accounting for managers

Accounting for Managers v 1.0 This is the book Accounting for Managers (v 1.0) This book is licensed under a Creative Commons by-nc-sa 3.0 (http://creativecommons.org/licenses/by-nc-sa/ 3.0/) license See the license for more details, but that basically means you can share this book as long as you credit the author (but see below), don't make money from it, and make it available to everyone else under the same terms This book was accessible as of December 29, 2012, and it was downloaded then by Andy Schmitz (http://lardbucket.org) in an effort to preserve the availability of this book Normally, the author and publisher would be credited here However, the publisher has asked for the customary Creative Commons attribution to the original publisher, authors, title, and book URI to be removed Additionally, per the publisher's request, their name has been removed in some passages More information is available on this project's attribution page (http://2012books.lardbucket.org/attribution.html?utm_source=header) For more information on the source of this book, or why it is available for free, please see the project's home page (http://2012books.lardbucket.org/) You can browse or download additional books there ii Table of Contents About the Authors Acknowledgments Dedication Preface Chapter 1: What Is Managerial Accounting? Characteristics of Managerial Accounting Planning and Control Functions Performed by Managers 14 Key Finance and Accounting Personnel 19 Ethical Issues Facing the Accounting Industry 24 Computerized Accounting Systems 31 Cost Terminology 36 How Product Costs Flow through Accounts 49 Income Statements for Manufacturing Companies 56 Chapter 2: How Is Job Costing Used to Track Production Costs? 88 Differentiating Job Costing from Process Costing 90 How a Job Costing System Works 94 Assigning Manufacturing Overhead Costs to Jobs 102 Job Costing in Service Organizations 117 Chapter Wrap-Up: Summary of Cost Flows at Custom Furniture Company 122 Chapter 3: How Does an Organization Use Activity-Based Costing to Allocate Overhead Costs? 154 Why Allocate Overhead Costs? 156 Approaches to Allocating Overhead Costs 158 Using Activity-Based Costing to Allocate Overhead Costs 166 Using Activity-Based Management to Improve Operations 187 Using Activity-Based Costing (ABC) and Activity-Based Management (ABM) in Service Organizations 191 Variations of Activity-Based Costing (ABC) 201 iii Chapter 4: How Is Process Costing Used to Track Production Costs? 240 Comparison of Job Costing with Process Costing 242 Product Cost Flows in a Process Costing System 247 Determining Equivalent Units 257 The Weighted Average Method 262 Preparing a Production Cost Report 279 Chapter 5: How Do Organizations Identify Cost Behavior Patterns? 303 Cost Behavior Patterns 305 Cost Estimation Methods 321 The Contribution Margin Income Statement 348 The Relevant Range and Nonlinear Costs 354 Appendix: Performing Regression Analysis with Excel 358 Chapter 6: How Is Cost-Volume-Profit Analysis Used for Decision Making? 389 Cost-Volume-Profit Analysis for Single-Product Companies 391 Cost-Volume-Profit Analysis for Multiple-Product and Service Companies 408 Using Cost-Volume-Profit Models for Sensitivity Analysis 422 Impact of Cost Structure on Cost-Volume-Profit Analysis 431 Using a Contribution Margin When Faced with Resource Constraints 434 Income Taxes and Cost-Volume-Profit Analysis 437 Using Variable Costing to Make Decisions 444 Chapter 7: How Are Relevant Revenues and Costs Used to Make Decisions? 485 Using Differential Analysis to Make Decisions 487 Make-or-Buy Decisions 490 Product Line Decisions 499 Customer Decisions 513 Review of Cost Terms Used in Differential Analysis 522 Special Order Decisions 524 Cost-Plus Pricing and Target Costing 532 Identifying and Managing Bottlenecks 535 Be Aware of Qualitative Factors 541 Appendix: Making Decisions Involving Joint Costs 543 iv Chapter 8: How Is Capital Budgeting Used to Make Decisions? 583 Capital Budgeting and Decision Making 585 Net Present Value 598 The Internal Rate of Return 609 Other Factors Affecting NPV and IRR Analysis 616 The Payback Method 623 Additional Complexities of Estimating Cash Flows 632 The Effect of Income Taxes on Capital Budgeting Decisions 637 Appendix: Present Value Tables 643 Chapter 9: How Are Operating Budgets Created? 662 Planning and Controlling Operations 664 The Budgeting Process 668 The Master Budget 671 Budgeting in Nonmanufacturing Organizations 704 Ethical Issues in Creating Operating Budgets 711 Chapter 10: How Do Managers Evaluate Performance Using Cost Variance Analysis? 