Managerial accounting 8e by hansen and mowen

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Managerial Accounting, Eighth Edition

Don R Hansen, Maryanne M Mowen

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The eighth edition of Hansen & Mowen’s Managerial Accounting introduces students

to the fundamentals of management accounting Though it is assumed that students

have been introduced to the basics of financial accounting, extensive knowledge of

financial accounting is not needed The emphasis is on the use of accounting

infor-mation in today’s business environment, so this text provides coverage of the most

cutting edge topics and developments in the field Thus, the text should be of value

to students with a variety of backgrounds Although written to serve undergraduates,

the text has been used successfully at the graduate level There is sufficient variety in

the assignment material to accommodate both undergraduate and graduate students

Many business school students who are required to take a course in

manage-ment accounting are not accounting majors For these students, it is often difficult to

appreciate the value of the concepts being taught Managerial Accounting, 8e,

over-comes this attitude by using introductory chapter scenarios based on real-world

set-tings, photos illustrating practical applications of management accounting concepts,

and realistic examples illustrating the concepts within the chapters Seeing that

effec-tive management requires a sound understanding of how to use accounting

informa-tion should pique the interests of both accounting and nonaccounting majors

One major area of improvement for this edition has been to enhance the quality

and quantity of end-of-chapter material As a result of extensive focused reviewing

and analysis, the end-of-chapter material now offers several activities by level of

dif-ficulty for each learning objective to ensure that students will have plenty of

oppor-tunity to practice the concepts they learn in the chapter The end-of-chapter activities

are unmatched by any text on the market

We are confident that this innovative managerial accounting text will prepare

your students to perform at their best The new edition will ensure stronger student

performance and ongoing satisfaction with your managerial accounting course

NEW Features of the Eighth Edition

The eighth edition now offers even more to ensure you and your students experience

a higher level of performance in managerial accounting, including:

The Most Current Coverage of Contemporary Topics. A new entire

chap-ter on Activity-Based Management (Chapchap-ter 5), a new chapchap-ter covering Lean

Accounting (Chapter 16), and a new appendix on Joint Product Costing (after

Chap-ter 7) in this edition dedicate significant attention to the most current issues in

managerial accounting today New materials on simplifying ABC are also introduced

in Chapter 4

Streamlined, Reorganized Table of Contents. We have streamlined,

reor-ganized, and carefully tailored this edition’s contents to reflect the way your students

best learn contemporary and traditional managerial accounting topics Special topics

are now grouped together in the last part of the text to enhance understanding

Variety and Strength in End-of-Chapter Problems and Exercises.

Based on detailed reviewer feedback, exercises and problems now offer more variety

and are clearly classified both by level of difficulty and by corresponding learning

objectives for your ease in selecting appropriate assignments for each class All

end-of-chapter materials directly correspond to AACSB and CMA standards to ensure

stu-dent comprehension and positive outcomes Furthermore, there are a significant

number of new and revised exercises and problems in each chapter

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New! Managers Decide Decision-Making Boxes. This edition’s newemphasis on decision-making throughout each chapter challenges students to applywhat they learn in a decision context and shows the relevance of managerialaccounting concepts to the real business world.

NEW! ThomsonNOW™ for Managerial Accounting. This outcomes-driven,integrated online learning and course management system provides the ultimate inflexibility and ease of use with the results you want NOW to support your coursegoals and ensure positive student performance You’ll save time as you efficientlyteach and reinforce content with an integrated eBook, interactive learning tools, andpersonalized study plans; test with an algorithmic test bank; and grade results based

on AACSB and CMA accreditation standards

budg-Unique Environmental Cost Management Chapter. Introduce your dents to the emerging field of environmental cost management with new, actualexamples that demonstrate the value of environmental cost management as theyshow how managers can reduce costs by implementing environmentally consciousprocesses

stu-New E-Commerce Coverage in First Chapter. A new section presentedearly in this edition (within Chapter 1) overviews the impact of e-commerce ontoday’s management accounting issues

Integrated Strategic Cost Management Concepts. An emphasis out this edition on budgeting, ABM, and decentralization keeps the materials rele-vant to situations encountered in the business world

through-Integrated Coverage of Contemporary and Traditional Topics. Thisedition introduces the latest costing techniques alongside more traditional topics tohelp students see the advantages and disadvantages of a traditional cost manage-ment system versus cost management systems that include practices such as ABC,ABM, target costing, and the Balanced Scorecard Coverage of both traditional andcontemporary topics helps ensure that students are well prepared to work in a vari-ety of business environments

Integrated Use of Spreadsheets. To accurately reflect industry practice, thisedition illustrates key managerial techniques, such as regression, using spreadsheetsrather than cumbersome manual calculations

International Coverage. A full chapter (Chapter 18) highlighting internationalissues, as well as numerous international examples integrated throughout the text,emphasizes the critical importance of this topic

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Least Squares Regression Manual Computation. Coverage of manual

computation of regression coefficients helps students understand the technical and

theoretical concepts underlying ordinary least squares analysis

Ethics Coverage. As with previous editions, the eigthth edition emphasizes the

study of ethical conduct for management accountants The role of ethics is discussed

in Chapter 1, and the Statement of Ethical Professional Conduct developed by the

Institute of Management Accountants is introduced The impact of the

Sarbanes-Oxley Act and its ethics requirements for publicly traded companies is discussed

Chapter 1 has several substantive problems on ethics, and subsequent chapters have

at least one problem or case involving an ethical dilemma These problems allow

the instructor to introduce value judgments into management accounting decision

making Chapter 14, dealing with international issues in management accounting,

also has a section that discusses ethics in the international environment

Real-World Emphasis. The eighth edition incorporates real-world applications

of management accounting concepts, making the study of these concepts more

familiar and interesting to the student Real-company examples are incorporated

throughout Names of real companies are highlighted throughout the text for easy

identification and are listed in a company index at the back of the text Photos are

included to help students relate to the real-world nature of management accounting

Increased Coverage of Service Industry. Service businesses are

experienc-ing unprecedented growth in today’s economy Managers of service businesses often

use the same management accounting models as manufacturers, but they must

adapt them to their own unique situations of providing intangibles to consumers

To address this need, many service industry applications are included in the eighth

edition In addition, many real-company examples of service businesses are given

Chapter Organization and Structure

Each chapter is carefully structured to help students focus on important concepts

and retain them Components found in each chapter include:

Learning Objectives. Each chapter begins with a set of learning objectives to

guide students in their study of the chapter These objectives outline the

organiza-tional flow of the chapter and serve as points of comprehension and evaluation

Learning objectives are tied to specific sections of topic coverage within the chapter

They are repeated in the margin at the beginning of the corresponding chapter

cov-erage and are summarized at the end of the chapter

Summary of Learning Objectives. Each chapter concludes with a

compre-hensive summary of the learning objectives Students can review and test their

knowledge of key concepts and evaluate their ability to complete chapter objectives

Scenario. An interesting, real-world scenario opens each chapter The scenario ties

directly to concepts covered in the chapter and helps students relate chapter topics

to actual business happenings “Questions to Think About,” critical-thinking

ques-tions that appear at the end of each scenario, are designed to pique student interest

in the chapter and stimulate class discussion

Key Terms. Throughout each chapter, key terms appear in bold font for quick

identification A list of key terms, with page references, is presented at the end of

each chapter to provide additional reinforcement All key terms are defined in a

comprehensive glossary at the end of the text

Review Problems. Each chapter contains at least one review problem with the

accompanying solution provided These review problems demonstrate the

applica-tion of major concepts and procedures covered in the chapter

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a margin icon.

Exercises. Exercises usually emphasize one or two chapter concepts and can becompleted fairly quickly (30 minutes maximum) Exercises require basic applicationand computation and often ask students to interpret and explain their results

Problems. Each chapter contains many end-of-chapter problems, with varyingdegrees of length and difficulty Problems usually have more than one issue andpresent challenging situations, complex computations, and interpretations

Managerial Decision Cases. Most chapters contain at least two cases Caseshave greater depth and complexity than problems They are designed to help stu-dents integrate multiple concepts and further develop their analytical skills Severalcases deal with ethical behavior

Research Assignments. Research assignments appear in all chapters (exceptChapter 1), allowing students to expand their research and communication skillsbeyond the classroom One research assignment in each chapter, labeled “Cyber-case,” requires the student to research information on the Internet

Check Figures. Key figures for solutions to selected problems and cases are vided at the end of the text as an aid to students as they prepare their answers

pro-Chapter by pro-Chapter Changes

Chapter 1 Added material on Sarbanes-Oxley (SOX) and ethics requirements forpublicly-traded companies Added section on corporate codes of conduct mandated

by SOX

Chapter 4 New materials on simplifying ABC have been added

Chapter 5 This is a newly named and formed chapter with some new materialand some elements previously found in other chapters; consolidating materials per-taining to activity-based management (ABM)

