 Hello and welcome to this session. This is Professor Farhad in which we would look at a framework for assessing cost accounting system. This topic is covered in cost accounting. As always, I'm going to remind you to connect with me on LinkedIn. If you haven't done so, YouTube is where you would need to subscribe. I have 1800 plus accounting or I think tax finance as well as Excel tutorials. If you like my lectures, please like them and share them. If they benefit you, it means they might benefit other people and connect with me on Instagram. On my website, farhadlectures.com, you will find additional resources to supplement this course as well as your other accounting, finance, CPA preparation. Check out my website if you're interested in learning more. Cost accounting system. How does it help? How does it help companies? Well, we have to understand what do companies do? Companies are run by managers and what do managers do? Managers are generally paid to make decisions to manage other people and those decisions would require you to have information. Now, what is the source of the information? The source of the information is accounting information system. Your accounting information will provide most of the information that you need for decision making. For example, it's going to tell you what's your total sales? What's your total cost of goods sold? Which in turn will tell you how much you will need to produce? Which in turn will tell you how much you will need to purchase? In raw material, how many employees you will need to hire? What should be your inventory? So on and so forth. So all this information is coming from the accounting information system. But basically we are going to summarize the benefit or the need for that accounting information system under four different tasks. Very general tasks that encompass everything. The first one is finding and eliminating activities that don't add value. So how can we evaluate if the system is good or not? Well, it doesn't have a feedback value. Feedback means does it tell us something about what we are doing and what is an activity? An activity is anything that consume cost. So if we can find an activity that does not add value and we could eliminate that activity, whatever that activity is, then the accounting information system is doing good. So what is a non-value added activities? Those are activities that, guess what? They're non-added value. They do not add any value. They do not add any features or benefit of goods and services to the client. So what should we do with those? We should eliminate them and we should look for those non-value added activities throughout the whole value chain. For what could be an example? For example, if you notice that you could replace your customer service, your routine customer service task with some type of automated system through a website. For example, rather than having people answering phone, reserving tickets, you can have a website that can do the same thing. Once again, we need to look at those non-value added activities throughout the whole value chain, not just in one place. So that's one thing the cost, the cost accounting system should give us. Eliminate, find and eliminate non-value added activities. The second thing is we should be able to do what's called cost benefit analysis. And what is cost benefit? It's a process comparing the benefit, what we can get, and what is a benefit? Benefit can be measured in two different ways. Either we have more savings or we increase profit. It's either we have more saving, we have less expenses, or we can increase revenue. We have more profit. So what we do is we try to see, look at the cost and benefit decision making. Does this system allow us to do cost benefit? It means it has to be a system that keeps track of our cost, can easily help us identify the benefits and we can evaluate the cost benefit. Three, identify strategic opportunities using cost analysis. Simply put, does it tell us if there is any place where we can add value to a customer at a low cost? Okay, for example, we might add a delivery route. Well, do we have enough information in our system that's going to allow us to determine the cost and the benefit of that new added value feature to that delivery route? So this is what we mean by identifying strategic opportunities. Also it should give us the chance to evaluate the managers, evaluate the employees. So a good cost accounting system should also be a feedback to upper management. Telling upper management what's going on within lower management. So help upper management, or the owners for that matter, evaluate the performance of the organization and the managers. Now the cost data for managerial decision, we need data, we need numbers. So the first thing is to evaluate any financial consequence alternative. If we're looking to make a decision, we have to be able to be able to estimate the future cost, revenue, assets, based on past information. Because when you make an estimate, it's for the future, but it's based on the past. Do we have good past information about cost, revenue, and assets? If that's the case, it's going to make it easier for us. So if we have enough experience in knowing what's going on, experience and knowledge of the company's cost can be used to estimate any cost changes. Cost changes mean future cost changes. Now one of the most important thing in cost accounting is something called the cost driver. And what's a cost driver? A cost driver is finding what's driving our cost, what activity, what process consume cost drives the cost. This is what cost activity cost driver is. And we'll talk about cost driver later on much, much more in the details. But remember, every time you have to make a decision between two alternatives, you have to consider two things. Something called differential cost and something called differential revenue. So what is differential cost and differential revenue? You just have to know those two definitions. Differential costs are those costs that differ among or between alternatives. So if the cost is the same, it's not relevant in the sense that it's not going to make any, it's not going to change my decision because it's the same. So if the cost differ, then it's called differential cost, differential revenue is the same thing. Our revenues, that changes in response to a particular course of action. The best way to show you this is to show you maybe some numbers. So this is basically the AM bakery. And this is their projected income statement. And they're planning to go with a new route. They're going to have a food truck. So this is the, this is their numbers right now. This is the status quo right now, the original bakery sales only. So people come and they buy bakery from the sales, sales revenues, 11,200 ingredient, flour, butter, and so on. 2700 labor utilities, rent, marketing. You have the numbers, total cost, then revenue minus cost equal to operating income. Now they want to open a new route. And what's the new route? It's a food truck