Ninth Edition Accounting for Decision Making and Control Jerold L Zimmerman University of Rochester ACCOUNTING FOR DECISION MAKING AND CONTROL, NINTH EDITION Published by McGraw-Hill Education, Penn Plaza, New York, NY 10121 Copyright © 2017 by McGraw-Hill Education All rights reserved Printed in the United States of America Previous editions © 2014, 2009, and 2006 No part of this publication may be reproduced or distributed in any form or by any means, or stored in a database or retrieval system, without the prior written consent of McGraw-Hill Education, including, but not limited to, in any network or other electronic storage or transmission, or broadcast for distance learning Some ancillaries, including electronic and print components, may not be available to customers outside the United States This book is printed on acid-free paper DOW/DOW ISBN 978-1-259-56455-0 MHID 1-259-56455-X Senior Vice President, Products & Markets: Kurt L Strand Vice President, General Manager, Products & 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decision making and control / Jerold L Zimmerman, University of Rochester Description: Ninth edition | New York, NY : McGraw-Hill Education, [2017] Identifiers: LCCN 2015043326 | ISBN 9781259564550 (alk paper) Subjects: LCSH: Managerial accounting Classification: LCC HF5657.4 Z55 2017 | DDC 658.15/11—dc23 LC record available at http://lccn.loc.gov/2015043326 The Internet addresses listed in the text were accurate at the time of publication The inclusion of a website does not indicate an endorsement by the authors or McGraw-Hill Education, and McGraw-Hill Education does not guarantee the accuracy of the information presented at these sites www.mhhe.com www.freebookslides.com About the Author Jerold L Zimmerman Jerold Zimmerman is Professor Emeritus at the William E Simon Graduate School of Business, University of Rochester He holds an undergraduate degree from the University of Colorado, Boulder, and a doctorate from the University of California, Berkeley While at Rochester, Dr Zimmerman has taught a variety of courses spanning accounting, finance, and economics Accounting courses include nonprofit accounting, intermediate accounting, accounting theory, and managerial accounting A deeper appreciation of the challenges of managing complex organizations was acquired by serving as the Simon School’s Deputy Dean and on the board of directors of several public corporations Professor Zimmerman publishes widely in accounting on topics as diverse as cost allocations, corporate governance, disclosure, financial accounting theory, capital markets, and executive compensation His paper “The Costs and Benefits of Cost Allocations” won the American Accounting Association’s Competitive Manuscript Contest He is recognized for developing Positive Accounting Theory This work, co-authored with colleague Ross Watts, at the Massachusetts Institute of Technology, received the American Institute of Certified Public Accountants’ Notable Contribution to the Accounting Literature Award for “Towards a Positive Theory of the Determination of Accounting Standards” and “The Demand for and Supply of Accounting Theories: The Market for Excuses.” Both papers appeared in the Accounting Review Professors Watts and Zimmerman are also co-authors of the highly cited textbook Positive Accounting Theory (Prentice Hall, 1986) Professors Watts and Zimmerman received the 2004 American Accounting Association Seminal Contribution to the Literature award Professor Zimmerman’s textbooks also include Managerial Economics and Organizational Architecture with Clifford Smith and James Brickley, 6th ed (McGraw-Hill, 2016) and Management Accounting in a Dynamic Environment with Cheryl McWatters (Routledge UK, 2016) He is a founding editor of the Journal of Accounting and Economics, published by Elsevier This scientific journal is one of the most highly referenced accounting publications He and his wife Dodie have two daughters, Daneille and Amy Jerry has been known to occasionally engage friends and colleagues in an amicable diversion on the links iii www.freebookslides.com Preface During their professional careers, managers in all organizations, profit and nonprofit, rely on their accounting systems Sometimes managers use the accounting system to acquire information for decision making At other times, the accounting system measures performance and thereby influences their behavior The accounting system is both a source of information for decision making and part of the organization’s control mechanisms—thus, the title of the book, Accounting for Decision Making and Control The purpose of this book is to provide students and managers with an understanding and appreciation of the strengths and limitations of an organization’s accounting system, thereby allowing them to be more intelligent users of these systems This book provides a framework for understanding accounting systems and a basis for analyzing proposed changes to these systems The text demonstrates that managerial accounting is an integral part of the firm’s organizational architecture, not just an isolated set of computational topics Changes in the Ninth Edition Feedback from reviewers and instructors using the prior editions and my own teaching experience provided the basis for the revision In particular, the following changes have been made: • Each chapter has been revised to further enhance readability and remove redundancy • References to actual company practices have been updated • Users were uniform in their praise of the problem material They found it challenged their students to critically analyze multidimensional issues while still requiring numerical problem-solving skills • The end-of-chapter problem material was revised by adding 45 new problems— including some related to health care and knowledge-based service firms—and removing outdated problems. • The ninth edition is a more concise revision that presents the same fundamental concepts, learning objectives, and challenging critical thinking end-of-chapter materials as in prior