Second Edition
• Measur ing ,1VI o n i t o r i n g,and1VI o t i v a t i n gPerformance
Leslie G. Eldenburg, PhDUniversity of Arizona
Susan K. Wolcott, PhD, CPA, CMACA School of Business and WolcottLynch Associates
A Musical NoteIf you think about it, jazz music is a good analogy for costaccounting. Jazz is an enticing mix of structure, interaction,context, and creativity. These are also the core ingredients of thistext.
Cost Management has a unifying structure to help studentsapproach, understand, and apply accounting information. Itanalyzes the interaction between accounting information andsound decision making. It shows students the importance_ofthe business context, the understanding of which is critical tocost management and high quality business decisions. Andit helps students develop the creativity needed for gooddecision-making, stimulating them to think about accountingproblems and problem-solving in more complex ways.
WILEY
John Wiley & Sons, Inc.
PART ONE MEASURING AND USING COSTS EORMANAGEMENT DECISIONS
1 The Role of Accounting Information in ManagementDecision Making 2MOTOROLA'S IRIDIUM PROJECT: LOOK BEFORE SNOW-BLADE SNOWBOARDS: IDENTIFYINGYOU LEAP 3 RELEVANT COSTS 12
STRATEGIC MANAGEMENT AND DECISION
MAKING 4Organizational Vision 4Organizational Core Competencies 4Organizational Strategies 5Operating Plans 5Actual Operations 6Measuring, Monitoring, and Motivating
Performance 6
LEVERS OF CONTROL 6Belief Systems 6Boundary Systems 6Diagnostic Control Systems 7Interactive Systems 8
COST ACCOUNTING AND STRATEGICMANAGEMENT 8
Management Accounting and FinancialAccounting 8
A Brief History of Cost Accounting 9Strategic Cost Management 9
INFORMATION SYSTEMS AND STRATEGICMANAGEMENT 9
Internal and External Reports 10Improvements in Information for
Management Decision Making 11Business Intelligence and Process
Management Systems 11
RELEVANT INFORMATION FORDECISION MAKING 11
Relevant and Irrelevant Cash Flows 11Relevance of Income StatementInformation 12
Importance of Identifying RelevantInformation 14
BUSINESS RISK 14Risk Management 14Business Risk and Cost Management
DECISION-MAKING BIASES 16
15
RISK OF BIASED DECISIONS: NONRATIONALESCALATION OF COMMITMENT 16
QUALITY OF MANAGEMENTDECISION-MAKING 17
ETHICAL DECISION MAKING 17Conflicting Interests 18Motive for Ethical Behavior 18
FOCUS ON ETHICAL DECISION MAKING:ETHICAL CONSIDERATIONS IN OUTSOURCINGDECISIONS 18
Reputation Effects of Suppliers' Unethical Actions 18
Analyzing the Ethics of a Decision 19
APPENDIX 1A STEPS FOR BETTER THINKING: ADECISION MAKING PROCESS 21
Summary 24Key to Symbols 26Self-Study ProblemsKey Terms 28Questions 28Exercises 29Problems 31Mini-Cases 34
26
XVIII
CONTENTS Xix
2 The Cost Function 38FLYING LOW DURING AN ECONOMICDOWNTURN 39
IDENTJFYING RELEVANT COSTSFOR A DECISION 40
Relevant Costs for a Cost Object 40Identifying Relevant Costs from the
Accounting System 40Direct and Indirect Costs 40Opportunity Costs 41Sunk Costs 41
COST BEHAVIOR 41Variable, Fixed, and Mixed Costs 42Classifying Costs 43 #'Relevant Range 43Cost Functions 44Cost Driver 45Identifying Potential Cost Drivers 46No Apparent Cost Driver 46Discretionary Costs 46Economies of Scale 46
FOCUS ON ETHICAL DECISION MAKING:DISCRETIONARY COSTS 46
Ethics and Pharmaceutical Advertising 47
INFORMATION USED TO ESTIMATE COSTS 47
COST ESTIMATION TECHNIQUES 47Engineered Estimate of Cost 48Analysis at the Account Level 48Scatter Plots 49Two-Point Method 50High-Low Method 50
RISK OF BIASED DECISIONS: INSENSITIVITYTOSAMPLE SIZE 51
ESTIMATING THE COST FUNCTION 51
SMALL ANIMAL CLINIC (PART 1): CREATINGA COST FUNCTION 51
Identify Relevant Costs and Obtain InformationNeeded for Estimation 51
Categorize Costs, Apply Cost Estimation Techniques,and Estimate Future Costs 52
Combine All Relevant Cost Estimates 53Estimating Profit 53
REGRESSION ANALYSIS 54Simple Regression Analysis 54Interpreting Simple Regression Results 54
SMALL ANIMAL CLINIC (PART 2): TWO-POINTMETHOD AND REGRESSION ANALYSIS 56
Revised Analysis of the Treatment Supplies Cost 56Quarterly Data 57Scatter Plots 57Two-Point Method 57Simple Regression Analysis 58Revised Cost Estimate 58Review of Methods, Total Cost Function 59
STRATEGIC RISK MANAGEMENT: SMALL ANIMALCLINIC (PART 2) 59
Cost Estimation Accuracy and Strategies 59
USES AND LIMITATIONS OF COSTESTIMATES 60
Cost Estimation and Managerial DecisionMaking 60
