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Managerial Accounting
Creating Value in a Dynamic Business Environment
Eighth edition
Cornell University
McGraw-HillIrwin
Boston Burr Ridge, IL Dubuque, IA New York San Francisco St. LouisBangkok Bogota Caracas Kuala Lumpur Lisbon London Madrid Mexico CityMilan Montreal New Delhi Santiago Seoul Singapore Sydney Taipei Toronto
Contents
The Changing Role of ManagerialAccounting in a Dynamic BusinessEnvironment 2
Managerial Accounting: A BusinessPartnership with Management 4
Managing Resources, Activities, andPeople 5
Decision Making 5
Planning 6
Directing Operational Activities 6
Controlling 6
How Managerial Accounting AddsA/alue to theOrganization 6
Objectives of Managerial AccountingActivity 6
The Balanced Scorecard 9
M.A.P. The Balanced Scorecard 10
Managerial versus FinancialAccounting 11
Managerial Accounting in Different Types ofOrganizations 12
Where Are Managerial Accountants Located inan Organization? 13
Organization Chart 13
Cross-Functional Deployment 14
Physical Location 15
Major Themes in Managerial Accounting 17
Information and Incentives 17
Behavioral Issues 18
Costs and Benefits 18
Evolution and Adaptation in ManagerialAccounting 18
M.A.P. The Internet as a Lifeline 22
Cost Management Systems 24
Strategic Cost Management and the ValueChain 25
The Ethical Climate of Business and the Roleof the Accountant 27
Managerial Accounting as a Career 28
Professional Organizations 28
Professional Certification 29
Professional Ethics 29
Focus on Ethics: IMA Statement of EthicalProfessional Practice 29
Chapter Summary 30
Key Terms 31
Review Questions 31
Exercises 32
Problems 32
Case 34
Basic Cost Management Conceptsand Accounting for MassCustomization Operations 36
What Do We Mean by a Cost? 36
Product Costs, Period Costs, andExpenses 39
Costs on Financial Statements 40
Income Statement 40
Balance Sheet 42
Note: Entries printed in blue denote topics that emphasizecontemporary issues in managerial accounting and cost management.
XXV
xxvi Contents
Manufacturing Operations and ManufacturingCosts 43
M.A.P. Mass Customization 44
Mass-Customization Manufacturing 44
Manufacturing Costs 45
Manufacturing Cost Flows 47Production Costs in Service Industry Firmsand Nonprofit Organizations 49
Basic Cost Management Concepts: DifferentCosts for Different Purposes 50
The Cost Driver Team 50
Variable and Fixed Costs 51
The Cost Management and ControlTeam 52
M.A.P. Airline Industry: Cost Structure,Cost Drivers, and a Shifting BusinessModel 54
The Outsourcing Action Team 56
Costs and Benefits of Information 59
Costs in the Service Industry 59
Focus on Ethics: Was WorldCom's ControllerJust Following Orders? 61
Chapter Summary 62
Review Problems on Cost Classifications 62
Key Terms 63
Review Questions 64
Exercises 64
Problems 67
Cases 77
Product Costing and CostAccumulation in a Batch ProductionEnvironment 80
Product and Service Costing 82
Product Costing in NonmanufacturingFirms 83
Flow of Costs in ManufacturingFirms 83
Types of Product-Costing Systems 85
Job-Order Costing Systems 85
Process-Costing Systems 86
Summary of Alternative Product-CostingSystems 86
Accumulating Costs in a Job-Order CostingSystem 86
Job-Cost Record 86
Direct-Material Costs 87
Direct-Labor Costs 89
Manufacturing-Overhead Costs 89
M.A.P. Supply Chain Management 90
Summary of Event Sequence in Job-OrderCosting 91
Illustration of Job-Order Costing 97
Purchase of Material 91
Use of Direct Material 93
Use of Indirect Material 93
Use of Direct Labor 93
Use of Indirect Labor 94
Incurrence of Manufacturing-OverheadCosts 94
Application of ManufacturingOverhead 95
Summary of OverheadAccounting 95