editions Overview of Content Chapter presents the book’s conceptual framework by using a simple decision context regarding accepting an incremental order from a current customer The chapter describes why firms use a single accounting system and the concept of economic Darwinism, among other important topics This chapter is an integral part of the text iv www.freebookslides.com Preface v Chapters 2, 4, and present the underlying conceptual framework The importance of opportunity costs in decision making, cost–volume–profit analysis, and the difference between accounting costs and opportunity costs are discussed in Chapter Chapter employs the economic theory of organizations and organizational architecture as the conceptual foundation to understand the role of the accounting system as part of the organization’s control mechanism Chapter describes the crucial role of accounting as part of the firm’s organizational architecture Chapter on capital budgeting extends opportunity costs to a multiperiod setting This chapter can be skipped without affecting the flow of later material Alternatively, Chapter can be assigned at the end of the course Chapter applies the conceptual framework and illustrates the trade-off managers face between decision making and control in a budgeting system Budgets are a decisionmaking tool to coordinate activities within the firm and are a device to control behavior This chapter provides an in-depth illustration of how budgets are an important part of an organization’s decision-making and control apparatus Chapter presents a general analysis of why managers allocate certain costs and the behavioral implications of these allocations Cost allocations affect both decision making and incentives Again, managers face a trade-off between decision making and control Chapter continues the cost allocation discussion by describing the “death spiral” that can occur when significant fixed costs exist and excess capacity arises This leads to an analysis of how to treat capacity costs—a trade-off between underutilization and overinvestment Finally, the chapter describes several specific cost allocation methods such as service department costs and joint costs Chapter applies the general analysis of overhead allocation in Chapters and to the specific case of absorption costing in a manufacturing setting The managerial implications of traditional absorption costing are provided in Chapters 10 and 11 Chapter 10 analyzes variable costing, and activity-based costing is the topic of Chapter 11 Variable costing is an interesting example of economic Darwinism Proponents of variable costing argue that it does not distort decision making and therefore should be adopted Nonetheless, it is not widely practiced, probably because of tax, financial reporting, and control considerations Chapter 12 discusses the decision-making and control implications of standard labor and material costs Chapter 13 extends the discussion to overhead and marketing variances Chapters 12 and 13 can be omitted without interrupting the flow of later material Finally, Chapter 14 synthesizes the course by reviewing the conceptual framework and applying it to various organizational innovations, such as total quality management, just in time, six sigma, lean production, and the balanced scorecard These innovations provide an opportunity to apply the analytic framework underlying the text Required=Results Adaptive THE FIRST AND ONLY ADAPTIVE READING EXPERIENCE DESIGNED TO TRANSFORM THE WAY STUDENTS READ More students earn A’s and B’s when they use McGraw-Hill Education Adaptive products SmartBook® Proven to help students improve grades and study more efficiently, SmartBook contains the same content within the print book, but actively tailors that content to the needs of the individual SmartBook’s adaptive technology provides precise, personalized instruction on what the student should next, guiding the student to master and remember key concepts, targeting gaps in knowledge and offering customized feedback, and driving the student toward comprehension and retention of the subject matter Available on smartphones and tablets, SmartBook puts learning at the student’s fingertips—anywhere, anytime Over billion questions have been answered, making McGraw-Hill Education products more intelligent, reliable, and precise www.freebookslides.com vii Preface Acknowledgments William Vatter and George Benston motivated my interest in managerial accounting The genesis for this book and its approach reflect the oral tradition of my colleagues, past and present, at the University of Rochester William Meckling and Michael Jensen stimulated my thinking and provided much of the theoretical structure underlying the book, as anyone familiar with their work will attest My long and productive collaboration with Ross Watts sharpened my analytical skills and further refined the approach He also furnished most of the intellectual capital for Chapter 3, including the problem material Ray Ball has been a constant source of ideas Clifford Smith and James Brickley continue to enhance my economic education Three colleagues, Andrew Christie, Dan Gode, and Scott Keating, supplied particularly insightful comments that enriched the analysis at critical junctions Valuable comments from Anil Arya, Ron Dye, Andy Leone, Dale Morse, Ram Ramanan, K Ramesh, Shyam Sunder, and Joseph Weintrop are gratefully acknowledged This project benefited greatly from the honest and intelligent feedback of n umerous instructors I wish to thank Mahendra Gupta, Susan Hamlen, Badr Ismail, Charles Kile, Leslie Kren, Don May, William Mister, Mohamed Onsi, Ram Ramanan, Stephen Ryan, Michael Sandretto, Richard Sansing, Deniz Saral, Gary Schneider, Joe Weber, and William Yancey This book also benefited from two other projects with which I have been involved Writing Managerial Economics and Organizational Architecture (McGraw Hill Education, 2016) with James Brickley and Clifford Smith and Management Accounting in a Dynamic Environment (Routledge, 2016) with Cheryl McWatters helped me to