Common Errors in Estimating RelevantCosts 60
Quality of Estimation Techniques 62Reliance on Cost Estimates 62
APPENDIX 2A REGRESSION ANALYSIS-ADDITIONAL TOPICS 62
MULTIPLE REGRESSION ANALYSIS 62Choosing Cost Drivers for MultipleRegression 62
PRINT MASTERS PRINT SHOP: USING MULTIPLEREGRESSION TO ESTIMATE A COST FUNCTION 63
Scatter Plots and Simple Regression Results 63Multiple Regression Analysis 64
REGRESSION ANALYSIS ASSUMPTIONS 65
ADDITIONAL REGRESSION ANALYSISCONSIDERATIONS 65
Stepwise Linear Fixed Costs 65Piecewise Linear Variable Costs 66Data Limitations 67
APPENDIX 2B LEARNING CURVES 67
Summary 68Key to Symbols 69Self-Study ProblemsKey Terms 71Questions 72Exercises 72Problems 77Mini-Cases 84
69
XX CONTENTS
_ l
3 Cost-Volume-Profit Analysis 88WIRED OR WIRELESS: ADJUSTING TO NEWMARKETS 89
90COST-VOLUME-PROFIT ANALYSIS 90
Profit Equation and Contribution MarginCVP AnalysiSijn Units 90CVP Analysis in Revenues 91CVP for Multiple Products 91Breakeven Point 92Cost-Volume-Profit Graph 92CVP with Income Taxes 92
DIE GEFLECKTE KUH EIS (THE SPOTTED COWCREAMERY) (PART 1): CVP ANALYSIS WITHINCOME TAXES 93
Estimating the Cost Function 93Estimating After-Tax Profit 93Calculating Revenues to Achieve Targeted
After-Tax Profit 93
RISK OF BIASED DECISIONS: OPTIMISM BIAS 94
PERFORMING CVP ANALYSES WITH ASPREADSHEET 94
CVP Calculations for a Sales Mix 94CVP Sensitivity Analysis 97Discretionary Expenditure Decision 97Planning, Monitoring, and Motivating
with CVP 98
DIE GEFLECKTE KUH EIS (THE SPOTTED COWCREAMERY) (PART 2): THE INFLUENCE OF SALESMIX ON PROFITABILITY 98
STRATEGIC RISK MANAGEMENT: SPOTTED COWCREAMERY (PART 2) 99
Business Risk and Decision Making 99
ASSUMPTIONS AND LIMITATIONS OFCOST-VOLUME-PROFIT ANALYSIS 99
Business Risk and Quality of Input DataQuality of CVP Technique 101CVP for Nonprofit Organizations 101
SMALL ANIMAL CLINIC: NOT-FOR-PROFITORGANIZATION CVP ANALYSIS WITH TWORELEVANT RANGES 101
Breakeven Compared to Budget 102Potential Investment in New Equipment 102Calculating and Analyzing Targeted Activity LevelCVP Adjusted for Change in Relevant Range 102
MARGIN OF SAFETY AND DEGREE OFOPERATING LEVERAGE 103
Margin of Safety 103Degree of Operating Leverage 104Using the Degree of Operating Leverage
to Plan and Monitor Operations 105
FOCUS ON ETHICAL DECISION MAKING:TEMPORARY LABOR 106
Ethics and Temporary Labor 107
Summary 107Key to Symbols 109Self Study Problems 109Key Terms 112Questions 112Exercises 112Problems 117Mini-Cases 124
99
102
4 Relevant Information for Decision Making 128INTERNATIONAL OUTSOURCING: THE GOOD, THEBAD, AND THE CONTROVERSIAL 129
RELEVANT INFORMATION FORDECISION MAKING 130
Process for Identifying and AnalyzingRelevant Information 130
Operating Decision Examples 132
SPECIAL ORDERS 132Quantitative Rule for Special OrderDecisions 132
BARKLEY BASKETBALLS: SPECIAL ORDER 133
Quantitative Analysis 133Qualitative Analysis 133Strategic Prioritization 134
STRATEGIC RISK MANAGEMENT: BARKLEYBASKETBALLS 134
Special Order Decision Process 134
Special Orders and Pricing Policies 134Qualitative and Risk Factors for Special
Order Decisions 135
KEEP OR DROP DECISIONS 135Quantitative Rule for Product and Business
Segment Keep or Drop Decisions 135
CONTENTS xx i
HOME AIDE SERVICES: KEEP OR DROP 136
Quantitative Analysis 136Qualitative Analysis 137Strategic Prioritization 137
STRATEGIC RISK MANAGEMENT: HOME AIDESERVICES 137
The Business Risk of Dropping a Product 137
Customer Profitability 137
RISK OF BIASED DECISIONS:CONFIRMATION BIAS 138
Costs of Carrying Inventory 138Qualitative and Risk Factors for Keep orDrop Decisions 139
INSOURCE OR OUTSOURCE (MAKE OR BUY)DECISIONS 139
Quantitative Rule for lnsource or OutsourceDecisions 139
ROADRUNNER PUBLISHERS (PART 1): INSOURCEOR OUTSOURCE 139 ' .:
Quantitative Analysis 140Qualitative Analysis 140Strategic Prioritization 140
Qualitative and Risk Factors for OutsourcingDecisions 140
FOCUS ON ETHICAL DECISION MAKING:OFFSHORING SURGERY 141
The Ethics of International Medical Outsourcing 141
PRODUCT EMPHASIS DECISIONS 142Quantitative Rule for Product EmphasisDecisions 142
Theory of Constraints and ConstrainedResources 142
Quantitative Rule for Choosing the ProductMix When Resources Are Constrained 143Quantitative Rule for Relaxing Constraintsfor One or Two Products 143
ROADRUNNER PUBLISHERS (PART 2):CONSTRAINED RESOURCE 144
Qualitative Analysis 144Quantitative Analysis 144Strategic Prioritization 144
