job cost travels through the accounting system by focusing on direct materials.  Below is an illustration for a company that buys unfinished pipe from a steel mill.  The manufacturing process entails a specialized heat treating, welding, and polishing process that readies the pipe for intense use by gas pipeline transmission companies.
The flow of direct materials occurs in the following four steps:
1.    Raw material is purchased from a supplier and placed in the raw materials inventory.
2.    Raw material is transferred to the production process.
3.    Upon completion of processing, the material is transferred to finished goods inventory.
4.    A customer takes delivery of the product, and it is removed from finished goods inventory.
Below is a diagram illustrating how the material flows from the supplier, through production, to the customer:
For purposes of this illustration, assume the stack of pipe in the first picture cost $10,000.  This expenditure must be captured in inventory and eventually transferred to cost of goods sold when the product is delivered to an end customer.  At the time it is acquired, the Raw Materials Inventory needs to be increased by $10,000, as shown in the T-Account below.  The second step will result in a reduction in the Raw Materials Inventory and a corresponding increase in the Work in Process InventoryUpon completion, that cost is transferred from Work in Process Inventory to Finished Goods Inventory.  When the product is sold, the cost moves out of Finished Goods Inventory.  At this point, only the cost flow of direct materials is being illustrated; shortly, you will see how to weave in the direct labor and overhead costs.
In general journal form, the preceding flow of costs is:
Carefully review the above set of entries, and focus on the fact that $10,000 of cost was incurred when the raw material was purchased in Step 1.  And, that cost eventually became a cost of goods sold at the end of the process when the goods were delivered to the customer in Step 4 (remember, only the direct material is being shown here; labor and overhead costs are yet to be considered).  Concurrent with recording the 4th entry, another entry would be made to record the sale (debit Accounts Receivable and credit Sales).  The difference between Sales and Cost of Sales would be the gross profit.  These entries assume a perpetual inventory system; the same result could be achieved with a periodic system like that illustrated earlier in the book.
DIRECT LABOR:  Now focus exclusively on the direct labor cost, ignoring materials and overhead.  Notice that laborers were present in the middle picture from the pipe plant.  This suggests the introduction of direct labor into the costing equation.  Like the cost of raw materials, the salaries payable for direct labor are added to Work in Process Inventory (at "stage 2" of the diagram).  The following entries assume that the pipe required 200 hours of direct labor at $15 per hour:
Notice that the accounts used in these entries are identical to those for direct material, except that the credit in the first entry is to Salaries Payable.  This reflects that the cost is attributable to an obligation to pay employees for their time.
APPLIED FACTORY OVERHEAD:  Take one more look at the "work in process" factory floor picture, and think about the factory overhead that is being "used" to process the pipe.  What components can you identify or contemplate?  Likely, your list will include utilities costs, insurance, factory maintenance, depreciation on the equipment, some supplies, and similar items.  As discussed earlier in the chapter, these costs must be attached to the products.  But, the method of attachment is by applying overhead based on a predetermined estimated rate  -- again, because it is virtually impossible to associate or match the incurrence of actual overhead with each job actually produced.
Assume the pipe factory applies overhead at the rate of $25 per direct labor hour.  Remember that 200 hours were needed for the job in question.  Thus, $5,000 ($25 x 200) is the amount of applied factory overhead.  The following entries are similar to those that were used to record the direct labor; compare them, and pick out the account that differs:
An account entitled "Factory Overhead" was uniquely credited in the first of the above entries.  What does this credit really represent?.  This account is one of the more confusing to explain; it is challenging for students to grasp.  As a result, there is a separate section later in this chapter (Accounting for Actual and Applied Overhead).  But, for the moment, accept this truncated explanation:  The credit to Factory Overhead is the allocation tool used to pass out the actual overhead costs to jobs in progress; the actual overhead costs are captured via debits to this account through a separate process described later in this chapter.
