ixth edition Managerial Accounting James Jiambalvo Quickly identify areas of strength and weakness before the first exam, and use the information to build a learning path to success. MANAGERIAL ACCOUNTING Managerial… Managerial A little time with ORION goes a long way. Based on usage data, students who engage in ORION adaptive practice—just a few minutes per week—get better outcomes. In fact, students who used ORION five or more times over the course of a semester reported the following results: Managerial Accounting A Note to Students… Dear Students of Managerial Accounting, Managerial Accounting is concerned with using information to effectively plan and control operations and make good business decisions. The overall objective of this book is to provide you with the concepts and tools needed in planning, control, and decision making. I’ve taught Managerial Accounting for many years, and my former students, many of whom are in senior executive positions, tell me that they’ve used these concepts and tools throughout their business careers. So, trust me. Work hard in this course, and you will reap major benefits! In approaching the course, realize that you need to take personal responsibility for your success. Of course your instructor will help you understand the material, but you’re the one who must make time to read the material before class and complete all assigned problems and cases. I recommend that you take a three-step approach to the study of each chapter in Managerial Accounting: • First, skim the chapter for a quick overview. • Second, read the chapter carefully, and pay particular attention to the illustra- tions. When you’re finished, make sure you understand each of the learning objectives. • Third, enhance and test your knowledge using the materials within WileyPLUS. If at all possible, you should also form a study group with one or two of your classmates. You’ll learn a lot from each other, and going over the homework together may actually be fun! With my best wishes for success, Jim Jiambalvo Dean and Kirby L. Cramer Chair in Business Administration Michael G. Foster School of Business University of Washington Sixth Edition Managerial Accounting James Jiambalvo University of Washington To my wife, Cheryl Vice President & Director George Hoffman Executive Editor Michael McDonald Associate Development Editor Rebecca Costantini Senior Content Manager Dorothy Sinclair Production Editor and Media Specialist Elena Santa Maria Marketing Manager Lauren Harrell Product Design Manager Allison Morris Senior Product Designer Greg Chaput Design Director Harry Nolan Cover and Interior Designer Maureen Eide Senior Photo Editor Mary Ann Price Cover Photo Malerapaso/Getty Images, Inc. This book was set in 10/12 Minion Pro Regular by Aptara, Inc. and printed and bound by Quad Graphics/Versailles. The cover was printed by Quad Graphics/Versailles. Tape measure icon credit: Image Source/Getty Images This book is printed on acid free paper. Founded in 1807, John Wiley & Sons, Inc. has been a valued source of knowledge and understanding for more than 200 years, helping people around the world meet their needs and fulfill their aspirations. Our company is built on a foundation of principles that include responsibility to the communities we serve and where we live and work. In 2008, we launched a Corporate Citizenship Initiative, a global effort to address the environmental, social, economic, and ethical challenges we face in our business. Among the issues we are addressing are carbon impact, paper specifications and procurement, ethical conduct within our business and among our vendors, and community and charitable support. 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Printed in the United States of America 10 9 8 7 6 5 4 3 2 1 About the Author JAMES JIAMBALVO, Dean of the Michael G. Foster School of Business at the University of Washington and Kirby L. Cramer Chair in Business Administration, joined the accounting faculty at Foster after receiving a Ph.D. in accounting from The Ohio State University. A CPA, he has audit experience with the firm of Haskins and Sells (now Deloitte & Touche), and has served on the national academic advisory board of Deloitte & Touche LLP. Dean Jiambalvo has served as chairman of the University of Washington Accounting Department and previously held the PricewaterhouseCoopers and Alumni Endowed Professorship. Dean Jiambalvo’s research has been published in top accounting journals, including The Accounting Review, Contemporary Accounting Research, the Journal of Accounting and Economics, and the Journal of Accounting Research. He is a former associate editor of The Accounting Review and has served on the editorial boards of The Accounting Review, Contemporary Accounting Research, and the Journal of Management Accounting Research. Dean Jiambalvo has received the Notable Contribution to the Auditing Literature Award, the Burlington Northern Foundation Faculty Achievement Award, the Andrew V. Smith Faculty Development Award, and the Lex N. Gamble Award for Excellence in the Field of E-Commerce. He has also been recognized for his teaching of mana- gerial accounting with the MBA Professor of the Year and Professor of the Quarter awards. He has taught numerous executive education courses, including courses for Alcoa, Boeing, Microsoft, Tyson, and other major firms. He currently serves on the board of Saltchuk Resources. ix What’sNew? WileyPLUS with ORION WileyPLUS with ORION is an adaptive study and practice tool that helps students build proficiency in course topics. Over 3,500 new questions are available for practice and review. Updated Design and Content A redesigned interior and new learning objective structure help students practice their understanding of concepts before they progress to different topics in other learning objectives. This provides a more organized learning experience. WileyPLUS Solution Walkthrough Videos Newly created solution walkthrough videos are available within the eText and as homework assistance. Approximately 50 videos are newly available to the Sixth Edition. The videos serve as guides through homework problems and solutions and review chapter-level concepts. Additional WileyPLUS Practice Students have more opportunities within WileyPLUS to practice questions that are similar to the ­end-of-chapter content before completing homework. Revised Excel Templates New Excel templates offer “What if?” scenarios to help students apply their understanding of Excel and chapter concepts from different perspectives. Links to Practice New Links to Practice throughout the textbook have an even stronger focus on engaging, real-world issues. xi Preface This book is intended to drive home the fundamental ideas of managerial accounting and motivate students to actually want to study the subject. As you will see, the text has a number of unique features that help accomplish these goals. Based on my teaching experi- ence and from what we have heard from professors using the previous editions, we believe students and professors want a textbook that: • Recognizes that most students will become managers, not accountants • Focuses attention on decision making • Stresses the fact that “You Get What You Measure” • Motivates students to learn managerial accounting by connecting concepts and techniques to the real world • Recognizes the growing importance of service businesses • Is clear, concise (can be covered in one semester), and current • Provides students with ample opportunities to test their knowledge. Here’s how the sixth edition of Managerial Accounting reflects these desires. Recognizes that most students will become managers, not accountants. Most students of introductory managerial accounting will pursue careers as managers, not accountants. Future managers most likely will not need to know the FIFO approach to process costing or how to calculate four overhead variances—so these and other less essential topics are not covered. Focuses more attention on decision making. Instructors want their students to be able to solve the types of problems that real managers face. This requires that more emphasis be placed on decision making skills. Accordingly, three of the chapters (Chapters 7, 8, and 10) focus specifically on decision making. Additionally, decision mak- ing, and the use of incremental analysis, are discussed in the first chapter and integrated throughout the book. By the time students get to Chapter 7 (The Use of Cost Information in Management Decision Making), they will already have a good understanding of costs that are relevant in making a decision. After reading Chapter 7, working homework prob- lems and discussing the material in class, students will have a greater understanding of decision making! Stresses the fact that “You Get What You Measure” Senior managers know that performance measures greatly affect how subordinates focus their time and attention. Thus, the subject of performance measurement is of great practical importance. In this book, every chapter makes reference to the critical idea that You get what you measure. Chapter 12 has an extensive discussion of performance measures. Motivates students to learn managerial accounting by connecting concepts and techniques to the real world. Business people often say that they wish they had known how important managerial accounting would have been to their success on the job— they would have studied the subject harder in school! Here, every effort is made to convince students that managerial accounting is of critical importance in the real world. Link to xii P r e f a c e xiii Practice boxes relate the text material to real companies. Additionally, each chapter has cases developed with feedback from managers who attested to their realism and relevance. An often-heard comment: “We had that exact situation at my company!” Recognizes the growing importance of service businesses. In the last 20 years, employment has shifted from manufacturing to the service sector. Now, more than 75% of all jobs are in the service economy. With this in mind, numerous examples of service companies are in the chapter and end-of-chapter materials. Clear, concise (can be covered in one semester), and current. According to students and faculty who used the previous editions, a major and much appreciated strength of the text is the clear and concise writing style. Discussions are to the point, ideas are illustrated, and examples are presented to make the ideas concrete. The entire text can be comfortably covered in one semester. Coverage is also up-to-date, including: Theory of Constraints, Economic Value Added, The Balanced Scorecard, Strategy Maps, Activity- Based Costing and Activity-Based Management, Why Budget-Based Compensation Can Encourage Padding and Income-Shifting, etc. Provides students with ample oppourtunities to test their knowledge. In each chapter, students are presented with a feature called Test Your Knowledge. At the end of each chapter, there are two comprehensive review problems as well as several multiple choice problems with solutions. These features allow students to assess their understad- ing of the material as they read through the chapter as well as after they have finished reading the entire chapter. The features also set students up for success in completing end- of-chapter assignments. WILEYPLUS Resources WileyPLUS is an innovative, research-based online environment for effective teaching and learning. WileyPLUS builds students’ confidence because it takes the guesswork out of studying by providing students with a clear roadmap: what to do, how to do it, if they did it right. Students will take more initiative, so you’ll have greater impact on their achievement in the classroom and beyond. Instructor Resources Solutions Manual The Solutions Manual provides detailed solutions for all end-of-chapter questions, exer- cises, problems, and cases. Test Bank The Test Bank consists of over 2,000 examination questions and exercises accompanied by solutions. Question types include true-false, multiple choice, completion, exercises, and short-answer. Instructor’s Manual The Instructor’s Manual is a comprehensive resource guide designed to