Chapter 6 Major revision due to the combining of two previous chapters on order costing and process costing

job-Chapter 7 Added appendix on joint product costing

Chapter 10 Combines two previous chapters into one Includes absorption andvariable costing, segmented reporting, investment center performance evaluation,and transfer pricing

Chapter 16 Half of this chapter is brand-new material focusing on lean turing and lean accounting Value streams, pull manufacturing, lead times, forms andsources of waste, value stream costing, value stream reporting, value stream reporting,and value-stream performance measurement are examples of topics discussed

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Instructor’s Manual, 0-324-37717-7 (Prepared by Scott Colvin, Naugatuck

Val-ley Community Technical College) The instructor’s manual contains a complete set

of lecture notes for each chapter and a transition guide for the seventh edition of

Management Accounting, as well as other widely used management accounting texts

Solutions Manual, 0-324-64499-X (Prepared by Don Hansen and Maryanne

Mowen, Oklahoma State University) The solutions manual contains the solutions

for all end-of-chapter questions, exercises, problems, and cases Solutions have been

verified multiple times to ensure their accuracy and reliability

Test Bank, 0-324-37622-7 (Prepared by Jane Stoneback, Central Connecticut State

University) Revised for the eighth edition, the test bank offers multiple-choice

prob-lems, short probprob-lems, and essay problems Designed to make exam preparation as

convenient as possible for the instructor, each test bank chapter contains enough

questions and problems to permit the preparation of several exams without

repeti-tion of material All quesrepeti-tions are identified by level of difficulty, learning objective,

and AACSB and CMA learning outcomes standards

ExamView® Testing Software. This supplement, included on the Instructor’s

Resource CD-ROM, contains all of the questions in the printed test bank This

pro-gram is an easy-to-use test creation software compatible with Microsoft Windows

Instructors can add or edit questions, instructions, answers, and select questions

(randomly or numerically) by previewing them on the screen Instructors can also

create and administer quizzes online, whether over the Internet, a local area network

(LAN), or a wide area network (WAN)

Spreadsheet Templates. Spreadsheet templates using Microsoft Excel are

avail-able for downloading from the product support website These templates provide

outlined formats of solutions for selected end-of-chapter exercises and problems

These exercises and problems are identified with a margin symbol The templates

allow students to develop spreadsheet and “what-if” analysis skills

PowerPoint Slides (Prepared by Gail Wright, Bryant University) Selected

trans-parencies of key concepts and exhibits from the text are available in PowerPoint

presentation software Available on the Instructor’s Resource CD-ROM or the

prod-uct support website

Instructor’s Resource CD-ROM, 0-324-23493-7 Key instructor ancillaries

(solutions manual, instructor’s manual, test bank, ExamView®, and PowerPoint®

slides) are provided on CD-ROM, giving instructors the ultimate tool for

customiz-ing lectures and presentations

Product Website(http://thomsonedu.com/accounting/hansen) A website

designed specifically for Managerial Accounting, 8e includes online and

download-able instructor and student resources The website features an interactive study center

organized by chapter, with learning objectives, Web links, glossaries, and online

quizzes with automatic feedback

ThomsonNOWTM Make the most of your course with ThomsonNOW™ for

Hansen & Mowen Managerial Accounting, 8e This integrated, online learning and

course management system provides the ultimate in flexibility and ease of use with

the results you want NOW ThomsonNOW supports your course goals and ensures

positive student performance You’ll save time as you efficiently teach and reinforce

content with an integrated eBook, Experience Managerial Accounting videos,

interac-tive learning tools, and personalized study plans; test with an algorithmic test bank;

and grade results based on AACSB and CMA accreditation standards For more

infor-mation visit http://www.thomsonedu.com

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dents’ understanding of material on the spot As students are quizzed using clickertechnology, instructors can use the instant feedback to lecture more efficiently.JoinIn on TurningPoint is the right solution to help you:

• Boost students’ interaction and engagement

• Assist students who lack confidence to participate by interacting anonymously

• Illustrate the relevance of lecture topics with polls, data slicing, and ranking thepopularity of answers

WebTutor™ Toolbox on WebCT® and on Blackboard®WebTutor Toolbox

complements Managerial Accounting, 8e by providing interactive reinforcement

Web-Tutor’s online teaching and learning environment brings together content ment, assessment, communication, and collaboration capabilities for enhancing in-class instruction or as a study resource for students Access certificates for WebTutorcan be bundled with the textbook or sold separately For more information, includ-ing a demo, visit http://e.thomsonlearning.com

manage-Business & Company Resource Center. The power to answer all types of

business queries is at your fingertips with Business & Company Resource Center

(BCRC) Unlike other available online business resources, this comprehensive

data-base offers a dynamic research opportunity, providing accurate, up-to-date companyand industry intelligence for thousands of firms BCRC provides access to a widevariety of global business information including competitive intelligence, career andinvestment opportunities, business rankings, company histories and much more Tolearn more visit http://www.gale.com/BusinessRC/

Experience Managerial Accounting Video Series.A series of 14 videosillustrating key management accounting concepts including job order, cost volumeprofit, activity based costing, Pricing, cost behavior, budgeting, process costing andmore These videos feature companies such as Washburn Guitar, BP, Hard Rock Café,Cold Stone Creamery, and more Access to these videos can be included at no addi-

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Acknowledgments

We would like to express our appreciation for all who have provided helpful ments and suggestions The reviewers of the prior editions helped make it a success-ful product Many valuable comments from instructors and students have helped usmake significant improvements in the text We would particularly like to thank thefollowing reviewers, who provided in-depth reviews:

com-Reviewers

Alex Ampadu

University at Buffalo

James Aselta

Sacred Heart University

Professor Rowland Atiase

University of Texas at Austin

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Middlesex Community College

J Mike Metzcar, CPA

Indiana Wesleyan University

Georgia Southern University

Abbie Gail Parham

Georgia Southern University

Montana State University

We also would like to thank our verifiers for the text and solutions manual—

Scott Butterfield, Clayton State University; and Ann Martel, Marquette University

Their careful editing helped us produce a text and ancillary package of high quality

and accuracy

We also want to express our gratitude to the Institute of Management

Accoun-tants for its permission to use adapted problems from past CMA examinations The

IMA has also given us permission to reprint the ethical standards of conduct for

management accountants

Finally, we should offer special thanks to the staffs of Thomson Publishing and

Lachina Publishing Services They have been helpful and have carried out their tasks

with impressive expertise and professionalism

Don R HansenMaryanne M Mowenhttp://downloadslide.blogspot.com

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Don R Hansen

Dr Don R Hansen is Professor of Accounting at Oklahoma State University Hereceived his Ph.D from the University of Arizona in 1977 He has an undergraduatedegree in mathematics from Brigham Young University His research interestsinclude activity-based costing and mathematical modeling He has published articles

in both accounting and engineering journals including The Accounting Review, The

Journal of Management Accounting Research, Accounting Horizons, and IIE Transactions.

He has served on the editorial board of The Accounting Review His outside interests

include family, church activities, reading, movies, watching sports, and studyingSpanish

Maryanne M Mowen

Dr Maryanne M Mowen is Associate Professor of Accounting at Oklahoma StateUniversity She received her Ph.D from Arizona State University in 1979 Dr Mowenbrings an interdisciplinary perspective to teaching and writing in cost and manage-ment accounting, with degrees in history and economics In addition, she doesscholarly research in behavioral decision theory She has published articles in jour-

nals such as Decision Science, The Journal of Economics and Psychology, and The Journal

of Management Accounting Research Dr Mowen’s interests outside the classroom

include reading, playing golf, traveling, and working crossword puzzles

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Preface iii

Chapter 1 Introduction: The Role, History, and Direction of Management

Accounting 2

Chapter 2 Basic Management Accounting Concepts 32

Chapter 3 Activity Cost Behavior 70

Chapter 4 Activity-Based Product Costing 116

Chapter 5 Activity-Based Management 164

Chapter 8 Budgeting for Planning and Control 314

Chapter 9 Standard Costing: A Managerial Control Tool 366

Chapter 10 Segmented Reporting, Investment Center Evaluation,

and Transfer Pricing 416

Chapter 15 Quality Costs and Productivity: Measurement, Reporting,

and Control 666

Chapter 16 Lean Accounting, Target Costing, and the Balanced

Scorecard 722

Chapter 17 Environmental Cost Management 776

Chapter 18 International Issues in Management Accounting 816

Part II

Chapter 6 Job-Order and Process Costing 212

Chapter 7 Support-Department Cost Allocation 270

Chapter 11 Cost-Volume-Profit Analysis: A Managerial Planning Tool 470

Chapter 12 Tactical Decision Making 514

Chapter 13 Capital Investment Decisions 562

Chapter 14 Inventory Management 620

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Information Needs of Managers

and Other Users 4 The Management

Process 5 Organization Type 7

Management Accounting and Financial

Perspective 13 Total Quality Management

13 Time as a Competitive Element 14

Efficiency 14 E-business 15

The Role of the Management Accountant 15

Structure of the Company 15

Sarbanes-Oxley Act of 2002 16

Management Accounting and Ethical

Conduct 17

Ethical Behavior 17 Company Codes

of Conduct and SOX 18 Standards of

Ethical Conduct for Management

Accountants 19

Certification 21

The CMA 21 The CPA 21 The CIA 22

Summary of Learning Objectives 22

Key Terms 23

Questions for Writing and Discussion 23

Exercises 24

Problems 28 Research Assignment 31

Chapter 2 • Basic Management Accounting Concepts 32

Cost Assignment: Direct Tracing, Driver Tracing, and Allocation 34

Cost 35 Cost Objects 35 Accuracy of Assignments 36

Product and Service Costs 39

Different Costs for Different Purposes 41 Product Costs and External Financial Reporting 42