OVERVIEW:  The preceding information can be combined and summarized as follows:
This graphic illustrates how the total job cost was measured as $18,000.  The general journal would include the following entries:
          Accounts Payable
  To record purchase of raw materials      
            Raw Materials Inventory    
            Salaries Payable    
            Factory Overhead    
  To transfer raw materials to production, record direct labor costs on job, and apply overhead at the predetermined rate      
            Work in Process Inventory    
  To transfer completed units to finished goods inventory      
  To record sale of finished pipe for $25,000      
            Finished Goods Inventory    
  To transfer finished goods to cost of goods sold      
As another illustration of the appropriate entries for job costing, compare the entries at this link to the Obekie job cost sheet illustrated earlier in the chapter.
FINANCIAL STATEMENT IMPACT SCENARIOS:  How job cost data appear on the financial statements depends on its condition at the financial statement date.  Considering the pipe illustration:
  • If the raw pipe had not yet started into production, its $10,000 cost would appear in the raw materials inventory category on the balance sheet:
  • If the pipe was in production but not complete, the total cost in the Work in Process account as of the balance sheet date would be aggregated and presented as work in process inventory on the balance sheet.  For example, assume all of the raw material was in process, but only half of the necessary labor tasks had been performed; in this case, the Work in Process Inventory account would include $14,000 ($10,000 direct material + $1,500 labor + $2,500 applied overhead):
  • If the drill pipe was completed but unsold, the finished goods inventory would be carried at $18,000 on the balance sheet:
  • If the drill pipe was sold for $25,000, the income statement would include sales ($25,000) and cost of goods sold ($18,000), netting to the $7,000 gross profit:
COST FLOWS TO THE FINANCIAL STATEMENTS:  If you are unclear about the flow of production costs into the financial statements, review the cost flow graphic presented in Chapter 17.  In so doing, remember that the nonmanufacturing "period" costs are charged directly to expense in the period incurred; they do not enter into the determination of inventory or cost of goods sold.
SUBSIDIARY ACCOUNTS:  You learned earlier in the book about subsidiary accounts. For example, a company’s general ledger will reveal the total accounts receivable, total accounts payable, total equipment, etc.  But, there is also a need to know subsidiary details about each of these accounts.  In other words, you must be able to identify the specific customers who owe money, how much is due to each vendor, how much depreciation to record for each asset, and so forth.  The same is true for the Work in Process account.  While it is imperative to know the total dollar value of all jobs, a company must also be able to pinpoint the amount attributable to each job. This is accomplished via an account numbering scheme where each job is given a unique number.  This enables ease of data mining.  The chart of accounts typically includes a number where the leading digits indicate the control account, and the trailing digits indicate the subsidiary account.  For work in process, this numbering could go as illustrated at right.
While the exact mechanics of maintaining subsidiary account balance information can vary, what is important is that you could inspect the general ledger and financial statements, and find $290,000 in work in process.  The subsidiary account information should be sufficient to allow you to find that Job A represents $35,000 of the total, Job B represents $25,000, and so forth.
GLOBAL TRADE AND TRANSFER:  Companies engaged in international commerce often establish separate operating units around the globe.  For instance, a company may establish a manufacturing facility in a country with lower wages and costs of production.  This trend has introduced a myriad of complex costing issues which generally fall under the heading of "transfer pricing."
The heart of the issue is how to assess costs and set prices for goods produced in one venue and transferred to an affiliate in another.  The governments of each country have a keen interest in taxing activities within their domain (whether it be by a value added tax, income tax, tariff system, custom duties, etc.).  And, companies will envision an opportunity to shift profits from high tax jurisdictions to low tax jurisdictions by shuffling costs and prices between entities.
This is a fertile area of tax dispute, and one that keeps many managerial accountants quite busy.  In the main, the applicable rules attempt to require the use of fair and equitable job costing, and require that transfers be based on "arms length" transaction pricing.  But, the devil is in the details of implementation.  A recent look on an internet search engine turned up almost five million hits for "transfer pricing rules!"
The above transfer pricing issues are not limited to global companies.  Similar issues can arise when products are shipped between affiliated companies in different states or provinces.  Also, affiliated companies may have divisional profit sharing, causing managers working for the same corporate parent to debate the costs assigned to products produced by their respective unit.  As you can see, there is a lot more to job costing than just adding up costs!
