ntroductioriTo
MANAGERIAL ACCOUNTING
N
Professor Miami University
Professor Emeritus, Brigham Young University
Professor Emeritus, University of Washington
McGraw-Hill
Irwin
CONTENTS
PROLOGUE
Managerial Accounting:
An Overview I
W H A T IS MANAGERIAL ACCOUNTING? 2
Planning 3
Controlling 3
Decision Making 4
W H Y DOES MANAGERIAL A C C O U N T I N G MATTER
TO YOUR CAREER? 5
Business Majors 5
Accounting Majors 6
Professional Certification—A Smart Investment 7
W H A T SKILLS D O MANAGERS NEED
TO SUCCEED? 8
Strategic Management Skills 8
Enterprise Risk Management Skills 9
Process Management Skills 10
Lean Production 11
The Theory of Constraints (TOC) I I
Measurement Skills 12
Leadership Skills 13
THE IMPORTANCE OF ETHICS IN BUSINESS 14
Code of Conduct for Management Accountants 14
CORPORATE SOCIAL RESPONSIBILITY 16
Summary 18
Glossary 18
Questions 19
CHAPTER ONE
Managerial Accounting and Cost
Concepts 20
Decision Feature: Understanding Costs Aids the Growth
of a Billion Dollar Company 21
GENERAL COST CLASSIFICATIONS 22
Manufacturing Costs 22
Direct Materials 22
Direct Labor 22
Manufacturing Overhead 23
Nonmanufacturing Costs 23
PRODUCT COSTS VERSUS PERIOD COSTS 23
Product Costs 23
Period Costs 24
Prime Cost and Conversion Cost 24
COST CLASSIFICATIONS FOR PREDICTING
COST BEHAVIOR 26
XXVI
Variable Cost 26
Fixed Cost 27
The Linearity Assumption and the Relevant Range
Mixed Costs 31
THE ANALYSIS OF MIXED COSTS
29
32
Diagnosing Cost Behavior with a Scattergraph Plot
The High-Low Method 34
The Least-Squares Regression Method 36
32
TRADITIONAL AND CONTRIBUTION FORMAT
INCOME STATEMENTS 38
The Traditional Format Income Statement 38
The Contribution Format Income Statement 39
COST CLASSIFICATIONS FOR ASSIGNING COSTS
T O COST OBJECTS 39
Direct Cost 39
Indirect Cost 40
COST CLASSIFICATIONS FOR DECISION MAKING
Differential Cost and Revenue 40
Opportunity Cost 41
Sunk Cost 41
Summary 42
Guidance Answers to Decision Point 44
Guidance Answers to Concept Checks 44
Review Problem I: Cost Terms 44
Review Problem 2: High-Low Method 45
Glossary 46
Questions 47
Applying Excel 48
The Foundational 15 49
Exercises 50
Problems 55
Building Your Skills 61
CHAPTER TWO
Job-Order Costing 64
Decision Feature: Two Former College Students Succeeding
as Entrepreneurs 65
JOB-ORDER C O S T I N G — A N OVERVIEW 66
JOB-ORDER COSTING—AN EXAMPLE 67
Measuring Direct Materials Cost 68
Job Cost Sheet 68
Measuring Direct Labor Cost 69
Computing Predetermined Overhead Rates 70
Applying Manufacturing Overhead 71
Manufacturing Overhead—A Closer Look 72
40
Contents
The Need for a Predetermined Rate 72
Choice of an Allocation Base for Overhead Cost
Computation of Unit Costs 74
JOB-ORDER COSTING—THE FLOW OF COSTS
73
76
The Purchase and Issue of Materials 77
Issue of Direct and Indirect Materials 77
Labor Cost 78
Manufacturing Overhead Costs 78
Applying Manufacturing Overhead 79
The Concept of a Clearing Account 80
Nonmanufacturing Costs 81
Cost of Goods Manufactured 82
Cost of Goods Sold 82
SCHEDULES OF COST OF GOODS MANUFACTURED
A N D COST OF GOODS SOLD 85
UNDERAPPLIEDAND OVERAPPLIED OVERHEAD—
A CLOSER LOOK 86
Computing Underapplied and Overapplied Overhead 86
Disposition of Underapplied or Overapplied Overhead
Balances 88
A General Model of Product Cost Flows 89
Multiple Predetermined Overhead Rates 89
JOB-ORDER COSTING IN SERVICE COMPANIES 90
Summary 91
Guidance Answer to Decision Point 92
Guidance Answers to Concept Checks 92
Review Problem: Job-Order Costing 93
Glossary 95
Questions 96
Applying Excel 96
The Foundational 15 98
Exercises 98
Problems 106
Building Your Skills 112