External Financial Statements 44

Income Statement: Manufacturing Firm 44 Income Statement: Service Organization 46

Types of Management Accounting Systems:

A Brief Overview 46

FBM versus ABM Accounting Systems 47 Choice of a Management Accounting System 50

Summary of Learning Objectives 51 Key Terms 51

Review Problems 52 Questions for Writing and Discussion 54 Exercises 55

Problems 61 Managerial Decision Cases 66 Research Assignments 68

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Chapter 3 • Activity Cost

Behavior 70

The Basics of Cost Behavior 72

Fixed Costs 72 Variable Costs 73 Mixed

Costs 74 Classifying Costs According to

Behavior 75

Activities, Resource Usage, and Cost

Behavior 78

Flexible Resources 78 Committed

Resources 78 Step-Cost Behavior 79

Implications for Control and Decision

Making 81

Methods for Separating Mixed Costs into

Fixed and Variable Components 82

Linearity Assumption 83 The High-Low

Method 86 The Scatterplot Method 87

The Method of Least Squares 90 Using

the Regression Programs 91

Reliability of Cost Formulas 93

R2—The Coefficient of Determination 93

Importance of Unit Product Costs 119

Production of Unit Cost Information 119

Functional-Based Product Costing 119

Plantwide Rates 120 Departmental

Activity-Based Product Costing: Detailed Description 129

Identifying Activities and Their Attributes

129 Assigning Costs to Activities 132 Assigning Activity Costs to Other Activities

133 Assigning Costs to Products 133 Detailed Classification of Activities 134

Reducing the Size and Complexity of the Activity-Based Costing System 137

Reducing Rates Using Consumption Ratios

137 Reducing Rates by Approximating ABC 137 Comparison with Functional- Based Costing 139

Problems 150 Managerial Decision Cases 158 Research Assignment 162

Chapter 5 • Activity-Based Management 164

Activity-Based Management: A Conceptual Overview 166

Implementing ABM 167 ABM and Responsibility Accounting 170 Financial- Based Responsibility Compared with Activity-Based Responsibility 171

Process Value Analysis 175

Driver Analysis: The Search for Root Causes

175 Activity Analysis: Identifying and Assessing Value Content 176 Activity Performance Measurement 178

Measures of Activity Performance 179

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Benchmarking 183 Drivers and

Behavioral Effects 184 Activity Capacity

Management 184

Activity-Based Customer and Supplier

Costing 186

Activity-Based Customer Costing 186

Activity-Based Supplier Costing 188

Problems 202 Managerial Decision Case 209 Research Assignment 210

Chapter 6 • Job-Order and Process

Costing 212

Characteristics of the Job-Order and Process

Environment 214

Job-Order Production and Costing 214

Process Production and Costing 214

Cost Flows Associated with Job-Order

Costing 215

Calculating Unit Cost with Job-Order

Costing 215 Job-Order Cost Sheet 216

The Flow of Costs through the Accounts

218

The Process Environment and Cost

Flows 225

Types of Process Manufacturing 226 How

Costs Flow Through the Accounts in Process

Costing 226 Accumulating Costs in the

Production Report 227

The Impact of Work-in-Process Inventories

on Process Costing 228

Equivalent Units of Production 228 Two

Methods of Treating Beginning

Work-in-Process Inventory 230

Weighted Average Costing 230

Five Steps in Preparing a Production Report

230 Example of the Weighted Average

Method 231 Evaluation of the Weighted

Average Method 233

Multiple Inputs and Multiple

Departments 234

Nonuniform Application of Manufacturing

Inputs 234 Multiple Departments 238

Appendix A: Production Report—FIFO Costing 239

Differences between the FIFO and Weighted Average Methods 239 Example of the FIFO Method 239

Appendix B: Journal Entries Associated with Job-Order and Process Costing 243

Journal Entries Associated with Job-Order Costing 243 Journal Entries Associated with Process Costing 245

Chapter 7 • Support-Department Cost Allocation 270

An Overview of Cost Allocation 272

Types of Departments 272 Allocating Costs from Departments to Products 273 Types of Allocation Bases 274 Objectives

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Direct Method of Allocation 281

Sequential Method of Allocation 282

Reciprocal Method of Allocation 285

Comparison of the Three Methods 286

Departmental Overhead Rates and Product

Costing 288

Appendix: Joint Cost Allocation 289

Accounting for Joint Product Costs 289

Chapter 8 • Budgeting for Planning

and Control 314

Description of Budgeting 316

Budgeting and Planning and Control 316

Advantages of Budgeting 317

Preparing the Master Budget 318

Directing and Coordinating 319 Major

Components of the Master Budget 319

Preparing the Operating Budget 319

Preparing the Financial Budget 325

Using Budgets for Performance

Evaluation 331

Static Budgets versus Flexible Budgets 331

The Behavioral Dimension of Budgeting 334

How Standards Are Developed 368 Types

of Standards 369 Why Standard Cost Systems Are Adopted 369

Standard Product Costs 371 Variance Analysis: General Description 373

Price and Efficiency Variances 373 The Decision to Investigate 373

Variance Analysis: Materials and Labor 376

Direct Materials Variances 376 Direct Labor Variances 380

Variance Analysis: Overhead Costs 382

Variable Overhead Variances 382 Fixed Overhead Variances 386

Appendix: Accounting for Variances 389

Entries for Direct Materials Variances 389 Entries for Direct Labor Variances 389 Disposition of Materials and Labor Variances 390 Overhead Variances 390

Review Problem 392 Questions for Writing and Discussion 394 Exercises 395

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Transfer Pricing 416

Decentralization and Responsibility Centers

418

Reasons for Decentralization 418 Divisions

in the Decentralized Firm 419

Measuring the Performance of Profit Centers

Using Variable and Absorption Income

Statements 422

Inventory Valuation 423 Income

Statements Using Variable and Absorption

Costing 423 Production, Sales, and Income

Relationships 424 The Treatment of Fixed

Overhead in Absorption Costing 427

Evaluating Profit-Center Managers 428

Segmented Income Statements Using

Variable Costing 429

Measuring the Performance of Investment

Centers Using ROI 431

Return on Investment 431 Margin and

Turnover 432 Advantages of ROI 433

Disadvantages of the ROI Measure 435

Economic Value Added 436

Residual Income 436 Economic Value Added (EVA) 438

Transfer Pricing 439

Impact of Transfer Pricing on Divisions and the Firm as a Whole 440 Transfer Pricing Policies 441 Market Price 442 Cost-Based Transfer Prices 442 Negotiated Transfer Prices 443

Chapter 11 • Cost-Volume-Profit

Analysis: A Managerial Planning

Tool 470

Break-Even Point in Units 472

Using Operating Income in CVP Analysis

472 Shortcut to Calculating Break-Even

Units 474 Unit Sales Needed to Achieve

Targeted Profit 475

Break-Even Point in Sales Dollars 477

Profit Targets and Sales Revenue 478

Comparison of the Two Approaches 479

The Profit-Volume Graph 483 The

Cost-Volume-Profit Graph 484 Assumptions of

Cost-Volume-Profit Analysis 485

Changes in the CVP Variables 487

Introducing Risk and Uncertainty 489 Sensitivity Analysis and CVP 491

CVP Analysis and Activity-Based Costing 492

Example Comparing Conventional and ABC Analysis 493 Strategic Implications:

Conventional CVP Analysis versus ABC Analysis 494 CVP Analysis and JIT 495

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Tactical Decision Making 516

Model for Making Tactical Decisions 517

Relevant Costs Defined 520 Ethics in

Tactical Decision Making 521

Relevance, Cost Behavior, and the Activity

Resource Usage Model 522

Flexible Resources 522 Committed

Resources 523

Illustrative Examples of Relevant Cost

Applications 524

Make-or-Buy Decisions 524 Keep-or-Drop

Decisions 526 Special-Order Decisions 530

Decisions to Sell or Process Further 531

Product Mix Decisions 533

One Constrained Resource 533 Multiple

Constrained Resources 534

Pricing 534

Cost-Based Pricing 534 Target Costing and

Pricing 536 Legal Aspects of Pricing 537

Fairness and Pricing 539

Appendix: Linear Programming 539

Summary of Learning Objectives 542

NPV Defined 569 An Example Illustrating

Net Present Value 570

Uniform Cash Flows 571 Multiple-Period Setting: Uneven Cash Flows 572

Postaudit of Capital Projects 573

Honley Medical Company: An Illustrative Application 573 One Year Later 574 Benefits of a Postaudit 574