APPLIED OVERHEAD:  A lot of this chapter has been devoted to discussing the application of overhead to production.  Overhead is applied based on a predetermined formula, and considerable thought needs to be put into the appropriate basis (cost drivers) for making this allocation.  An account called "Factory Overhead" is credited to reflect this overhead application to work in process.
But, what is the source of the debits to Factory Overhead?
THE FACTORY OVERHEAD ACCOUNT:  The Factory Overhead account is not a typical account.  It does not represent an asset, liability, expense, or any other element of financial statements.  Instead, it is a "suspense" or "clearing" account.  Amounts go into the account and are then transferred out to other accounts.  In this case, actual overhead goes in, and applied overhead goes out!  The credits to this account are generated when overhead is applied to production; now focus on the debits which represent the actual amounts being spent on overhead.
ACTUAL OVERHEAD:  As the cost components of overhead are actually incurred, the Factory Overhead account is debited, and the logically offsetting accounts are credited.  The table at right provides representative examples of factory overhead items.
The indirect labor would relate to the cost of factory staff not directly involved in production.  This can include break-time of line workers, shop managers, maintenance, guards, and so forth.  The indirect materials relates to supplies and components that are not a significant cost item.  Importantly, selling and administrative costs not related to production (e.g., advertising, salaries for non-production related staff, sales commissions, rent of the corporate offices, etc.) are separately expensed, and are not part of factory overhead.  A typical entry to record factory overhead costs would be as follows:
            Salaries Payable    
            Prepaid Insurance    
            Accumulated Depreciation    
            Taxes Payable    
            Utilities Payable    
  To record various factory overhead costs      
THE BALANCE OF FACTORY OVERHEAD:  Since the Factory Overhead account is debited for actual overhead incurred and credited for allocated overhead, the general ledger account would appear as follows (the job costs are newly assumed for this illustration):
The next graphic provides a visual representation of the cost flow associated with the Factory Overhead account.  In this case, the applied overhead equaled the actual overhead, leaving a zero balance.  This means that the predetermined allocation rate was exactly what was incurred during the period.  More often that not, this level of perfection will not result.

UNDERAPPLIED OVERHEAD:  A more likely outcome is that the applied overhead will not equal the actual overhead.  The following graphic shows a case where $100,000 of overhead was actually incurred, but only $90,000 was applied.
This situation is called "underapplied" overhead.  It is said to be an "unfavorable" outcome, because not enough jobs were produced to absorb all of the overhead incurred.  This might result from below normal levels of output, or overspending.  In any event, the fact remains that more was spent than allocated.  Because the Factory Overhead account is just a clearing account (not a financial statement account), the remaining balance must be transferred out.  Several options are available for disposing of this amount, but one approach is to remove (credit) the underapplied amount and charge (debit) Cost of Goods Sold:
            Factory Overhead    
  To transfer underapplied overhead to cost of goods sold      
This entry has the effect of reducing income for the excessive overhead.
OVERAPPLIED OVERHEAD:  If the applied overhead exceeds the actual amount incurred, overhead is said to be "overapplied."  This is usually viewed as a favorable outcome, because less has been spent than anticipated for the level of achieved production.
The next journal entry shows the reduction of cost of goods sold to offset the amount of overapplied overhead:
            Cost of Goods Sold    
  To reduce cost of goods sold for the overapplied overhead      
Always keep in mind that the goal is to "zero out" the Factory Overhead account and measure the actual cost incurred.  In this last example, $100,000 was actually spent and accounted for: $110,000 charged to specific jobs and $10,000 offset as a reduction in cost of goods sold.
These illustrations of the disposition of under- and overapplied overhead are typical, but not the only available solution.  A more theoretically correct approach would be to reduce cost of goods sold, work in process inventory, and finished goods inventory on a pro-rata basis.  However, this approach is clearly more cumbersome and can sometimes run afoul of the specific accounting rules discussed in the next paragraph.  In a subsequent chapter, you will learn more about how to handle the "variances" arising from underapplied overhead.
INFLUENCE OF GAAP:  Although managerial accounting information is generally viewed as for internal use only, be mindful that many manufacturing companies do prepare external financial statements.  And, generally accepted accounting principles dictate the form and content of those reports.  For example, a specific Statement of the Financial Accounting Standards Board (SFAS No. 151) requires that underapplied overhead relating to idle facilities, wasted material, the allocation of fixed production overhead, and so forth, be charged to current period income by means similar to those just illustrated.
