Week 1 - Accounting & decision relevance

Question 1

Activity measure

Answer 1

A quantitative measure of how much activity is performed, eg. no. of cars produced, no. of kilowatts used

Question 2

Cost driver

Answer 2

An activity that causes the total cost to CHANGE

Question 3

Relevant range + importance

Answer 3

The range of activity within which the presumed cost structure and relationships are expected to remain valid
- for FIXED costs up to a certain limit
- Important b/c the cost structure & cost behaviour assumptions are only VALID within this expected range of activity.

*If fixed cost doesn’t change, the cost is irrelevant.

Question 4

Cost behaviour
Cost traceability
Cost flexibility

Answer 4

1. Cost behaviour - fixed & variable costs
2. Cost traceability - direct & indirect costs (ie. can the costs be directly traced to the cost object?)
3. Cost flexibility
   - Flexible costs - resources that are acquired as used or needed; their acquisition do not require a long-term commitment.
   - Committed costs - resources that are acquired in advance of when they are used, and are contractually fixed.

Question 5

Unit cost

Answer 5

An average cost for one level of activity, computed by dividing total costs by a specific level of activity

The use of a unit cost to predict total costs assumes that all costs vary PROPORTIONALLY with activity levels -> may be problematic if any costs are FIXED, can lead to poor decision analysis.

Question 6

5 criteria for information to become decision-relevant

Answer 6

1. Objectivity
   - info should represent STATUS QUO; mirror the economic reality of org. (past and present within & outside co.)
2. Strategy
   - info should also consider FUTURE-related strategic aspects
3. Balance
   - between too much & too little info
4. Robustness
   - the info should mean the same in diff. contexts; comparable
   eg. might have to adjust for inflation, convert to same currency
5. Timeliness
   - info should be quickly accessible

Question 7

Relevant vs Irrelevant costs and revenues

Answer 7

Relevant costs & revenues
- FUTURE costs & revenues that are AFFECTED by the decision, not independent from it
- Do not remain the same under all possible courses of action

Irrelevant
- SUNK COSTS (past costs already incurred as a result of past decisions)
- Costs & revenues NOT affected by decision, INDEPENDENT from it
- INDIFFERENTIAL; remain identical under all possible courses of action

Question 8

7 challenges affecting accounting relevance

The increasingly dynamic organisational environment requires the constant adaption and refinement of managerial accounting systems (see Drucker, 1995)

Answer 8

Changing cost structure (indirect costs up / direct costs down)
1. Shorter product life cycles
- co.s need to think about their competitive advantage, how to keep their products up-to-date
2. Product diversification
- eg. brand, reputation -> indirect costs for luxury cars
- eg. diff. tables & chairs w/ diff. colours means cannot just divide cost
3. Customisation
- implies more costs

Require the measurement of NON-FINANCIAL DATA
4. Knowledge-based organisations
5. Increasing competition
- co.s need to know what they’re competing at - price or quality?
6. Orientation along value chains
- co.s can keep their comp. advantage by getting better at what they’re good at.
eg. Coca-Cola keeps their recipe (their value) secret to themselves
7. Customer orientation

Question 9

2 ways to evaluate and choose cost drivers (between machine hours & labour hours, when both are economically plausible)

Answer 9

1. Logic - based upon the degree of automation
2. Regression analysis - based on the strength and robustness of the correlation
   - points closer to the line means smaller std devs
   - concentration of relevant range (modelling the production better)

Question 10

3 main types of error in costing systems + trade-off between… (Datar & Gupta, 1994)

Answer 10

1. Wrong allocation base (cost driver)
   - NO DIRECT LINK between OH costs & allocation base
2. Aggregation error = wrong allocation rate
   - added heterogeneous activities to derive a single allocation rate
   eg. power used in office vs power for mfg process
3. Wrong measurement of costs within a pool / cost driver usage (‘quantity’ of activities)

Empirical evidence of trade-off between ACCURACY of allocations & RELIABILITY of measurements
- Usually, ABC costing more accurate but less reliable
- Traditional costing system more reliable but less accurate since aggregating costs

Question 11

Is accuracy always wanted?
(Merchant & Shields, 1993)

2 roles of costing systems

Answer 11

Greater accuracy may not always be wanted!
1. Managers may deliberately add BIASES to the costs to induce certain desirable responses,
ie. “BEHAVIOURALLY-oriented cost systems” (may have political agenda)

Examples
1. Systematic upward bias
- Sales managers in COMPETITIVE PRICING SITUATIONS may be tempted
to set the price TOO LOW/grant excessive discounts to secure
business and reach their revenue targets
- Solution: OVERSTATE product costs to protect against the tendency to shave profit margins excessively when making pricing decisions
2. Systematic downward bias
- firms using TARGET COSTING set cost standards based on estimates of what an item should cost to be able to compete effectively
- targets are typically BELOW currently attainable standards and encourage innovation and improvement (costs are UNDERSTATED)
3. Low sophistication
- Firms keep the number of cost pools low to focus managers’ attention only on A FEW BUT CRUCIAL COST DRIVERS
- for long-term competitiveness

1. DECISION-MAKING role
   - Accurate costing systems important to support strategy development, to know the CRITICAL SUCCESS FACTORS
2. CONTROL role
   - If CSFs are known, costing systems used more to implement strategy instead