STRATEGIC RISK MANAGEMENT: ROADRUNNERPUBLISHERS (PART 2) 144
Reducing the Risk of Lost Sales 144
PRODUCT EMPHASIS: MULTIPLE RESOURCECONSTRAINTS AND MULTIPLE PRODUCTS 145
Quantitative Rule for Maximizing ContributionMargin with Multiple Constraints and MultipleProducts 145
BERTRAM GOLF CARTS: MULTIPLE CAPACITYCONSTRAINTS AND MULTIPLE PRODUCTS 145
STRATEGIC RISK MANAGEMENT: BERTRAMGOLF CARTS 147
Risky Assumptions 147
METHODS FOR RELAXING CONSTRAINTS 148Use Constrained Resources More
Efficiently 148Increase Available Resources 148Qualitative and Risk Factors for ProductEmphasis and Constrained ResourceProblems 148
QUALITY OF OPERATING DECISIONS 149Quality of Information 149Strategic Alignment 149Decision-Maker Bias 149Opportunity Costs 150
ROADRUNNER PUBLISHERS (PART 3): INSOURCEOR OUTSOURCE WITH OPPORTUNITY COSTS 150
Business Risk and Sensitivity Analysis 151Control System Incentive and Behavioral
Effects 151
APPENDIX 4A USING EXCEL SOLVER FORPRODUCT EMPHASIS AND CONSTRAINEDRESOURCE DECISIONS 151
1. Determine the Objective (Target)Function 151
2; Create Constraint Functions 1523. Set Up an Excel Spreadsheet 1524. Use Excel Solver to Maximize the
Objective Function 1535. Interpret the Solver Output 155
Summary 156Key to Symbols 158Self-Study Problem 158Key Terms 159Questions 159Exercises 160Problems 167Mini-Cases 172
xx i i CONTENTS
PART TWO MEASURING AND ASSIGNING COSTS FOR INTERNALAND EXTERNAL REPORTING
5 Job Costing 176BOMBARDIER:CUSTOM MANUFACTURING 177
ASSIGNING PRODUCT COSTS TO INDIVIDUAL
GOODS OR SERVICES 178Product Costs 178Process Costing 178Job Costing 179
JOB COSTING IN MANUFACTURING 179Assigning Direct Costs 180Computerized and Manual Job Costing
Systems 180
ALLOCATING OVERHEAD 181Actual and Normal Costing 183
ALUMINUM BENDERS (PART 1): ALLOCATINGOVERHEAD COSTS IN JOB COSTING 184
Evaluating Overhead Cost Pools and AllocationBases 184
Understanding the Overhead Cost Allocation Method 184
GENERAL LEDGER ENTRIES FOR AMANUFACTURER 185
Overapplied and Underapplied Overhead 186
SERVICE SECTOR JOB COSTING 188
NIGHTHAWK, LLP: JOB COSTING INA LAW FIRM 189
Estimated Job Costs and Price 189Competitor's Job Costs and Price 189Monitoring Job Costs 189
STRATEGIC RISK MANAGEMENT:NIGHTHAWK, LLP 190
Relevance of Fixed Costs 190
JOB COST INFORMATION, DECISION MAKING,AND INCENTIVES 190
Allocated Overhead Costs and DecisionMaking 190
ALUMINUM BENDERS (PART 2): JOB COSTSRELEVANT FOR DECISION MAKING 191
Qualitative Factors 191
Judgment and Uncertainties in Job CostingSystem Design 191
Measuring Job Costs for DiagnosticControl 192
Allocated Overhead and Relevent Costs 192
RISK OF BIASED DECISIONS: HINDSIGHT BIAS 192
FOCUS ON ETHICAL DECISION MAKING:OVERBILLING CLIENTS FOR EXPENSES 193
Tracing Rebates and Discounts Directly to Jobs 193
SPOILAGE, REWORK, AND SCRAP INJOB COSTING 193
Normal and Abnormal Spoilage 194
ALUMINUM BENDERS (PART 3): ASSIGNINGSPOILAGE COSTS 194
Rework 195Scrap 195
PRODUCTION QUALITY AND BEHAVIORIMPLICATIONS 196
Spoilage Opportunity Costs 196Investing in Quality 196Effect of Accounting on Manager
Behavior 197External Monitoring 197
Summary 197Key to Symbols 199Self-Study Problems 199Key Terms 201Questions 201Exercises 202 —Problems 207Mini-Cases 212
6 Process Costing 2 1 6NESTLE: BOTTLING WATER IN TENNESSEE 217
ACCOUNTING FOR THE COST OFMASS-PRODUCED GOODS 218
Assigning Direct Materials andConversion Costs 218
Work in Process and Equivalent Units 219
PROCESS COSTING METHODS 219Detailed Example 220
RISK OF BIASED DECISIONS: LAKE WOBEGONEFFECT 224
CONTENTS XXiii
GENERAL LEDGER ACCOUNTS FOR PROCESSCOSTING 225
PREMIER PLASTICS (PART 1): CHOOSINGA PROCESS COSTING METHOD 226
Weighted Average and FIFO Process Cost Reports 226Comparison of Weighted Average and FIFO 228
FOCUS ON ETHICAL DECISION MAKING:HUMANE TREATMENT OF CHICKENS 228
77ie Ethics of Production Methods 229
PROCESS COSTING UNDER DIFFERENTASSUMPTIONS 229
Direct Materials Added During theProcess 229
Nonuniform Conversion Costs andMultiple Cost Pools 229 J '
Costs Transferred from AnotherDepartment 229
PREMIER PLASTICS (PART 2): COSTS TRANSFERREDFROM ANOTHER DEPARTMENT AND DIRECTMATERIALS ADDED LATER IN THE PROCESS 230
ALTERNATIVE SYSTEMS FOR COSTING MASSPRODUCTION 232
Standard Costing 232Just-in-Time and Long-Term Procurement
Contracts 233Hybrid Costing Systems and Operation
Costing 234
ACCOUNTING FOR SPOILAGE IN PROCESSCOSTING 234