better understand how to present certain topics To the numerous students who endured the development process, I owe an enormous debt of gratitude I hope they learned as much from the material as I learned teaching them Some were even kind enough to provide critiques and suggestions, in particular Jan Dick Eijkelboom Others supplied, either directly or indirectly, the problem material in the text The able research assistance of P K Madappa, Eamon Molloy, Jodi Parker, Steve Sanders, Richard Sloan, and especially Gary Hurst, contributed amply to the manuscript and problem material Janice Willett and Barbara Schnathorst did a superb job of editing the manuscript and problem material The very useful comments and suggestions from the following reviewers are greatly appreciated: Urton Anderson Howard M Armitage Vidya Awasthi Kashi Balachandran Da-Hsien Bao Ron Barden Howard G Berline Margaret Boldt David Borst Eric Bostwick Marvin L Bouillon Wayne Bremser David Bukovinsky Linda Campbell William M Cready James M Emig Gary Fane Anita Feller Tahirih Foroughi Ivar Fris Jackson F Gillespie Irving Gleim Jon Glover Gus Gordon Sylwia Gornik-Tomaszewski Tony Greig Susan Haka Bert Horwitz Steven Huddart Robert Hurt Douglas A Johnson Lawrence A Klein Thomas Krissek A Ronald Kucic Daniel Law Chi-Wen Jevons Lee Suzanne Lowensohn James R Martin Alan H McNamee Marilyn Okleshen Shailandra Pandit Sam Phillips www.freebookslides.com viii Preface Frank Probst Kamala Raghavan William Rau Jane Reimers Thomas Ross Harold P Roth P N Saksena Donald Samaleson Michael J Sandretto Richard Saouma Arnold Schneider Henry Schwarzbach Elizabeth J Serapin Norman Shultz James C Stallman William Thomas Stevens Monte R Swain Heidi Tribunella Clark Wheatley Lourdes F White Paul F Williams Robert W Williamson Peggy Wright Jeffrey A Yost S Mark Young To my wife Dodie and daughters Daneille and Amy, thank you for setting the right priorities and for giving me the encouragement and environment to be productive Finally, I wish to thank my parents for all their support Jerold L Zimmerman University of Rochester www.freebookslides.com Brief Contents Introduction 1 The Nature of Costs 22 Opportunity Cost of Capital and Capital Budgeting 85 Organizational Architecture 127 Responsibility Accounting and Transfer Pricing 161 Budgeting 216 Cost Allocation: Theory 280 Cost Allocation: Practices 327 Absorption Cost Systems 392 10 Criticisms of Absorption Cost Systems: Incentive to Overproduce 448 11 Criticisms of Absorption Cost Systems: Inaccurate Product Costs 483 12 Standard Costs: Direct Labor and Materials 538 13 Overhead and Marketing Variances 575 14 Management Accounting in a Changing Environment 609 Solutions to Concept Questions 655 Glossary 665 Index 675 ix www.freebookslides.com 676 Index ATMs, 613 AT&T, 170, 490, 626 automatic teller machines (ATMs) See ATMs average cost See also unit costs defined, 30 excess capacity and, 27–28 minimizing, 164–165, 165t production and, 30, 30f unit cost vs., 17 volume and, 422–424, 423f B balanced scorecards, 9, 626–632, 627f, 628t Bank of America, 234 Bank of Montreal, 626 banks ATMs and, 613 balanced scorecard failure, 631–632 budgeting and, 234 the Internet and, 13 basic estimating factors, 217 batch-level costs, 489 Bausch & Lomb, 175–176, 176t behavior basic concepts of, 128–133 controlling, decision management vs decision control, 143–144 dysfunctional, 227–229, 630 performance measurements and, 140 satisficing, 556–557, 556n2 benchmarking accounting variances and, 18 defined, payback method and, 105 performance and, 49 Best Buy, 170, 228 “big bath,” 227 big data, 13 bill of materials, 541 Boeing, 544 bond contracts, debt-to-equity ratio, book value, 393, 410–411 Boston Manufacturing Co., 505 bottleneck, 225, 561 bottom-up budgeting, 221, 224–225, 229–230 bottom-up technique for standard costing, 545 brand-name capital, 167, 503, 613 break-even analysis, 40 break-even point cost vs profit, 35–36 decision making and, 40 estimated vs real, 37 explanation of, 35 product bundles and, 40–41 British Electric Traction Co., 455 British Rail, 351 budgetary control, 217–218 budgeted volume, 576, 583–584 budget lapsing, 236 budgets/budgeting See also capital budgeting; participative budgeting applications, 218, 223, 224, 228, 229, 231, 234 assumptions in, 217, 224–225, 234 common practices in, 227 comprehensive illustration of, 242–251 corporate considerations in, 222–225 cost centers and, 164 criticisms in, 230 decision making in, 217–218, 222 decision management vs decision control, 226–233 defined, 217 economic crises and, 240 flexible, 236, 403–405, 579, 579f, 580f, 587 generic processes for, 219–226 importance, 232–233, 560 improving process of, 230–232 incremental budgets, 239–240 Kaizen costing, 545 line-item budgets, 235–236, 235t for overhead, 403–405 purpose of, 3, 18, 217, 225, 232 ratchet effect of, 227–229 rolling budgets, 234 short-run vs long-run, 233–235 static vs flexible, 236–238 volume changes and, 236–237 zero-based budgets, 239–240 Burnham Holdings, Inc., 588 business strategy, 612–615, 632–633 C CAM See computer-aided manufacturing (CAM) capacity See also excess capacity constraints on, 38 marginal cost and, 29 opportunity cost of, 460–461 capacity-sustaining costs, 489–490 capital budgeting, 86 complexities of, 99–104 decision making in, 2, 96–97, 98t discounting cash flow in, 98–99 profit centers and, 165 working capital and, 99 Carnegie, Andrew, 12, 395 carrying costs See holding costs CASB See Cost Accounting Standards Board (CASB) cash flow budgeting and, 234 cost allocations and, 285, 288 decision rights and, 137 depreciation and, 98n2, 103 discounting, 92, 95, 98–100 fixed costs and, 424 future value of, 2, 89–90 multiplicity in, 94–96 opportunity cost of, 96 www.freebookslides.com Index 677 payback method, 104–105 perpetuities and, 92–93 present value of, 90–91, 90f profit and, 87–88, 88t risk and, 99–100 T-accounts and, 396 taxes and, 102–104 time elements of, 86, 88, 96t variability in, 42 working capital and, 99 cash-flow return on investment See economic value added (EVA) Catalyst Paper Corporation, 590 Caterpillar Inc., 144, 544, 625 CFO See chief financial officer (CFO) chargeback systems, 178 Charles Machine Works, Inc., 557 Chicago White Sox, 223 chief financial officer (CFO), 9–11 Citicorp, 626 Coase, Ronald, 23, 135–136 Coca-Cola Company, 170 codes of conduct, function of, 11 Colgate, 51 common costs, 281–282, 296, 297–298, 345, 393 See also joint costs common resources activity-based costing and, 503 compensation and, 296 cost allocation of, 282 death spiral and, 228, 333 job order costing, 393, 396–397 marginal cost of, 299 practical capacity of, 332 compensation See also pay-for-performance budgeting and, 228 competition and, 557 cost allocation and, 296 education and, 87 for executives, 147–148, 162, 614 externalities and, 291 horizon problems and, 131 incentives and, 5, 130, 166, 220n3, 625 interest rate and, 101 inventory holding and, 453 organizational architecture and, 612 performance and, 140, 142, 173, 554, 557, 612, 629–632 price takers and, 50–51 stock options in, 162 competition change forces in, 615 monitoring, 13 operating leverage and, 43 price takers and, 50–51 pricing laws and, 16 standard costing, 557 TQM and, 618–619 transfer pricing and, 187n11 compound interest explanation of, 89–90 future value and, 89–90, 90f, 125t interval for, 95 computer-aided manufacturing (CAM), 560, 623 congestion costs, 48 Constellation Energy Group, 26 Continental Teves, 544 contracts advantages of, 128 agency problem and, 130 enforcing compliance with, 132, 136 markets vs firms, 135–137 contribution margin break-even point and, 35 defined, 35, 460 price and, 37, 52 variances vs., 588 control/control system, 3, 3n1, 11–12 See also decision management vs decision control controllability principle, 174–175, 237, 298 controllers, 10 See also accountants conversion costs, 47 Corning, 613 Cost Accounting Standards Board (CASB), 287 cost allocations See also absorption costing; specific cost allocation methods absorption costing vs activity-based costing, 484n1 applications, 285, 286, 288, 292, 329, 334, 339, 349, 351, 485 death spiral, 328–332 decision management vs decision control, 288–289 defined, 281 departments vs divisions, 333–344, 334f, 335f examples of, 281, 293–296 externalities and, 290–296 in hospitals, 284, 285 insulating vs noninsulating, 296–299 joint costs and, 344–353 in manufacturing, 283–284 methods of, 335–344 opportunity cost and, 294 pervasiveness of, 228, 281–286 reasons for, 286–291 role of, 18, 393 steps in, 282 as a tax system, 228, 289–290 transfer pricing and, 175, 339–342 in universities, 284–285 cost-based reimbursement, 287–288 cost centers, 162, 163–165, 163t cost drivers activity-based costing for, 496–499, 498f, 503 choosing, 489–494, 500–501 defined, 33 indirect costs and, 500 managing, 488 net benefits vs number of, 502, 502f for overhead, 414 for supervisors, 400 cost object, 281 cost of capital EVA and, 172 explanation of, 168–169, 168n3 residual income and, 170 www.freebookslides.com 678 Index cost of equity, 169 cost of goods, 6, 45 cost per ton mile, 48 cost-plus pricing, 54 cost pool, 411–412 costs See also specific kinds of costs activity measures, 33–34 agency problem and, 131, 132 applications, 26, 30, 45, 48 benefits versus, 86, 87 cost-volume-profit analysis, 35–44 decision rights and, 138 economic Darwinism, 8–9 estimating, 48–49 explanation of, 23, 50n5 identifying purposes of, internal vs external processes, 13 linear approximations of, 31–32, 32f, 37f marmots vs grizzly bears, minimizing, 164 pricing decisions and, 50–54 real-time analysis of, 13 reconciliation of, recording, structure of, 400 variation of, 29–35 cost systems, 13 cost-volume-profit analysis, 35–44 credit, effect of, 99 See also tax credits Crest, 51 customer base, 614 customer profitability analysis, 411 D Daihatsu, 545 data analytics, 13 DCF See discounted cash flow (DCF) analysis death spiral in cost allocations application of, 329 explanation of, 328–332 joint costs and, 346–348 resolving, 332 decision management vs decision control See also organizational structure balanced scorecards, 626 behavior, 143–144, 143f, 146 budgets/budgeting, 226–233 cost allocations, 288–289 framework for, 393 inventory accounting, 397 organizational architecture, 611–612 standard costs, 543–544 decision rights accounting for, 162 agency costs and, 146–147 asymmetric information and, 179–180 budgets and, 217, 236 (See also budgets/budgeting) cost allocations and, 288, 296 examples of, 14, 133–134, 144, 221 explanation of, 14, 133–134, 163t fixed vs variable costs, 459 incentives and, 137–138, 501 investment and, 167 knowledge and, 134–137, 163, 167, 221, 230, 232–233, 559, 612 market activity and, 136–137 partitioning of, 139, 140, 143, 218, 610, 611–612, 611f, 614–615 pay-for-performance and, 141, 142 performance measurement and, 141–142, 163, 186–187, 544 production and, 454 scorecard for, 626 TQM and, 619 wage variances and, 549–550 dedicated flow lines, 621 Dell Computer Inc., 626 demand budgeting for, 230–231 business strategies for, 612 for common resources, 296 controllability principle, 174 decision making for, 144, 233 externalities and, 292 JIT production and, 453–454, 620, 623 lean manufacturing and, 560, 625 macroeconomics of, 218, 344, 406, 503, 623 one-stop shopping and, 503–504 opportunity cost of, 27 pricing and, 224 profit maximizing and, 54 real-interest rate and, 101 technological change and, 615, 633 volume and, 422–424, 423f demand curve, 134 denominator volume See budgeted volume Department of Veterans Affairs (VA), 142 depreciation See also straight-line depreciation of assets, 27 capital budgeting and, 97 cash flow and, 98n2, 103 as commitment device, 333 controllability principle, 174 cost allocation and, 228, 333 inflation and, 101 responsibility accounting for, 164 taxes and, 102–104, 104t depreciation accounting, 27 direct allocation method, 335–336, 336t direct costing See variable costs/costing direct costs See also variable costs/costing allocating, 282 explanation of, 46 externalities and, 291 direct labor variances, 