sales. So basically they want to open a new source of revenue. Well, here's what's going to happen. The revenue, the new revenue, the revenue will be 16,800. So is there a differential revenue? And the answer is yes. We're going to have 5,600 more in revenues. This is a differential revenue. Why? Because the revenue does change as a result of going through a food truck sales. The ingredient, the ingredient, it's going to go from 2,700 to 3950, which is a 50% higher. The ingredient will have a 50% higher cost no, I'm sorry, 45, not 50, 45% higher cost. Labor obviously will increase. Labor is also be 45% higher cost. Utilities will increase by 20%. A rent will stay the same. We're not paying any additional rent. We're going to have a new truck lease of 900. And marketing will increase by $50. So basically what we do is we look at the new revenues and costs and we compute the difference. Then we net the difference of revenues minus the difference in expenses. And we find out that we are better off, in other words, we are $1,790 better off if based on differential revenues and expenses, revenues and cost or expenses, practically the same thing. So this is what we are saying here. You only have to look at the differential revenues and the differential cost. Also, we could use cost information system for control and evaluation. What does it mean control and evaluation? It means how do you make sure your employees, you are evaluating, you are controlling what they're doing? Well, you look at their numbers, you have to somehow monitor what's going on. So a cost information system should help us with that because most companies, what they do, they divide responsibilities for specific function among their employees. And hopefully you are familiar with this concept where each individual is responsible for something, for a function. Oftentimes, these functions are grouped into organizational units. So we call them units. Now these units, depending how large is the company, it might be called a department, a division, a segment or sometimes it's a subsidiary, if it's a large company, specify the reporting relation within the firm. So we have those units. Now, what do we call those units really from an accounting perspective? The term that we use is called responsibility center, is used to refer to these units. So the manager assigned to those responsibility centers or to that unit is accountable. They have responsibility for its operation and its resources. Now, what could be an example of that? For example, let's look at this bakery once again. We have Adam the president and Adam has two VPs, Ed and Eddie. Ed is responsible for the bakery sale and Eddie is responsible for the new route. So what we do is we break down sales and revenues and cost for each segment separately. Here we have basically two segments, the bakery segment and the food truck segment. And what we do is we compute the profit for the bakery, the profit for the food truck sales, net the profit for both, computing revenues and expenses separately that each one is responsible for. Now, then we have some common costs. For example, corporate office operation, look at note C, it says include the general manager salary, which is it's not, this 5,400, you cannot put it for bakery or the food truck, it covers both. Same thing with other. So just there's another 2,900 here. Those are what's called common costs and we'll talk about that later on. But this is what we're seeing where we have different unit and each unit has its own revenues and expenses, its own responsibility center. So when I evaluate ad, I evaluate ad based on these figures. I cannot evaluate ad based on the common cost or based on what Eddie does in the food truck. Okay, so that's why the units are important. Also, as part of control, we can have a budget and what is a budget? Hopefully, we're all familiar with a budget. If you're attending school, if you run a home, you should always have a budget. Basically, you basically plan ahead on how much you are going to receive and how much you're going to spend in the near future. So a budget is a financial plan for revenues and resources needed to carry out a tasks and meet the financial obligation. So how do budgeting help? It helps managers decide whether their goals can be achieved. And if not, what modifications are necessary? So basically, you plan. How do you plan? Well, you put it down on a piece of paper. How do you put it down on a piece of paper? You create a budget for your revenues and your expenses. And don't worry, we're going to have a whole chapter about budget. So this is what a budget, a simple budget would look like. We're going to look at a more complicated budget down the road. So this is the bakery, sales, actual and budgeted cost for the month of August. This is what actually happened. And this is what we thought it was going to happen. Starting with, let's start with revenue. Revenue is at the bottom. Revenue, 52,000, the actual and the budgeted was, I'm sorry, 52,200, 52,200. The difference is not a zero zip. We did good. I mean, we came within budget. Ingredient, the actual was 3,900. We thought we're only going to spend 3,700. Well, guess what? We spent more. The difference is this is, we're going to call later on unfavorable. It was not good because we spent more on flour than we thought. And eventually, we're going to have to find out why did we spend more because maybe the flour cost was higher, or did we spend more because the employees were not doing a good job and they wasted flour. Okay, butter, same thing, 3,500, 3,400 unfavorable. Oil, we thought we're going to spend 1,800. We only spent 1,700. This is a favorable, a favorable difference, 100. Fruit, we spent more again, unfavorable. Nuts, we spend more unfavorable. Chocolate, the same other, something other unfavorable. And we'll do the same thing for the others. We'll do the same thing for the others. But eventually, we would look at each number of these favorable and favorable when we evaluate. But this is also feedback. This is also part of controlling the operation. Now, I can talk to the people working on the front line at the bakery, say, could you tell me why did we spend more flowers, $200 more? And that's a lot, $200 dollar of 3,700, that's a lot. So could you tell me what's going on? Why did we spend more? Okay, explain it to me. So the cost information system, it's going to give you those signals, those flags that's going to help you run the company, and those are good features of cost, a good cost accounting information system. In the next session, we would look at trend and cost accounting throughout the value chain. We talked about the value chain, we're going to look at some modern trend. And maybe 10 years from now, this recording will be useless because we'll have new trends. Again, as always, I'm going to remind you to like this recording, share it, and please visit farhatlectures.com for additional resources for this course as well as other courses. Good luck, study hard, and most importantly,