743 Flexible Budgets 745 Standard Costs 747 Direct Materials Variance Analysis 758 Direct Labor Variance Analysis 768 Variable Manufacturing Overhead Variance Analysis 779 Determining Which Cost Variances to Investigate 787 Using Variance Analysis with Activity-Based Costing 793 Fixed Manufacturing Overhead Variance Analysis 799 Appendix: Recording Standard Costs and Variances 806 Chapter 11: How Do Managers Evaluate Performance in Decentralized Organizations? 842 Using Decentralized Organizations to Control Operations 844 Maintaining Control over Decentralized Organizations 852 Comparing Segmented Income for Investment Centers 857 Using Return on Investment (ROI) to Evaluate Performance 862 Using Residual Income (RI) to Evaluate Performance 881 Using Economic Value Added (EVA) to Evaluate Performance 888 Wrap-Up of Game Products, Inc 898 Appendix: Transfer Prices between Divisions 902 v Chapter 12: How Is the Statement of Cash Flows Prepared and Used? 938 Purpose of the Statement of Cash Flows 940 Three Types of Cash Flow Activities 943 Four Key Steps to Preparing the Statement of Cash Flows 949 Using the Indirect Method to Prepare the Statement of Cash Flows 955 Analyzing Cash Flow Information 984 Appendix: Using the Direct Method to Prepare the Statement of Cash Flows 993 Chapter 13: How Do Managers Use Financial and Nonfinancial Performance Measures? 1030 Trend Analysis of Financial Statements 1033 Common-Size Analysis of Financial Statements 1044 Ratio Analysis of Financial Information 1053 Wrap-Up of Chapter Example 1095 Nonfinancial Performance Measures: The Balanced Scorecard 1098 vi About the Authors Kurt Heisinger Kurt Heisinger (CMA, CPA, MBA) teaches financial and managerial accounting full time and holds a tenured position at Sierra College He recently received the 2011–12 Faculty of the Year award, which was voted on and presented by the Associated Students of Sierra College Kurt has also taught accounting classes at the University of California—Davis and American River College Kurt began his career in public accounting with Ernst & Young and continued as a manager of a large local accounting firm in California He received his MBA at the University of California—Davis and is currently a certified management accountant (CMA) and certified public accountant (CPA) The knowledge Kurt gained from his seven years in industry and more than 15 years in education has enabled him to write a clear and concise book filled with real world examples Joe Ben Hoyle Joe Hoyle is an associate professor of accounting at the Robins School of Business at the University of Richmond In 2006, he was named by BusinessWeek as one of 26 favorite undergraduate business professors in the United States In 2007, he was selected as the Virginia Professor of the Year by the Carnegie Foundation for the Advancement of Teaching and the Council for the Advancement and Support of Education In 2009, he was judged to be one of the 100 most influential members of the accounting profession by Accounting Today Joe has two market-leading textbooks published with McGraw-Hill—Advanced Accounting (eleventh edition, 2012) and Essentials of Advanced Accounting (fifth edition, 2012), both coauthored with Tom Schaefer of the University of Notre Dame and Tim Doupnik of the University of South Carolina About the Authors At the Robins School of Business, Joe teaches fundamentals of financial accounting, intermediate financial accounting I, intermediate financial accounting II, and advanced financial accounting He earned his BA degree in accounting from Duke University and his MA degree in business and economics, with a minor in education, from Appalachian State University He has written numerous articles and continues to make many presentations around the country on teaching excellence He maintains a blog on teaching at http://www.joehoyle-teaching.blogspot.com Joe also has three decades of experience operating his own CPA (Certified Public Accountant) Exam review programs In 2008, he created CPA Review for Free (http://www.CPAreviewforFREE.com), which provides thousands of free questions to help accountants around the world prepare for the CPA Exam Joe and his wife, Sarah, have four children and four grandchildren Acknowledgments We would like to thank the following reviewers Their insightful feedback and suggestions for improving the material helped us make this a better text: • • • • • • • • • • • • • • • • • • • • • • • • • • • • • William Murphy, University of Wisconsin—Stout Carleton Donchess, Bridgewater State University Jason Sharp, Ferrum