546–550, 547f direct materials variances, 550–554, 550f–552f DirecTV, 170 discounted cash flow (DCF) analysis capital budgeting and, 99 investment evaluation and, 104 IRR vs., 107–109 www.freebookslides.com 679 Index discount rates, 100 diversification, risk reduction with, 228, 554 double-declining-balance depreciation, 103–104 Drucker, Peter F., 505 dual transfer pricing systems, 177 E.I Du Pont de Nemours Powder Company, 168 Du Pont Powder Company, 12 Duriron Company Pump Division, 414 E earned volume See standard volume Eastern Corp See Toronto Engine Plant of Eastern Corp Eaton, 172 economic Darwinism absorption costing, 460 caveats, decision making and, 146–147 explanation of, 8–9 markets vs firms, 136 economic profit See economic value added (EVA) economic value added (EVA), 9, 170–175 effective annual interest, 95 Eisenhower, Dwight D., 217 electronic data interchange (EDI), 13, 622 embezzlement, 11–12, 130, 146 employee empowerment, 134 employee theft, 11–12, 130, 132 empowerment, 134, 619 Enron Corp., 26 Ernst & Young, 177 estimated costs, 540–541 See also standard costs ethics codes, 11 EVA See economic value added (EVA) excess capacity activity-based costing and, 504 death spiral and, 228, 333 fixed costs and, 332, 343 opportunity cost of, 27–28, 329, 422, 460 transfer pricing and, 179, 185, 187, 329 volume and, 410 expected volume, 406–410, 576 expense centers, 163n2 expenses, 24, 553 See also costs external failure costs, 619 externalities, 290–296, 555–557, 615–616 external reporting systems See also internal reporting systems cost allocations and, 286–287 procedures for, role of, 5, 5f, variable costing and, 460–461 F FASB See Financial Accounting Standards Board (FASB) Fast Change, 404–405, 406t, 407t Federal Reserve, 240 Fells, J., 455 FIAMA (textile firm), 460 Financial Accounting Standards Board (FASB), 5, 12 first-in, first-out (FIFO), 397, 419, 420 fundamental law of, 86–87 risk reduction, 228, 554 safe dollars vs risky dollars, 99–100 Fisher Body, 622 fixed costs ABC systems and, 491–492 average costs and, 146 death spiral and, 228 direct costs as, 47 excess capacity and, 332, 343 explanation of, 29, 29f operating leverage and, 42–43 overproduction and, 450–451, 450n2 price takers and, 50–51 pricing and, 50–52, 53t variability of, 29 variable costs vs., 30, 32n4, 185n10, 459 volume and, 406 flexible budgets See budgets/budgeting Florida Power & Light, 620 Ford Motor Company, 625 fraud, 11–12, 132, 138, 227 free-rider problem, 131, 132, 220n3, 453, 556 Friendly Supermarket, 588, 589t, 590t full cost, 185–187, 187t future cash flows See cash flow future value (FV) of annuities, 93–94, 126t compound interest and, 89–90, 90f equation for, 90 G GAAP See generally accepted accounting principles (GAAP) Garcke, E., 455 General Electric, 218 generally accepted accounting principles (GAAP), 403, 461n3 General Motors, 13, 166, 175, 281, 622 GlaxoSmithKline, 178 goal incongruence, 133 Goetz, B., 505 Greenspan, Alan, 240 gross margin, 12, 145 H H J Heinz, 227 Haier, 141 Harley-Davidson, 624 Hewlett-Packard, 623 historical costs depreciation, 101, 333 explanation of, 24 opportunity cost and, 27, 45, 449, 503, 539 period/product costs as, 46 www.freebookslides.com 680 Index historical costs—Cont reporting of, 45 resource acquisition and, 502 standard costs and, 540 value of, 8–9, 539 volume and, 410 holding costs, 453, 555 Home Depot, 626 Honda, 31–32 horizon problem, 131, 131t Hughes Communications, 240 Hyundai, I IBM, 13, 334 Illinois Tool Works, 508 implementation, decision making and, 143, 144, 222 incentives agency problem and, 133 budgeting and, 226n5, 228–229, 232, 236, 237 compensation and (See compensation) cost allocations and, 228, 296 decision rights and, 137–138, 501 effects of, 554–557 EVA and, 173 markets vs firms, 137 moral hazard problem and, 133 net income and, 167 productivity and, 131 residual income and, 171 ROI and, 169 sales and, 15–17 stock options and, 162 transfer pricing and, 179 welfare and, 128 income statements absorption costing, 455–456, 455t T-accounts in, 397, 398t incremental budgets See budgets/budgeting indirect cost pools, 284 indirect cost rate, 284 indirect costs See common costs; overhead inflation adjusting for, 541 budgeting and, 220, 238 interest and, 100–101 risk and, 111 transfer pricing and, 187 information asymmetry, 130, 179–180 information system accounting system as, decision making and, explanation of, function of, 334 supplementing data from, 17 information technology See also technology advances in, 13 big data and, 13 cost allocation, 282, 341 costs of, customer service and, 613 performance measurement and, 141 transfer pricing and, 188 initiation, decision making and, 143, 144, 222 Inktomi Corp., 45 Innophos Holdings, Inc., 591 installed base, 223 Insteel, 500 insulating allocation, 297–298 insurance, adverse selection and, 133 Intel, 29, 452, 626 interest See also compound interest; effective annual interest; nominal interest rate; real interest rate as an opportunity cost, 27 compounding, 89 future cash flow and, 99 future value and, 89–90 inflation and, 101 IRR and, 107 law of one interest rate, 94, 99 multiple cash flows and, 94–95 internal accounting system See also accounting systems characteristics of, decision making and, 5–6, 45 explanation of, goals of, performance measurement and, 140–142 purpose of, 3, 4, 393 trade-offs with, when to change, 632–633 internal auditors, 10–11, 144 internal control system See control/control system internal failure costs, 619 internal rate of return (IRR) cash flow and, 107–110 numerical solution for, 108n4 practical use of, 110, 110t internal reporting systems See also external reporting systems procedures for, role of, 5–6, 5f structure of, 9–10, 10f variable costing and, 460–461 Internal Revenue Service (IRS) Advance Pricing Agreement Program, 178 cost allocation requirements, 461 depreciation methods and, 102 role of, tax evasion and, 176 International Organization of Standards (ISO), 617 international taxation, 175–176 international trade, regulation of, inventory See also