assist professors in preparing lectures and assignments. The manual includes chapter reviews, lecture outlines, assignment classification tables, teaching illustrations, and quizzing exercises. xiv P r e f a c e PowerPoint™ Presentations PowerPoint™ Presentations contain key concepts and images from the textbook. Student Resources Study Guide The Study Guide is comprised of a chapter review with true-false question, multiple- choice exercises, and problems. Excel Templates The Excel Templates help students to complete select end-of-chapter exercises and problems identified by an icon in the margin of the textbook. Acknowledgments I am indebted to my academic colleagues and former students for enriching my understanding of managerial accounting. The team at Wiley provided expert help, guidance, and support throughout the publication process. In particular, Michael McDonald, executive editor, made a number of valu- able suggestions for improving the sixth edition. Other Wiley staff who contributed to the text and media are: Rebecca Costantini, associate development editor; Allie Morris, product design manager; Greg Chaput, senior product designer; Elena Santa Maria, production editor; Maureen Eide, senior designer; Mary Anne Price, senior photo editor. Other individuals whose input is greatly appreciated are indicated below. Ancillary Authors, Proofers, and Accuracy Checkers for the Sixth Edition LuAnn Bean, Florida Institute of Technology; Debby Bloom CMA, CFM; Bea Chiang, The College of New Jersey; Jill Misuraca, University of Tampa; Alice Sineath, University of Maryland University College; Diane Tanner, University of North Florida; Melanie Yon, WileyPLUS developer. Reviewers The development of this sixth edition of Managerial Accounting benefited greatly from the com- ments and suggestions of colleagues who teach managerial accounting. I would like to acknowledge the contributions made by the following individuals: Stephen Asare, University of Florida; LuAnn Bean, Florida Institute of Technology; Brenda Bradford, Missouri Baptist University; Kurt Fanning, Grand Valley State University; Amanda Farmer, University of Georgia, Athens; Timothy Foley, University at Albany; George Gerner, University at Albany; John Giles, North Carolina State University; Michael Hammond, Missouri State University; Catherine Katagiri, The College of Saint Rose; Ethan Kinory, Baruch College; Curtis Ksenak, Saint Joseph’s College; Gary Laycock, Ivy Tech Community College; Daniel McGeough, Mt. San Antonio College; Christopher McKittrick, North Carolina State University; James McKittrick, University of Portland; Michael Newman, University of Houston; Jorge Romero, Towson University; Anwar Salimi, University of Laverne; Jason Stanfield, Purdue University, West Lafayette; Michael Sweeney, Hillsdale College; Diane Tanner, University of North Florida; Robin Thomas, North Carolina State University; Kim Walker, Johnson C. Smith University Prior Edition Reviewers Ajay Adhikari, American University; Gilda Agacer, Monmouth University; Natalie Allen, Texas A&M University; Sekhar Anantharaman, Indiana University of Pennsylvania; Christie Anderson, Whitworth College; Walt Austin, Mercer College; Noah Barsky, Villanova University; Connie Belden, Butler Community College; William Blosel, California University of Pennsylvania; Cynthia Bolt, The Citadel— The Military College of South Carolina; Nat Briscoe, Northwestern State University; Wayne Bremser, Villanova University; Ann Brooks, Central New Mexico Community College; Carol Brown, Oregon State University; Leonor Cabrera, San Mateo County Community College; Betty Chavis, California State University, Fullerton; Richard Claire, San Mateo County Community College; Cheryl Crespi, Central Connecticut State University; Terry Dancer, Arkansas State University; Carleton Donchess, Bridgewater State College; Bob Everett, Lewis and Clark Community College; Anthony Fortner, Carl Albert College; Cynthia Greeson, Ivy Tech Community College; Rosalie Hallbauer, Florida Memorial University; Deborah Hanks, Cardinal Stritch University; Candice Heino, Anoka-Ramsey Community College; Dave Henderson, College of Charleston; Carol Hutchinson, Asheville-Buncombe Technical Community College; Ron Krug, Allegony College of Maryland; D. Jordan Lowe, Arizona State University; Steven Markoff, Montclair State University; Laurie McWhorter, Mississippi State University; Cathy Montesarchio, Broward Community College; Carmen Morgan, Oregon Institute of Technology; Al Oddo, Niagara University; Nick Powers, Devry University—Chicago; Denise C. Probert, Viterbo College; Dr. Anwar Y. Salimi, California State University, Pomona; Betty Saunders, University of North Florida; Charles Stanley, Baylor University; Sakaran Venkateswar, Trinity University; Jeffery Yost, College of Charleston; Christian E. Wurst Jr., Temple University xv Contents 1 Managerial Accounting in the Information Age 2 GOAL OF MANAGERIAL ACCOUNTING 4 Software Systems That Impact Value Planning4 Chain Management 16 Budgets for Planning, 4 Enterprise Resource Planning Systems, 16 Supply Chain Management Systems, 16 Customer Control4 Relationship Management Systems, 17 Performance Reports for Control, 5 Ethical Considerations in Managerial Decision Making 6 Decision Making 18 A Comparison of Managerial and Financial Accounting 7 Ethical and Unethical Behavior 18 Internal versus External Users, 7 Need to Use Sarbanes-Oxley Act, 19 GAAP, 7 Detail of Information, 8 Emphasis A Framework for Ethical Decision Making 20 on Nonmonetary Information, 8 Emphasis on the Future, 8 IMA Statement of Ethical Professional Practice 20 Similarities between Financial and Managerial The Controller as the Top Management Accounting8 Accountant21 Summary of Learning Objectives 23 Cost Terms Used in Discussing Planning, Appendix IMA Statement of Ethical Control, and Decision Making 8 Professional Practice2 24 Variable and Fixed Costs 9 Principles24 Variable Costs, 9 Fixed Costs, 9 Standards24 Sunk Costs 10 Resolution of Ethical Conflict 24 Opportunity Costs 10 Direct and Indirect Costs 10 Link to Practice: Controllable and Noncontrollable Costs 11 Long Supply Chains Create Opportunity Costs, 10 Problems Related to the Wrong Performance Measures, 14 Casinos Two Key Ideas in Managerial Manage with Data from CRM Systems, 17 Feds Investigat- Accounting12 ing Walmart Over Bribery in Mexico, 19 Are the Procurement Decision Making Relies on Incremental Practices of the Hershey Company Ethical?, 21 Analysis, 12 Review Problems 25 The Information Age and Managerial Key Terms 26 Accounting14 Self-Assessment26 Impact of Information Technology on Management Questions27 of the Value Chain 15 Exercises28 Information Flows between Milano and Customers, 16 Problems31 Information Flows between Milano and Suppliers, 16 Cases34 Using Information Technology to Gain Internal Efficiencies, 16 xvii xviii C o n t e n t s 2 Job-Order Costing for Manufacturing and Service Companies 36 Cost Classifications for Manufacturing Relation Between the Costs of Jobs and Firms38 the Flow of Costs in Work in Process, Manufacturing Costs 38 Finished Goods, and Cost of Goods Sold 55 Direct Material, 38 Direct Labor, 39 Allocating Overhead to Jobs: Manufacturing Overhead, 39 A Closer Look 56 Nonmanufacturing Costs 39 Overhead Allocation Rates 56 Selling Costs, 39 General and Administrative The Overhead Allocation Base 56 Costs, 39 Activity-Based Costing (ABC) and Multiple Product and Period Costs 40 Overhead Rates 57 Product Costs, 40 Period Costs, 40 Predetermined Overhead Rates 58 Eliminating Overapplied or Underapplied Product Cost Information in Financial Overhead59 Reporting and Decision Making 41 Job-Order Costing for Service Balance Sheet Presentation of Product Companies60 Costs42 Comprehensive Example 61 Flow of Product Costs in Accounts 43 Modern Manufacturing Practices and Product Costing Systems 63 Income Statement Presentation Just-in-Time (JIT) Production 63 of Product Costs 43 Lean Manufacturing, 64 Cost of Goods Manufactured, 44 Cost of Goods Computer-Controlled Manufacturing 64 Sold, 44 Total Quality Management 65 Types of Costing Systems 46 Summary of Learning Objectives 67 Overview of Job Costs and Financial Link to Practice: Statement Accounts 46 Product and Period Costs at SpaceX, 41 Examples of Job-Order Costing System 48 Companies Using Job-Order and Process Costing Systems, Direct Material Cost 49 46 Lean Principles Are Not Just for Manufacturing Firms, 64 Just-in-Time or Just-in-Case, 65 Can There Be Too Much Direct Labor Cost 50 Emphasis on Quality?, 66 Journal Entry to Record Direct Labor, 51 Manufacturing Overhead 52 Review Problems 68 Key Terms 71 Journal Entries to Record Manufacturing Overhead, 52 Self-Assessment71 Questions72 Assigning Costs to Jobs: A Summary 53 Exercises72 Eastlake Revisited: Using Job Cost Problems76 Information53 Cases83 3 Process Costing 86 Difference Between Job-Order Cost Flows through Accounts 90 and Process Costing Systems 88 Direct Material, 91 Direct Labor, 91 Manufacturing Product and Cost Flows 89 Overhead, 91 Transferred-in Cost, 91 Product Flows through Departments 89 Calculating Unit Cost 92 C o n t e n t s xix Equivalent Units 92 Process Costing and incremental Cost per Equivalent Unit 93 analysis100 “You get What You measure!” and Calculating and Applying Cost Per Equivalent ­manufacturing processes 102 Unit: Mixing Department Example 93 Cost Transferred Out 95 Summary of Learning Objectives 102 Ending Work in Process 95 Link to Practice: Production Cost Report 95 What Type of Costing System Is Used by ExxonMobil Corpora- tion for the Product Mobil 1?, 88 Virtual Plant Tour for Reconciliation of Units 96 Company Using Process Costing, 90 Reconciliation of Costs 97 Basic Steps in Process Costing: Review Problems 103 A Summary 97 Key Terms 105 Self-Assessment106 Kent Chemical Revisited: Answering Stacy’s Question 98 Questions107 Exercises107 Dealing with Transferred-In Cost: Problems111 Packaging Department Example 98 Cases119 4 Cost-Volume-Profit Analysis 122 COMMON COST BEHAVIOR PATTERNS 124 MULTIPRODUCT ANALYSIS 141 Variable Costs 124 Contribution Margin Approach 141 Fixed Costs 125 Contribution Margin Ratio Approach 142 Discretionary versus Committed Fixed ASSUMPTIONS IN CVP ANALYSIS 145 Costs, 125 CODECONNECT EXAMPLE REVISITED: Mixed Costs 126 ANSWERING MARY’S QUESTIONS 146 Step Costs 126 Planning, 146 Control, 146 Decision Making, 47 Relevant Range 127 OPERATING LEVERAGE 148 CONSTRAINTS149 COST ESTIMATION METHODS 129 Account Analysis 129 Summary of Learning Objectives 150 Scattergraphs131 Appendix USING REGRESSION IN EXCEL TO High-Low Method 131 ESTIMATE FIXED AND VARIABLE COSTS 150 Regression Analysis 134 Setting Up the Spreadsheet 150 The Relevant Range and Cost Estimation 135 Interpreting the Output of the Regression Program 151 Link to Practice: COST-VOLUME-PROFIT ANALYSIS 136 Using Less Water but Paying Higher Rates!, 125 Breaking Even The Profit Equation 137 on a Golf Course Is Harder than Making Par, 138 Deciding to Use the Contribution Margin per Unit or the Contribution Margin Break-Even Point 137 Ratio, 146 Which Firm Has the Higher Contribution Margin Margin of Safety, 138 Ratio?, 147 Impact of Operating Leverage at Vulcan Materials, Contribution Margin 139 148 Fixed Costs Too High—Make Them Variable!, 149 Units Needed to Achieve Profit Target, 139 Review Problems 152 Contribution Margin Ratio 140 Key Terms 154 Dollar Sales Needed to Achieve Profit Self-Assessment 154 Target, 140 Questions155 “What If” Analysis 140 Exercises156 Change in Fixed and Variable Costs, 141 Change in Problems161 Selling Price, 141 Cases170 xx C o n t e n t s 5 Variable Costing 174 Full (Absorption) and Variable Costing 176 Variable Costing Limits Management of Variable Costing Income Statement 177 Earnings via Production Volume 186 EFFECTS OF PRODUCTION ON INCOME FOR FULL Summary of Learning Objectives 186 VERSUS VARIABLE COSTING: THE ­CLAUSENTUBE Link to Practice: EXAMPLE178 German Companies More Likely to Use Variable Costing, 177 Quantity Produced Equals Quantity Sold 179 Overproduction to Avoid Showing a Loss, 179 Cut in Produc- Quantity Produced Is Greater Than Quantity Sold 181 tion at John Deere Likely to Hurt Profit Margin, 184 Quantity Produced Is Less Than Quantity Sold 182 Review Problems 187 Explaining What Happened at ClausenTube 184 Key Terms 189 Impact of JIT on the Income Effects of Full versus Variable Costing 185 Self-Assessment189 Questions190 Benefits of Variable Costing for ­Internal Exercises191 Reporting185 Problems193 Variable Costing Facilitates CVP Analysis 185 Cases202 6 Cost Allocation and ­Activity-Based Costing 204 Purposes of Cost Allocation 206 ACTIVITY-BASED COSTING 218 To Provide Information for Decision Making 206 The Problem of Using Only Measures of Production To Reduce Frivolous Use of Common Resources 207 Volume to Allocate Overhead 218 To Encourage Evaluation of Services 207 The ABC Approach 219 To Provide “Full Cost” Information 208 Hierarchy of Activities, 220 Relating Cost Pools to Products Using Cost Drivers 221 PROCESS OF COST ALLOCATION 209 The ABC Approach at McMaster Screen Technologies: Determining the Cost Objective 209 A Comprehensive Example 221 Forming Cost Pools 209 McMaster’s Costs under the Traditional Approach, 221 McMaster’s Costs under the ABC Approach, 222 Selecting an Allocation Base 210 Pros and Cons of ABC 225 ALLOCATING SERVICE DEPARTMENT COSTS 212 Benefits, 225 Limitations, 226 Direct Method of Allocating Service Department ACTIVITY-BASED MANAGEMENT 226 Costs212 Allocating Budgeted and Actual Service Remember—You Get What You Measure! 