College Todd Jensen, Sierra College Robert Walsh, University of Dallas Michael Brown, Millikin University Jennifer Robinson, Trident Technical College James Aitken, Central Michigan University Delvan Roehling, Ivy Tech Community College Carol Lawrence, Northern Kentucky University Curtis Crocker, Central Georgia Technical College Kathleen Fitzpatrick, University of Toledo Walt Walczykowski, Sierra College Annette Fisher, Glendale Community College Walter Austin, Mercer University Hubert Glover, Drexel University Steven LaFave, Augsburg College Joan Van Hise, Fairfield University Holly Ratwani, Bridgewater College Alan Shattuck, Sierra College Paul Fisher, Rogue Community College Rick Blumenfeld, Sierra College Paula Wilson, University of Puget Sound Jianing Fang, Iona College Dan Sevall, Lincoln University Alan Adams, Dean College John Stancil, Florida Southern College Christy Land, Catawba Valley Community College Birendra Mishra, University of California—Riverside Dedication Kurt Heisinger To my parents for their continued optimism and support; to my wife and children for their patience and encouragement; and to Michael Maher, professor of management at the University of California—Davis, who served as my mentor and encouraged me to write this book I could not have done it without him Chapter 13 How Do Managers Use Financial and Nonfinancial Performance Measures? Debt to equity Times interest earned b Compute the following market valuation measures for 2010, and provide a brief explanation after each measure (state market capitalization in billions, and round price-earnings ratio to two decimal places): Market capitalization (assume 218,000,000 shares were issued and outstanding at January 29, 2011, and the market price was $40.08 per share) Price-earnings ratio (assume the earnings per share amount was $2.80) 38 Income Statement Trend, Common-Size, and Profitability Analysis The following condensed income statement and balance sheet are for Starbucks Corporation, a large retailer of specialty coffee with stores throughout the world 13.5 Nonfinancial Performance Measures: The Balanced Scorecard 1115 Chapter 13 How Do Managers Use Financial and Nonfinancial Performance Measures? Required: a Prepare a trend analysis of the income statements from 2010 to 2011 Use the format shown in Figure 13.1 "Income Statement Trend Analysis for " as a guide (Round computations to one decimal place.) b Identify all items that changed by more than 20 percent in the trend analysis prepared in requirement a, and briefly comment on the results c Prepare a common-size analysis of the income statements for 2011 and 2010 Use the format shown in Figure 13.5 "Common-Size Income Statement Analysis for " as a guide (Round computations to one decimal place.) d What does the common-size analysis prepared in requirement c tell you about the company? e Compute the following profitability ratios for 2011, and provide a brief explanation after each ratio (round percentage computations to one decimal place and earnings per share to two decimal places): Gross margin ratio 13.5 Nonfinancial Performance Measures: The Balanced Scorecard 1116 Chapter 13 How Do Managers Use Financial and Nonfinancial Performance Measures? Profit margin ratio Return on assets Return on common shareholders’ equity Earnings per share (assume weighted average shares outstanding totaled 748,300,000 shares) 39 Short-Term Liquidity, Long-Term Solvency, and Market Valuation Refer to the information presented in Problem 38 for Starbucks Required: a Compute the following short-term liquidity ratios for 2011, and provide a brief explanation after each ratio (round computations to two decimal places): Current ratio Quick ratio Receivables turnover ratio and average collection period (assume all sales are on account) Inventory turnover ratio and average sale period b Compute the following long-term solvency ratios for 2011, and provide a brief explanation after each ratio (round computations to two decimal places): Debt to assets Debt to equity Times interest earned c Compute the following market valuation measures for 2011, and provide a brief explanation after each measure (state market capitalization in billions, and round price-earnings ratio to two decimal places): Market capitalization (assume 744,800,000 shares were issued and outstanding at October 2, 2011, and the market price was $37.14 per share) 13.5 Nonfinancial Performance Measures: The Balanced Scorecard 1117 Chapter 13 How Do Managers Use Financial and Nonfinancial Performance Measures? Price-earnings ratio (assume the earnings per share amount was $1.66) 40 Balance Sheet Trend and Common-Size Analysis The following condensed income statement and balance sheet are for Wal-Mart Stores, Inc (note that Wal-Mart’s 2010 fiscal year ends on January 31, 2011 This is called the 2010 fiscal year because only one month is in 2011, the other 11 months of the fiscal year are in 2010, and the company has chosen to refer to this as the 2010 fiscal year This same concept applies to fiscal year 2009.) 