THE MANUFACTURING ECONOMY:  The last hundred-plus years have been remarkable.  A primarily agriculture-based world economy gave way to the industrial revolution.  This revolution took root and continues to sweep around the globe.  Following the growth in manufacturing has been an even greater proliferation of support and service roles.  Perhaps as few as 10% of workforce members are now actively producing a tangible end product.
THE SERVICE SECTOR:  Most employees in the private sector are engaged in nonmanufacturing activities like accounting, sales, computing, and administration.  New businesses have developed in the areas of law, healthcare, food services, electronic information delivery, transportation, entertainment, and others.  The not-for-profit sector is increasing; consider the size and scope of educational institutions, hospitals, foundations, and so forth.  And, not to be forgotten, is the size and scope of governmental entities.  Cities provide services like municipal infrastructure, fire, police, water utilities, and code enforcement.  State and provincial governments may provide for the educational system, highways, and prisons.  At the federal level, governments may provide military, welfare, transportation, and countless other services.  It is no wonder that most people work in a nonmanufacturing role.
The job costing model presented in this chapter is generally suggestive of the idea that a "job" can be identified as some tangible product.  But, that is not necessarily the case.  This chapter opened with an illustration for Castle Electric.  If you think deeper about that example, you will realize that most of what Jack Castle provided to his customers was a "service."  But, the utilization of job costing methodologies was still highly relevant.  The cost of services, whether provided in the private sector, not-for-profit, or governmental arenas, must be determined with some reasonable degree of accuracy.  The growth, indeed dominance, of these sectors of the economy underscores the need to extend costing methods beyond the traditional manufacturing setting.
The concept of a "job" gives way to more abstract connotations: "client," "surgical procedure," "seat mile," "student credit hour," "fire call," or other measure of output.  Clearly, direct materials become a less significant part of the overall picture.  But, overhead can take on heightened levels of importance.  Perhaps you have experienced a costly hospital stay.  The itemized billing that follows usually includes some shocking components (e.g., $5 for an aspirin).  These prices cannot be justified based on direct material cost alone.  Clearly, the hospital has tremendous and costly overhead.  In addition, you don't just pop an aspirin in the hospital as you would at home.  The pill must be administered, documented, and billed; efforts which consume expensive labor time.
If costing methods are not employed correctly, the organization may find that it has underestimated its costs of services.  This can lead to financial failure.  On the other hand, many will question the cost drivers and methods of allocations that are used in service type activities.  For instance, a city may determine that the full cost of a fire department is several hundred thousand dollars per residential house fire.  This type of job costing could lead one to conclude that a fire department is not cost effective.  The problem with this approach is that it ignores that one fire would quickly spread to an entire city without a suppression action by the fire department.  And, firefighters save countless lives for which there can be no rational economic measure.  So, what is the actual "job" and how are costs to be assigned to that "job?"  This measurement problem is pervasive and challenging in the service sector.
CAPACITY UTILIZATION:  The root of the problem is that traditional job costing allocates overhead based on the expected output.  In contrast, it may sometimes make more sense to charge individual jobs based on full capacity utilization, provided a plan is in place to maintain the financial viability of the organization.  Capacity utilization refers to the degree to which an organization's output capabilities are being deployed or utilized.
To illustrate this concept, assume that a local ambulance service was capable of providing 30,000 calls per year, but only expected to make 10,000 actual calls.  If the overhead of the ambulance company was $30,000,000, the overhead allocation would be either $3,000 per call (based on estimated activity) or $1,000 per call (based on full capacity utilization).  If the entity set customer charges based on the $3,000 amount, it might soon find that it generates fewer calls, because people opt not to utilize the service.  In essence, a handful of actual patients are put in the position of paying for the ambulance service that is available to everyone.  A more logical approach might be to cost the service based on the $1,000 figure, and then recover the additional cost by some form of tax or fee that falls on all potential patrons of the ambulance service (whether they use it or not during a given time period). 