Mutually Exclusive Projects 575

NPV Compared with IRR 575 Example: Mutually Exclusive Projects 576

Computation and Adjustment of Cash Flows 578

Adjusting Forecasts for Inflation 578 Conversion of Gross Cash Flows to After-Tax Cash Flows 580

Capital Investment: The Advanced Manufacturing Environment 585

How Investment Differs 586 How Estimates of Operating Cash Flows Differ

586 Salvage Value 588 Discount Rates 589

Appendix A: Present Value Concepts 589

Future Value 589 Present Value 590 Present Value of an Uneven Series of Cash Flows 591 Present Value of a Uniform Series of Cash Flows 591

Chapter 14 • Inventory Management 620

Traditional Inventory Management 622

Inventory Costs 622 Traditional Reasons for Holding Inventory 622 Economic Order Quantity: The Traditional Inventory Model 624 Computing EOQ 625 Reorder http://downloadslide.blogspot.com

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JIT Inventory Management 628

Basic Features of JIT 629 Setup and

Carrying Costs: The JIT Approach 632

Due-Date Performance: The JIT Solution

634 Avoidance of Shutdown and Process

Reliability: The JIT Approach 634

Discounts and Price Increases: JIT Purchasing

versus Holding Inventories 637 JIT’s

Limitations 638

Theory of Constraints 639

Key Terms 646 Review Problems 646 Questions for Writing and Discussion 648 Exercises 649

Chapter 15 • Quality Costs and

Productivity: Measurement, Reporting,

and Control 666

Measuring the Costs of Quality 668

Quality Defined 668 Costs of Quality

Defined 670 Measuring Quality Costs 671

Reporting Quality Cost Information 673

Quality Cost Reports 673 Quality Cost

Function: Acceptable Quality View 675

Quality Cost Function: Zero-Defects View

675 Activity-Based Management and

Optimal Quality Costs 678 Trend

Analysis 679

Using Quality Cost Information 680

Scenario A: Strategic Pricing 681 Scenario

B: New Product Analysis 683

Productivity: Measurement and Control 684

Partial Productivity Measurement 686

Total Productivity Measurement 688

Price-Recovery Component 691 Quality and

Lean Manufacturing 724

Value by Product 725 Value Stream 725 Value Flow 726 Pull Value 729 Pursue Perfection 731

Lean Accounting 732

Focused Value Streams and Traceability of Overhead Costs 733 Value Stream Costing with Multiple Products 735 Value Stream Reporting 736 Decision Making 736 Performance Measurement 737

Life-Cycle Cost Management and the Role of Target Costing 738

The Balanced Scorecard: Basic Concepts 744

Strategy Translation 744 The Role of Performance Measures 745 The Financial Perspective 748 Customer Perspective 748 Process Perspective 750 Learning and Growth Perspective 754

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Measuring Environmental Costs 778

The Benefits of Ecoefficiency 778

Environmental Quality Cost Model 780

Environmental Cost Report 782 Reducing

Environmental Costs 783 An

Environmental Financial Report 785

Assigning Environmental Costs 786

Environmental Product Costs 786

Functional-Based Environmental Cost

Assignments 786 Activity-Based

Environmental Cost Assignments 787

Life-Cycle Cost Assessment 788

Product Life Cycle 788 Assessment

Importing and Exporting 819

Wholly Owned Subsidiaries 821 Joint

Transfer Pricing and the Multinational Firm 833

Performance Evaluation 833 Income Taxes and Transfer Pricing 834

Ethics in the International Environment 836 Summary of Learning Objectives 838

Key Terms 838 Review Problem 839 Questions for Writing and Discussion 840 Exercises 840

Glossary 852 Subject Index 864 Company Index 873

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Basic Management Accounting Concepts

Chapter 1: Introduction: The Role, History, and Direction

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Introduction: The Role, History, and Direction of Management Accounting

l e a r n i n g o b j e c t i v e s

After studying this chapter, you should be able to:

1 Discuss the need for management accounting information.

2 Differentiate between management accounting and financial accounting.

3 Provide a brief historical description of management accounting.

4 Identify the current focus of management accounting.

5 Describe the role of management accountants in an organization.

6 Explain the importance of ethical behavior for managers and management

accountants

7 List three forms of certification available to management accountants.

chapter 1

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Consider the following comments made by

individuals from several different organizations:

A Partner of a Legal Firm: The managing

partner of Collins, Ling, and Jefferson, a

large regional law firm, just received a

request to bid on a potential job from

MegaProducts, Inc (MPI) MPI had decided

to outsource most of its legal work Its

request for proposals provided each law

firm with a record of the hours of legal

service and the types of services provided

by MPI’s internal legal staff for the past

five years The bid was to take the form of

a flat hourly billing rate Competition for

this job was intense In order to generate

a competitive bid, the partner needed an

accurate assessment of cost per hour for

each type of legal service that would be

performed Then she could obtain the

weighted-average cost per hour based on

the expected hours of each type of service

Finally, she could calculate an hourly billing

rate that would provide the law firm with

a reasonable dollar return (Product costing

and pricing decision)

B Plant Manager: Jeff Rand, plant manager,

identified three projects that could

improve quality and decrease the factory’s

production time First, only suppliers who

provide components with a defect rate of

less than one per thousand would be

selected Second, die-making operations

could be automated Third, manufacturing

cells would be formed for each major

prod-uct Jeff knew that once the alternatives

were implemented he would need to know

if and by how much the number of

defec-tive units dropped and if cycle time

actu-ally decreased He also needed a way to

track those changes to the resulting

pro-duction costs to see if they decreased—to

see if cost improvement actually occurred

(Continuous improvement)

C Chief Executive Officer of a Cruise Line:

The recession had resulted in decreased

profits; the CEO wondered if the cruise line

should consider reducing costs and services

The controller suggested that profit wouldincrease if current passenger volume wasmaintained but variable costs were reduced

by $10 per passenger The marketing vicepresident suggested that reducing farescould increase overall profit She claimedthat reducing fares by 20 percent andincreasing advertising by $500,000 wouldincrease the number of passengers by 20percent A combination of the twoapproaches might change the strategicposition of the cruise line Therefore, theCEO asked for revised budgets to see whichapproach (or a combination of the two)offered the most profit—in both the shortrun and the long run (Planning and cost-volume-profit analysis)

D Hospital Administrator: After reading the

latest monthly performance report for units of the hospital, the administrator wasvery pleased with the performance of thelaboratory Last month, the laboratory hadreduced costs even while the number oftests run had increased As a result, thelaboratory attracted more business bycharging lower rates that were justified bythe lower costs The lab manager had toldthe administrator that the activity-basedmanagement approach that had beeninstalled had resulted in significant wastereduction The administrator felt that thismanagement system could be profitablyused by other subunits, such as radiologyand physical therapy (Managerial control)

sub-Q u e s t i o n s t o T h i n k A b o u t

1 Who uses management accounting

information?

2 For what purposes is management

accounting information used?

3 Should a management accounting system

provide both financial and nonfinancialinformation?

4 What organizations need a management

accounting information system?

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Management Accounting Information System

The management accounting information system provides information needed to

satisfy specific management objectives At the heart of a management accountinginformation system are processes; they are described by activities such as collecting,measuring, storing, analyzing, reporting, and managing information Information oneconomic events is processed into outputs that satisfy the system’s objectives Out-puts may include special reports, product costs, customer costs, budgets, performancereports, and even personal communication The operational model of a manage-ment accounting information system is illustrated in Exhibit 1-1

The management accounting information system is not bound by any formalcriteria that define the nature of the processes, inputs, or outputs The criteria areflexible and based on management objectives The management accounting systemhas three broad objectives:

1 To provide information for costing out services, products, and other objects ofinterest to management

2 To provide information for planning, controlling, evaluation, and continuousimprovement

3 To provide information for decision making

These three objectives show that managers and other users need access to agement accounting information and need to know how to use it It can help themidentify and solve problems and evaluate performance Accounting information isused in all phases of management, including planning, controlling, and decisionmaking Furthermore, the need for such information is not limited to manufacturingorganizations; it is used in manufacturing, merchandising, service, and nonprofitorganizations as well

man-Information Needs of Managers and Other Users

The opening scenarios can be used to illustrate each of the management accountingsystem objectives Scenario A (bidding by a legal firm) shows the importance ofdetermining the cost of products (objective 1) Scenario B emphasizes the impor-tance of tracking costs and nonfinancial measures of performance over time Thus,Scenario A emphasizes the importance of accuracy in product costing, while Sce-nario B underscores the importance of tracking efficiency measures—using bothfinancial and nonfinancial measures (objective 2) Trends in these measures allow

Users Inputs

Special ReportsProduct CostsCustomer CostsBudgetsPerformance ReportsPersonal Communication

Outputs

Exhibit 1-1 Operational Model: Management Accounting Information Systemhttp://downloadslide.blogspot.com

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managers to evaluate the soundness of decisions designed to improve productivity,

lower costs, increase market share, and improve profitability For example, Huffman

pro-ducing its products The cycle time for propro-ducing the latest version of its

computer-ized grinding machine dropped from 2,400 hours to 800 hours within a five-year

period These productivity gains have created a 35 percent compound growth rate in

earnings.1Accuracy in cost assignments and the use of nonfinancial information by

both managers and nonmanagers have emerged as fundamental requirements for

many organizations These and other related issues have led to the development of

an improved management accounting information system known as an activity-based

cost management information system.