PREMIER PLASTICS (PART 3): FIFO COST REPORTWITH NORMAL AND ABNORMAL SPOILAGE 235
FIFO Process Cost Report and Journal Entries withSpoilage 235
Using Spoilage Cost Information 237
STRATEGIC RISK MANAGEMENT: PREMIERPLASTICS (PART 3) 238
Acceptability of Normal Spoilage 238
Quality-Related Costs 238
PROCESS COST INFORMATION AND MANAGER'SINCENTIVES AND DECISIONS 238
Diagnostic Control of Process Qualityand Costs 239
Process Costing Information and DecisionMaking 239
Mismeasurement of Cost Flows 239Work in Process Units at Different
Stages of Completion 239
Summary 240Key to Symbols 241Self-Study Problem 242Key Terms 244Questions 244Exercises 244Problems 248Mini-Cases 252
7 Multi-Pool, Multi-Driver Costing Methods 256SUN LIFE: ANALYZING THE COST OF CLAIMSPROCESSING 257
ACTIVITY-BASED COSTING (ABC) 258Traditional Cost Accounting Systems 258Activity-Based Costing Systems 259
ABC COST HIERARCHY 260Organization-Sustaining Activities 260Facility-Sustaining Activities 261Customer-Sustaining Activities 261Product-Sustaining Activities 262Batch-Level Activities 262Unit-Level Activities 262
ASSIGNING COSTS USING AN ABCSYSTEM 262
1. Identify the Relevant Cost Object 2632. Identify Activities 2633. Assign Costs to Activity-Based Cost
Pools 2644. For Each ABC Cost Pool, Choose a Cost
Driver 264
5. For Each ABC Cost Pool, Calculate anAllocation Rate 264
6. For Each ABC Cost Pool, Allocate ActivityCosts to the Cost Object 265
KEENER DOORS AND WINDOWS (PART 1):COMPARISON OF ABC AND TRADITIONAL JOBCOSTING 265
Product Costs Using Job Costing 266Product Costs Using ABC 266Using ABC Product Cost Information 268
STRATEGIC RISK MANAGEMENT: KEENER DOORSAND WINDOWS (PART 1) 268
Product Cost Information Bias 268
ABC IN SERVICE ORGANIZATIONS 268
ACTIVITY-BASED MANAGEMENT 269Managing Customer Profitability 269Managing Product and Process Design 269
xx i v CONTENTS
KEENER DOORS AND WINDOWS (PART 2):CUSTOMER PROFITABILITY ANALYSIS, WARRANTYCOST ANALYSIS, AND ABM 270
Using ABC for Customer Profitability 270Using ABC for Warran ty Costs 271
Managing Environmental Costs 271Managing Quality 272Drawbacks of ABC 273
SWISS WATCH: ABM AND THE COST OFQUALITY 273
Estimating the Costs of Quality 273Using Quality Cost Information to Better Manage
Operations 273
STRATEGIC RISK MANAGEMENT: SWISSWATCH 274
Quality and Reputation 274
Modified Versions of ABC 275
FOCUS ON ETHICAL DECISION MAKING:PROMOTING INAPPROPRIATE USES OF ABC
Ethics of Consultant Services 276
275
OTHER MULTI-POOL, MULTI-DRIVER COSTACCOUNTING SYSTEMS 276
Grenzplankostenrechnung (GPK) 276Resource Consumption Accounting (RCA) 277Cost Pool Calculations Under GPK
and RCA 277Idle/Excess Capacity Analysis 278Multi-Level Income Statement 278Drawbacks of GPK and RCA 280
RISK OF BIASED DECISIONS: STATUS QUOBIAS 280
MULTI-POOL, MULTI-DRIVER SYSTEMS,DECISION MAKING, AND INCENTIVES 281
Benefits of ABC, GPK, and RCA Systems 281Costs of ABC, GPK, and RCA Systems 282
Summary 282Key to Symbols 284Self-Study Problems 284Key Terms 286Questions 286Exercises 287Problems 292Mini-Cases 295
8 Measuring and Assigning Support Department Costs 300RECIPROCAL METHOD 310ALLOCATING SUPPORT DEPARTMENT COSTS IN
SEATTLE 301
SUPPORT DEPARTMENT COST ALLOCATIONObjectives for Support Department Cost
Allocation 302
302
PROCESS FOR ALLOCATING SUPPORTDEPARTMENT COSTS 303
Clarifying the Purpose ^304Identifying Support and Operating Department
Cost Pools 304Assigning Costs to Cost Pools and Choosing
Allocation Bases 305Allocation Methods 306
DIRECT METHOD 306
MIDDLETOWN CHILDREN'S CLINIC (PART 1):DIRECT METHOD ALLOCATION 306
Cost Object, Cost Pools, and Assigning Costs 306Choosing Allocation Bases 307Direct Method Calculations 307
STEP-DOWN METHOD 309
MIDDLETOWN CHILDREN'S CLINIC (PART 2):STEP-DOWN METHOD ALLOCATION 309
MIDDLETOWN CHILDREN'S CLINIC (PART 3):RECIPROCAL METHOD ALLOCATION 310
Allocating Support Costs Among SupportDepartments 310
Allocating Support Costs to Operating Departments 311Comparing Results and Choosing an Allocation
Method 312
STRATEGIC RISK MANAGEMENT: MIDDLETOWNCHILDREN'S CLINIC (PART 3) 312
Accuracy of Cost Measurement 312
Comparing the Direct, Step-Down, andReciprocal Methods 312
SINGLE- VERSUS DUAL-RATE ALLOCATIONS 312
MIDDLETOWN CHILDREN'S CLINIC (PART 4): DUALRATES AND RECIPROCAL METHOD WITH THREESUPPORT DEPARTMENTS 313