228 Department Costs 213 Summary of Learning Objectives 228 PROBLEMS WITH COST ALLOCATION 213 Appendix Activity-Based Management 229 Responsibility Accounting and Controllable Step 1: Determine Major Activities 229 Costs213 Step 2: Identify Resources Used by Each Activity 230 Arbitrary Allocations 214 Step 3: Evaluate the Performance of the Activities 230 Unitized Fixed Costs and Lump-Sum Allocations 215 Step 4: Identify Ways to Improve the Efficiency and/or The Problem of Too Few Cost Pools 217 ­Effectiveness of the Activities 231 Using Only Volume-Related Allocation Bases 218 CONCLUSION231 C o n t e n t s xxi Link to Practice: Review Problems 231 Cost-plus Contracts Create Incentive to Misallocate Costs, Key Terms 234 208 Basis for Allocating Costs to Federal Grants and Self-Assessment234 Contracts, 211 Disputes over Allocations not Limited to the Questions235 Private Sector, 215 Avoiding a Disastrous Decision by Using ABC, 225 Banks and Other Service Companies Use ABM, Exercises236 227 ABC Points to Process Improvement and Cost Control, Problems240 227 Cases251 7 The Use of Cost Information in Management Decision Making 254 INCREMENTAL ANALYSIS 256 Step 1: Identify the Binding Constraint 273 When Your Boss Asks, “What Does This Product Step 2: Optimize Use of the Constraint 274 (Service) Cost?” You Should Say, “Why Do You Step 3: Subordinate Everything Else to the Want to Know?” 258 Constraint275 Analysis of Decisions Faced Step 4: Break the Constraint 275 by Managers 259 Step 5: Identify a New Binding Constraint 275 Additional Processing Decision 259 IMPLICATIONS OF TOC FOR INSPECTIONS, BATCH Make-or-Buy Decisions: The General Refrigeration SIZES, AND ACROSS-THE-BOARD CUTS 275 Example261 Dropping a Product Line 265 Link to Practice: Sell Partially Completed Superyacht?, 261 Boeing’s Global Beware of the Cost Allocation Death Spiral! 267 Outsourcing Strategy Blamed for 3-Year Delay in 787, Summary of Incremental, Avoidable, 262 PACCAR Decides to Make as Well as Buy!, 264 Sunk, and ­Opportunity Costs 267 Indian Wireless Company Outsources to U.S. and European Firms!, 264, Spike TV Drops Impact Wrestling, 266 Ronald Decisions Involving Joint Costs 269 H. Coase’s Contribution to Incremental Analysis, 268 The Sunk Allocation of Joint Costs 269 Cost Effect, 270 Qualitative Considerations in Outsourcing to Additional Processing Decisions and China, 272 Joint Costs 271 Review Problems 276 Qualitative Considerations in ­Decision Key Terms 278 Analysis271 Self-Assessment278 Summary of Learning Objectives 273 Questions279 Exercises279 Appendix The Theory of Constraints 273 Problems284 THE FIVE-STEP PROCESS OF TOC 273 Cases292 8 Pricing Decisions, Customer Profitability Analysis, and ­ Activity-Based Pricing 294 The Profit-Maximizing Price 296 Analyzing Customer Profitability: ­Revisiting the Priced Right Office Supplies Case 302 Pricing Special Orders 297 Customer Profitability and ­Performance Cost-Plus Pricing 299 Measures306 Target Costing 301 Activity-Based Pricing 306 xxii C o n t e n t s Summary of Learning Objectives 307 Review Problems 308 Key Terms 313 Link to Practice: Self-Assessment 313 Pricing Strategy: Apple’s Approach to Pricing, 297 Pricing Power More Important Than Management, 298 Pricing Questions314 Treasure Hunt Items at Costco, 300 Insull’s Most Radical Exercises314 Innovation Wasn’t Technology—It Was Pricing!, 301 Target Problems319 Costing Analyst Position at ­Whirlpool, 302 How to Fix Unprof- Cases324 itable Customers, 305 Sprint Drops Customers for Excessive Use of Customer Service, 305 9 Capital Budgeting and Other Long-Run Decisions 326 CAPITAL BUDGETING DECISIONS 328 Payback Period Method 344 EVALUATING INVESTMENT OPPORTUNITIES: Accounting Rate of Return 345 TIME VALUE OF MONEY APPROACHES 328 The Accounting Rate of Return Is Not a Reliable Basic Time Value of Money Calculations 329 Estimate of the Internal Rate of Return, 347 The Net Present Value Method 331 CONFLICT BETWEEN PERFORMANCE Steps in the NPV Method, 331 An Example EVALUATION AND CAPITAL BUDGETING 347 of the NPV Approach, 331 Comparing WILSON AIR EXAMPLE REVISITED 349 Alternatives with NPV, 333 Summary of Learning Objectives 350 The Internal Rate of Return Method 334 The Internal Rate of Return with Unequal ® Appendix A USING EXCEL TO CALCULATE NPV Cash Flows 336 AND IRR 350 Summary of Net Present Value and Internal Rate Link to Practice: of Return Methods 337 Royal Caribbean International Invests $1.4 Billion in Cruise CONSIDERING “SOFT” BENEFITS Ship, 329 NPV of Livengood Gold Mine Depends on Esti- IN ­INVESTMENT DECISIONS 337 mates, 333 College Education Yields 15% Return, 336 Use Calculating the Value of Soft Benefits Required of NPV and IRR by CFOs, 338 Soft Benefits Related to to Make an Investment Acceptable 338 Investing in ERP System, 339 Cost of Capital for Various Busi- ness ­Sectors, 340 Depreciation Tax Shield at Delta Air Lines, ESTIMATING THE REQUIRED RATE OF RETURN 339 342 Payback on Home Solar Power, 345 ADDITIONAL CASH FLOW CONSIDERATIONS 340 Review Problems 354 Cash Flows, Taxes, and the Depreciation Tax Shield 340 Key Terms 355 Adjusting Cash Flows for Inflation 342 Self-Assessment355 OTHER LONG-RUN DECISIONS 343 Questions356 Exercises357 SIMPLIFIED APPROACHES TO CAPITAL ­ Problems359 BUDGETING344 Cases366 10 BUDGETARY Planning and Control 368 USE OF BUDGETS IN PLANNING AND CONTROL 370 DEVELOPING THE BUDGET 370 Planning370 Budget Time Period 372 Control370 Zero-Based Budgeting 372 C o n t e n t s xxiii THE MASTER BUDGET 373 Why Budget-Based Compensation Can Lead Sales Budget 373 to Budget ­Padding and Income Shifting 388 Production Budget 375 EVALUATION, MEASUREMENT, AND ­MANAGEMENT Direct Material Purchases Budget 376 BEHAVIOR389 Direct Labor Budget 376 THE PRESTON JOYSTICK CASE REVISITED 390 Manufacturing Overhead Budget 377 Summary of Learning Objectives 390 Selling and Administrative Expense Budget 377 Link to Practice: Budgeted Income Statement 377 Problems with Five-Year Budgets, 372 People Problems in Capital Acquisitions Budget 379 Budgeting, 372 Budget Process in Great Britain, 374 Cash Budget 379 Address Cash Flow Uncertainty with a Revolving Loan, Budgeted Balance Sheet 382 383 Spreadsheets for Budgeting, 383 Using Rolling Budgets to Deal with ­Changes in Economic Conditions, 387 Ratcheting USE OF COMPUTERS IN THE BUDGET and the Ability to Achieve ­Budget Targets, 389 PLANNING PROCESS 383 Review Problems 391 BUDGETARY CONTROL 384 Key Terms 395 Budgets as a Standard for Evaluation 384 Self-Assessment395 Static and Flexible Budgets 384 Questions396 INVESTIGATING BUDGET VARIANCES 386 Exercises397 CONFLICT IN PLANNING AND CONTROL USES Problems400 OF BUDGETS 387 Cases412 11 Standard Costs and Variance Analysis 414 STANDARD COSTS 416 TEST YOUR KNOWLEDGE: COMPREHENSIVE Standard Costs and Budgets 416 EXAMPLE426 Development of Standard Costs 416 Material Variances 428 Ideal versus Attainable Standards 417 Labor Variances 428 Overhead Variances 429 A GENERAL APPROACH TO VARIANCE INVESTIGATION OF STANDARD COST ANALYSIS418 VARIANCES429 MATERIAL VARIANCES 419 Management by Exception 430 Material Price Variance 419 Favorable Variances May Be Unfavorable 430 Material Quantity Variance 420 Can Process Improvements Lead to Unfavorable Variances?431 DIRECT LABOR VARIANCES 421 Beware: Evaluation in Terms of Variances Labor Rate Variance 421 Can Lead to ­Excess Production 431 Labor Efficiency Variance 421 RESPONSIBILITY ACCOUNTING AND ­VARIANCES 432 Summary of Learning Objectives 432 OVERHEAD VARIANCES 422 Controllable Overhead Variance 422 Appendix Recording Standard Costs in Accounts433 Detailed Analysis of the Controllable Overhead Variance422 Recording Material Costs 433 Overhead Volume Variance 424 Recording Labor Cost 433 Computing the Overhead Volume Variance, 424 Recording Manufacturing Overhead 434 Interpreting the Overhead Volume Variance, 425 Recording Finished Goods 434 Calculating the Financial Impact of Operating Recording Cost of Goods Sold 435 at More or Less than Planned Capacity 426 Closing Variance Accounts 435 xxiv C o n t e n t s Link to Practice: Self-Assessment438 Starbucks Uses Standard Costs, 416 How Often Do Questions438 Companies Update ­Standards?, 417 Standard Costing— Exercises439 In the ­Beginning, 418 You Get What You Measure!, 420 Problems443 Cases449 Review Problems 435 Key Terms 438 12 Decentralization and ­Performance Evaluation 450 Why Firms Decentralize 452 Scenario 3. Customer Dimension, 470 Scenario 4. Advantages of Decentralization 452 Financial Dimension, 470 Disadvantages of Decentralization 453 How Balance Is Achieved in a Balanced Scorecard 470 Why Companies Evaluate the ­Performance Developing a Strategy Map For a of Subunits and Subunit Managers 454 Balanced Scorecard 471 Evaluating Subunits 454 Keys to a Successful ­Balanced ­Scorecard: Evaluating Subunit Managers 454 Targets, ­Initiatives, ­Responsibility, Funding, Top Management Support 472 Responsibility Accounting and Performance Evaluation454 Targets, 472 Initiatives, 472 Responsibility, 472 Funding, 472 Top Management Support, 472 Cost Centers, Profit Centers, and Investment Centers 455 Summary of Learning Objectives 473 Cost Centers 455 Appendix TRANSFER PRICING 474 Profit Centers 456 MARKET PRICE AS THE TRANSFER PRICE 474 Investment Centers 456 MARKET PRICE AND OPPORTUNITY COST 475 Evaluating Investment Centers with ROI 457 VARIABLE COST AS THE TRANSFER PRICE 476 Measuring Income and Invested Capital When Calculating ROI 458 FULL COST PLUS PROFIT AS THE TRANSFER Problems with Using ROI 460 PRICE477 Problems of Overinvestment and Underinvestment: NEGOTIATED TRANSFER PRICES 478 You Get What You Measure! 