Scenarios B, C, and D illustrate planning, controlling, evaluation, and

continu-ous improvement (objective 2) Managers, executives, and workers need an

informa-tion system that will identify problems, such as the possibility of cost overruns, or

benefits, such as the ability of a subunit manager to innovate and increase efficiency

(Scenario C) Once problems are known, actions can be taken to identify and

imple-ment solutions Scenario B also illustrates that both financial and nonfinancial

information is needed so that workers can evaluate and monitor the effects of

deci-sions that are intended to improve operational and unit performance Operational

and financial performance information allows workers to assess the effectiveness of

their efforts to improve Workers and managers should be committed to

continu-ously improving the activities they perform Continuous improvement means

searching for ways to increase the overall efficiency and productivity of activities by

reducing waste, increasing quality, and reducing costs Thus, information is needed

to help identify opportunities for improvement and to evaluate the progress made in

implementing actions designed to create improvement

The third objective, providing information for decision making, is intertwined

with the first two For example, information on the costs of products, customers,

processes, and other objects of interest to management can be the basis for

identify-ing problems and alternative solutions Similar observations can be made about

information pertaining to planning, controlling, and evaluation Examples include

using product costs to prepare a bid (Scenario A), helping a manager decide whether

to increase profits by reducing prices and increasing advertising or decreasing

vari-able costs or both, or helping a manager decide whether to change the

organiza-tion’s strategic position (Scenario C) This last scenario also underscores the

impor-tance of strategic decision making, which is defined as the process of choosing

among alternative strategies with the goal of selecting one or more strategies that

provide a company with a reasonable assurance of long-term growth and survival

The Management Process

The management process is defined by the following activities: (1) planning, (2)

con-trolling, and (3) decision making The management process describes the functions

carried out by managers and empowered workers Empowering workers to

partici-pate in the management process means giving them a greater say in how the

com-pany operates Thus, employee empowerment is the authorizing of operational

per-sonnel to plan, control, and make decisions without explicit authorization from

middle- and higher-level management

Employee empowerment rests on the belief that employees closest to the work

can provide valuable input in terms of ideas, plans, and problem solving Workers

are allowed to shut down production and identify and correct problems Their input

1 Steve Liesman, “High-Tech Devices Speed Manufacturing and May Play Larger Role in Economy,” Wall Street

Journal Interactive Edition (February 15, 2001) Access the referenced article in the chapter web links at the

Interactive Study Center at http://www.thomsonedu.com/accounting/hansen.

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is sought and used to improve production processes Two examples illustrate thepower of this concept First, empowered workers at Duffy Tool and Stamping

saved $14,300 per year by redesigning a press operation.2In one department, pleted parts (made by a press) came down a chute and fell into a parts tub Whenthe tub became full, press operators had to stop operation while the stock operatorremoved the full tub and replaced it with an empty one Empowered workersredesigned the operation so that each press had a chute with two branches—eachleading to a different tub Now completed parts are routed into one branch of thechute When the tub associated with the active branch becomes full, the completedparts are routed to the other branch and its tub while the full tub is being removedand replaced with an empty tub This new design avoids machine downtime andproduces significant savings Second, GR Spring and Stampingimplemented anemployee empowerment program, and within a four-year period, the number ofideas implemented increased from 0.67 per employee to 11.22 per employee.3Increased involvement in managing the company through employee empowerment

com-is a key element in enhancing continuous improvement efforts

Planning The managerial activity called planning is the detailed formulation of

action to achieve a particular end; it requires setting objectives and identifying ods to achieve those objectives For example, a firm’s objective may be to increase itsprofitability by improving the overall quality of its products By improving productquality, the firm should be able to reduce scrap and rework, decrease the number ofcustomer complaints and warranty work, reduce the cost of inspection, and so on,thus increasing profitability But how can this be accomplished? Managers mustdevelop a plan that, when implemented, will lead to the achievement of the desiredobjective A plant manager, for example, may start a supplier evaluation program toidentify and select suppliers who are willing and able to supply defect-free parts Inanother example, empowered workers might identify production causes of defectsand create new methods for producing a product that will reduce scrap and reworkand the need for inspection The new methods should be clearly specified anddetailed in the plan

meth-Direct labor workers

are very closely

con-nected to products

and services They

are often able to see

empower-ment recognizes this

and affords

employ-ees the power to

make beneficial

changes.

2 George F Hanks, “Excellence Teams in Action,” Management Accounting (February 1995): p 35.

3 Joseph F Castellano, Donald Klein, and Harper Roehm, “Minicompanies: The Next Generation of Employee

Empowerment,” Management Accounting (March 1998): pp 22–30.

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Controlling Planning is only half the battle Once a plan is created, it must be

implemented and monitored by managers and workers to ensure that the plan is

being carried out as intended Controlling is the managerial activity of monitoring

a plan’s implementation and taking corrective action as needed Control is usually

achieved with the use of feedback Feedback is information that can be used to

evaluate or correct the steps being taken to implement a plan Based on feedback,

a manager (or worker) may decide to let the implementation continue as is, take

corrective action of some type to put the actions back in harmony with the original

plan, or do some midstream replanning

Feedback is a critical part of the control function Feedback can be financial or

nonfinancial For example, the chute redesign at Duffy Tool and Stamping saved

more than $14,000 per year (financial feedback) Moreover, the redesign eliminated

machine downtime and increased the number of units produced per hour

(opera-tional feedback) Both measures are part of the management accounting information

system and convey important information Often financial and nonfinancial

feed-back is in the form of formal reports, called performance reports, that compare

actual data with planned data or benchmarks

Decision Making The process of choosing among competing alternatives is

deci-sion making This managerial function is intertwined with planning and

control-ling A manager cannot plan without making decisions Managers must choose

among competing objectives and methods to carry out the chosen objectives Only

one of numerous competing plans can be chosen Similar comments can be made

concerning the control function

A major role of the management accounting information system is to supply

information for decision making For example, the partner in the legal firm in

Sce-nario A was faced with the prospect of submitting a bid on a contract for legal

ser-vices A large number of bids are possible, but the partner must choose just one to

submit to the prospective customer The partner requested information concerning

the expected hourly cost for each type of legal service This cost information, along

with the partner’s knowledge of competitive conditions, should improve his or her

ability to select a bid price Imagine having to submit a bid without some idea of

the cost of providing the legal services

Organization Type

The use of accounting information by managers is not limited to manufacturing

Regardless of the organizational form, managers must be proficient in using

accounting information The basic concepts taught in this text apply to a variety of

settings The four scenarios at the beginning of this chapter involved legal services,

manufacturing, health care, leisure services, profit, and nonprofit organizations

Hos-pital administrators, presidents of corporations, dentists, educational administrators,

and city managers can all improve their managerial skills by being well grounded in

the basic concepts and use of accounting information

Management Accounting and Financial Accounting

An organization’s accounting information system has two major subsystems: a

man-agement accounting system and a financial accounting system The two accounting

subsystems differ in their objectives, the nature of their inputs, and the type of

processes used to transform inputs into outputs The financial accounting

informa-tion system is primarily concerned with producing outputs for external users, using

well-specified economic events as inputs and processes that meet certain rules and

conventions For financial accounting, the nature of the inputs and the rules and

Objective 2

Differentiatebetweenmanagementaccounting andfinancial accounting.http://downloadslide.blogspot.com

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conventions governing processes are defined by the Securities and Exchange mission (SEC), the Financial Accounting Standards Board (FASB), and for publiccompanies, the Public Company Accounting Oversight Board (PCAOB) The overallobjective is the preparation of external reports (financial statements) for investors,creditors, government agencies, and other outside users This information is used forsuch things as investment decisions, stewardship evaluation, monitoring activities,and regulatory measures Financial accounting could be called external accounting.Because the management accounting system produces information for internalusers, such as managers, executives, and workers, it could be properly called internalaccounting Management accounting identifies, collects, measures, classifies, andreports information that is useful to internal users in planning, controlling, anddecision making.