Selling and Administrative Costs 96
Completion of a Production Job 97
Sale of Goods 97
Underapplied and OverappliedOverhead 97
Schedule of Cost of GoodsManufactured 99
Schedule of Cost of GoodsSold 99
Posting Journal Entries to theLedger 100
Further Aspects of OverheadApplication 100
Actual and Normal Costing 100
Choosing the Cost Driver for OverheadApplication 100
Departmental Overhead Rates 103
Two-Stage Cost Allocation 704
Project Costing: Job-Order Costing inNonmanufacturing Organizations 105
Contents xxvii
Changing Technology in ManufacturingOperations 707
EDI and XML 108
M.A.P. Radio Frequency IdentificationSystems (RFID) 108
Use of Bar Codes 108
Focus on Ethics: Did Boeing ExploitAccounting Rules to Conceal Cost Overrunsand Production Snafus? 709
Chapter Summary 7 70
Review Problem on Job-OrderCosting 7 70
Key Terms 712
Review Questions 112
Exercises 712
Problems 7 78
Case 730
Process Costing and Hybrid Product-Costing Systems 134
Comparison of Job-Order Costing andProcess Costing 736
Flow of Costs 136
Differences Between Job-Order andProcess Costing 138
Equivalent Units: A Key Concept 738
Equivalent Units 138
Illustration of Process Costing 740
Basic Data for Illustration 141
M.A.P. New York Wine Industry 142
Weighted-Average Method of ProcessCosting 143
Other Issues in Process Costing 747
Actual versus Normal Costing 147
Other Cost Drivers for OverheadApplication 147
Subsequent ProductionDepartments 148
Hybrid Product-Costing Systems 748
Operation Costing for Batch ManufacturingProcesses 148
Chapter Summary 752
Review Problem on Process Costing 752
Key Terms 753
Review Questions 754
Exercises 754
Problems 757
Case 766
Activity-Based Costingand Management 168
Traditional, Volume-Based Product-CostingSystem 7 77
Trouble in Denver 171
Activity-Based Costing System 7 72
ABC Stage One 173
ABC Stage Two 174
Interpreting the ABC Product Costs 178
The Punch Line 179
Why Traditional, Volume-Based SystemsDistort Product Costs 180
M.A.P. Cost Distortion at RockwellInternational 182
Activity-Based Costing: Some KeyIssues 782
M.A.P. Cost Distortion at DHL 183
Cost Drivers 183
Collecting ABC Data 184
Activity Dictionary and Bill of Activities 186
Activity-Based Management 786
Two-Dimensional ABC 186
Using ABM to Identify Non-Value-AddedActivities and Costs 187
Customer-Profitability Analysis 789
Illustration of Customer-ProfitabilityAnalysis 190
xxviii Contents
M.A.P. Customer Profitability Analysis at BankOne Corp. - 191
Activity-Based Costing in the ServiceIndustry 792
M.A.P. Customer Profitability Analysis atBest Buy 193
Activity-Based Costing at Delaware MedicalCenter 194
Interpreting the Primary Care Unit's ABCInformation 197
Focus on Ethics: Ethical Issues SurroundingActivity-Based Costing 798
Chapter Summary 799
Review Problems on Cost Drivers andProduct-Cost Distortion 799
Key Terms 200
Appendix to Chapter 5: Just-in-Time Inventoryand Production Management 207
Review Questions 202
Exercises 203
Problems 209
Cases 228
6 Activity Analysis, Cost Behavior, andCost Estimation 232
Cost Behavior Patterns 235
Variable Costs 235
Step-Variable Costs 236
Fixed Costs 237
Step-Fixed Costs 237
Semivariable Cost 239
Curvilinear Cost 240
Using Cost Behavior Patterns to PredictCosts 241
M.A.P. Is Direct Labor a Variable or a FixedCost? 242
Engineered, Committed,and DiscretionaryCosts 243
Cost Behavior in Other Industries 244
Cost Estimation 244
Account-Classification Method 244
Visual-Fit Method 245
High-Low Method 247
Least-Squares Regression Method 248
Multiple Regression 250
Data Collection Problems 250
Engineering Method of CostEstimation 251
Effect of Learning on Cost Behavior 257