stock-turn ratio cost of goods sold and, 6, 45 fixed vs variable costs, 451t, 459 holding costs for, 453, 555 incentives for, 555 interest and, 99 JIT production and, 453–454 www.freebookslides.com 681 Index keeping track of, 2, 3, 48 LIFO vs FIFO, 397 managing, 10, 623 opportunity cost and, 25, 555 penalties for, 453 throughput time and, 621 turnover ratio for, 622 investment centers, 162, 163t, 166–170 IRR See internal rate of return (IRR) IRS See Internal Revenue Service (IRS) ISO 9000, 617 ITT Automotive Division See Continental Teves J job order costing averaging, 415 explanation of, 393–394 multiple products and, 394–395, 395t overhead and, 398–399 process costing vs., 415 schematic of, 398f Jobs, Steve, 134 joint benefits, 354 joint costs, 344–353, 348f, 349, 505 joint products, 344, 345f, 346, 351, 505 just-in-time (JIT) production systems, 453–454, 550, 620–624, 633 K Kaiser Aluminum, 170 Kaizen costing, 545 Kerviel, Jérôme, 132 key performance indicators, 626 knowledge creation of, 614–615 decision rights and, 134–137, 163, 167–169, 221, 230, 232–233, 559, 612 KPMG, 626 L labor direct variances for, 546–550, 547f incentive effects of, 554–557 JIT manufacturing and, 622 opportunity cost of, 25 labor efficiency variance, 549–551 last-in, first-out (LIFO), 397, 419 law of one interest rate, 94, 99 law of one price, 87 lean accounting systems, 9, 560, 625 lean manufacturing, 560, 625 liability, costs and, 26 LIFO (last-in, first-out), 397, 419 Lincoln Electric Company, 141 line-item budgets See budgets/budgeting L.L Bean, 503–505 loans, agency problems and, 147 Lockheed Martin, Lord & Taylor, 145 M Macy’s, 145 Madoff, Bernie, 138 management accounting See also internal accounting system applications, 613, 614, 617, 618, 620, 622, 624, 625, 629, 632–633 in China, 399, 614 cost allocations and, 188, 489f (See also cost allocations) evolution of, 12–15 framework for, 14f ideality in, 632–633 organizational innovations and, 610, 616–632 (See also specific innovations) purpose of, 12 technology advances in, 13 manufacturing absorption costing for, 393, 450–451, 495 (See also absorption costing) activity-based costing in, 496, 498, 506 changes in, 414, 615 computer-aided, 560, 623 cost allocation in, 282, 334, 415 (See also cost allocations) factory volume in, 399 fixed costs in, 454 flexible budgeting for, 238 flexible systems for, 559 ISO 9000 certification for, 617 job order costing in, 394–395 just-in-time, 550 leanness in, 560 opportunity cost of, 25, 460 organizational architecture and, 139–140, 162 overhead in, 46, 403 (See also overhead) performance measures for, 14, 141, 555 process type, 393 reporting costs of, 6, 12, 45 standard costing in, 541, 543 throughput of, 621 transfer pricing and, 176, 183 marginal cost average cost and, 295 defined, 29 overhead and, 293f–295f production and, 29, 30f transfer pricing and, 182 marginal revenue, 36 margins, pricing and, 54 marketing variances See variances market power chain reactions in, 615 decision making and, 135–137 example of, 51–53 explanation of, 51 market pricing, 181–182, 187, 187t www.freebookslides.com 682 Index Marshall Field’s, 13, 145 master budget, 244f materials direct variances of, 550–554, 550f–552f JIT manufacturing and, 621 opportunity cost of, 24–25 McDonald’s, 626 McDonnell Douglas, 620 McKinsey, James O., 164, 217, 232, 288 McKinsey & Co., 164, 217 Medicare, 339 Medicare Cost Report, 339 Medici family, Medsupplies, 15–17 MetLife, 553 Metro-Goldwyn-Mayer Inc (MGM), 30 Microsoft, 231 mixed costs, 33, 33f mix variances See variances Mobil, 626 monitoring See also mutual monitoring decision making and, 143, 144, 222 mutual, 298, 408, 556 Montgomery Ward, 145 moral hazard problem, 133 motion studies, 49 Motorola, 624 mutual monitoring, 298, 408, 556 N NAFTA See North American Free Trade Agreement (NAFTA) National Aeronautics and Space Administration (NASA), National Institutes of Health, 284 National Science Foundation, 284 negative externality, 291, 292 negotiated transfer prices, 186, 187t Nestlé Waters Division, 224 net income, 167–169 net present value (NPV) See also discounted cash flow (DCF) analysis costs vs benefits, 87 decision making and, 96–97, 98t depreciation and, 103, 104t explanation of, 92 IRR and, 107–110, 109f payback method and, 105 practical use of, 110, 110t process improvements, 131, 131n6 warranties and, 103 net realizable value (NRV) as allocation method, 348–351, 348f decision making and control, 352–353 defined, 345f, 346 Nissan, 544, 545 nominal interest rate, 101 noninsulating allocation, 228, 297–298, 298n3, 299, 353 normal volume, 406–410, 576 North American Free Trade Agreement (NAFTA), 615 Norwegian StatOil, 234 NPV See net present value (NPV) NRV See net realizable value (NRV) O Obamacare, 620 objectives, financial, 2–3 OLAP See online analytical process (OLAP) one-stop shopping, 503–504 online analytical process (OLAP), 13 operating leverage, 42–43, 45 opportunity cost See also holding costs accounting costs vs., 45–48 activity-based costing measurement of, 503 application, 86–87 of capacity, 460–461 cash flow and, 96 characteristics of, 24 cost allocation and, 294 decision making based on, 24–28 defined, 23, 86 determining, 23–24 estimating, 45 of excess capacity, 27–28, 329, 422, 460 explanation of, 17 interest and, 94, 96 marginal cost and, 181–182 market price and, 182 for overhead, 398–400 (See also overhead) profit and, 87, 89t purpose of, 23 residual income and, 169 standard costs as, 541, 543 time element of, 86 transfer pricing and, 178, 179–180 opportunity loss, 87 organizational structure accounting’s role in, 145–147 applications, 130–133, 135–139, 141, 142, 144, 145 architecture of, 14–15, 139–145, 162, 217, 544, 610, 616, 618–619, 626, 633 decision making and, 14, 611 management accounting and, 12–13, 14f outline of, 9–10, 10f short-run vs long-run budgets, 233–235 three-legged stool of, 139–142 output defined, 33 maximizing, 164 revenue and, 36 outsourcing, 182, 184 overhead ABC systems and, 488, 508, 508n11 absorbed, 580f, 581 absorption costing vs variable costing, 