Com-When management accounting is compared with financial accounting, severaldifferences can be identified Some of the more important differences are summa-rized in Exhibit 1-2

• Targeted users Management accounting focuses on the information needs of

inter-nal users, while financial accounting focuses on information for exterinter-nal users

• Restrictions on inputs and processes Management accounting is not subject to the

requirements of generally accepted accounting principles The Securities andExchange Commission (SEC), the Public Company Accounting Oversight Board(PCAOB), and the Financial Accounting Standards Board (FASB) set the account-ing procedures that must be followed for financial reporting The inputs andprocesses of financial accounting are well-defined and restricted Only certainkinds of economic events qualify as inputs, and processes must follow generallyaccepted methods Unlike financial accounting, management accounting has noofficial body that prescribes the format, content, and rules for selecting inputsand processes and preparing financial reports Managers are free to choose what-ever information they want—provided it can be justified on a cost-benefit basis

• Type of information The restrictions imposed by financial accounting tend to

pro-duce objective and verifiable financial information For management accounting,information may be financial or nonfinancial and may be more subjective innature

• Time orientation Financial accounting has a historical orientation It records and

reports events that have already happened Although management accountingalso records and reports events that have already occurred, it strongly emphasizesproviding information about future events Management, for example, may notonly want to know what it costs to produce a product, it may also want to know

what it will cost to produce a product Knowing what it will cost helps in

plan-ning material purchases and making pricing decisions, among other things Thisfuture orientation is demanded to support the managerial planning and decisionmaking

• Degree of aggregation Management accounting provides measures and internal

reports used to evaluate the performance of entities, product lines, departments,and managers Very detailed information is needed and provided Financialaccounting, on the other hand, focuses on overall firm performance, providing amore aggregated viewpoint

• Breadth Management accounting is much broader than financial accounting It

includes aspects of managerial economics, industrial engineering, and ment science, as well as numerous other areas

manage-It should be emphasized, however, that both management accounting andfinancial accounting information systems are part of the total accounting informa-tion system Unfortunately, the content of the management accounting system isoften driven by the needs of the financial accounting system The reports of manage-ment and financial accounting are frequently derived from the same database, whichhttp://downloadslide.blogspot.com

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may have been established to support the reporting requirements of financial

accounting Many organizations need to redesign this database in order to satisfy

more fully the needs of the internal users For example, while overall firm

profitabil-ity is of interest to investors, managers need to know the profitabilprofitabil-ity of individual

products The accounting system should be designed to provide total profits and

profits for individual products The key is flexibility—the accounting system should

be able to supply different information for different purposes

A Brief Historical Perspective of Management Accounting

Most of the product-costing and management accounting procedures used in the

20th century were developed between 1880 and 1925.4Prior to 1914, many of the

early developments concerned product costing—tracing a firm’s profitability to

indi-vidual products and using this information for strategic decision making By 1925,

Management Financial

Accounting Accounting

1 Internally focused 1 Externally focused

2 No mandatory rules 2 Must follow externally imposed rules

3 Financial and nonfinancial information; 3 Objective financial information

subjective information possible

4 Emphasis on the future 4 Historical orientation

5 Internal evaluation and decisions based 5 Information about the firm as

on very detailed information a whole

6 Broad, multidisciplinary 6 More self-contained

Exhibit 1-2 Comparison of Management and Financial Accounting

Objective 3

Provide a briefhistoricaldescription ofmanagementaccounting

4 The information in this section is based on H Thomas Johnson and Robert Kaplan, Relevance Lost: The Rise

and Fall of Management Accounting (Boston: Harvard Business School Press, 1987).

The development

of sophisticated tools of analysis mirrors the growth

in the demands placed on management accountants Where once paper and pencil sufficed for simple product costing, now complex decisions, in a global marketplace, require the use of high-powered com- puters and servers.

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most of this emphasis had been abandoned in favor of inventory costing—assigningmanufacturing costs to products so that the cost of inventories could be reported toexternal users of a firm’s financial statements.

Financial reporting became the driving force for the design of cost accountingsystems Managers and firms were willing to accept aggregated average cost informa-tion about individual products, as they did not feel the need for more detailed andaccurate cost information about individual products As long as a company had rela-tively homogeneous products that consumed resources at about the same rate, theaverage cost information supplied by a financially driven cost system was goodenough Furthermore, for some firms, even as product diversity increased, the need

to have more accurate cost information was offset by the high cost of the processingrequired to provide such information For many firms, the cost of a more detailedcost system apparently exceeded its benefits

Some effort to improve the managerial usefulness of conventional cost systemstook place in the 1950s and 1960s Users discussed the shortcomings of informationsupplied by a system designed to prepare financial reports Efforts to improve thesystem, however, essentially centered on making the financial accounting informa-tion more useful to users rather than on producing an entirely new set of informa-tion and procedures apart from the external reporting system

In the 1980s and 1990s, many recognized that the traditional managementaccounting practices no longer served managerial needs Some claimed that existingmanagement accounting systems were obsolete and virtually useless More accurateproduct and resource costing were needed for managers to improve quality and produc-tivity and to reduce costs In response to the perceived failure of the traditional manage-ment accounting system, efforts were made to develop a new management accountingsystem that would satisfy the demands of the current economic environment

Current Focus of Management Accounting

The economic environment has required the development of innovative and relevantmanagement accounting practices Consequently, activity-based management

accounting systems have been developed and implemented in many organizations.Additionally, the focus of management accounting systems has been broadened toenable managers to better serve the needs of customers and manage the firm’s valuechain Furthermore, to secure and maintain a competitive advantage, managers mustemphasize time, quality, and efficiency, and accounting information must be pro-duced to support these three fundamental organizational goals More recently, theemergence of e-business requires management accounting systems to provide infor-mation that enables managers to deal with this new environment

Activity-Based Management

The demand for more accurate and relevant management accounting information

has led to the development of activity-based management Activity-based

manage-ment is a systemwide, integrated approach that focuses managemanage-ment’s attention on

activities with the objective of improving customer value and the resulting profit.Activity-based management emphasizes activity-based costing (ABC) and processvalue analysis Activity-based costing improves the accuracy of assigning costs by firsttracing costs to activities and then to products or customers that consume theseactivities Process value analysis emphasizes activity analysis—trying to determinewhy activities are performed and how well they are performed The objective is tofind ways to perform necessary activities more efficiently and to eliminate those that

do not create customer value

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Customer Orientation

Activity-based management has the objective of increasing customer value by

man-aging activities Customer value is a key focus because a firm can establish a

compet-itive advantage by creating better customer value for the same or lower cost than

that of its competitors or creating equivalent value for a lower cost than that of its

competitors Customer value is the difference between what a customer receives

(customer realization) and what the customer gives up (customer sacrifice) What is

received is called the total product The total product is the complete range of

tangi-ble and intangitangi-ble benefits that a customer receives from a purchased product Thus,

customer realization includes basic and special product features, service, quality,

instructions for use, reputation, brand name, and any other factors deemed

impor-tant by customers Customer sacrifice includes the cost of purchasing the product,

the time and effort spent acquiring and learning to use the product, and

postpur-chase costs, which are defined as the costs of using, maintaining, and disposing

of the product Increasing customer value means increasing customer realization,

decreasing customer sacrifice, or both

Strategic Positioning Increasing customer value to create a sustainable

compet-itive advantage is achieved through judicious selection of strategies Cost

informa-tion plays a critical role in this process through a process called strategic cost

manage-ment Strategic cost management is the use of cost data to develop and identify

superior strategies that will produce a sustainable competitive advantage Generally,

firms choose a strategic position that corresponds to one of two general strategies:

(1) cost leadership and (2) superior products through differentiation.5The objective

of the cost leadership strategy is to provide the same or better value to customers at

a lower cost than competitors; its objective is to increase customer value by reducing

sacrifice For example, reducing the cost of making a product by improving a process

would allow the firm to reduce the product’s selling price, thus reducing customer

sacrifice A differentiation strategy, on the other hand, increases customer value by

increasing realization Providing customers with something not provided by

com-petitors creates a competitive advantage For example, a computer retailer could offer

on-site repair service, a feature not offered by other rivals in the local market Of

course, a viable differentiation strategy must ensure that the value added to the

cus-tomer by differentiation exceeds the firm’s cost of providing the differentiation

Typi-cally, different strategies require different cost information, implying that cost

sys-tems may differ according to the strategy adopted by a firm

Value-Chain Framework A focus on customer value means that the

manage-ment accounting system should produce information about both realization and

sacrifice Collecting information about customer sacrifice means gathering

informa-tion outside the firm But there are even deeper implicainforma-tions Successful pursuit of

cost leadership and/or differentiation strategies requires an understanding of a firm’s

internal and industrial value chains Effective management of the internal value

chain is fundamental to increasing customer value, especially if maximizing

cus-tomer realization at the lowest possible cost (to the firm) is a goal The internal

value chain is the set of activities required to design, develop, produce, market, and

deliver products and services to customers Thus, emphasizing customer value forces

managers to determine which activities in the value chain are important to

cus-tomers A management accounting system should track information about a wide

variety of activities that span the internal value chain Consider, for example, the

5 Japanese firms have also shown that it is possible to pursue a strategy that combines the two: a

differentia-tion with cost advantage strategy.