Charges Based on Single-Rate Allocation 313Analysis of Cost Behavior and Revision of Cost Pools 314Charges Based on Variable Cost Allocation 315Dual-Rate Allocation 316
STRATEGIC RISK MANAGEMENT: MIDDLETOWNCHILDREN'S CLINIC (PART 4) 316
CONTENTS XXV
Support Cost Allocations in a Diagnostic ControlSystem 316
SUPPORT COST ALLOCATIONS, DECISION MAKING,AND INCENTIVES 317
Relevant Support Costs for DecisionMaking 317
Support Department Allocations as TransferPrices 317
Setting Transfer Prices for SupportServices 318
Incentive Effects of Budgeted Versus ActualRates 318
Fairness and Allocation o f Common <*Costs 319
RISK OF BIASED DECISIONS: FAIRNESS BIAS 320
Incentives Under Cost-Based Contract ing 320
FOCUS ON ETHICAL DECISION MAKING:CLASSIFYING OVERHEAD COSTS AT STANFORDUNIVERSITY 321
The Ethics of Accurate Cost Classification 321
APPENDIX 8A USING SOLVER TO CALCULATESIMULTANEOUS EQUATIONS FOR THE RECIPROCALMETHOD 321
Summary 323Key to Symbols 325Self-Study Problem 325Key Terms 327Questions 328Exercises 328 ,Problems 332Mini-Cases 337
9 Joint Product and By-Product CostingHYPERION-TURNING WASTE INTO PROFIT 343
JOINT PRODUCTS AND COSTS 344
ALLOCATING JOINT COSTS 344Physical Output Method 345Sales Value at Spl i t -Of f Point Method 346Net Realizable Value Method 347Constant Gross Marg in NRV Method 347
CHOOSING AN APPROPRIATE JOINT COST
ALLOCATION METHOD 348Pros and Cons o f Alternative Allocation
Methods 348
MERRITT BROTHERS (PART 1): CHOOSING ANAPPROPRIATE ALLOCATION METHOD 349
PROCESSING A JOINT PRODUCT BEYOND THESPLIT-OFF POINT 350
MERRITT BROTHERS (PART 2): JOINT PRODUCTDECISION MAKING 350
Quantitative and Qualitative Factors 351
STRATEGIC RISK MANAGEMENT: MERRITTBROTHERS(PART 2) 351
Relevant Information for Product Line Decisions 351
Judgment and Bias in Incremental Revenue andCost Estimates 351
RISK OF BIASED DECISIONS: JOINT-VERSUS-SEPARATE PREFERENCE REVERSALS 351
JOINT PRODUCTS AND BY-PRODUCTSAccounting for By-Products 352
352
342Income Statement Effects of Recognizing
By-Product Value at Time of ProductionVersus at Sale 352
JOINT PRODUCT COSTING WITH A SALESMIX 353
PREMIUM PINEAPPLE COMPANY: JOINT PRODUCTCOSTING WITH A SALES MIX 354
Physical Output Method 354Sales Value at Split-Off Point Method 354Net Realizable Value Method 355Constan t Gross Margin NRV Method 355Comparing Methods 355
STRATEGIC RISK MANAGEMENT: PREMIUMPINEAPPLE COMPANY 356
Responsibility for Sales and Costs 356
JOINT COST ALLOCATIONS, DECISION MAKING,AND INCENTIVES 356
Diagnostic Control o f Joint Processes andCosts 357
FOCUS ON ETHICAL DECISION MAKING:HAZARDOUS CEMENT 357
Ethics and Hazardous Waste 358
Summary 358Key to Symbols 360Self-Study Problem 360Key Terms 362Questions 362Exercises 363Problems 366Mini-Cases 370
XXVi CONTENTS
PART THREE • PLANNING, MONITORING, AND MOTIVATING
1CT Static and Flexible Budgets 374PLANNING FOR A MOVING TARGET 375
BUDGETS AND THE STRATEGIC MANAGEMENTPROCESS 376'
Budgets and Levers of Control 376MASTER BUDGET 377
Developing a Master Budget 377Forecasting 377
RISK OF BIASED DECISIONS: RECENCY EFFECT 379UNIQUE SINKS (PART 1): DEVELOPING A MASTERBUDGET 380Developing the Revenue Budget 380Developing the Production Budget 380Developing the Direct Materials'and Direct Labor
Budget 381Developing the Manufacturing Overhead Budget 382Developing the Budgeted Statement of Cost of Goods
Manufactured and Sold 382Developing the Selling and Administration Budget 383Developing the Cash Receipts and Disbursements
Budget 383Developing the Short-Term Financing Budget 384Developing the Budgeted Statement of Income and
Retained Earnings-- 384Developing the Budgeted Balance Sheet 385Approving and Using the Master Budget 385
STRATEGIC RISK MANAGEMENT: UNIQUE SINKS(PART 1) 386Budgets as Controls 386Budget Assumptions and Business Risks 386Bias in Operational Planning 386
Budgeting in IMonmanufacturingOrganizations 386
Budgeting in International Organizations 386
FLEXIBLE BUDGETS 386Budget Sensitivity Analysis 387UNIQUE SINKS (PART 2): DEVELOPING AND USINGA FLEXIBLE BUDGET 387Developing a Flexible Budget 387Flexible Budget Operating Income and Breakeven Point 388Flexible Budget Cash Receipts and Disbursements 388Using the Flexible Budget for Planning 388
STRATEGIC RISK MANAGEMENT: UNIQUE SINKS(PART 2) 389
Flexible Budget and Quality of Information 389
BUDGETS AS PERFORMANCE BENCHMARKS 389Budget Variances and Analyses 389
UNIQUE SINKS (PART 3): DEVELOPING A VARIANCEREPORT 390