Focus on Ethics: Cisco Systems,Wal-Mart,Taco Bell, Starbucks, U-Haul, GeneralDynamics, and Farmer's Insurance: Is DirectLabor a Variable Cost? 253
Chapter Summary 253
Review Problems on Cost Behavior andEstimation 254
Key Terms 255
Appendix to Chapter 6: Least-SquaresRegression Using Microsoft Excel 255
Review Questions 257
Exercises 258
Problems 262
Cases 270
Cost-Volume-Profit Analysis 274
Illustration of Cost-Volume-ProfitAnalysis 277
Projected Expenses and Revenue 277
The Break-Even Point 278
Contribution-Margin Approach 278
Equation Approach 279
Graphing Cost-Volume-ProfitRelationships 280
Interpreting the CVP Graph 281
Alternative Format for the CVP Graph 283
Profit-Volume Graph 283
Target Net Profit 284
Contribution-Margin Approach 284
Contents xxix
Equation Approach 284
Graphical Approach 285
Applying CVP Analysis 285
Safety Margin 285
Changes in Fixed Expenses 285
Changes in the Unit ContributionMargin 286
Predicting Profit Given ExpectedVolume 287
Interdependent Changes in KeyVariables 288
CVP Information in Published AnnualReports 289
M.A.P. Airlines Keep a Close Eye on Break-Even Load Factors 289
CVP Analysis with Multiple Products 290
Assumptions Underlying CVP Analysis 292
Role of Computerized Planning Models andElectronic Spreadsheets 292
CVP Relationships and the IncomeStatement 293
Traditional Income Statement 293
Contribution Income Statement 293
Comparison of Traditional and ContributionIncome Statements 294 '
Cost Structure and Operating Leverage 295
Operating Leverage 296
M.A.P. Operating Leverage Helps These WebCompanies Become Profitable 297
Cost Structure and Operating Leverage:A Cost-Benefit Issue 298
M.A.P. Cost Structure and OperatingLeverage 299
CVP Analysis, Activity-Based Costing, andAdvanced Manufacturing Systems 299
A Move toward JIT and FlexibleManufacturing 300
Chapter Summary 302
Review Problem on Cost-Volume-ProfitAnalysis 303
Key Terms 303
Appendix to Chapter 7: Effect of IncomeTaxes 304
Review Questions 306
Exercises 307
Problems 309
Cases 327
Absorption and Variable Costing 324
Product Costs 326
Illustration of Absorption and VariableCosting 327
Absorption-Costing IncomeStatements 328
Variable-Costing IncomeStatements 328
Reconciling Income under Absorption andVariable Costing 329
Cost-Volume-Profit Analysis 331
Evaluation of Absorption and VariableCosting 332
M.A.P. IRS: Unique Product Packaging Is anInventoriable Cost 333
Throughput Costing 333
Throughput-Costing IncomeStatements 334
Focus on Ethics: Incentive to OverproduceInventory 335
Chapter Summary 335
Review Problem on Absorption and VariableCosting 336
Key Terms 337
Review Questions 337
Exercises 338
Problems 340
Cases 344
Profit Planning and Activity-BasedBudgeting 346
Purposes of Budgeting Systems 348
Types of Budgets 349
XXX Contents
The Master Budget: A Planning Tool 350
Sales of Services or Goods 350
Sales Forecasting 351
Operational Budgets 351
Budgeted Financial Statements 352
Nonprofit Organizations 352
M.A.P. Activity-Based Budgeting (ABB) atAmerican Express and AT&T Paradyne 353
Activity-Based Budgeting 353
Using Activity-Based Budgeting to Prepare theMaster Budget 354
Sales Budget 355Production Budget 356Direct-Material Budget 356Direct-Labor Budget 358Manufacturing-Overhead Budget 359Selling, General, and Administrative (SG&A)Expense Budget 360
Cash Receipts Budget 362Cash Disbursements Budget 363
Cash Budget: Combining Receipts andDisbursements 364
Budgeted Schedule of Cost of GoodsManufactured and Sold 365
Budgeted Income Statement 366
Budgeted Statement of Cash Flows 367
Budgeted Balance Sheet 368
Assumptions and Predictions Underlying theMaster Budget 369