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Applesauce Production

Distribution

of Apples Harvesting

Planting and Cultivating

Firm B

Firm C

Exhibit 1-3 Value Chain: Apple Industry

delivery segment Timely delivery of a product or service is part of the total productand, thus, of value to the customer Customer value can be increased by increasingthe speed of delivery and response Federal Expressexploited this part of the valuechain and successfully developed a service that was not being offered by the U.S.

denied This seems to indicate that a good management accounting system ought todevelop and measure indicators of customer satisfaction

The industrial value chain is also critical for strategic cost management The

industrial value chain is the linked set of value-creating activities from basic raw

materials to the disposal of the final product by end-use customers Exhibit 1-3 trates a possible value chain for the apple industry A given firm operating withinthe industry may not span the entire value chain The exhibit illustrates that differ-ent firms participate in different segments of the chain Breaking down a firm’s valuechain into its strategically important activities is basic to successful implementation

illus-of cost leadership and differentiation strategies Fundamental to a value-chain work is the recognition of the complex linkages and interrelationships among activi-

frame-ties both within and external to the firm There are two types of linkages: internal

and external Internal linkages are relationships among activities that are performed

within a firm’s portion of the industrial value chain (the internal value chain)

Exter-nal linkages are activity relationships between the firm and the firm’s suppliers and

customers Thus, we can talk about supplier linkages and customer linkages Using these

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linkages to bring about a win-win outcome for the firm, its suppliers, and its

cus-tomers is the key to successful strategic cost management It is also the key feature

of what is now called supply chain management Supply chain management is the

management of material flows beginning with suppliers and their upstream

suppli-ers, moving to the transformation of materials into finished goods, and finishing

with the distribution of finished goods to customers and their downstream customers

Understanding the industrial value chain and going beyond immediate suppliers

and customers may reveal hidden benefits Of course, the firm’s objective is to

man-age these linkman-ages better than its competitors, thus creating a competitive advantman-age

Companies have internal customers as well For example, the procurement

process acquires and delivers parts and materials to producing departments

Provid-ing high-quality parts on a timely basis to managers of producProvid-ing departments is

just as vital for procurement as it is for the company as a whole to provide

high-quality goods to external customers The emphasis on managing the internal value

chain and servicing internal customers reveals the importance of a cross-functional

perspective

Cross-Functional Perspective

Managing the value chain means that a management accountant must understand

many functions of the business, from manufacturing to marketing to distribution to

customer service This need is magnified when the company is involved in

interna-tional trade We see this in the varying definitions of product cost Activity-based

management has moved beyond the traditional manufacturing cost definition of

product cost to more inclusive definitions These product costs may include initial

design and engineering costs, manufacturing costs, and the costs of distribution,

sales, and service An individual who understands the shifting definitions of cost

from the short run to the long run can be invaluable in determining what

informa-tion is relevant in decision making For example, strategic decisions may require a

product cost definition that assigns the costs of all value-chain activities, whereas a

short-run decision that is concerned with whether a special order should be accepted

or rejected may require a product cost that assigns only marginal or incremental

costs

Why try to relate management accounting to marketing, management,

engineer-ing, finance, and other business functions? When a value-chain approach is taken

and customer value is emphasized, we see that these disciplines are interrelated; a

decision affecting one affects the others For example, many manufacturing

compa-nies engage in frequent trade loading, the practice of encouraging (often by offering

huge discounts) wholesalers and retailers to buy more product than they can quickly

resell As a result, inventories become bloated, and the wholesalers and retailers stop

purchasing for a time This looks like a marketing problem, but it is not—at least

not entirely When selling stops, so does production Thus, trade-loading companies

experience wild swings in production Sometimes, their factories produce around the

clock to meet demand for the heavily discounted product; other times, their factories

are idle, and workers are laid off In effect, the sales end up costing the companies

mil-lions of dollars of added production cost A cross-functional perspective lets us see the

big picture This broader vision allows managers to increase quality, reduce the time

required to service customers (both internal and external), and improve efficiency

Total Quality Management

Continuous improvement is crucial to establishing manufacturing excellence

Mak-ing products with little waste that actually perform accordMak-ing to specifications are

the twin objectives of world-class firms; they are the keys to survival in today’s

world-class competitive environment A philosophy of total quality management,

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in which manufacturers strive to create an environment that will enable workers tomanufacture perfect (zero-defect) products, has replaced the “acceptable quality”attitudes of the past This total emphasis on quality has also created a demand for amanagement accounting system that provides financial and nonfinancial informa-tion about quality.

Service industries are also dedicated to improving quality Service firms presentspecial problems because quality may differ from employee to employee As a result,service firms are emphasizing consistency through the development of systems tosupport employee efforts For example, Park Place Lexusof Plano, Texas, is a 2005Malcolm Baldridge Quality Award winner Park Place Lexus measures client satisfac-tion with new vehicles (99.8 percent), with pre-owned vehicles (98 percent), andwith vehicle maintenance and service (near 98 percent) Park Place Lexus is alsoimproving in profitability; its gross profit increased by 51.3 percent from 2000 to

2004 Clearly, quality initiatives are paying off.6Quality cost measurement and reporting are key features of a managementaccounting system for manufacturing and service industries In both cases, the sys-tem should be able to provide both operational and financial information aboutquality, including information such as the number of defects, quality cost reports,quality cost trend reports, and quality cost performance reports

Time as a Competitive Element

Time is a crucial element in all phases of the value chain.7World-class firms reducetime to market by compressing design, implementation, and production cycles.These firms deliver products or services quickly by eliminating non-value-addedtime, that is, time of no value to the customer (for example, the time a productspends on the loading dock) Interestingly, decreasing non-value-added time appears

to go hand in hand with increasing quality The overall objective, of course, is toincrease customer responsiveness

The rate of technological innovation has increased for many industries, and thelife of a particular product can be quite short Managers must be able to respondquickly and decisively to changing market conditions Information to allow them toaccomplish this must be available For example, Hewlett-Packardhas found that it

is better to be 50 percent over budget in new product development than to be sixmonths late This correlation between cost and time is the kind of information thatshould be available from a management accounting information system

Efficiency

While quality and time are important, improving these dimensions without sponding improvements in profit performance may be futile, if not fatal Improvingefficiency is also a vital concern Both financial and nonfinancial measures of effi-ciency are needed Cost is a critical measure of efficiency Trends in costs over timeand measures of productivity changes can provide important measures of the effi-cacy of continuous improvement decisions For these efficiency measures to be ofvalue, costs must be properly defined, measured, and assigned; furthermore, produc-tion of output must be related to the inputs required, and the overall financial effect

corre-of productivity changes should be calculated

6 As reported in the Baldridge Award Recipient profile, http://www.nist.gov/public_affairs/baldrige_2005/ parkplacelexus.htm.

7 An excellent analysis of time as a competitive element is contained in A Faye Borthick and Harold P Roth,

“Accounting for Time: Reengineering Business Processes to Improve Responsiveness,” Journal of Cost

Manage-ment (Fall 1993): pp 4–14.

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Electronic business (e-business) is any business transaction or information exchange

that is executed using information and communication technology E-business is

expected to grow significantly over the coming years It provides opportunities for a

company to expand sales throughout the world and may lower costs significantly

rel-ative to paper-based transactions It also facilitates value-chain (supply) management

Management accountants need to understand the benefits and risks of e-business as

well as its opportunities They also play a vital role in providing relevant cost

infor-mation concerning e-business For example, managers may need to know the cost

per electronic transaction versus the cost per paper transaction

The Role of the Management Accountant

Business today is moving faster than ever before Changes in technology,

communi-cations, economic conditions, and the legal environment are affecting firms and

their management accountants in new ways Management accountants must support

management in all phases of business decision making As specialists in accounting,

they must be intelligent, well prepared, up to date with new developments, and

familiar with the customs and practices of all countries in which their firms operate

They are expected to be knowledgable about the legal environment of business and,

in particular, about the Sarbanes-Oxley Act of 2002

Structure of the Company

The role of management accountants in an organization is one of support They

assist those individuals who are responsible for carrying out an organization’s basic

objectives Positions that have direct responsibility for the basic objectives of an

organization are referred to as line positions Positions that are supportive in nature

and have only indirect responsibility for an organization’s basic objectives are called

staff positions.