461 TRANSFER PRICING AND INCOME TAXES Evaluation in Terms of Profit Can Lead to IN AN INTERNATIONAL CONTEXT 478 Overinvestment, 461 Evaluation in Terms of ROI Can Lead to Underinvestment, 462 Link to Practice: Evaluation Using Economic Value Added Subunits at Nordstrom, 457 The Focus on ROI and Share- (EVA)462 holder ­Value Is Not the Same in France, Germany, and Japan as It Is in the United States and Great Britain, 458 Did Boeing’s Residual Income (RI) 463 Focus on ROI Lead to Excessive Outsourcing?, 461 Companies Revisiting the Situation at Action Industries, 463 That Have Used EVA, 464 Deere & Company Uses SVA Rather Solving the Overinvestment and Underinvestment Than EVA, 464 Focus on EVA Affects Key Decisions across an Problems463 Organization, 466 Use of EVA at Whole Foods, 468 Brigham and Women’s Hospital Receives Award for Its Balanced Score- Economic Value Added (EVA) 464 card, 473 Transfer Pricing at Starbucks, 478 EVA Example, 465 Review Problems 478 Using a Balanced Scorecard to Evaluate Performance468 Key Terms 483 Tying the Balanced Scorecard Measures to the Self-Assessment483 Strategy for Success, 469 Scenario 1. Learning Questions484 and Growth Dimension, 469 Scenario 2. Internal Exercises484 Process Dimension, 469 Problems487 Cases493 C o n t e n t s xxv Chapters 13 & 14 Available in WileyPlus 13 Statement of Cash Flows 496 NEED FOR A STATEMENT OF CASH FLOWS 498 INTERPRETING INFORMATION IN THE STATEMENT OF CASH FLOWS: THE SITUATION AT RAVIRA TYPES OF BUSINESS ACTIVITIES AND THE RESTAURANT SUPPLY 509 CLASSIFICATION OF CASH FLOWS 498 You Get What You Measure and Incremental Analysis Operating Activities 500 Linked to the Statement of Cash Flows 509 Investing Activities 500 Summary of Learning Objectives 510 Financing Activities 500 Link to Practice: Spotting a Cash Cow, 508 THE STATEMENT OF CASH FLOWS PREPARED USING THE DIRECT METHOD 500 Review Problems 511 Current Asset and Current Liability Accounts, Key Terms 513 501 Long-Term Asset Accounts, 503 Long-Term Self-Assessment513 Liabilities and Stockholders’ Equity, 504 Questions514 PREPARING THE STATEMENT OF CASH FLOWS Exercises515 USING THE INDIRECT METHOD 504 Problems519 Five-Step Approach to Calculating Cash Flows Cases529 from ­Operating Activities under the Indirect Method504 Statement of Cash Flows for Ravira Restaurant Supply—Indirect Method 506 14 Analyzing Financial Statements: A Managerial Perspective 530 WHY MANAGERS ANALYZE OTHER SOURCES OF INFORMATION FINANCIAL STATEMENTS 532 ON FINANCIAL PERFORMANCE 538 Control of Operations 532 Management Discussion and Analysis 538 Assessment of Vendors, Customers, and Other Credit Reports 539 Business Partners 532 News Articles 539 Assessment of Appearance to Investors and Creditors533 RATIO ANALYSIS 540 Profitability Ratios 540 HORIZONTAL AND VERTICAL ANALYSES 533 Financial Leverage, 541 Summary of the Analysis of the Balance Sheet 533 Profitability Ratios, 541 Analyzing the Income Statement 535 Turnover Ratios 541 Summary of Turnover Ratios, 543 EARNINGS MANAGEMENT AND THE NEED TO COMPARE EARNINGS AND CASH-FLOW Debt-Related Ratios 543 INFORMATION537 Summary of Debt-Related Ratios, 544 xxvi C o n t e n t s A MANAGERIAL PERSPECTIVE ON THE ­ Link to Practice: ANALYSIS OF HGW’S FINANCIAL STATEMENTS 544 Watching Cash Flow versus Earnings, 537 Tribune Control of Operations 544 Company Took on Too Much Debt, 544 Comparative Financial Ratios and Decision Making, 544 Ratio Data, 545 Financial Ratios in a Balanced Scorecard: You Get Review Problems 548 What You Measure!, 545 Key Terms 550 Stability of Vendors, Customers, and Other Self-Assessment550 Business Partners 545 Questions551 Appearance to Investors and Creditors 545 Exercises552 SUMMARY OF ANALYSES 546 Problems557 Cases567 Summary of Learning Objectives 547 List of Cases Each chapter of Managerial Accounting includes one or more Chapter 5 cases that: 5–1: MicroImage Technology, INC. A start-up company has a negative gross margin and it appears • Promote critical thinking and decision making skills. that “the more it sells, the more it loses.” Use of variable costing • Provide an opportunity for group work and/or written reveals that this is not the case. communication work. 5–2: RainRuler Stains • Integrate information from other business disciplines. A variable-costing income statement is used to show the finan- cial impact of sales related to a new customer category. Chapter 1 Chapter 6 1–1: LOCAL 635 6–1: EASTSIDE MEDICAL TESTING A union is disputing “cost of meal” charges to hotel employees. This case presents a service company example of ABC. 1–2: BOSWELL PLUMBING PRODUCTS 6–2: QuantumTM A senior manager wants to know a product’s cost. But the This case shows how ABC affects product costs and considers “cost” information needed depends on the decision the s­ enior the use of ABC information in decision making. manager is facing. Chapter 7 Chapter 2 7–1: PRIMUS CONSULTING GROUP 2–1: Ethics Case: BRIXTON SURGICAL DEVICES A consulting firm is considering a client offer of a fee that is less To meet an aggressive earnings target, two senior executives are than standard rates. planning to increase production to “bury” fixed overhead costs in inventory. 7–2: FIVE STAR TOOLS A tool manufacturer is faced with a production constraint, and 2–2: YSL MARKETING RESEARCH needs to consider the financial impact of a plan to deal with the A marketing research firm is considering various costs when situation. bidding on a job. 2–3: DUPAGE POWDER COATING Chapter 8 8–1: PRESTON CONCRETE A company’s product costs are being distorted by its approach to overhead allocation. The company is considering moving away from its cost-plus pricing approach when an increase in interest rates reduces Chapter 3 housing starts and the demand for c­ oncrete. 3–1: TEch-Tonic Sports Drink 8–2: Galloway University Medical Center Pharmacy A producer of a sports drink is considering alternative treat- A university hospital pharmacy is considering the profit impli- ments for the cost of lost units. cations of alternative approaches to encouraging prescription 3–2: JENSEN PVC renewals from “out-of-area” patients. A company is considering lowering prices to increase sales and reduce unit costs by making better use of excess capacity. Chapter 9 9–1: Ethics Case: JUNIPER PACKAGING SOLUTIONS Chapter 4 A plant manager is considering a plan to circumvent a freeze on 4–1: ROTHMUELLER MUSEUM capital expenditures. A curator at a museum is trying to estimate the financial 9–2: SERGO GAMES impact of a planned e­ xhibit. A game company is considering outsourcing manufacturing of 4–2: MAYFIELD SOFTWARE, CUSTOMER TRAINING CDs. The customer training facility of a software company is show- Chapter 10 ing a loss. The manager needs to determine the number of 10–1: Ethics Case: COLUMBUS PARK—WASTE TREATMENT classes that must be offered to break even. FACILITY 4–3: KROG’S METALFAB, INC. The manager of a waste treatment facility is planning to pad A company is estimating the lost profit related to fire damage so it costs in her budget because the city controller is likely to cut can submit an insurance claim. whatever budget is submitted. xxvii xxviii L i s t o f C a s e s 10–2: ABRUZZI OLIVE OIL COMPANY 12–2: Win Tech Motors A small producer of olive oil is preparing production budgets to Owners of a sports and luxury auto dealership are faced with consider the i­mpact of various sales levels. (Note that this case negative EVA and must cut their investment in inventory. is best “solved” using a spreadsheet.) For Cases in Chapters 13 and 14 go to www.wiley.com/college/ Chapter 11 jiambalvo 11–1: Jackson Sound Chapter 13 Work in process inventory is building up at Jackson Sound even 13–1: Wellcomp COMPUTERS though the company has a JIT system. A computer company is considering the impact of a price 11–2: CHAMPION INDUSTRIES ­reduction on cash flow. A purchasing manager is considering a material that has a price higher than standard, but also a number of desirable properties. Chapter 14 14–1: JORDAN-WILLIAMS, INCORPORATED Chapter 12 A publisher of college textbooks is evaluating the financial 12–1: Home Value Stores ­condition of a potential business partner. A company that operates membership warehouse stores is evaluating using EVA. 1 Managerial Accounting in the Information Age What type of job will you hold in the future? You may be a marketing manager for a consumer electronics firm, you may be the director of human resources for a biotech firm, or you may be the president of your own company. In these and other managerial positions you will have to plan oper- ations, evaluate subordinates, and make a variety of decisions using accounting information. In some cases, you will find information from your firm’s balance sheet, income statement, statement of retained earnings, and statement of cash flows to be useful. However, much of the information in these statements is more relevant to external users of accounting information, such as stockholders and creditors. In addition, you will need information prepared specifically for firm managers, the internal users of accounting information. This type of information is referred to as managerial accounting information. If you are like most users of this book, you have already studied financial account- ing. Financial accounting stresses accounting concepts and procedures that relate to preparing reports for external users of accounting information. In comparison, managerial accounting stresses accounting concepts and procedures that are relevant to preparing reports for internal users of accounting information. This book is devoted to the subject of managerial accounting, and this first chapter provides an overview of the role of managerial accounting in planning, control, and decision mak- ing. The chapter also defines important cost concepts and introduces key ideas that will be emphasized throughout the text. The chapter ends with a discussion of the information age and the impact of information technology on business, a framework for ethical decision making, and the role of the controller as the top management accountant. Note that you can enhance and test your knowledge of the chapter using Wiley’s online resources and the self-assessment quiz at the end of the chapter. The end-of-chapter material also includes two solved review problems. Monkey Business Images/Shutterstock Learning Objectives 1 Explain the primary goal of managerial accounting and distinguish between financial and mana- gerial accounting. 2 Define cost terms used in planning, control, and decision making. 3 Explain the two key ideas in managerial accounting. 4 Discuss the impact of information technology on business processes and the interactions companies have with suppliers and customers. 5 Describe a framework for ethical decision making and discuss the duties of the controller. 3 4 c h a p te r 1 M a n a g e r i a l A c c o u n t i n g i n t h e I n f o r m a t i o n A g e Learning GOAL OF MANAGERIAL ACCOUNTING Objective 1 Virtually all managers need to plan and control their operations and make a variety of Explain the primary goal decisions. The goal of managerial accounting is to provide the information they need of managerial account- for planning, control, and decision making. If your goal is to be an effective manager, ing and distinguish a thorough understanding of managerial accounting is essential. between financial and managerial accounting. Planning Planning is a key activity for all companies. A plan communicates a company’s goals to employees aiding coordination of various functions, such as sales and production. A plan also specifies the resources needed to achieve company goals. Budgets for Planning. The financial plans prepared by managerial accountants are referred to as budgets. A wide variety of budgets may be prepared. For example, a profit bud- get indicates planned income, a cash-flow budget indicates planned cash inflows and outflows, and a production budget indicates the planned quantity of production and the expected costs. Consider the production cost budget for the Surge Performance Beverage Company. In the coming year, the company plans to produce 5,000,000 12-ounce bottles of bev- erage. This amount is based on forecasted sales. To produce this volume, the company estimates it will spend $1,500,000 on bottles, $400,000 on ingredients, $150,000 on water, and pay workers at its bottling plant $300,000. It also expects to pay $60,000 for rent, incur $80,000 of depreciation of equipment, and pay $100,000 for other miscellaneous costs. The production cost budget presented in Illustration 1-1 summarizes this informa- tion. This budget informs the managers of Surge about how many bottles the company intends to produce and what the necessary resources will cost. Control Control of organizations is achieved by evaluating the performance of managers and the operations for which they are responsible. The distinction between evaluating managers and evaluating the operations they control is important. Managers are evaluated to deter- mine how their performance should be rewarded or punished, which in turn motivates them to perform at a high level. Based on an evaluation indicating good performance, a manager might receive a substantial bonus. An evaluation indicating a manager per- formed poorly might lead to the manager being fired. In part because evaluations