CHAPTER "THREE
Activity-Based Costing
I 16
Decision Feature: Managing Product Complexity I 17
ASSIGNING OVERHEAD COSTS TO PRODUCTS I 18
Plantwide Overhead Rate I 18
Departmental Overhead Rates 119
Activity-Based Costing (ABC) 119
DESIGNING A N ACTIVITY-BASED COSTING
SYSTEM 121
Hierarchy of Activities 122
An Example of an Activity-Based Costing System Design 124
USING ACTIVITY-BASED COSTING 125
Comtek Sound, Inc.'s Basic Data 125
Direct Labor-Hours as a Base 126
Computing Activity Rates 127
Computing Product Costs 128
Shifting of Overhead Cost 129
xxvii
TARGETING PROCESS IMPROVEMENTS 131
EVALUATION OF ACTIVITY-BASED COSTING 131
The Benefits of Activity-Based Costing 131
Limitations of Activity-Based Costing 132
The Cost of Implementing Activity-Based Costing 133
Limitations of the ABC Model 133
Modifying the ABC Model 133
Activity-Based Costing and Service Industries 134
Summary 135
Guidance Answer to Decision Point 135
Guidance Answers to Concept Checks 135
Review Problem: Activity-Based Costing 136
Glossary 138
Questions 138
Applying Excel 138
The Foundational 15 141
Exercises 142
Problems 147
Building Your Skills 152
CHAPTER FOUR
/' ' ' I
Process Costing
156
u
Decision Feature: Costing the "Quicker-Picker-Upper" 157
COMPARISON OF JOB-ORDER A N D PROCESS
COSTING
158
Similarities between Job-Order and Process Costing 158
Differences between Job-Order and Process Costing 158
COST FLOWS IN PROCESS COSTING 159
Processing Departments 159
The Flow of Materials, Labor, and Overhead Costs 160
Materials, Labor, and Overhead Cost Entries 161 *
Materials Costs 161
Labor Costs 161
Overhead Costs 161
Completing the Cost Flows 162
EQUIVALENT UNITS OF PRODUCTION
164
Weighted-Average Method 164
COMPUTE A N D APPLY COSTS 166
Cost per Equivalent Unit—Weighted-Average
Method 166
Applying Costs—Weighted-Average Method 167
Cost Reconciliation Report 168
Summary 169
Guidance Answer to Decision Point 170
Guidance Answers to Concept Checks 170
Review Problem: Process Cost Flows and Costing Units 170
Glossary 173
Questions 173
Applying Excel 174
The Foundational 15 175
Exercises 176
Problems 180
Building Your Skills 184
xxviii
Contents
CHAPTERiFIVE
Cost-VolumevProfit
Relationships 186
CHAPTER^!*
Variable Costing and Segment
Reporting:Tools for Management
Decision Feature: Moreno Turns Around the Los Angeles
Angels 187
THE BASICS OF COST-VOLUME-PROFIT (CVP)
ANALYSIS 188
Contribution Margin 189
CVP Relationships in Equation Form 191
CVP Relationships in Graphic Form 192
Preparing the CVP Graph 192
Contribution Margin Ratio (CM Ratio) 195
Some Applications of CVP Concepts 196
Change in Fixed Cost and Sales
Volume 198
Change invariable Cost and Sales
Volume 199
Change in Fixed Cost, Selling Price, and Sales
Volume 199
Change in Variable Cost, Fixed Cost, and Sales
Volume 200
Change in Selling Price 201
TARGET PROFIT A N D BREAK-EVEN
ANALYSIS 201
Target Profit Analysis 201
The Equation Method 202
The Formula Method 202
••'
Target Profit Analysis in Terms of Sales
Dollars 202
Break-Even Analysis 203
Break-Even in Unit Sales 203
Break-Even in Sales Dollars 204
The Margin of Safety 205
CVP CONSIDERATIONS IN CHOOSING A COST
STRUCTURE 206
tCost Structure and Profit Stability 206
' Operating Leverage 208
STRUCTURING SALES COMMISSIONS 210
SALES MIX 210
The Definition of Sales Mix 210
Sales Mix and Break-Even Analysis 211
ASSUMPTIONS OF CVP ANALYSIS 213
Summary 213
Guidance Answer to Decision Point 214
Guidance Answers to Concept Checks 215
Review Problem: CVP Relationships 215
Glossary 218
Questions 218
Applying Excel 218
The Foundational 15 220
Exercises 220