For example, assume that the basic mission of an organization is to produce and

sell laser printers The vice presidents of manufacturing and marketing, the factory

manager, and the assemblers are all line positions The vice presidents of finance

and human resources, the cost accountant, and the purchasing manager are all staff

positions

The partial organization chart shown in Exhibit 1-4 illustrates the organizational

positions for production and finance Because one of the basic objectives of the

organization is to produce, those directly involved in production hold line positions

Although management accountants, such as controllers and cost accounting

man-agers, may wield considerable influence in the organization, they have no authority

over the managers in the production area The managers in line positions are the

ones who set policy and make the decisions that impact production However, by

supplying and interpreting accounting information, management accountants can

have significant input into policies and decisions

The controller, the chief accounting officer, supervises all accounting

depart-ments Because of the critical role that management accounting plays in the

opera-tion of an organizaopera-tion, the controller is often viewed as a member of the top

management team and is encouraged to participate in planning, controlling, and

decision-making activities As the chief accounting officer, the controller has

respon-sibility for both internal and external accounting requirements This charge may

include direct responsibility for internal auditing, cost accounting, financial

account-ing (includaccount-ing SEC reports and financial statements), systems accountaccount-ing (includaccount-ing

Objective 5

Describe the role

of managementaccountants in anorganization

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analysis, design, and internal controls), and taxes The duties and organization ofthe controller’s office vary from firm to firm For example, in some firms, the inter-nal audit department may report directly to the financial vice president; similarly,the systems department may report directly to the financial vice president or someother vice president One possible organization of a controller’s office is also shown

in Exhibit 1-4

The treasurer is responsible for the finance function Specifically, the treasurer

raises capital and manages cash and investments The treasurer may also be incharge of credit, collection, and insurance As shown in Exhibit 1-4, the treasurerreports to the financial vice president

Sarbanes-Oxley Act of 2002

In June 2002, Congress passed the Sarbanes-Oxley Act This legislation was passed

in response to the collapse of Enron and the revelations of securities fraud andaccounting misconduct associated with companies such as WorldCom, Adelphia,

and HealthSouth The Sarbanes-Oxley Act (SOX) established stronger government

control and regulation of public companies in the United States SOX applies to

publicly traded companies, companies that issue stock traded on U.S stock

exchanges Major sections of SOX include establishment of the Public CompanyAccounting Oversight Board (PCAOB), enhanced auditor independence, tightenedregulation of corporate governance, control over management, and management/auditor assessment of the firm’s internal controls SOX also led to increased atten-tion to corporate ethics, and this is discussed in the next section

Importantly, private companies, nonprofit entities, and governmental agencies

or entities are not covered by SOX and not subject to PCAOB control However,these entities have been affected by SOX through their dealings with constituentsand their boards of directors In particular, the intense scrutiny of internal controlunder SOX is a feature that many would like to see applied to nonprofit entities.Internal control is a process put into place by management and the board of direc-tors to ensure that objectives are achieved in the areas of effectiveness and efficiency

of operations, reliability of financial reporting, and compliance with applicable laws

President

Financial Vice President

Internal

Exhibit 1-4 Partial Organization Chart, Manufacturing Company

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and regulations.8All entities should achieve their legitimate objectivies, and good

internal control can help to ensure that Management accountants, through the

offices of internal auditing or the chief financial officer (CFO), are the people in

the organization who are expected to help their organizations comply with SOX

Management Accounting and Ethical Conduct

Virtually all management accounting practices were developed to assist managers in

maximizing profits Traditionally, the economic performance of the firm has been

the overriding concern Yet managers and management accountants should not

become so focused on profits that they develop a belief that the only goal of a

busi-ness is maximizing its net worth The objective of profit maximization should be

constrained by the requirement that profits be achieved through legal and ethical

means While this has always been an implicit assumption of management

account-ing, the assumption should be made explicit To help achieve this objective, many

of the problems in this text force explicit consideration of ethical issues

Ethical Behavior

Ethical behavior involves choosing actions that are “right,” “proper,” and “just.”

Our behavior can be right or wrong; it can be proper or improper; and the decisions

we make can be just or unjust Though people often differ in their views of the

meaning of the ethical terms cited, a common principle seems to underlie all ethical

systems This principle is expressed by the belief that each member of a group bears

some responsibility for the well-being of other members Willingness to sacrifice

one’s self-interest for the well-being of the group is the heart of ethical action

This notion of sacrificing one’s self-interest for the well-being of others produces

some core values—values that describe what is meant by right and wrong in more

concrete terms James W Brackner, writing for the “Ethics Column” in Management

Accounting, made the following observation:

For moral or ethical education to have meaning, there must be agreement

on the values that are considered “right.” Ten of these values are identified

and described by Michael Josephson in “Teaching Ethical Decision Making

and Principled Reasoning.” The study of history, philosophy, and religion

reveals a strong consensus as to certain universal and timeless values

essen-tial to the ethical life

These ten core values yield a series of principles that delineate right and

wrong in general terms Therefore, they provide a guide to behavior.9

The ten core values referred to in the quotation follow:

6 Caring for others

7 Respect for others

9 James W Brackner, “Consensus Values Should Be Taught,” Management Accounting (August 1992): p 19 For

a more complete discussion of the ten core values, see also Michael Josephson, “Teaching Ethical Decision

Making and Principled Reasoning,” Ethics: Easier Said Than Done (Winter 1988): pp 29–30.

Objective 6

Explain theimportance ofethical behavior for managers and managementaccountants

Although it may seem contradictory, sacrificing one’s self-interest for the collective

good may not only be right and bring a sense of individual worth but may also

ET ETHICS

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be good business sense Companies with a strong code of ethics can create strongcustomer and employee loyalty While liars and cheats may win on occasion, theirvictories are often short term Companies in business for the long term find that itpays to treat all of their clients honestly and loyally.

Company Codes of Conduct and SOX

The Sarbanes-Oxley Act requires that a company’s senior financial officers be subject

to a code of ethics or that the company must disclose publicly that they are not.

Since no company wants to say publicly that its CEO or CFO is not subject to acode of ethics, companies not only have codes of ethics, those codes do apply to thetop corporate officers In practice, companies have developed codes of ethics, oftencalled codes of conduct, that are applicable to all their employees The codes can,and do, differ from company to company Some are lengthy, with ample guidancefor particular circumstances Others are briefer and more general; they expect employ-ees to internalize the ethical guidelines and to apply them in a variety of circum-stances A number of companies, including GlaxoSmithKline, John Deere, Nike, andPixar, have posted their codes of conduct on their websites This is now standardpractice for public companies

http://www.gsk.com/responsibility/cr_issues/business_ethics.htmhttp://www.deere.com/en_US/investinfo/corpgov/ethics.htmlhttp://www.nike.com/nikebiz/nikebiz.jhtml?page=25&cat=codehttp://corporate.pixar.com/downloads/Code_of_Conduct.pdfManagement accountants and all employees are expected to be knowledgeableabout their company’s code of ethics Along with other employees, they may beasked to sign a document stating that they have read and understand the code Theyshould also be aware of provisions for whistle-blower assistance SOX gives protec-tion to those who blow the whistle on financial misconduct or fraudulent financialreporting Companies must establish mechanisms through which employees andother stakeholders can report suspected misconduct The company is required, then,

to follow up on all such reports Many public companies have outsourced theirethics hotlines to reputable outside companies in order to provide assurance thatemployee complaints and tips can be made anonymously

M a n a g e r s D e c i d e

Joseph Menardi,* a new

graduate of the Culinary

Institute of America, was

hired as head chef of a

pop-ular local restaurant Several

months after Joseph started

work, the restaurant’s meat

supplier offered him six

choice steaks—worth about

$100—as a gift for “being

such a great customer.”

Joseph was surprised andpleased by the offer; helooked forward to treatinghis friends to a special din-ner Is is all right for Joseph

to accept the gift? A newchef may think that it is—

but this is wrong! The pose of the gift is to make

pur-Joseph less objective in hischoice of supplier He could

be fired for such behavior Infact, many corporate codes

of conduct explicitly prohibitsuch behavior ■

*This is a real situation, but the name has been changed.

Gifts and Conflicts of Interest

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Standards of Ethical Conduct for Management Accountants

Organizations commonly establish standards of conduct for their managers and

employees Professional associations also establish ethical standards For example,

the Institute of Management Accountants has established ethical standards for

man-agement accountants In 2005, the IMA issued a revised statement outlining

stan-dards of ethical conduct for management accountants Called the “Statement of

Eth-ical Professional Practice,” the revised statement was designed to accord with the

provisions of the Sarbanes-Oxley Act of 2002 and to meet the global needs of IMA’s

international members The revised statement is based on the principles of honesty,

fairness, objectivity, and responsibility The Statement of Ethical Professional Practice

and the recommended resolution of ethical conflicts are presented in Exhibit 1-5

To illustrate an application of the statement, suppose a manager’s bonus increases

as reported profits increase The manager has an incentive to find ways to increase

profits, including unethical approaches For example, he or she could delay

promot-ing deservpromot-ing employees or use cheaper parts to make a product In either case, if the

motive is simply to increase the reported income, and the bonus, the behavior could

be unethical Neither action is in the best interest of the company or its employees

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