of managers are typically tied to compensation and promotion opportunities, managers work hard to ensure that they will receive favorable evaluations. (Of course, managers Illustration 1-1 Production cost budget Budgeted Production Costs For the Year Ended December 31, 2017 Budgeted Production 5,000,000 Bottles Cost of bottles $1,500,000 Ingredient cost 400,000 Water 150,000 Labor cost 300,000 Rent 60,000 Depreciation 80,000 Other 100,000 Total budgeted production cost $2,590,000 Goal of Managerial Accounting 5 may also work hard because they love their jobs, receive respect from coworkers, or value the sense of accomplishment from a job well done!) Operations are evaluated to provide information as to whether they should be changed or not (i.e., expanded, contracted, or modified in some way). An evaluation of an operation can be negative even when the evaluation of the manager responsible for the operation is basically positive. For example, the manager of one of the two bottling plants at Surge Performance Beverage Company may do a good job of controlling costs and meeting deadlines, given that the plant is old and out-of-date. Still, senior manage- ment may decide to close the plant because, given the outdated equipment in the plant, it is not an efficient operation. In this scenario, the manager receives a positive evaluation whereas the operation receives a negative evaluation. Company plans often play an important role in the control process. Managers can compare actual results with planned results and decide whether corrective action is necessary. If actual results differ from the plan, the plan may not have been followed properly; the plan may have not have been well thought out; or changing circumstances may have made the plan out-of-date. Illustration 1-2 presents the major steps in the planning and control process. Once a plan has been made, actions are taken to implement it. These actions lead to results that are compared with the original plan. Based on this evaluation, managers are rewarded (e.g., given substantial bonuses or promoted if performance is judged to be good) or punished (e.g., given only a small bonus, given no bonus, or even fired if performance is judged to be poor). Also, based on the evaluation process, operations may be changed. Changes may consist of expanding (e.g., adding a second shift), contracting (e.g., closing a production plant), or improving operations (e.g., training employees to do a better job answering customer product inquiries). Changes may also consist of revising an unrealistic plan. Performance Reports for Control. The reports used to evaluate the performance of managers and the operations they control are referred to as performance reports. Although there is no generally accepted method of preparing a performance report, such reports frequently involve a comparison of current-period performance with per- formance in a prior period or with planned (budgeted) performance. Illustration 1-2 Planning and control process Plan Decisions to change Action taken to operations or revise plans implement plan Results Decisions to reward Comparison of planned or punish managers and actual results Evaluation 6 c h a p te r 1 M a n a g e r i a l A c c o u n t i n g i n t h e I n f o r m a t i o n A g e Suppose, for example, that during 2017, Surge Performance Beverage Company actually produced 5,000,000 bottles and incurred these costs: Cost of bottles $1,650,000 Ingredient cost 450,000 Water 152,000 Labor cost 295,000 Rent 60,000 Depreciation 80,000 Other 101,000 Total actual production cost $2,788,000 A performance report comparing these actual costs to the budgeted costs is presented in Illustration 1-3. Typically, performance reports only suggest areas that should be investigated; they do not provide definitive information on performance. For example, the performance report presented in Illustration 1-3 indicates that something may be amiss in the control of bottle and ingredient cost. Actual costs are $150,000 more than planned for bottles and $50,000 more than planned for ingredients. There are many possible reasons why these costs are greater than the amounts budgeted. Perhaps the price of bottles or key ingredients increased, or perhaps bottles were damaged in the production process. Management must investigate these possibilities before taking appropriate corrective action. Although performance reports may not provide definitive answers, they are still extremely useful. Managers can use them to flag areas that need closer attention and to avoid areas that are under control. It would not seem necessary, for example, to investigate labor, rent, depreciation, or other costs, because these costs are either equal to or relatively close to the planned level of cost. Typically, managers follow the principle of management by exception when using performance reports. This means that managers investigate departures from the plan that appear to be exceptional; they do not investigate minor departures from the plan. Decision Making As indicated in Illustration 1-2, decision making is an integral part of the planning and control process—decisions are made to reward or punish managers, and decisions are Illustration 1-3 Performance report Performance Report, Production Costs For the Year December 31, 2017 Difference Actual Budget (Actual Minus Budget) Production (number of bottles) 5,000,000 5,000,000 -0- Cost of bottles $1,650,000 $1,500,000 $150,000* Ingredient cost 450,000 400,000 50,000* Water 152,000 150,000 2,000 Labor cost 295,000 300,000 (5,000) Rent 60,000 60,000 -0- Depreciation 80,000 80,000 -0- Other 101,000 100,000 1,000 Total production cost $2,788,000 $2,590,000 $ 198,000 Red numbers indicate differences deemed deserving of investigation. Goal of Managerial Accounting 7 made to change operations or revise plans. Should a firm add a new product? Should it drop an existing product? Should it manufacture a component used in assembling its major product or contract with another company to produce the component? What price should a firm charge for a new product? These questions indicate just a few of the key decisions that confront companies. How well they make these decisions will determine future profitability and, possibly, the survival of the company. Recognizing the impor- tance of making good decisions, we devote all of Chapters 7, 8, and 9 to the topic. Below you’ll see that one of the two key ideas of managerial accounting relates to decision making and its focus on so-called incremental analysis. Finally, at the end of each chapter, there is a feature called Making Business Decisions. This feature will remind you of how the chapter material is linked to decision making, and it will summarize the knowledge and skills presented in the chapter that will help you make good decisions as a manager. T est y o u r K N O W L E D G E With respect to managerial accounting, which of the following statements are valid? a. Budgets are used for planning. b. Performance reports are used for control. c. A goal of managerial accounting is to provide information useful in decision making. d. All of the above are valid statements. Correct answer is d. A Comparison of Managerial and Financial Accounting As suggested in the opening of this chapter, there are important differences between managerial and financial accounting: 1. Managerial accounting is directed at internal rather than external users of accounting information. 2. Managerial accounting may deviate from generally accepted accounting principles (GAAP). 3. Managerial accounting may present more detailed information. 4. Managerial accounting may present more nonmonetary information. 5. Managerial accounting places more emphasis on the future. Internal versus External Users. Financial accounting is aimed primarily at external users of accounting information, whereas managerial accounting is aimed primarily at internal users (i.e., company managers). External users include investors, creditors, and government agencies, which need information to make investment, lending, and regu- latory decisions. Their information needs differ from those of internal users, who need information for planning, control, and decision making. Need to Use GAAP. Much of financial accounting information is required. The Securities and Exchange Commission (SEC) requires large, publicly traded companies to prepare reports in accordance with generally accepted accounting principles (GAAP). Even companies that are not under the jurisdiction of the SEC prepare financial account- ing information in accordance with GAAP to satisfy creditors. Managerial accounting, however, is completely optional. It stresses information that is useful to internal managers for planning, control, and decision making. If a company believes that deviating from GAAP will provide more useful information to managers, GAAP need not be followed. 8 c h a p te r 1 M a n a g e r i a l A c c o u n t i n g i n t h e I n f o r m a t i o n A g e Detail of Information. Financial accounting presents information in a highly summa- rized form. Net income, for example, is presented for the company as a whole. To run a company, however, managers need more detailed information; for example, information about the cost of operating individual departments versus the cost of operating the com- pany as a whole or sales broken out by product versus total company sales. Emphasis on Nonmonetary Information. Both managerial and financial accounting reports generally contain monetary information (information expressed in dollars, such as revenue and expense). But managerial accounting reports often contain a substantial amount of additional nonmonetary information. The quantity of material consumed in production, the average time taken to process a customer service call, and the number of product defects are examples of important nonmonetary data that appear in managerial accounting reports. Emphasis on the Future. Financial accounting is primarily concerned with present- ing the results of past transactions. Managerial accounting, however, places considerable emphasis on the future. As indicated previously, one of the primary purposes of mana- gerial accounting is planning. Thus, managerial accounting information often involves estimates of the costs and benefits of future transactions. Similarities between Financial and Managerial Accounting We should not overstate the differences between financial accounting and managerial accounting in terms of their respective user groups. Financial accounting reports are aimed primarily at external users, and managerial accounting reports are aimed primarily at internal users. However, managers also make significant use of financial accounting reports, and external users occasionally request financial information that is generally considered appropriate for internal users. For example, creditors may ask management to provide them with detailed cash-flow projections. T est y o u r K N O W L E D G E Which of the following is false? a. Compared to financial accounting, managerial accounting places more emphasis on generally accepted accounting principles (GAAP). b. Compared to financial accounting, managerial accounting may present more non- monetary information. c. Compared to financial accounting, managerial accounting places more emphasis on the future. d. Compared to financial accounting, managerial accounting may present more detailed information. Correct answer is a. Learning Cost Terms Used in Discussing Planning, Objective 2 Control, and Decision Making Define cost terms used in planning, control, and When managers discuss planning, control, and decision making, they frequently use the decision making. word cost. Unfortunately, what they mean by this word is often ambiguous. This section defines key cost terms so that you will have the accounting vocabulary necessary to begin discussing issues related to planning, control, and decision making. The treatment will Cost Terms Used in Discussing Planning, Control, and Decision Making 9 be brief because we will return to these cost terms and examine them in detail in later chapters. Variable and Fixed Costs The classification of a cost as variable or