Problems 226
Building Your Skills 234
Decision Feature: IBM's $2.5 Billion Investment in Technology 237
OVERVIEW OF VARIABLE A N D ABSORPTION
COSTING 238
Variable Costing 238
Absorption Costing 238
Selling and Administrative Expenses 239
Summary of Differences 239
VARIABLE A N D ABSORPTION COSTING—
A N EXAMPLE 240
Variable Costing Contribution Format Income
Statement 240
Absorption Costing Income Statement 242
RECONCILIATION OF VARIABLE COSTING W I T H
ABSORPTION COSTING INCOME 244
ADVANTAGES OF VARIABLE COSTING A N D THE
CONTRIBUTION APPROACH 247
Enabling CVP Analysis 247
Explaining Changes in Net Operating Income 248
Supporting Decision Making 248
Adapting to the Theory of Constraints 249
SEGMENTED INCOME STATEMENTS A N D THE
CONTRIBUTION APPROACH 249
Traceable and Common Fixed Costs and the Segment
Margin 249
Identifying Traceable Fixed Costs 251
Traceable Costs Can Become Common Costs 251
SEGMENTED INCOME STATEMENTS—AN
EXAMPLE 251
Levels of Segmented Income Statements 253
Segmented Income Statements and Decision Making 253
SEGMENTED INCOME STATEMENTS—COMMON
MISTAKES 255
Omission of Costs 255
Inappropriate Methods for Assigning Traceable Costs
among Segments 255
Failure to Trace Costs Directly 255
Inappropriate Allocation Base 255
Arbitrarily Dividing Common Costs among Segments 256
INCOME STATEMENTS—AN EXTERNAL REPORTING
PERSPECTIVE 256
Companywide Income Statements 256
Segmented Financial Information 257
Summary 258
Guidance Answer to Decision Point 258
Guidance Answers to Concept Checks 259
Review Problem I: Contrasting Variable and Absorption
Costing 259
Review Problem 2: Segmented Income Statements 261
Glossary 262
Questions 262
236
Contents
Applying Excel 263
The Foundational 15 264
Exercises 265
Problems 271
Building Your Skills 278
CHAPTER SEVEN
Profit Planning 282
Decision Feature: Planning for a Crisis—Civil War Preservation
Trust 283
THE BASIC FRAMEWORK OF BUDGETING 284
Advantages of Budgeting 284
Responsibility Accounting 285
Choosing a Budget Period 285
The Self-imposed Budget 286
Human Factors in Budgeting 287
The Master Budget: An Overview 288
PREPARING THE MASTER BUDGET 289
The Sales Budget 291
The Production Budget 293
Inventory Purchases—Merchandising Company 294
The Direct Materials Budget 294
The Direct Labor Budget 297
The Manufacturing Overhead Budget 298
The Ending Finished Goods Inventory Budget 299
The Selling and Administrative Expense Budget 300
The Cash Budget 301
The Budgeted Income Statement 305
The Budgeted Balance Sheet 306
Summary 308
Guidance Answer to Decision Point 309
Guidance Answers to Concept Checks 309
Review Problem: Budget Schedules 309
Glossary 311
Questions 312
Applying Excel 312
The Foundational 15 314
Exercises 314
Problems 320
Building Your Skills 330
xxix
FLEXIBLE BUDGET VARIANCES 340
Revenue Variances 340
Spending Variances 341
FLEXIBLE BUDGETS W I T H MULTIPLE COST
DRIVERS 341
STANDARD COSTS—SETTING THE STAGE 343
Setting Direct Materials Standards 344
Setting Direct Labor Standards 344
Setting Variable Manufacturing Overhead Standards 345
Using Standards in Flexible Budgets 345
A GENERAL MODEL FOR STANDARD COST
VARIANCE ANALYSIS 346
USING STANDARD COSTS—DIRECT MATERIALS
VARIANCES 347
The Materials Quantity Variance 348
The Materials Price Variance 349
USING STANDARD COSTS—DIRECT LABOR
VARIANCES 351
The Labor Efficiency Variance 351
The Labor Rate Variance 352
USING STANDARD COSTS—VARIABLE
MANUFACTURING OVERHEAD VARIANCES 353
The Variable Manufacturing Overhead Efficiency and
Rate Variances 354
A N IMPORTANT SUBTLETY IN THE MATERIALS
VARIANCES 356
Summary 358