Static Versus Flexible Budget Variances 390Relevant Variance Information 391
STRATEGIC RISK MANAGEMENT: UNIQUE SINKS(PART 3) 390
Variances in a Diagnostic Control System 390
Variances and the Degree of BusinessRisk 391
PEOPLE: THE CENTER OF THE BUDGETINGPROCESS 391
Budget Responsibility and PerformanceEvaluation 391
Participation in Budgeting 391Budget Manipulation 392Zero-Based Budgeting 392
FOCUS ON ETHICAL DECISION MAKING: TIMELYREPORTING OF BUDGET PROBLEMS 393Budgets, Teamwork, and Ethics 393
BEYOND TRADITIONAL BUDGETING 393Activity-Based Budgets 394GPK and RCA Budgets 394Beyond Budgeting: Relative PerformanceEvaluation 394
Beyond Budgeting: Dynamic Forecasting(Rolling Budgets) 395
Kaizen Budgets 396Technology and Budgeting 396
Summary 396Key to Symbols 398Self-Study ProblemsKey Terms 400Questions 400Exercises 400Problems 406Mini-Cases 410
398
11 Standard Costs and Variance Analysis 414RESPONDING TO UNEXPECTED CHANGES IN VARIANCE ANALYSIS AND THE STRATEGICRESOURCE SUPPLIES AND PRICES 415 MANAGEMENT PROCESS 416
CONTENTS XXVii
Variance Analysis 416Variance Analysis in a Diagnostic Control
System 416Behavior Implications of Variances in a
Diagnostic Control System 417Variance Analysis in an Interactive Control
System 418
STANDARD COSTING 418Standard Costing System and Variances 419Standard Cost Categories 419Developing Standard Costs 420
CEMENTOS JUAREZ (PART 1): SETTING STANDARDCOSTS 420
Setting Cost Standards 420Summary of Direct and Overhead Cost Standards 422Cost Budget 422
RISK OF BIASED DECISIONS: ANCHORINGTRAP 421
STRATEGIC RISK MANAGEMENT: CEMENTOSJUAREZ (PART 1) 422
Standard Costs in a Diagnostic Control System 422
DIRECT COST VARIANCES 422Price Variances 422Efficiency Variances 423Journal Entries for Direct Costs andVariances 424
CEMENTOS JUAREZ (PART 2): VARIANCES FORDIRECT MATERIALS AND DIRECT LABOR 426
Direct Materials Price Variance 426Direct Labor Price Variance 426Direct Materials Efficiency Variance 426Direct Labor Efficiency Variance 426
ANALYZING DIRECT COST VARIANCEINFORMATION 427
Identifying Reasons for Direct CostVariances 427
Recognizing Resource and QualityTrade-Offs 428
CEMENTOS JUAREZ (PART 3): ANALYZING DIRECTCOST VARIANCE INFORMATION 429
OVERHEAD VARIANCES 429
Variable Overhead Spending Variance 430Variable Overhead Efficiency Variance 431Fixed Overhead Spending Variance 431Production Volume Variance 431Journal Entries for Overhead Costs and
Variances 433
CEMENTOS JUAREZ (PART 4): OVERHEADVARIANCES 433
Variable Overhead Spending and Efficiency VariancesFixed Overhead Spending and Production Volume
Variances 434
433
ANALYZING OVERHEAD VARIANCEINFORMATION 435
Analyzing Overhead Spending VariancesInterpreting the Variable Overhead
Efficiency Variance 435Interpreting the Production Volume
Variance 436
COST VARIANCE ADJUSTMENTS 436
FOCUS ON ETHICAL DECISION MAKING:WASTED SOUP 437
Ethics and Continuous Improvement 438
435
438APPENDIX 11A PROFIT-RELATED VARIANCESRevenue Variances 438Sales Price and Revenue Sales QuantityVariances 438
Contribution Margin-Related Variances 440Contribution Margin Variance and ContributionMargin Sales Volume Variance 440
Contribution Margin Sales Mix Variance andContribution Margin Sales QuantityVariance 441
Analyzing Revenue and Contribution MarginVariance Information 442
Summary 443Key to Symbols 447Self-Study Problems 447Key Terms 451 _Questions 451Exercises 451Problems 456Mini-Cases 461
12 Strategic Investment Decisions 464KEEPING AN EYE ON CHINESE MANUFACTURINGCAPACITY 465
STRATEGIC INVESTMENT DECISIONSCapital Budgeting 466
466
Identifying and Prioritizing InvestmentOpportunities 466
Relevant Cash Flows 467Quantitative and Qualitative Analyses 468
xxvi i i CONTENTS
NET PRESENT VALUE METHOD 468Present Value of a Series of Cash Flows 469Net Present Value of a Project 470Profitability Index 470Identifying a Reasonable Discount Rate 470
BUSINESS RISK AND SENSITIVITY ANALYSIS 471Cash Flow Risks 471Estimating Project Life and Discount Rates 471Sensitivity Analysis 471
RISK OF BIASED DECISIONS: OVERCONFIDENCETRAP 472
BOULDER MEDICAL SUPPLY (PART 1): NET PRESENTVALUE WITH OPPORTUNITY COST AND SENSITIVITYANALYSIS 472
Relevant Cash Flows and TimelineNPVAnalysis 473
472
STRATEGIC RISK MANAGEMENT: BOULDERMEDICAL SUPPLY (PART 1) 474
Relevant Information for a Strategic Investment 474
INTERNAL RATE OF RETURN 4741RR Calculations 474Comparison of NPV and 1RR Methods 475