fixed depends on how the cost changes in rela- tion to changes in the level of business activity. Variable Costs. Costs that increase or decrease in proportion to increases or decreases in the level of business activity are variable costs. Material and direct labor are generally considered to be variable costs because in many situations they fluctuate in proportion to changes in production (business activity). Suppose that for Surge Performance Beverage Company, the cost of bottles, ingredients, water, and labor are variable costs and in the prior month, when production was 400,000 bottles, costs were $120,000 for bottles, $32,000 for ingredients, $12,000 for water, and $24,000 for labor. How much variable cost should the company plan on for the current month if production is expected to increase by 20 percent, to 480,000 bottles? Since the variable costs change in proportion to changes in activity, if production increases by 20 percent, these costs should also increase by 20 percent. Thus, the cost of bottles should increase to $144,000, the cost of ingredients should increase to $38,400, the cost of water to $14,400, and the cost of labor to $28,800. Prior Month Current Month Production 400,000 Bottles Per Unit 480,000 Bottles Per Unit Variable costs: Cost of bottles $120,000 $0.30 $144,000 $0.30 Ingredient cost 32,000 0.08 38,400 0.08 Water 12,000 0.03 14,400 0.03 Labor cost 24,000 0.06 28,800 0.06 Total variable cost $188,000 $0.47 $225,600 $0.47 Note that although the total variable cost increases from $188,000 to $225,600 when production changes from 400,000 to 480,000 units, the variable cost per unit does not change. It remains $0.47 per bottle. With variable cost of $0.47 per bottle, variable cost increases by $37,600 (i.e., $0.47 × 80,000) when production increases by 80,000 bottles. Fixed Costs. Costs that remain constant when there are changes in the level of business activity are fixed costs. Depreciation and rent are costs that typically do not change with changes in business activity. Suppose that in the prior month, Surge Performance Beverage Company incurred $20,000 of fixed costs including $5,000 of rent, $6,667 of depreciation, and $8,333 of other miscellaneous fixed costs. If the company increases production to 480,000 bottles in the current month, the levels of rent, depreciation, and other fixed costs incurred should remain the same as when production was only 400,000 bottles. However, with fixed costs, the cost per unit does change when there are changes in production. When production increases, the con- stant amount of fixed cost is spread over a larger number of units. This drives down the fixed cost per unit. With an increase in production from 400,000 to 480,000 units, total fixed costs remains at $20,000. Note, however, that fixed cost per unit decreases from $0.0500 per unit to $0.0417 per unit. 10 c h a p te r 1 M a n a g e r i a l A c c o u n t i n g i n t h e I n f o r m a t i o n A g e Prior Month Current Month Production 400,000 Bottles Per Unit 480,000 Bottles Per Unit Fixed costs: Rent $ 5,000 $0.0125 $ 5,000 $0.0104 Depreciation 6,667 0.0167 6,667 0.0139 Other 8,333 0.0208 8,333 0.0174 Total fixed cost $20,000 $0.0500 $20,000 $0.0417 Sunk Costs Costs incurred in the past are referred to as sunk costs. These costs are not relevant for decision making because they do not change when decisions are made. For example, suppose you buy a ticket to a play for $30. Before the play, you run into a friend who invites you to a party. If you go to the party, you won’t be able to attend the play. The cost of the ticket is irrelevant to the decision as to whether you should go to the party. What matters is how much you will enjoy the party versus the play and how much you can sell the ticket for (not how much you paid for it). Whether you go to the play or go to the party, you are out $30 (the price of the ticket to the play, which is sunk). Opportunity Costs The value of benefits forgone when one decision alternative is selected over another is an opportunity cost. For example, suppose Surge Performance Beverage Company refuses an order to produce 50,000 bottles for a grocery chain because taking on the order will require the company to miss delivery deadlines on orders already taken. Suppose the order would have generated $50,000 of additional revenue (the product sells for $1 per bottle) and $23,500 of additional costs. Then the opportunity cost (the net benefit forgone) associated with meeting current delivery deadlines is $26,500 ($50,000 − $23,500). Link to Practice Long Supply Chains Create Opportunity the production process. Further, the distance shipped Costs creates delays in getting products to market. Both of these situations create opportunity costs. Wrong colors Today, much of the textiles sold in the United States and errors in stitching patterns may mean lost sales, as come from China and other Asian countries. Labor is may delays in getting textiles into the hands of consum- relatively cheap in Asia, and the direct cost of ship- ers. These lost sales are opportunity costs associated ping isn’t that significant. Given this, why are some with the decision to use a supplier located thousands U.S. companies considering manufacturing closer to of miles away. home—such as in Mexico? The reason is opportunity costs. With a long-distance supplier in, say, China, there Source: Peter T. Leach, “What Goes Around Comes Around: may be a lack of reliability due to misunderstandings Long Supply Chains Can Create Opportunity Costs,” Gulf and the inability of the purchaser to directly monitor Shipper (December 2007), 6–9. Direct and Indirect Costs Costs that are directly traceable to a product, activity, or department are direct costs. Indirect costs are those that either cannot be directly traced to a product, activity, or department or are not worth tracing. The distinction between a direct and an indirect cost depends on the object of the cost tracing. For example, Surge Performance Beverage C o s t T e r m s U s e d i n D i s c u s s i n g P l a n n i n g , C o n t r o l , a n d D e c i s i o n M a k i n g 11 Illustration 1-4 Insurance as both a direct and Insurance for indirect cost Bottling Plant Direct Cost Indirect Cost to Various Drinks to Bottling Plant Bottled at the Plant Surge Original Green Surge Blue with Electrolytes and Metabolites Surge Red with Caffeine and Ginseng Company has a production facility in Memphis for which it incurs insurance costs. The insurance cost related to the Memphis plant is obviously a direct cost of the Memphis plant. However, the insurance cost is an indirect cost with respect to the individual types of sports drinks produced in the Memphis plant because direct tracing of the insurance cost to each type of drink is not possible. This situation is presented in Illustration 1-4. Controllable and Noncontrollable Costs A manager can influence a controllable cost but cannot influence a noncontrollable cost. The distinction between controllable and noncontrollable costs is especially important when evaluating a manager’s performance. A manager should not be evaluated unfavorably if a noncontrollable cost sharply increases. As an example of controllable and noncontrollable costs, consider a plant supervisor. This individual influences labor and material costs by scheduling workers and ensur- ing an efficient production process. Thus, labor and material costs are the supervisor’s controllable costs. However, the supervisor cannot determine insurance for a plant. A plant manager or an insurance specialist makes decisions regarding insurance. Therefore, insurance cost is a supervisor’s noncontrollable cost but a plant manager’s or an insurance specialist’s controllable cost. T est y o u r K N O W L E D G E Susan Evans paid a $5,000 nonrefundable fee to attend a 5-day management seminar on leadership, hosted by the Bradford College of Business. After registering for the course, her boss asked Susan to be the lead consultant on a project with a major client and, unfortunately, the start of the engagement conflicted with the seminar. Her boss, however, said that she’d be happy to ask another coworker to be the lead if Susan still wanted to attend the seminar. With respect to the decision Susan faces (go to the seminar or take the lead position on a consulting engagement), the $5,000 cost of the seminar is: a. A variable cost. b. A fixed cost. c. A sunk cost. d. An opportunity cost. Correct answer is c. 12 c h a p te r 1 M a n a g e r i a l A c c o u n t i n g i n t h e I n f o r m a t i o n A g e Learning Two Key Ideas in Managerial Accounting Objective 3 The subject of managerial accounting has many concepts. However, two ideas are fun- Explain the two key damental to understanding the use of managerial accounting information in planning, ideas in managerial control, and decision making. Keep these two ideas in mind as you progress through your accounting. business career—you’ll find them to be invaluable! Because the ideas are so important, one or both will be emphasized in each chapter of the book and identified with an icon. 1. Decision making relies on incremental analysis—an analysis of the revenues that increase (decrease) and the costs that increase (decrease) if a decision alternative is selected. 2. You get what you measure! Decision Making/ Decision Making Relies on Incremental Analysis. Incremental analysis is the Incremental appropriate way to approach the solution to all business problems. Essentially, incremen- Analysis tal analysis involves the calculation of the difference in revenue and the difference in cost between decision alternatives. The difference in revenue is the incremental revenue of one alternative over another, whereas the difference in cost is the incremental cost of one alternative over another. If an alternative yields an incremental profit (the difference between incremental revenue and incremental cost), it is the preferred alternative. In the simplified example that follows, decision alternative 1 should be selected because, compared with alternative 2, it yields an incremental profit of $3,000. Comparison of Decision Alternatives Alternative Alternative 1 2 Revenue $15,000 − $10,000 = $5,000 Incremental Revenue Cost 8,000 − 6,000 = 2,000 Incremental Cost Profit $ 7,000 − $ 4,000 = $3,000 Incremental Profit Although the idea is simple, implementing it in practice can be difficult—that’s why we devote all of Chapters 7, 8, and 9 to decision making. For now, let’s look at a decision facing Surge Performance Beverage Company to gain a better understanding of incremental analysis. Recall that at Surge Performance Beverage Company, the budgeted annual produc- tion costs for 5,000,000 bottles was $2,590,000: Production 5,000,000 bottles Cost of bottles $1,500,000 Ingredient cost 400,000 Water 150,000 Labor cost 300,000 Rent 60,000 Depreciation 80,000 Other 100,000 Total production cost $2,590,000 Cost per unit $ 0.518 T w o K e y I d e a s i n M a n a g e r i a l A c c o u n t i n g 13 Currently, Surge sells its product only to grocery and health food stores, at $1 per bottle. Now assume that Surge is approached by Costless, a company that sells products in no-frills, self-service warehouse facilities. Costless offers to buy 200,000 bottles in the coming year, but only if the price is reduced to $0.75 per bottle. In this case there are two decision alternatives: (1) stick with the status quo and decline the offer, or (2) accept the offer. If the offer is accepted, incremental revenue (the increase in revenue due to accept- ing the offer versus declining the offer) will be $150,000 and incremental cost (the increase in cost due to accepting the offer versus declining the offer) will be $94,000. Thus, the incremental profit of accepting the offer is $56,000. Assuming that the company has the capacity to produce the additional 200,000 bottles and that other orders will not have to be turned down if this large order is accepted (i.e., assuming that there are no opportunity costs), Surge Performance Beverage Company should accept this order. Incremental revenue ($.75 × 200,000 bottles) $150,000 Less incremental costs: Increase in cost of bottles ($.30 × 200,000) $60,000 