These capacity utilization and costing considerations are in play for all organizations, but they seem to present a particularly vexing problem for the service sector.  As a general rule, when overhead is allocated based on full capacity rather than expected output, one can expect considerable underapplied overhead.  Managers need to be keenly aware of this as they plot their ultimate financial strategies.  Great care must be taken to avoid dysfunctional decisions based on erroneously high or low costing.  There are many theories and methods, but none of them replace a savvy decision made by a well informed manager who understands the nuances of job costing.
HISTORICAL FOCUS:  Accountants have a reputation for being focused on cost control.  Perhaps this reputation can be traced back to the 1843 book by Charles Dickens entitled A Christmas Carol.  In that tale, Ebenezer Scrooge is a penny-pinching miser who cares nothing for the people around him.  His sole purpose is making money, and his trusted but suffering accountant is Bob Cratchit who painstakingly tracks every penny.  Fear not, Mr. Scrooge eventually sees the light when visited by the ghost of his former partner, but that's another story.
Today's accountants still focus on measuring and controlling the costs of a business.  And, this pursuit sometimes earns them the scorn of their associates who may be more interested in engineering, product development, marketing, and other facets of the business.  The accountants, and their numbers, are sometimes seen as profit obsessed and, therefore, limiting the potential to achieve other objectives.
But, modern managerial accounting techniques are causing a shift in this reputation.  Technologically advanced information systems mean less time needs to be spent on data capture, and more time can be devoted to analyzing data and making sound business decisions.  As you will see, modern evaluative techniques are looking beyond the bottom line.
GLOBAL COMPETITION:  One result of the rise in global competition has been a cross-pollination of best business practices.  Interestingly, many profitable businesses come out of environments where profit is not the primary motivation.  What has been learned from this is that business success can be driven by a fixation on issues such as quality, employee involvement, customer satisfaction, and the like; profit is the result not the objective.  Let's focus on several contemporary trends where management accountants play an important implementation role.
KAIZEN:  Kaizen is a Japanese term used to describe a blitz like approach to study processes and install efficiency within an organization.  This approach relies on frontline employee input for "quick fix" suggestions relating to business processes.  Essentially, focus sessions are conducted in search of the obvious areas of operational improvement.  These sessions are usually "observed" or "moderated" by members of the strategic finance/managerial accounting/industrial engineering teams.  But, these "experts" are supposed to listen and learn, not suggest or lead the discussions.  What is sought are simple and common sense solutions for issues that may not have even been seen as problems for the business.  In one setting, for example, a production facility manufactured metal shelving to be used in refrigeration equipment.  Essentially, the product required sheet metal to be stamped and shaped in a series of operations.  The facility was cramped, and the product flowed down the three production lines like this:
The business was not profitable, and was acquired by an entrepreneur who immediately conducted a Kaizen session.  The workers pointed out that they were bumping into each other and disrupting the manufacturing activity as they moved the work in process between the three production lines.  The simple fix was to reverse the middle line as follows:
This was a simple, and in retrospect obvious, corrective measure.  The savings were huge from this and other Kaizen event fixes!  The entrepreneur sold the business at a greatly increased price within just a few years after buying it.  There are few businesses that cannot benefit by taking time to listen to employees in search of operational suggestions that make sense.  The cost and efficiency savings can be enormous.  These Kaizen sessions are also useful in helping employees understand business cost control and its importance to the entire business team.
LEAN MANUFACTURING:  A term popularized in recent years has been "lean manufacturing."  This descriptive term is indicative of an environment where waste has been trimmed.  But, it also entails a focus on speed and quality.  Another benchmark of lean manufacturing is the pursuit of standardization for as many processes as possible, without compromising responsiveness to customer demand.
The development of a lean manufacturing facility is not a quick fix like Kaizen.  Accountants and others will conduct an extensive and in-depth study of each process with the goal of bringing efficiency to the business.  Often, consultants and experts are engaged; these outsiders can bring a fresh perspective and valuable insight gained by their service to a variety of other businesses.