Financial Planning Models 371
Budget Administration 372
M.A.P. Budget Administration at CornellUniversity 373
International Aspects of Budgeting 373
Budgeting Product Life-Cycle Costs 374
Behavioral Impact of Budgets 375
Budgetary Slack: Padding the Budget 375
Focus on Ethics: Is Padding the BudgetUnethical? 376
Participative Budgeting 377
Chapter Summary 377
Review Problem on Preparing Master BudgetSchedules 377
Key Terms 379Review Questions 380
Exercises 380
Problems 384
Cases 396
10 Standard Costing, OperationalPerformance Measures, and theBalanced Scorecard 402
Managing Costs 404
Management by Exception 405
Setting Standards 405
Methods for Setting Standards 405
Participation in Setting Standards 406
Perfection versus Practical Standards: ABehavioral Issue 406
Use of Standards by Service
Organizations 407
Cost Variance Analysis 407
Direct-Material Standards 408
Direct-Labor Standards 408
Standard Costs Given Actual Output 409
Analysis of Cost Variances 409
Direct-Material Variances 409
Direct-Labor Variances 411
M.A.P. Parker Hannifin Corporation's BrassProducts Division 413
Multiple Types of Direct Material or DirectLabor 413
Allowing for Spoilage or Defects 413
Significance of Cost Variances 474
A Statistical Approach 416
Behavioral Impact of StandardCosting 477
Controllability of Variances 477
Interaction among Variances 418
Standard Costs and Product Costing 479
Evaluation of Standard Costing Systems 420
Advantages of Standard Costing 420
Contents xxxi
Criticisms of Standard Costing in Today'sManufacturing Environment 420
M.A.P. Cost of Ownership 422
Operational Performance Measures in Today'sManufacturing Environment 422
Gain-Sharing Plans 425
The Balanced Scorecard 425
Lead and Lag Measures: The Key to theBalanced Scorecard 428
Linking the Balanced Scorecard toOrganizational Strategy 429
M.A.P. Linking the Balanced Scorecard toOrganizational Strategy 430
Focus on Ethics: Sacrificing Quality to CutStandard Costs 432
Chapter Summary 432
Review Problems on Standard Costing andOperational Performance Measures 433
Key Terms 435
Appendix to Chapter 10: Use of StandardCosts for Product Costing 435
Review Questions 437
Exercises 438
Problems 447
Cases 452
11 Flexible Budgeting and theManagement of Overhead and SupportActivity Costs 456
Overhead Budgets 458
Flexible Budgets 458
Advantages of Flexible Budgets 459
The Activity Measure 460
Flexible Overhead Budget Illustrated 467
Overhead Application in a Standard-CostingSystem 463
Choice of Activity Measure 464
Criteria for Choosing the ActivityMeasure 464
Cost Management Using OverheadCost Variances 465
Variable Overhead 466
Fixed Overhead 469
Overhead Cost Performance Report 477
M.A.P. Cost Management Systems inGermany 472
Activity-Based Flexible Budget 472
Flexible Budgeting in the ServiceIndustry 474
Focus on Ethics: Misstated Standards AffectAccuracy of Reports 476
Chapter Summary 477
Review Problem on Overhead Variances 477
Key Terms 478
Appendix A to Chapter 11: Standard Costsand Product Costing 479
Appendix B to Chapter 11: SalesVariances 480
Review Questions 487
Exercises 482
Problems 485
Cases 497
12 Responsibility Accounting, QualityControl, and Environmental CostManagement 500
Responsibility Centers 502
Illustration of ResponsibilityAccounting 503
Performance Reports 506
Budgets, Variance Analysis, andResponsibility Accounting 508
Cost Allocation 508
Cost Allocation Bases 508
Allocation Bases Based on Budgets 508
Activity-Based ResponsibilityAccounting 510
xxxii Contents
Behavioral Effects of ResponsibilityAccounting 570
Information versus Blame 510
Controllability 510
Motivating Desired Behavior 511
Segmented Reporting 577