Increase in cost of ingredients ($.08 × 200,000) 16,000 Increase in cost of water ($.03 × 200,000) 6,000 Increase in cost of labor ($.06 × 200,000) 12,000 94,000 Incremental profit $ 56,000 Note that in the analysis, we use only four of the production cost items (cost of bottles, cost of ingredients, cost of water, and cost of labor). These are the only costs that increase with the new order, because all other costs (rent, depreciation, and other) are fixed and will not increase with an increase in production. Therefore, they are not incre- mental costs and are not relevant to the decision at hand. Think about rent expense. If the special order is rejected, rent expense will be $60,000. If the special order is accepted, rent expense will still be $60,000. Since rent expense does not change, it is not incremental, and it is not relevant in analyzing the decision. You get what you You Get What You Measure! The second key idea in managerial accounting is “You M e a s u r e get what you measure!” In other words, performance measures greatly influence the behavior of managers. You Get What You Measure! Performance Measures Drive Behavior Performance Measures Potential Actions of Managers Customer satisfaction at auto Give customers a loaner car while auto is repair shop being repaired Injuries on the job at home Develop training program for new employees at construction site construction site Sales to new customers of office More sales calls on potential versus current supply company customers Companies can select from a vast number of performance measures when deciding how they want to assess performance. Profit, market share, sales to new customers, prod- uct development time, number of defective units produced, and number of late deliveries are examples of measures in common use. Because rewards often depend on how well 14 c h a p te r 1 M a n a g e r i a l A c c o u n t i n g i n t h e I n f o r m a t i o n A g e an employee performs on a particular measure, employees direct their attention to what is measured and may neglect what isn’t measured. For example, suppose that at Surge Performance Beverage Company, sales to new customers is introduced as a primary measure of the performance of the sales manager. How would this influence the behavior of the sales manager? Most likely, this measure will lead the manager to spend more time developing business with new customers. Although that may be just what senior management desires from the performance measure, it could lead to problems. Suppose a sales manager greatly reduces the time spent attending to the needs of existing customers, and the company loses the business of several key accounts. To avoid this and other unintended consequences, companies need to develop a balanced set of performance measures and avoid placing too much emphasis on any single measure. T est y o u r K N O W L E D G E Jason Deen is the owner of Deen’s Custom Motorcycles. Recently, his cousin, Jake, crashed his bike and brought it in for repairs. Jason offered to fix the bike and charge his cousin for just the incremental costs. Which of the following is an incremental cost associated with the repair job? a. Depreciation on tools. b. Salary paid to the accountant at Deen’s. c. Required parts. d. Utilities (e.g., heat and electricity). Correct answer is c. Link to Practice Problems Related to the Wrong employees to respond quickly to incoming calls. But to Performance Measures do this, employees quickly and incompletely answered customer calls so they could get off the line and pick As documented by Dean Spitzer, a performance mea- up the next incoming call. The result was that cus- surement thought leader, in his book Transforming tomers frequently had to call back to get additional Performance Measurement, bad things can happen information, and that certainly didn’t lead to customer when the wrong performance measure is used to satisfaction. evaluate employees. For example, he notes that at When the CEO of the company realized the problem, an insurance company known for its customer focus, the “wait time” measure was replaced with “percentage digital scoreboards were mounted at a call center of callers who complete their business on the first call and reported on the average wait time for teams to with no need for additional follow-up.” respond to customer calls. The idea was to motivate Learning The Information Age and Managerial Objective 4 Accounting Discuss the impact of information technology In recent years, advances in information technology have radically changed access to on business processes information and, as a consequence, the business landscape—so much so that the current and the interactions business era is frequently referred to as the information age. Since managerial accounting companies have with is about providing information in order to plan and control operations and to make deci- suppliers and customers. sions, part and parcel of an understanding of managerial accounting is an understanding of the impact of information technology on business processes and the interactions companies have with suppliers and customers. These topics are discussed in this section. T h e I n f o r m a t i o n A g e a n d M a n a g e r i a l A c c o u n t i n g 15 Illustration 1-5 Value Chain The value chain Inbound Outbound Marketing & Customer Operations logistics logistics sales service Infrastructure Human Resource Management Technology Development Procurement Impact of Information Technology on Management of the Value Chain The value chain comprises the fundamental activities a firm engages in to create value. The idea was developed by Michael Porter in his groundbreaking book, Competitive Advantage. According to Porter, firms engage in a series of primary and secondary activities. The primary activities are inbound logistics (receiving and storing goods and materials), operations to transform materials into finished products, outbound logistics (storing and shipping products to customers), marketing and sales, and after-sale cus- tomer service. (See Illustration 1-5.) The secondary activities include firm infrastructure (e.g., accounting, finance, and legal affairs), human resource management (e.g., hiring, training, benefits administration), technology development, and procurement of goods and services. When the value to the customer of receiving products and services exceeds the cost of these activities, firm value is created. Information flows up and down a company’s value chain and also between the company and its suppliers and between the company and its customers. Illustration 1-6 shows this for Milano Clothiers. Milano has 35 stores throughout the United States and annual sales of over $800 million. For Milano to be successful, its suppliers must provide high-quality items, on time, to the right location, at a reasonable price. Also, Milano’s own operations must be efficient. It must be able to market effectively and offer prod- ucts that customers want. How can Milano ensure that this happens? The key is to take advantage of information flows up and down the value chain and between Milano and its suppliers and between Milano and its customers. This is where advances in information technology are having an impact. Note that in Illustration 1-6, the lines between suppliers and Milano and between customers and Milano are dashed lines. These represent the fact that the organizational boundaries are somewhat permeable because a lot of information is being transmitted both ways. Let’s see some examples of how this works. Illustration 1-6 Information Flows Information flows within Milano and between Milano and its Milano Clothiers Suppliers Customers suppliers and Milano and its Value Chain customers 16 c h a p te r 1 M a n a g e r i a l A c c o u n t i n g i n t h e I n f o r m a t i o n A g e Information Flows between Milano and Customers. When customers make pur- chases, a Milano employee scans a bar code attached to the sale item, thereby automat- ically transferring the sale information into a database. This information can be used to update inventory records and ensure the company does not run out of “hot” items. The database also provides information on slow-moving merchandise that Milano can sell to a discount department store so that it doesn’t take up valuable floor space. Further analysis of the sales data can reveal regional tastes in clothes, helping Milano to buy the right styles for stores in different parts of the country. Milano may also track the buying patterns of customers who identify themselves by using Milano’s credit card or a special customer discount card. This information can help Milano direct targeted selling mes- sages to different customer types via direct-mail advertising. Information Flows between Milano and Suppliers. With several key suppliers, Milano has set up processes whereby the suppliers monitor Milano’s sales of their merchandise using information from Milano’s internal database. Milano shares this information because the suppliers use it to improve their production scheduling, gain efficiencies, and pass along some of the related cost savings to Milano in the form of lower prices. Milano also tracks the status of its orders using its suppliers’ websites. Thus, Milano knows the exact time merchandise will be arriving at each of its locations, and this information is available any time of the day. Milano uses this information, in part, to time its advertising campaigns. Using Information Technology to Gain Internal Efficiencies. Internally, Milano uses information technology to automate purchasing and accounts payable, sales and customer billing, as well as other accounting and finance functions. While in the past the company could not close its books until 1 month after year-end, it can now close in a week. This provides senior managers with timely information on the company’s profitability and allows the company to provide timely financial reports to shareholders and creditors. The company has over 2,000 employees. Each employee has access to a company human resources (HR) Web site that provides comprehen- sive information on company policies and allows employees to select from a menu of alternative health and retirement plans. The launch of the Web site has eliminated the need for five full-time HR staff who previously responded to employee questions and processed paperwork. Software Systems That Impact Value Chain Management Companies use a variety of software systems to process information and improve the operation of the value chain. Here, we briefly discuss three systems: enterprise resource planning (ERP) systems, supply chain management (SCM) systems, and customer relationship management (CRM) systems. Enterprise Resource Planning Systems. ERP systems grew out of material require- ments planning (MRP) systems that have been used since the 1960s. MRP systems com- puterized inventory control and production planning. Key features included an ability to prepare a master production schedule and a bill of materials and generate purchase orders. ERP systems update MRP systems with better integration, relational databases, and graphical user interfaces. ERP components now include accounting and finance, human resources, and other applications including SCM and CRM, which are discussed next. Supply Chain Management Systems. Supply chain management (SCM) is the organization of activities between a company and its suppliers in an effort to provide for T h e I n f o r m a t i o n A g e a n d M a n a g e r i a l A c c o u n t i n g 17 the profitable development, production, and delivery of goods to customers. By sharing information, production lead times and inventory holding costs have been reduced, while on-time deliveries to customers have been improved. SCM software systems support the planning of the best way to fill orders and help tracking of products and components among companies in the supply chain. Walmart and Procter & Gamble (P&G) are two companies that have become well known for their cooperation in the use of SCM. When P&G products are scanned at a Walmart store, P&G receives information on the sale via satellite and, thus, knows when to make more product