Guidance Answer to Decision Point 359
Guidance Answers to Concept Checks 359
Review Problem I: Variance Analysis Using a Flexible Budget 359
Review Problem 2: Standard Costs 361
Glossary 363
Questions 363
Applying Excel 364
The Foundational 15 365
Exercises 366
Problems 373
Building Your Skills 378
Appendix 8A : Predetermined Overhead Rates and Overhead
Analysis in a Standard Costing System 381
Appendix 8A Glossary 387
Appendix 8A Exercises and Problems 387
Appendix 8B: Journal Entries to Record Variances 393
Appendix 8B: Exercises and Problems 394
CHAPTERtEipHT
Flexible Budgets, Standard Costs, and
Variance Analysis 334
CHAPTERl NINE
V
• i
Performance Measurement in
Decentralized Organizations 398
Decision Feature: Managing Materials and Labor 335
THE VARIANCE ANALYSIS CYCLE 336
FLEXIBLE BUDGETS 337
Characteristics of a Flexible Budget 337
Deficiencies of the Static Planning Budget 337
How a Flexible Budget Works 339
Decision Feature: Sony Attempts to Rebound 399
DECENTRALIZATION IN ORGANIZATIONS 400
Advantages and Disadvantages of Decentralization 400
RESPONSIBILITY A C C O U N T I N G 401
Cost, Profit, and Investment Centers 401
Cost Center 401
XXX
Contents
Profit Center 401
Investment Center 401
EVALUATING INVESTMENT CENTER
PERFORMANCE—RETURN O N INVESTMENT 402
The Return on Investment (ROI) Formula 402
Net Operating Income and Operating Assets Defined 402
Understanding ROI 403
Criticisms of ROI 405
RESIDUAL INCOME 406
Motivation and Residual Income 407
Divisional Comparison and Residual Income 409
OPERATING PERFORMANCE MEASURES 410
Delivery Cycle Time 410
Throughput (Manufacturing Cycle) Time 410
Manufacturing Cycle Efficiency (MCE) 411
BALANCED SCORECARD 413
Common Characteristics of Balanced Scorecards 413
A Company's Strategy and the Balanced Scorecard 416
Tying Compensation to the Balanced Scorecard 418
Advantages of Timely and Graphic Feedback 419
Summary 419
Guidance Answer to Decision Point 420
Guidance Answers to Concept Checks 421
Review Problem: Return on Investment (ROI) and Residual
Income 421
Glossary 422
Questions 422
Applying Excel 422
The Foundational 15 423
Exercises 424
Problems 429
Building Your Skills 436
CHAPTER TEN \ \
Differential Analysis: The Key to
Decision Making 438
Decision Feature: Massaging the Numbers
439
COST CONCEPTS FOR DECISION MAKING
440
Identifying Relevant Costs and Benefits 440
Different Costs for Different Purposes 441
An Example of Identifying Relevant Costs and Benefits 441
Reconciling the Total and Differential Approaches 444
Why Isolate Relevant Costs? 446
ADDING AND DROPPING PRODUCT LINES
AND OTHER SEGMENTS 447
An Illustration of Cost Analysis 447
A Comparative Format 449
Beware of Allocated Fixed Costs 449
THE MAKE OR BUY DECISION 451
An Example of Make or Buy 452
OPPORTUNITY COST 453
SPECIAL ORDERS 454
UTILIZATION OF A CONSTRAINED RESOURCE
455
Contribution Margin per Unit of the Constrained
Resource 456
Managing Constraints 458
JOINT PRODUCT COSTS A N D THE CONTRIBUTION
APPROACH 461
The Pitfalls of Allocation 462
Sell or Process Further Decisions 462
Summary 464
Guidance Answer to Decision Point 465
Guidance Answers to Concept Checks 465
Review Problem: Differential Analysis 466
Glossary 467
Questions 467
Applying Excel 468
The Foundational 15 469
Exercises 470
Problems 478
Building Your Skills 485
CHAPTER ELEVEN
Capital Budgeting Decisions
11 I
490
Decision Feature: Capital Investments: A Key to Profitable
Growth 491
CAPITAL BUDGETING—PLANNING
INVESTMENTS 492
Typical Capital Budgeting Decisions 492
The Time Value of Money 492
THE NET PRESENTVALUE METHOD 493
Emphasis on Cash Flows 494