Segments versus Segment Managers 512
Key Features of Segmented Reporting 513
Customer-Profitability Analysis and Activity-Based Costing 513
Total Quality Management 574
Measuring and Reporting QualityCosts 514
Changing Views of Optimal ProductQuality 516
M.A.P. Six Sigma for Quality Management andCost Reduction 518
ISO 9000 Standards 579
Environmental Cost Management 520
Classifying Environmental Costs 520
Managing Private Environmental Costs 521
Environmental Cost Strategies 522
Tie-In to the Responsibility-AccountingSystem 523
Focus on Ethics: Short-Sighted View of CostCutting 523
Chapter Summary 524
Review Problem on ResponsibilityAccounting 525
Key Terms 526
Review Questions 526
Exercises 527
Problems 530
Cases 538
13 Investment Centers and TransferPricing 542
Delegation of Decision Making 544
Obtaining Goal Congruence: A BehavioralChallenge 545
Adaptation of Management ControlSystems 545
Measuring Performance in InvestmentCenters 546
Return on Investment 546
Residual Income 548
Economic Value Added 551
M.A.P. Pay for Performance Basedon EVA 552
Measuring Income and Invested Capital 553
Invested Capital 553
Measuring Investment-Center Income 556
Inflation: Historical-Cost versus Current-Value Accounting 557
Other Issues in Segment PerformanceEvaluation 557
Alternatives to ROI, Residual Income, andEconomic Value Added (EVA) 557
Importance of NonfinancialInformation 558
Measuring Performance in NonprofitOrganizations 558
Transfer Pricing '559
Goal Congruence 559
General Transfer-Pricing Rule 560
Transfers Based on the External MarketPrice 563
Negotiated Transfer Prices 564
Cost-Based Transfer Prices 565
Standard versus Actual Costs 566
Undermining Divisional Autonomy 566
M.A.P. Transfer Pricing and Tax Issues 567
An International Perspective 567
Transfer Pricing in the Service Industry 568
Behavioral Issues: Risk Aversion andIncentives 568
Goal Congruence and Internal ControlSystems 569
Chapter Summary 570
Review Problems on Investment Centers andTransfer Pricing 570
Key Terms 577
Review Questions 572
Exercises 572
Problems 575
Cases 587
Contents xxxiii
14 Decision Making: Relevant Costs andBenefits 586
The Managerial Accountant's Role in DecisionMaking 588
Steps in the Decision-MakingProcess 589
Quantitative versus QualitativeAnalysis 589
Obtaining Information: Relevance, Accuracy,and Timeliness 590
Relevant Information 597
Unique versus Repetitive Decisions 591
Importance of Identifying Relevant Costsand Benefits 592
Identifying Relevant Costs and Benefits 592
Sunk Costs 592
Irrelevant Future Costs and Benefits 595
Opportunity Costs 595
Summary 596
Analysis of Special Decisions 596
Accept or Reject a Special Offer 596
Outsource a Product or Service 598
M.A.P. Outsourcing 599
Add or Drop a Service, Product, orDepartment 601
M.A.P. Adding a Service 603
Special Decisions in ManufacturingFirms 603
Joint Products: Sell or ProcessFurther 603
Decisions Involving LimitedResources 605
Uncertainty 607
Activity-Based Costing and Today's AdvancedManufacturing Environment 608
Conventional Outsourcing (Make-or-Buy)Analysis 609
Activity-Based Costing Analysis of theOutsourcing Decision 610
Other Issues in Decision Making 67 7
Incentives for Decision Makers 611
Short-Run versus Long-Run Decisions 612
Pitfalls to Avoid 612
Focus on Ethics: Effects of Decision to Close aDepartment and Outsource 673
Chapter Summary 674
Review Problem on Relevant Costs 674
Key Terms 675
Appendix to Chapter 14: LinearProgramming 675
Review Questions 677
Exercises 678
Problems 627
Cases 634
15 Target Costing and Cost Analysis forPricing Decisions 638
Major Influences on Pricing Decisions 640
Customer Demand 641