13.5 Nonfinancial Performance Measures: The Balanced Scorecard 1118 Chapter 13 How Do Managers Use Financial and Nonfinancial Performance Measures? Required: a Prepare a trend analysis of the balance sheets from 2009 to 2010 Use the format shown in Figure 13.2 "Balance Sheet Trend Analysis for " as a guide (Round computations to one decimal place.) b Prepare a common-size analysis of the balance sheets for 2010 and 2009 Use the format shown in Figure 13.6 "Common-Size Balance Sheet Analysis for " as a guide (Round computations to one decimal place.) c What does the balance sheet common-size analysis prepared in requirement b tell you about the company? 41 Income Statement Trend and Common-Size Analysis; Profitability Ratios Refer to the information presented in Problem 40 for Wal-Mart Required: a Prepare a trend analysis of the income statements from 2009 to 2010 Use the format shown in Figure 13.1 "Income Statement Trend Analysis for " as a guide (Round computations to one decimal place.) 13.5 Nonfinancial Performance Measures: The Balanced Scorecard 1119 Chapter 13 How Do Managers Use Financial and Nonfinancial Performance Measures? b Based on the income statement trend analysis prepared in requirement a, describe what caused the increase in operating income from 2009 to 2010 c Prepare a common-size analysis of the income statements for 2010 and 2009 Use the format shown in Figure 13.5 "Common-Size Income Statement Analysis for " as a guide (Round computations to one decimal place.) d What does the income statement common-size analysis prepared in requirement c tell you about the company? e Compute the following profitability ratios for 2010, and provide a brief explanation after each ratio (round percentage computations to one decimal place and earnings per share to two decimal places): Gross margin ratio Profit margin ratio Return on assets Return on common shareholders’ equity Earnings per share (assume weighted average shares outstanding totaled 3,656,000,000 shares) 42 Short-Term Liquidity, Long-Term Solvency, Market Valuation, and Balanced Scorecard Refer to the information presented in Problem 40 for Wal-Mart Required: a Compute the following short-term liquidity ratios for 2010, and provide a brief explanation after each ratio (round computations to two decimal places): Current ratio Quick ratio Receivables turnover ratio and average collection period (assume all sales are on account) Inventory turnover ratio and average sale period 13.5 Nonfinancial Performance Measures: The Balanced Scorecard 1120 Chapter 13 How Do Managers Use Financial and Nonfinancial Performance Measures? b Compute the following long-term solvency ratios for 2010, and provide a brief explanation after each ratio (round computations to two decimal places): Debt to assets Debt to equity Times interest earned c Compute the following market valuation measures for 2010, and provide a brief explanation after each measure (state market capitalization in billions, and round price-earnings ratio to two decimal places): Market capitalization (assume 3,516,000,000 shares were issued and outstanding at January 31, 2011, and the market price was $54.58 per share) Price-earnings ratio (assume the earnings per share amount was $4.48) d Assume Wal-Mart uses a balanced scorecard to assess performance Provide at least two learning and growth measures the company can use on its balanced scorecard One Step Further: Skill-Building Cases 43 Trend Information in Annual Reports Refer to Note 13.9 "Business in Action 13.1" Why is trend information important to shareholders? 44 Earnings per Share Refer to Note 13.28 "Business in Action 13.3" Was AnnTaylor Stores’ earnings per share higher or lower than analysts expected? Explain whether you would expect the company’s stock price to increase or decrease as a result of the press release 45 Inventory Turnover in the Computer Industry Refer to Note 13.42 "Business in Action 13.4" Why you think inventory turnover for the computer hardware industry is so quick? 46 Financial Leverage in the Auto Industry Refer to Note 13.48 "Business in Action 13.5" Why most investors consider GM to be highly leveraged? 