and the specific Walmart stores to which the product should be shipped. Related cost savings are passed on, at least in part, to Walmart customers. Customer Relationship Management Systems. CRM systems are used to manage information related to a variety of customer interactions. At their heart is a database of many, if not all, customer interactions. Company employees (and, in some cases, cus- tomers) can access this database for many purposes, including these: • Salespeople can examine the history of all sales calls made to customers and customers’ responses. This allows the sales force to personalize their messages so that they match a specific customer’s needs. • Analysis of data in the CRM system can support targeted direct-mail advertising, taking into account customers’ past purchases. • A CRM system can be used to suggest future purchases to customers based on their past purchases. This is a well-known feature of the CRM system at Amazon.com. • A CRM system can allow customers to track the status of their orders. For example, the CRM system used by FedEx allows customers to track their shipments. • A CRM system can allow customers to access information on product updates. For example, Canon has a CRM system that allows customers to update printer drivers. Link to Practice Casinos Manage with Data from CRM address is available. As another example, if a casino Systems learns that a customer plays golf, then the casino can offer a discount on this activity. This would be especially Casinos have been leaders in using data collected from profitable if a golf outing caused a customer to stay 2 their CRM systems in marketing decisions. Some give or 3 days longer at the casino and gamble. customers a card that they can use as they bet, buy meals, Customers who are especially profitable, such as buy spa services, and pay for golf outings. Information from those who play higher-denomination slot machines, applying for and using the card includes patron age and would also be offered incentives and advertising stressing home location, e-mail address, number and length of visits, the excitement and glamour of playing slots. Individuals retail purchase data, food and beverage data, table game who avoided playing slot machines but loved playing preference, and slot machine denomination preference. blackjack might be sent ads stressing the excitement Casinos can use this information to determine which and glamour of playing this game. And individuals like customers are most profitable and then target them with me won’t be sent any incentives since I don’t find gam- promotions that encourage repeat visits. These promo- bling to be either exciting or glamorous! tions can be sent via e-mail since the customer’s e-mail 18 c h a p te r 1 M a n a g e r i a l A c c o u n t i n g i n t h e I n f o r m a t i o n A g e T est y o u r K N O W L E D G E Which of the following is false? a. Companies use CRM systems to manage information related to customers. b. Supply chain management systems may be used to share information with suppliers. c. Enterprise resource planning systems may include CRM and SCM applications. d. CRM systems are primarily used to manage information generated by suppliers. Correct answer is d. Learning Ethical Considerations in Managerial Objective 5 Decision Making Describe a framework for ethical decision Remember that when we discuss decision making throughout this book, we will focus making and discuss the on incremental analysis as the approach to making good decisions. However, in addi- duties of the controller. tion to performing incremental analysis, it is equally important that managers consider the ethical aspects of their decisions. Why focus on ethics? First and foremost, ethical decision making is simply the right thing to do. But additionally, when managers behave ethically, they gain the confidence of their customers, suppliers, subordinates, and com- pany stockholders, and that confidence is likely to translate into gains to the bottom line and to their company’s stock price. Ethical and Unethical Behavior Ethical behavior requires that managers recognize the difference between what’s right and what’s wrong and then make decisions consistent with what’s right. In recent years, we’ve witnessed a plethora of disclosures, indictments, and convictions, indicating that key managers in major companies either can’t tell right from wrong or don’t care to make decisions consistent with what’s right. Some examples: Enron managers misled investors by hiding debt in so-called special-purpose entities. Kenneth Lay, Enron’s CEO, touted Enron’s stock to employees just weeks before the energy company imploded, leaving many with worthless 401(k) retirement accounts. Lay was found guilty of securities fraud and related charges. He faced a sentence of more than 20 years but died of a heart attack in 2006, prior to sentencing. WorldCom, America’s number two long-distance company, disclosed the biggest case of fraudulent accounting in U.S. history, with profits overstated by billions. The result—the company declared bankruptcy and laid off 17,000 employees. Bernard Ebbers, CEO of WorldCom, received a 25-year prison sentence in 2005. Dennis Kozlowski, who made more than $300 million as head of Tyco, was charged with conspiring with art dealers to avoid sales tax on art he bought for $13.2 million. Tyco’s share price took a nosedive following the disclosure. In 2005, Kozlowski was convicted for misappropriations of corporate funds including granting himself unauthorized bonuses and having millions of dollars of personal expenses paid by Tyco, including a $15,000 umbrella stand and a $6,000 shower curtain. He was sentenced to a jail term of 8 to 20 years. E t h i c a l C o n s i d e r a t i o n s i n M a n a g e r i a l D e c i s i o n M a k i n g 19 Sarbanes-Oxley Act. The abuses just cited, along with others, led Congress to enact the Sarbanes-Oxley Act in July 2002. This law, named after Senator Paul Sarbanes and Representative Michael Oxley, has changed the financial reporting landscape for public companies and their auditors. Some of the act’s most important provisions are: • A requirement that chief executive officers and chief financial officers of a company certify that, based on their knowledge, their financial statements do not contain any untrue statements or omissions of material facts that would make the statements misleading. • A ban on certain types of work by the company’s auditors to ensure their independence. For example, the act bans auditors from performing bookkeeping services and designing or implementing financial information systems for clients. • Longer jail sentences and larger fines for corporate executives who knowingly and willfully misstate financial statements. Fines now run up to $5 million and jail terms up to 20 years. • A requirement that companies report on the existence and reliability of their internal controls as they relate to financial reports. The cost of complying with Sarbanes-Oxley has been substantial. According to a survey conducted by Charles River Associates of 90 companies with average annual gross revenue of $8.1 billion, the average cost to comply with the act in the first year was $7.8 million. This amount should be contrasted with the $63 billion lost by shareholders in Enron. Will the net benefits of Sarbanes-Oxley outweigh the costs? Time will tell. There is no doubt, however, that the act has reminded corporate leaders that they have a clear obligation to ensure that financial statements do not mislead investors. And the act has put needed distance between senior managers and auditors of publicly traded companies. In addition to conspicuous and rather clear-cut examples of unethical behavior, some companies and individuals have been accused of paying unconscionably low wages to workers in undeveloped countries, using child labor, endangering the environment with toxic chemicals, and bribing officials to promote sales abroad. But are these accu- sations clearly indicative of ethical lapses? Low wages are better than no wages, and, while child labor is reprehensible, the additional income earned by a child may save a family from starvation. The point is that ethical dilemmas are often complex and the situations managers face are often gray rather than black and white. When this is the case, a framework for ethical decision making may help understanding of “what’s right.” Link to Practice Feds Investigating Walmart Over Bribery be a violation of the U.S. Foreign Corrupt Practices Act in Mexico (FCPA). The probe expanded to China, India, and Brazil and is ongoing as of 2015. Walmart spent $439 million Wouldn’t it have been wonderful if corporate wrongdoing in FCPA investigation and compliance costs in 2013 had ceased after the events at Enron, WorldCom, and and 2014. And the company estimates such costs will Tyco? Unfortunately, that hasn’t been the case. Here’s exceed $200 million in fiscal 2015! an example of more recent alleged wrongdoing: In 2012, the Justice Department began a criminal Sources: Asri Horwithz and Jia Lynn Yang, “Wal-Mart Faces Criminal Probe into Bribery Allegations,” The Washington investigation of Walmart related to allegations the com- Post, April 24, 2012; David Voreaqcos and Renee Dudley, pany paid more than $24 million in bribes to Mexican “Wal-Mart Says Bribe Probe Cost $439 Million in Two Years,” officials for construction permits. Such bribes would Bloomberg News, March 26, 2014. 20 c h a p te r 1 M a n a g e r i a l A c c o u n t i n g i n t h e I n f o r m a t i o n A g e A Framework for Ethical Decision Making The following framework for ethical decision making consists of seven questions.1 Hopefully, answering these questions will serve as an aid in identifying “what’s right.” But certainly, answering them doesn’t guarantee ethical decision making. A Seven-Question Framework for Ethical Decision Making When evaluating a decision, ask: 1. What decision alternatives are available? 2. What individuals or organizations have a stake in the outcome of my decision? 3. Will an individual or an organization be harmed by any of the alternatives? 4. Which alternative will do the most good with the least harm? 5. Would someone I respect find any of the alternatives objectionable? After deciding on a course of action, but before taking action, ask: 6. At a gut level, am I comfortable with the decision I am about to make? 7. Will I be comfortable telling my friends and family about this decision? Any Q ue s tion s ? Q: Why focus on the seven-question framework for ethical decision making? Many, if not most, companies have written codes of ethics, so when managers make decisions, they just need to consult their company’s code to determine whether their decision stacks up to what’s right in their company’s environment. A : Managers should definitely be familiar with their company’s code of ethics. However, codes of ethics aren’t always good guides to ethical behavior. Part of the problem is that codes often specify what can’t be done rather than what should be done. And some codes focus more on ensuring that decisions are legal rather than right! A number of exercises, problems, and cases in the end-of-chapter material present ethical dilemmas, and you should refer to this framework when preparing your answers to them. Alternatively, you may wish to consider other ethical perspectives. A large amount of material is available on the Web to help your understanding of ethical deci- sion making. IMA Statement of Ethical Professional Practice The Institute of Management Accounting (IMA) is a professional organization that focuses, as its name indicates, on management accounting. One of the contributions of the IMA is the development of a Statement of Ethical Professional Practice, which is presented in the appendix to this chapter. The IMA has also developed an ethics helpline that members can call to discuss ethical dilemmas they face at their companies. Callers are assigned a code number to preserve anonymity and are then referred to a counselor 1 Developing these questions was aided by three resources located on the Web. The first is A Guide to Moral Decision Making by Chris MacDonald