457–458, 458t applications, 404, 414, 588, 590, 591 components of, 404 cost allocation of, 282–283, 286, 293–295, 293f–295f, 412f www.freebookslides.com 683 Index direct costs vs., 46–47 expected vs normal volume, 406–409 explanation of, 46–47 fixed vs variable, 579–580 flexible budgeting for, 403–405 GAAP and, 403 overabsorbed/underabsorbed, 400–403, 407–408, 539 permanent vs temporary volume, 410 plantwide vs multiple rates for, 411–415, 412f, 413f profit centers, 165–166 rates of, 398–400 T-accounts for, 401, 403 tracking of, 488, 577 variances in, 579–588, 585f overhead efficiency variance, 583, 585 overhead rate, 580–581 overhead spending variance, 582 overhead volume variance, 583–585 overproduction absorption costing and, 449, 450–451 applications, 452 profit margins and, 450t, 484 residual income and, 453t unit costs and, 165 variable costing and, 454–461 P Parker Brass, 543 Parker Hannifin Corporation, 543 participative budgeting, 229–230 payback method, 104–105 pay-for-performance, 141, 142 PepsiCo, 613 perfect substitutes, 51 performance evaluation system cooperation and, 556 cost minimization and, 501 decision rights and, 612 mutual monitoring and, 556 performance measures See also specific types abuse of, 142 balanced scorecards and, 629–630 budgeting and, 221–222, 232, 234 controllability principle and, 174 financial vs nonfinancial, 140–142 importance of, 14 investment centers and, 166 JIT manufacturing and, 621 managerial motivation and, 173 objective vs subjective, 139–140 overhead variances and, 587 purpose of, 14 scorecard for, 142 stock price as, 162 transfer pricing and, 186 period costs, 45, 46 perpetuities, 92–93 P&G See Procter & Gamble (P&G) Philips Electronics, 629 planning See also strategic planning accounting control systems and, 10, 13 activity-based costing and, 500 budgets and, 217, 224, 243 decision making and, 3, 4, 12, 228–229 importance of, 217 lean production and, 625 target costing and, 545 Ponzi scheme, 138 positive externality, 291, 292 practical capacity, 332, 332n1 present value (PV) for annuities, 93, 124t compound interest and, 95–96, 95t, 123t computing, 88, 90–91 of multiple cash flows, 94–96 prevention costs, 619 price takers, costs and, 50–51 price variances See variances pricing See also transfer pricing costs and, 50–54 decision making and, 134 maximizing profit and, 52, 54 principal-agent problem See agency problem Principal Financial Group, 240 process costing as averaging, 415 explanation of, 393–394 systems for, 416–422 procrastination decision, 86 Procter & Gamble (P&G), 484 product costs absorption costing for, 450 activity-based costing for, 414, 499–505, 507, 508 allocating, 282 categorization of, 489f customer profitability analysis, 411 explanation of, 45, 46 fixed costs as, 454 inaccuracy in, 449, 484–488, 505 JIT manufacturing and, 624 job order cost system for, 398–399 labor costs and, 559 overhead and, 47–48, 403 period costs vs., 46, 47 standard costing, 551, 558 target costing, 545 unit costing and, 461–463 volume and, 407–408, 410, 581 production See also manufacturing defined, 345 inventory and, 550 markets vs firms, 135–137 volume and, 577–578 production planning system, productivity, 131 product-level costs, 489 product line cannibalization, 28 www.freebookslides.com 684 Index profit abnormality in, 92 calculating, 37 cost allocations and, 285, 484 cost-volume-profit analysis, 35–44 executive compensation and, 147–148 explanation of, maximizing, 2, 16–17, 35–36, 39, 51, 53t, 164, 165t, 166, 423 payback method and, 105 pricing and, 54 taxes and, 102 profit centers, 162, 163t, 165–166, 174, 178 projected costs, 540 See also standard costs Public Company Accounting Reform and Investor Protection Act See Sarbanes-Oxley Act of 2002 PV See present value (PV) Q quality See also Total Quality Management (TQM) costs of, 619–620, 620f JIT manufacturing and, 621 quantity variances See variances R ratchet effect, 227–229, 556 ratification, decision making and, 143, 144, 222 real interest rate, 101 reciprocal allocation method, 342–344, 354–356, 355t reconciliation of costs, reinvestment rate, 109 relevant range, 32 reporting systems, See also external reporting systems; internal reporting systems residual income EVA and, 170–171 explanation of, 169–170, 170t overproduction and, 453, 453t resource utilization activity-based costing and, 501 cost allocations and, 285, 295–296 opportunity cost and, 543 overhead and, 398–399 responsibility accounting See also transfer pricing applications, 164, 166, 168, 169, 172, 174 controllability principles, 174–175 cost centers, 163–165 economic value added, 170–173 explanation of, 162–163 investment centers, 166–170 profit centers, 165–166 return on capital, 172 return on investment (ROI) historical application of, 168 investment centers and, 166, 167–169 net present value and, 105–107 return on net assets (RONA), 167 return on total assets (ROA), 167, 622 revenue See also marginal revenue curve for, 35, 36f, 37f gross margin and, 12 incremental, 16 incremental cost vs incremental revenue, 16–17 maximizing, 51 opportunity cost and, 24 revenue centers, 163n2 rewards budgeting and, 232 costs and, 15–17 performance and, 14, 141–142, 222 sales revenue and, 15 risk budget lapsing and, 236 cash flow and, 99–100 cost of capital and, 169 cost of equity and, 169 discount rate, 99–100 diversification of, 228, 554 effects of, 87 estimating, 43 fixed costs and, 30 interest rate and, 94 internal consulting and, 11 operating leverage and, 42, 43, 45 price takers and, 50–51 reducing, 554 Sarbanes-Oxley Act and, 11, 26 risk management, 11, 132 ROA See return on total assets (ROA) Robinson-Patman Act, 16 ROI See return on investment (ROI) rolling budgets See budgets/budgeting RONA See return on net assets (RONA) routing sheets, 541 S Safety-Cleen, 135 Saia Inc., 618 sales budgeting and, 224, 227 costs and, 15–17 incentives and, 15–17 ROI and, 168 variances in (See variances) Salt Union Limited, 455 sandbagging, 227 Sarbanes-Oxley Act of 2002, 11, 26 satisficing behavior, 556–557 Sears, Roebuck and Co., 13 