47 Market Capitalization Categories Refer to Note 13.54 "Business in Action 13.6" Define what is meant by small-cap, midcap, and large-cap In which category does Coca-Cola belong? Explain 13.5 Nonfinancial Performance Measures: The Balanced Scorecard 1121 Chapter 13 How Do Managers Use Financial and Nonfinancial Performance Measures? 48 Internet Project: Financial Statement Analysis Using the Internet, find the most recent annual report (or form 10K) for a manufacturing or retail company of your choice Most companies have links to the information at their Web sites under titles, such as investor relations or financial reports Print the income statement and balance sheet for the company selected and include these documents with your response to the following requirements Required: a Compute the following profitability ratios for the most current year, and provide a brief explanation after each ratio (round percentage computations to one decimal place): Gross margin ratio Profit margin ratio Return on assets Return on common shareholders’ equity b Compute the following short-term liquidity ratios for the most current year, and provide a brief explanation after each ratio (round computations to two decimal places): Current ratio Quick ratio Receivables turnover ratio and average collection period (assume all sales are on account) Inventory turnover ratio and average sale period c Compute the following long-term solvency ratios for the most current year, and provide a brief explanation after each ratio (round computations to two decimal places): Debt to assets Debt to equity 13.5 Nonfinancial Performance Measures: The Balanced Scorecard 1122 Chapter 13 How Do Managers Use Financial and Nonfinancial Performance Measures? d Provide a one-page written report summarizing your results in requirements a, b, and c Identify any areas of concern as well as areas of strength for the company 49 Group Activity: Analyzing Lowe’s Companies, Inc The condensed income statement and balance sheet information provided as follows is for Lowe’s Companies, Inc., a large retail company that sells building materials and supplies Lowe’s had 1,354,000,000 shares issued and outstanding at January 28, 2011, and the market price per share on that date was $24.83 (Note that Lowe’s 2010 fiscal year ends on January 28, 2011 This is called the 2010 fiscal year because only one month is in 2011, the other 11 months of the fiscal year are in 2010, and the company has chosen to refer to this as the 2010 fiscal year This same concept applies to fiscal year 2009.) 13.5 Nonfinancial Performance Measures: The Balanced Scorecard 1123 Chapter 13 How Do Managers Use Financial and Nonfinancial Performance Measures? Form groups of two to four students Each group is to be assigned one of the following three categories of financial measures: Profitability measures Gross margin ratio Profit margin ratio Return on assets Return on common shareholders’ equity Short-term liquidity measures Current ratio Quick ratio Inventory turnover ratio and average sales period Long-term solvency and market valuation measures Debt to assets Debt to equity Market capitalization 13.5 Nonfinancial Performance Measures: The Balanced Scorecard 1124 Chapter 13 How Do Managers Use Financial and Nonfinancial Performance Measures? Required: a Calculate the financial measures assigned to your group Round all computations to two decimal places, except the market capitalization measure, which can be rounded to the nearest billion dollars b Provide a brief explanation of each measure your group calculated in requirement a c Discuss the results of your group with the class 50 Performing Income Statement Trend Analysis Using Excel Review the information for Apple, Inc., in Brief Exercise 14 Required: Perform income statement trend analysis for Apple, Inc., using an Excel spreadsheet The format should be similar to the one in Figure 13.1 "Income Statement Trend Analysis for " Round percent computations to one decimal place Comprehensive Cases 51 Financial Statement Analysis and Industry Standards; Manufacturing Company Susan Hartford is the president and CEO of Computer Makers, Inc The company is in the process of looking for a supplier of computer chips, and Susan has asked her staff to review the financial stability of Intel Corporation, the world’s largest maker of computer chips Susan’s staff began by collecting industry average information, which is shown as follows, and would like your help in calculating and evaluating these measures for Intel Measure Industry Average Intel Gross margin 57.7 percent ? Profit margin 21.9 percent ? Return on assets 17.7 percent ? 