PAYBACK METHOD 476Advantages and Disadvantages of the Payback
Method 476
ACCRUAL ACCOUNTING RATE OF RETURNMETHOD 476
Advantages and Disadvantages of the AccrualAccounting Rate of Return Method 476
OTHER CONSIDERATIONS FOR STRATEGICINVESTMENT DECISIONS 476
Qualitative Factors 477Reputation, Environment, Quality, and
Community 477Making and Monitoring Strategic Investment
Decisions 478
FOCUS ON ETHICAL DECISION MAKING: THE RIGHTTHING TO DO 478
Ethical Priorities for Strategic Investments 478
INCOME TAXES AND THE NET PRESENT VALUEMETHOD 479
U.S. Income Tax Provisions 479Calculating Incremental Tax Cash Flows 480
BOULDER MEDICAL SUPPLY (PART 2): NET PRESENTVALUE WITH INCOME TAXES 481
After-Tax Incremental Operating Cash Flows 481Depreciation Tax Shield 481
* After-Tax Terminal Cash Flow 482Net Present Value and Investment Decision 482
APPENDIX 12A INFLATION AND THE NET PRESENTVALUE METHOD 482
Real and Nominal Methods for NPVAnalysis 482
Internal Consistency in NPV Analysis 483
CENTRAL IRRIGATION, INC.: NPVANALYSIS WITHINCOME TAXES AND INFLATION 484
NPV Calculations: Real Method 484NPV Calculations: Nominal Method 485Comparison of Nominal and Real Methods 485
Real and Nominal Methods under VaryingInflation Rates 486
APPENDIX 12B PRESENT AND FUTURE VALUETABLES 487
Summary 491Key to Symbols 493Self-Study ProblemsKey Terms 495Questions 496Exercises 496Problems 499Mini-Cases 502
493
-:^tmMd'''i--:¥
13 Strategic Pricing and Cost ManagementCOMPETITION AND STRATEGIC LOSSES 507
506
SECTION 1 CONTINUOUS COSTIMPROVEMENT 508
VALUE CHAIN ANALYSIS 508Value-Added and Non-Value-Added
Activities 508Supply Chain Analysis 510Using the Internet to Improve Inventory
Supply 510Just-in-Time Production 510
Other Benefits of Analyzing Production andService Systems 512
BUILDING DESIRED PROFIT INTO DECISIONS
TARGET COSTING 512Target Costing Process 513Factors That Affect the Success of Target
Costing 514
MOUNT RAINIER BIKES (PART 1): TARGETCOSTING 515
512
CONTENTS XXix
Determine Product Target Price, Quality, andFunctionality 515
Determine Target Cost 515Design Product and Production Process to Achieve Target
Cost 515Product Design Changes 516Supplier Negotiations 516Nonmanufacturing Costs 516Total Planned Cost Reduction 517Pilot Project to Evaluate Feasibility 517
KAIZEN COSTING 517Planned Cost Reductions 517Achieving Planned Cost Reductions 518
•y
MOUNT RAINIER BIKES (PART 2): KAIZENCOSTING 518
Cost Reductions ,518Continuous Monitoring of Costs 519
Using Target and Kaizen Costingover Time 519
LIFE CYCLE COSTING 519
RISK OF BIASED DECISIONS: POSITIVEILLUSIONS 521
LEAN ACCOUNTING 521
SECTION 2 PRICE MANAGEMENT
PRICING METHODS 522 ,,Cost-Based Pricing 522Market-Based Pricing 524
522
PROFIT-MAXIMIZING MARKET-BASED PRICE 524Price Elasticity of Demand 524
FRENCH PERFUMERY: USING PRICE ELASTICITY TOCALCULATE PRODUCT PRICES 525
Profit-Maximizing Prices for Breezy and Exotique 525Market Price Guidelines 525
Estimating the Effect of Prices onDemand 526
OTHER MARKET-BASED PRICING METHODS 526
COST-BASED VERSUS MARKET-BASED
PRICING 526
OTHER INFLUENCES ON PRICE 527
FOCUS ON ETHICAL DECISION MAKING: PRICEGOUGING AFTER TRAGEDY 528
Ethics in a Strategic Pricing Decision 528
PRICING IN NOT-FOR-PROFIT
ORGANIZATIONS 528
GOVERNMENT REGULATIONS AND PRICING 528
Summary 529Key to Symbols 532Self-Study Problems 532Key Terms 534Questions 534Exercises 534Problems 538Mini-Cases 543
14 Measuring and Assigning Costs forINVENTORY: SCARCITY OR ABUNDANCE? 547
ABSORPTION COSTING AND VARIABLE
COSTING 548Absorption Costing 548Variable Costing 549Managers' Incentives Under Absorption Costing
and Variable Costing 549
RISK OF BIASED DECISION MAKING: WEASELWORDS 550
BOATS AFLOAT YACHT COMPANY (PART 1):ABSORPTION COSTING AND VARIABLE COSTINGINCOME STATEMENTS 550
Absorption Costing 550
Reconciling Absorption and Variable CostingIncomes 551
BOATS AFLOAT YACHT COMPANY (PART 2):RECONCILING ABSORPTION COSTING ANDVARIABLE COSTING INCOME STATEMENTS 552
Income Statements 546THROUGHPUT COSTING 553
Advantages of Throughput Costing 554
COMPARISON OF ABSORPTION, VARIABLE, AND
THROUGHPUT COSTING 554
ABSORPTION COSTING USING NORMAL
COSTING 554Motivation for Normal Costing 555Allocation Rate Denominator Considerations 555Volume Variance with Normal Costing 556Evaluating Denominator Choices 557
SKI DOODLE: COMPARING RESULTS USINGACTUAL PRODUCTION VOLUMES AND NORMALCAPACITY 557