Typical Cash Outflows 494
Typical Cash Inflows 495
Simplifying Assumptions 495
Choosing a Discount Rate 495
An Extended Example of the Net Present Value Method 496
EXPANDING THE NET PRESENTVALUE METHOD 498
The Total-Cost Approach 498
The Incremental-Cost Approach 499
Least-Cost Decisions 500
—
PREFERENCE DECISIONS—THE RANKING OF
INVESTMENT PROJECTS 502
THE INTERNAL RATE OF RETURN METHOD 504
THE NET PRESENTVALUE METHOD A N D INCOME
TAXES 504
OTHER APPROACHES TO CAPITAL BUDGETING
DECISIONS 504
The Payback Method 504
Evaluation of the Payback Method 505
An Extended Example of Payback 506
Payback and Uneven Cash Flows 506
The Simple Rate of Return Method 508
Criticisms of the Simple Rate of Return 509
POSTAUDIT OF INVESTMENT PROJECTS 510
Contents
Summary "511
Guidance Answer to Decision Point 512
Guidance Answers to Concept Checks 512
Review Problem: Comparison of Capital Budgeting Methods
Glossary 514
Questions 514
Applying Excel 515
The Foundational 15 516
Exercises 517
Problems 520
Building Your Skills 526
Appendix I I A:The Concept of Present Value 528
Review Problem: Basic Present Value Computations 532
Appendix 11A Glossary 533
Appendix 11A Exercises 533
Appendix I IB: Present Value Tables 535
CHAPTER TWELVE
Statement of Cash Flows
512
538
ji
Decision Feature: Understanding Cash Flows 539
THE STATEMENT OF CASH FLOWS: KEY
CONCEPTS 541
Organizing the Statement of Cash Flows 541
Operating Activities: Direct or Indirect Method? 542
The Indirect Method: A Three-Step Process 543
Investing and Financing Activities: Gross Cash Flows 546
Property, Plant, and Equipment 546
Retained Earnings 548
Summary of Key Concepts 549
AN EXAMPLE OF A STATEMENT OF CASH
FLOWS 550
Operating Activities 551
Investing Activities 553
Financing Activities 553
Seeing the Big Picture 555
INTERPRETING THE STATEMENT OF CASH
FLOWS 556
Consider a Company's Specific Circumstances 556
Consider the Relationships among Numbers 557
Free Cash Flow 557
Earnings Quality 558
Summary 559
Guidance Answer to Decision Point 559
Guidance Answers to Concept Checks 559
Review Problem 560
Glossary 564
Questions 564
The Foundational 15 564
Exercises 566
Problems 569
XXXI
Building Your Skills 577
Appendix l2A:The Direct Method of Determining the Net
Cash Provided by Operating Activities 577
Appendix 12A Exercises and Problems 579
CHAPTER TJHIRTEEN
Financial Statement Analysis 582
Decision Feature: Keeping an Eye on Dividends 583
LIMITATIONS OF FINANCIAL STATEMENT
ANALYSIS 584
Comparing Financial Data across Companies 584
Looking beyond Ratios 584
STATEMENTS IN COMPARATIVE A N D COMMON-SIZE
FORM 584
Dollar and Percentage Changes on Statements 585
Common-Size Statements 587
RATIO ANALYSIS—THE C O M M O N
STOCKHOLDER 589
Earnings per Share 589
Price-Earnings Ratio 590
Dividend Payout and Yield Ratios 591
The Dividend Payout Ratio 591
The Dividend Yield Ratio 591
Return on Total Assets 592
Return on Common Stockholders' Equity 592
Financial Leverage 593
Book Value per Share 593
RATIO ANALYSIS—THE SHORT-TERM CREDITOR 594
Working Capital 594
Current Ratio 594
Acid-Test (Quick) Ratio 595
Accounts Receivable Turnover 595
Inventory Turnover 596
RATIO ANALYSIS—THE LONG-TERM CREDITOR 597
Times Interest Earned Ratio 598
Debt-to-Equity Ratio 598
SUMMARY OF RATIOS A N D SOURCES OF
COMPARATIVE RATIO DATA 599
—
Summary 602
Guidance Answer to Decision Point 602
Guidance Answers to Concept Checks 602
Review Problem: Selected Ratios and Financial Leverage 602
Glossary 605
Questions 605
The Foundational 15 605
Exercises 606
Problems 61 I
Building Your Skills 618
Credits 622
Index 623