13.5 Nonfinancial Performance Measures: The Balanced Scorecard 1125 Chapter 13 How Do Managers Use Financial and Nonfinancial Performance Measures? Return on common shareholders’ equity 21.5 percent ? Current ratio 2.3 to ? Quick ratio 1.9 to ? Receivables turnover 12.8 times ? Inventory turnover 4.8 times ? Debt to assets 0.21 to ? Debt to equity 0.26 to ? Market capitalization $80,000,000,000 ? Intel’s income statement and balance sheet are provided as follows The price for share of common stock at December 25, 2010, the end of Intel’s fiscal year, was $20.13 The number of shares issued and outstanding at December 25, 2010, totaled 5,581,000,000 Assume all sales were on account 13.5 Nonfinancial Performance Measures: The Balanced Scorecard 1126 Chapter 13 How Do Managers Use Financial and Nonfinancial Performance Measures? Required: a Using the industry average measures provided, compute the same measures for Intel for its fiscal year ended December 25, 2010 (State your results in the same format used for industry averages.) b Summarize your results in requirement a by completing a table using the following headings: Measure Industry Average Intel Corporation Immediately following each measure, indicate whether Intel’s financial condition is better or worse than the industry average c Using your answers to requirements a and b to support your position, determine whether Intel is financially stable 52 Ethics: Manipulating Data to Meet Loan Requirements Custom Tech, Inc., designs and produces computers for a variety 13.5 Nonfinancial Performance Measures: The Balanced Scorecard 1127 Chapter 13 How Do Managers Use Financial and Nonfinancial Performance Measures? of customers The company has encountered a cash shortage resulting from collection problems with several customers If Custom Tech is unable to collect a significant portion of its receivables relatively soon, the company will not be able to pay suppliers and employees next quarter As a result, Custom Tech’s president, Don Lardner, began discussions with a local bank about obtaining a short-term loan Don did not mention the cause of the cash flow shortage other than to say, “This happens the same time every year due to the cyclical nature of our business.” In a meeting with the bank’s loan officer, Jan Johnson, Don was told the loan should not be a problem as long as Custom Tech maintains a profit margin ratio above 10 percent, quick ratio above 1.0 to 1, and debt to equity ratio below 1.4 to Don indicated this was in line with his company’s performance and agreed to provide financial statements for the most recent year at their next meeting The financial statements shown as follows are for Custom Tech’s most recent year ended December 31 This information has not yet been provided to the bank 13.5 Nonfinancial Performance Measures: The Balanced Scorecard 1128 Chapter 13 How Do Managers Use Financial and Nonfinancial Performance Measures? Required: a Calculate the ratios required by the bank and determine whether Custom Tech will qualify for the loan b Assume you are the CFO for Custom Tech Don Lardner asks you to reclassify $30,000 in current liabilities to common stock Don states, “We owe it to our shareholders and employees to whatever it takes to get this loan! Without it, we may have to file for bankruptcy and let our employees go Once we get this loan and collect our outstanding receivables we’ll be in good shape.” Prepare a revised balance sheet after making the $30,000 reclassification, recalculate the ratios required by the bank, and determine whether Custom Tech will qualify for the loan with the revised numbers c Are the president’s actions ethical? If you were the CFO, how would you handle the president’s request? (To answer these questions, you may want to review the presentation of ethics in Chapter "What Is Managerial Accounting?".) 13.5 Nonfinancial Performance Measures: The Balanced Scorecard 1129 ... managers, sales managers, and any other personnel in the organization who use accounting information for decision making Managerial accounting3 focuses on internal users—executives, product managers, ... financial information for external users in accordance with U.S GAAP Managerial accounting provides detailed financial and nonfinancial information for internal users who use the information for decision... Managerial accounting detailed information provided monthly Managerial accounting information is for future projections and involves a segment of the company Financial accounting historical information