- Variable Costing 557Absorption Costing with Actual Volume 558Absorption Costing with Normal Capacity 559Choice of Fixed Overhead Allocation Rate Denominator and
Volume Variance Adjustment 559
XXX CONTENTS
The Effects of Beginning Inventory Balances onIncome Reconciliation 560
FLYING FORTRESS: ABSORPTION AND VARIABLEINCOME STATEMENTS WITH BEGINNINGINVENTORIES 560
Variable Costing ' 561Absorption Costing 561Reconciliation df Variable and Absorption Costing
Income 562Using Variable and Absorption Costing Information 563
DECISION MAKING AND MANAGERINCENTIVES 563
Incentives to Build Up Inventories 563Disincentives to Build Up Inventories 563
Desirable Inventory Levels and Business Risk 563Different Methods for Different Purposes 564
FOCUS ON ETHICAL DECISION MAKING: CHANNELSTUFFING AT BRISTOL-MYERS SQUIBB 564
Thinking Critically about Ethics and Channel Stuffing 565
Summary 565Key to Symbols 567Self-Study Problem 567Key Terms 572Questions 572Exercises 572Problems 577Mini-Cases 579
1 5 Performance Evaluation and Compensation 582Economic Value AddedNUCOR: A GROUP OF PEOPLE IN HEADLONG
PURSUIT OF A SHARED PURPOSE 583
AGENCY THEORY 584Agency Costs 584Alternative Theories of Manager and Employee
Behavior 584
DECISION-MAKING AUTHORITY ANDRESPONSIBILITY 585
Centralized and Decentralized Organizations586
General Versus Specific Knowledge 586Technology and Globalization 586Choosing a Centralized Versus Decentralized
Organizational Structure 586Organizational Structure and Span of
Control 587
RESPONSIBILITY ACCOUNTING 588Cost Centers 589Revenue Centers 589Profit Centers 589Investment Centers 589Responsibility Centers, Managers' Incentives,
and Diagnostic Controls 589
INVESTMENT CENTER PERFORMANCE
593
EVALUATION 590Return on Investment 590
COMPUTER WIZARDS (PART 1): RETURN ONINVESTMENT AND DUPONT ANALYSIS 591
Strategies for Increasing ROI 591Choosing a Plan of Action 592
ROI and Managers' Incentives 592Residual Income 593
594
COMPUTER WIZARDS (PART 2): COMPARINGALTERNATIVE INVESTMENT CENTERMEASURES 594
Calculating Residual Income and EVAAnalyzing the Results of Alternative
Performance Measures 594Residual Income, EVA, and Managers'
Incentives 595
MOTIVATING PERFORMANCE WITHCOMPENSATION 595
Bonus System Incentives 595Using Budgets to Monitor and Reward
Performance 596Performance Measure Targets 596Budget and Variance Adjustments 597
RISK OF BIASED DECISIONS: REGRESSION TOTHE MEAN 597
Long-Term Versus Short-TermIncentives 597
International Executive Compensation 598
FOCUS ON ETHICAL DECISION MAKING: BAILOUTSAND BONUSES 598
Ethics of Compensation Practices 599
TRANSFER PRICE POLICIES 599Transfer Prices and Conflicts Among
Managers 599Setting an Appropriate Transfer Price 600
COMPUTER WIZARDS (PART 3): NEGOTIATEDTRANSFER PRICES 601
xxxi i CONTENTS
17 Sustainability Accounting 664THE SCOOP ON SOCIAL AND ENVIRONMENTALREPORTING AT BEN ft JERRY'S 665
SUSTAINABLE MANAGEMENT 666Sustainability and Sustainable
Management 666Strategic Process for Sustainable
Management 666
FOCUS ON ETHICAL DECISION MAKING: ROOTINGOUT BRIBERY 669
Ethics and Similar Codes of Conduct in Practice 669
Sustainability and Levers of Control 670
SUSTAINABILITY ACCOUNTING ANDREPORTING 670
Sustainability Accounting and SustainabilityManagement Accounting 670
Internal and External SustainabilityReporting 671
EXTERNAL SUSTAINABILITY REPORTING 671Motivations for External Sustainability
Reporting 672
RISK OF BIASED DECISIONS:GREENWASHING 672
Frameworks and Guidelines for ExternalSustainability Reporting 673
Recognition for High-Quality SustainabilityManagement and Reporting 676
SUSTAINABILITY MANAGEMENT ACCOUNTINGTOOLS 677
Relevant Sustainability Costs and Benefits forDecision Making 678
More Accurate Assignment of SustainabilityCosts 680
Material Flow Accounting 681Material Flow Cost Accounting 681
PREMIER PLASTICS (PART 4): MATERIAL FLOWFIFO COST REPORT 682
STRATEGIC RISK MANAGEMENT: PREMIERPLASTICS (PART 4) 683
Accounting for Manufacturing Material Flow 683
Sustainability Life Cycle Costing 683Sustainability and Capital Budgeting 684Sustainability Balanced Scorecard 686Role of Management Accounting in
Sustainability 687
Summary 688Key to Symbols 690Self-StudyKey TermsQuestionsExercisesProblemsMini-Case
Problems 690692
692693697700
Sustainability Homework in OtherChapters 701
GLOSSARY 703
CREDITS 723
ORGANIZATION AND PEOPLEINDEX 725
SUBJECT INDEX 728