Securities and Exchange Commission (SEC), 5, 10 segment reporting, 353–354, 353t semivariable costs See mixed costs shareholder value added See economic value added (EVA) Shinseki, Eric, 144 short-run vs long-run budgets, 233–235 single unit-based allocation system, 495–496 Six Sigma, 624–625 www.freebookslides.com 685 Index slope, defined, 30n3 Smith, Adam, 137 social media, time and cost of, 131 Société Générale, 132 Sony, 626 spend management, 553 SRM See supplier relationship management (SRM) standard costs abandonment of, 559, 560–561 agency problems and, 146 applications of, 543–545, 557, 560 as benchmark, 18, 539, 541 decision management vs decision control, 543–544 defined, 539 direct labor and, 546–554 disposition of variances, 557–559 explanation of, 539–546 implementation costs, 559–561 incentive effects of, 554–557 pervasiveness of, 541 purpose of, 576 reasons for, 540–541 risk reduction and, 554 setting, 541–544 variances in, 543 (See also variances) Standard & Poor’s, 230 standard volume, 576, 581t, 583–584 Stanford University, 284 static budgets See budgets/budgeting step costs, 33, 33f step-down allocation method, 337–339, 337f, 338t, 340–342 Stern Stewart & Co., 170n4 stock market arbitrage in, 132 cost of equity in, 169 forward looking, 162 stock-turn ratio, 12, 145 stock-turn ratio, 12, 145 straight-line depreciation double-declining-balance vs., 104 historical costs and, 27 IRS rules for, 102 strategic planning, 233–234 sunk costs, 25–26, 99 supplier relationship management (SRM), 553 sustainability programs, 25 T T-accounts in income statements, 397, 398t for overhead, 401, 403 target costing, 544, 545–546 See also standard costs tax credits, 174 taxes See also international taxation cash flow and, 102–104 depreciation and, 103, 104t tax shields, 103 teamwork See also productivity free-rider problem, 131, 132, 220n3, 453, 556 target costing, 544 value of, 128 technology See also information technology budgeting and, 229 changes in, 449, 615 computer-aided manufacturing, 560, 623 cost allocation, 282 operating leverage and, 45 organizational architecture, 611, 616 social media and, 131 spending variances and, 582 Tenneco, 626 Teva Pharmaceutical Industries Ltd., 183 Textron, 625 Thompson Steel Works, 395 throughput accounting, 460 throughput time, 621, 622–623 time studies, 49 time value of money, 105, 106 Time Warner, 233 top-down budgeting, 224–225, 229–230 top-down technique for standard costing, 545 Toronto Engine Plant of Eastern Corp., 576–578, 577t, 578t, 581t, 584t total business return See economic value added (EVA) total cost activity-based costing systems and, 491–492 cost allocations and, 293–296, 293f–295f curve for, 29f, 30f, 32f, 36f equations for, 32, 36 operating leverage and, 42–43 Total Quality Management (TQM), 610, 617–620, 620f Toyota, 503, 545, 623, 625 TQM See Total Quality Management (TQM) transfer pricing See also cost allocations applications, 177, 178, 182, 183 cost allocations and, 175, 339–342 death spiral of, 228 defined, 175 economics of, 177–181 excess capacity and, 179, 185, 187, 329 manufacturing and, 176, 183 methods of, 181–186, 187t opportunity cost and, 178, 179–180 reorganization, 186 taxation, 175–176 variable costs/costing and, 182–185, 187, 187t, 454 U UMC See unit manufacturing cost (UMC) Unilever, 234 unit costs See also average cost computing, 6, 54 excess capacity and, 27–28 hazards of, 449 incremental costs, 16–17 for railroads, 48 www.freebookslides.com 686 Index United Airlines, 29 United International Pictures, 30 unit-level costs, 489, 490 See also unit costs unit manufacturing cost (UMC), 46 U.S Constitution, 143 U.S Department of Defense, 287 U.S Steel, 13, 395 V VA See Department of Veterans Affairs (VA) value agency problem and, 133 balanced scorecard and, 629–630, 630f decision rights and, 134 markets vs firms, 136–137 maximizing, 2, standard costing and, 561 variable costs/costing applications, 455, 460 as approximation of marginal cost, 32 direct costs as, 46 explanation of, 31 fixed costs vs., 30, 32n4, 185n10, 454 on income statements, 455–456, 455t overproduction and, 449 (See also overproduction) pricing and, 52, 53t problems with, 458–460 transfer pricing and, 182–185, 187, 187t, 454 variable cost systems, 18 variances activity-based costing and, 503, 507 applications of, 588, 590, 591 in budgeting, 219–222, 227, 240, 459, 543 calculating, 18 controlling, 624 in direct labor, 546–550, 547f disposition of, 557–559 exception reports, 543 explanation of, 539 Kaizen costing, 545 in marketing, 588–591 in materials, 550–554, 551f, 552f mix variance, 589–591 in overhead, 579–588 overhead and, 401, 457 performance measurement with, 540 price variances, 588 quality and, 617–618 quantity variances, 588 randomness of, 541 reasons for, 582 sales variance, 589–591 VBL Co., 496 volume activity-based costing and, 499–501 cost-volume-profit analysis, 35–44 operating leverage and, 42–43 terminology in, 576 Vortec Inc., 15–18 W weighted average method, 420–421 Whirlpool Corp., 170 WIP See work in process (WIP) working capital, 99 work-in-process (WIP) appraisal costs for, 619 costing of, 552, 557–558 JIT manufacturing and, 620–622 opportunity cost of, 25 overhead and, 401, 403, 407, 581 process costing of, 415–418, 418t, 420t T-accounts for, 396 X Xerox Corp., 35–36, 41, 175, 223, 233, 613, 615 XHTML, 13 Y Yahoo!, 45 Z zero-based budgets See budgets/budgeting www.freebookslides.com www.freebookslides.com www.freebookslides.com www.freebookslides.com ...Ninth Edition Accounting for Decision Making and Control Jerold L Zimmerman University of Rochester ACCOUNTING FOR DECISION MAKING AND CONTROL, NINTH EDITION Published by McGraw-Hill... necessary for planning and making decisions (decision making) and (2) to help motivate and monitor people in organizations (control) The most basic control use of accounting is to prevent fraud and. .. accounting provides information for planning decisions and control It is useful for assigning decision- making authority, measuring performance, and determining rewards for individuals within