Actions of Competitors 641
Costs 641
Political, Legal, and Image-RelatedIssues 642
Economic Profit-Maximizing Pricing 643
Total Revenue, Demand, and MarginalRevenue Curves 643
Total Cost and Marginal Cost Curves 643
Profit-Maximizing Price and Quantity 646
Price Elasticity 646
Limitations of the Profit-MaximizingModel 646
Costs and Benefits of Information 648
Role of Accounting Product Costs inPricing 648
Cost-Pius Pricing 648
Absorption-Cost Pricing Formulas 650
Variable-Cost Pricing Formulas 650
Determining the Markup 650
xxxiv Contents
Cost-Pius Pricing: Summary andEvaluation 652
M.A.P. Price Competition and CostManagement 653
Strategic Pricing of New Products 653
Target Costing 654
M.A.P. Pricing on the Internet by "e-Tailers" 655
A Strategic Profit and Cost ManagementProcess 655
Activity-Based Costing and TargetCosting 657
Product-Cost Distortion and Pricing: TheRole of Activity-Based Costing 658
Value Engineering and Target Costing 658
Time and Material Pricing 660
Competitive Bidding 667
Effect of Antitrust Laws on Pricing 663
Chapter Summary 664
Review Problem on Cost-Pius Pricing 665
Key Terms 666
Review Questions 666
Exercises 667
Problems 670
Cases 676
16 Capital Expenditure Decisions 680Section 1: Discounted-Cash-FlowAnalysis 683
Net-Present-Value Method 684
Internal-Rate-of-Return Method 684
Comparing the NPV and IRR Methods 687
Assumptions Underlying Discounted Cash-Flow Analysis 687
Choosing the Hurdle Rate 688
Depreciable Assets 689
Comparing Two Investment Projects 689
Managerial Accountant's Role 689
Postaudit 692
Real Option Analysis 693
Section 2: Income Taxes and CapitalBudgeting 693
After-Tax Cash Flows 693
Accelerated Depreciation 696
Modified Accelerated Cost RecoverySystem (MACRS) 697
Gains and Losses on Disposal 700
Investment in Working Capital 701
Extended Illustration of Income-Tax Effectsin Capital Budgeting 702
M.A.P. Capital Budgeting at PharmaceuticalFirms 704
Ranking Investment Projects 705
Section 3: Alternative Methods for MakingInvestment Decisions 707
Payback Method 707
Accounting-Rate-of-Return Method 709
Estimating Cash Flows: The Role of Activity-Based Costing 77 7
Justification of Investments in AdvancedManufacturing Systems 772
Focus on Ethics: Dysfunctional Focus on EarlyCash Flows 773
Chapter Summary 774
Review Problems on Capital ExpenditureDecisions 774
Key Terms 775
Appendix A to Chapter 16: Future Value andPresent Value Tables 776
Appendix B to Chapter 16: Impact ofInflation 778
Review Questions 720
Exercises 727
Problems 724
Cases 730
17 Allocation of Support Activity Costsand Joint Costs 734
Section 1: Service Department CostAllocation 736
Contents XXXV
Direct Method 739
Step-Down Method 739
Reciprocal-Services Method 740
Fixed versus Variable Costs 741
M.A.P. Cost Management in the Health CareIndustry 743
Dual Cost Allocation 743
Allocate Budgeted Costs 744
Today's Advanced ManufacturingEnvironment 745
The Rise of Activity-Based Costing 746
Section 2: Joint Product Cost Allocation 746
Allocating Joint Costs 747
M.A.P. Joint Cost Allocation in the PetroleumIndustry 749
Chapter Summary 749
Review Problem on Service Department CostAllocation 749
Key Terms 750
Appendix to Chapter 17: Reciprocal-ServicesMethod 757
Review Questions 752
Exercises 753
Problems 755
Cases 760
Appendix I: The Sarbanes-Oxley Act,Internal Controls, and ManagementAccounting 762
Appendix II: Compound Interest and theConcept of Present Value 768
Appendix III: InventoryManagement 776
References for "In Their OwnWords" 784
Glossary 787
Photo Credits 798
Index of Companies andOrganizations 801
Index of Subjects 803
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