To illustrate, there was a time when automakers had many options for each car produced, and the customers spent considerable time deciding which options they preferred and could afford.  This, in turn, complicated the manufacturer's production and inventory management.  In time, they discovered that the manufacturing process, inventory management, and customer buying experience could be improved by bundling options into two or three packages.  The "leaning" process resulted in a more standardized/streamlined production effort, and produced a better customer experience.  The point is that making a lean manufacturing operation does not mean simply cutting, cutting, and cutting some more.  It is the result of an intensive effort to streamline and standardize production, without disappointing the customer!
JUST IN TIME INVENTORY:  Inventory management often benefits from studies into the development of a lean manufacturing environment.  Maintaining raw materials inventory entails not only a considerable upfront investment, but the potential for costly damage and obsolescence.  Lean companies will attempt to minimize their raw materials inventory.  One method is adopting "just in time" (JIT) inventory systems.  In an ideal application, raw materials are received from suppliers just as they are needed in the production process.  This approach requires a complete and reliable logistics system, as any disruption in the flow of materials can bring the whole production process to a devastating stop.  Such systems are usually dependent upon a strong information system that often links the manufacturer directly to the supplier with automated procurement procedures.  A Japanese term that is associated with JIT is "Kanban," which means some form of signal that a particular inventory is ready for replenishment.
A popular modification of the JIT system is for suppliers to "store" their inventory at the manufacturer's physical location.  This enables the manufacturer to "buy" raw materials directly from the supplier's stock located within the same physical location.  Finally, look carefully as you travel through industrial areas, and notice that "compatible" businesses are located in close proximity.  For example, a beverage bottler's neighbor is apt to be an aluminum can manufacturer.  All of these measures evolve from significant endeavors to develop lean manufacturing processes, and are usually based upon detailed job cost studies.
TOTAL QUALITY MANAGEMENT:  Total quality management (TQM) is a key driver of customer satisfaction and business success.  Globalization increases the level of competition and drive toward higher product quality.  This is often achieved by incorporating detailed standards into the management and productive processes.  There is now a globally recognized organization, The International Organization for Standardization, that provides standards and guidelines relating to processes that drive the production of quality outputs.  An "ISO 9000" certification suggests that a company, no matter where operating around the world, is able to demonstrate that is has successfully implemented quality management standards.  This becomes increasingly important in selecting global trading partners.
An important part of TQM is to stress quality by comparing products and processes to other "world-class" firms.  This comparative process is commonly known as benchmarking.
SIX SIGMA:  Motorola developed a quality-focused management approach that is responsible for billions of dollars in savings.  So popular is the approach, that it has been trademarked by Motorola.  The company now offers training into their quality management processes.  Those processes are known as Six Sigma, and they are being deployed by many other companies.  GE is a fan of the approach, and its website notes: "Six Sigma is a highly disciplined process that helps us focus on developing and delivering near-perfect products and services."
"Sigma" is a term learned in statistics.   It is a measure of deviation from a norm.  In the case of production management the "norm" is perfection.  With Six Sigma, the organization tracks and monitors "defects" in a process.  Then, methods are sought to systematically eliminate the opportunity for such defects.  The goal is to achieve nearly  "zero defects" --  a defect rate that is at least six standard deviations from the norm (hence the name "six sigma").  Such a distribution would have only 3.4 defects per million observations.  Importantly, the defects relate not only to final products, but to all business processes, whether they be in manufacturing, record keeping, or whatever!
Six Sigma revolves around the definition, measurement, and analysis of defects.  The management accounting group will be heavily involved in this process.  And, it is often the management accounting unit's responsibility to suggest improvements and provide controls necessary to drive an organization toward the near-zero defect goal.  But, how does this result in cost savings?  Companies have learned that quality defects are very costly.  The costs come about directly in terms of the of corrective actions like warranty work, and indirectly through lost customer satisfaction that can adversely impact future sales.  Significant savings are realized via the reduction in the cost of poor quality.
REFLECTING ON MODERN COST MANAGEMENT:  This chapter should serve to highlight an important message:  The modern managerial accountant is increasingly deploying technology to deal with the mundane data capture, thereby freeing resources to study and analyze techniques needed to drive business success.  While penny-pinching is an important part of building a financially successful business, it is also true that one can be penny-wise and pound foolish.  Thus, the management accountant is not solely focused on cost cutting, but must also be mindful of measuring and instituting controls that drive an efficiently produced product of high quality.