Starfax inc manufactures a small part

Accounting Discussion

S e c o n d E d i t i o n

Eric W. Noreen, Ph.D., CMA Professor Emeritus University of Washington

Peter C. Brewer, Ph.D., CPA Miami University —Oxford, Ohio

Ray H. Garrison, D.B.A., CPA Professor Emeritus Brigham Young University

managersMANAGERIAL ACCOUNTING for

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MANAGERIAL ACCOUNTING FOR MANAGERS Published by McGraw-Hill/Irwin, a business unit of The McGraw-Hill Companies, Inc., 1221 Avenue of the Americas, New York, NY, 10020. Copyright © 2011, 2008 by The McGraw-Hill Companies, Inc. All rights reserved. No part of this publication may be reproduced or distributed in any form or by any means, or stored in a database or retrieval system, without the prior written consent of The McGraw-Hill Companies, Inc., including, but not limited to, in any network or other electronic storage or transmission, or broadcast for distance learning.

Some ancillaries, including electronic and print components, may not be available to customers outside the United States.

This book is printed on acid-free paper.

1 2 3 4 5 6 7 8 9 0 DOW/DOW 1 0 9 8 7 6 5 4 3 2 1 0

ISBN 978-0-07-352713-0 MHID 0-07-352713-0

Vice president and editor-in-chief: Brent Gordon Editorial director: Stewart Mattson Publisher: Tim Vertovec Director of development: Ann Torbert Development editor: Emily A. Hatteberg Vice president and director of marketing: Robin J. Zwettler Marketing manager: Kathleen Klehr Vice president of editing, design and production: Sesha Bolisetty Lead project manager: Pat Frederickson Lead production supervisor: Carol A. Bielski Senior designer: Mary Kazak Sander Senior photo research coordinator: Lori Kramer Photo researcher: Keri Johnson Media project manager: Jennifer Lohn Cover designer: Gino Cieslik Interior design: Gino Cieslik Cover photo: Integrated Laser Pointer, courtesy of VSON Technology Co., Ltd. Typeface: 10.5/12 Times Roman Compositor: Laserwords Private Limited Printer: R. R. Donnelley

Library of Congress Cataloging-in-Publication Data Noreen, Eric W. Managerial accounting for managers / Eric W. Noreen, Peter C. Brewer, Ray H. Garrison.—2nd ed. p. cm. Includes index. ISBN-13: 978-0-07-352713-0 (alk. paper) ISBN-10: 0-07-352713-0 (alk. paper) 1. Managerial accounting. I. Brewer, Peter C. II. Garrison, Ray H. III. Title. HF5657.4.N668 2011 658.15’11—dc22 2009037451

www.mhhe.com

Dedication To our families and to our many colleagues who use this book.

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About the Authors

Eric W. Noreen has held appointments at institutions in the United States, Europe, and Asia. He is

emeritus professor of accounting at the University of

Washington.

His BA degree is from the University of Washington and his

MBA and PhD degrees are from Stanford University. A Certified

Management Accountant, he was awarded a Certificate of

Distinguished Performance by the Institute of Certified

Management Accountants.

Professor Noreen has served as associate editor of The Accounting Review and the Journal of Accounting and Economics. He has had numerous articles published in academic journals including: the Journal of Accounting Research; the Accounting Review; the Journal of Accounting and Economics; Accounting Horizons; Accounting, Organizations and Society; Contemporary Accounting Research; the Journal of Management Accounting Research; and the Review of Accounting Studies.

Professor Noreen has won a number of awards from students for his teaching.

Peter C. Brewer is a professor in the Department of Accountancy at Miami University, Oxford, Ohio.

He holds a BS degree in accounting from Penn State University,

an MS degree in accounting from the University of Virginia, and

a PhD from the University of Tennessee. He has published

more than 30 articles in a variety of journals including:

Management Accounting Research, the Journal of Information Systems, Cost Management, Strategic Finance, the Journal of Accountancy, Issues in Accounting Education, and the Journal of Business Logistics.

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About the Authors Professor Brewer is a member of the editorial boards of Issues in Accounting Education and the Journal of Accounting Education. His article “Putting Strategy into the Balanced Scorecard” won the 2003 International Federation of Accountants’

Articles of Merit competition and his articles “Using Six Sigma to Improve the

Finance Function” and “Lean Accounting: What’s It All About?” were awarded the

Institute of Management Accountants’ Lybrand Gold and Silver Medals in 2005 and

2006. He has received Miami University’s Richard T. Farmer School of Business

Teaching Excellence Award and has been recognized on two occasions by the Miami

University Associated Student Government for “making a remarkable commitment to

students and their educational development.” He is a leading thinker in undergraduate

management accounting curriculum innovation and is a frequent presenter at various

professional and academic conferences.

Prior to joining the faculty at Miami University, Professor Brewer was employed as

an auditor for Touche Ross in the firm’s Philadelphia office. He also worked as an

internal audit manager for the Board of Pensions of the Presbyterian Church (U.S.A.).

He frequently collaborates with companies such as Harris Corporation, Ghent

Manufacturing, Cintas, Ethicon Endo-Surgery, Schneider Electric, Lenscrafters, and

Fidelity Investments in a consulting or case writing capacity.

Ray H. Garrison is emeritus professor of accounting at Brigham Young University, Provo, Utah. He

received his BS and MS degrees from Brigham Young University

and his DBA degree from Indiana University.

As a certified public accountant, Professor Garrison has been

involved in management consulting work with both national

and regional accounting firms. He has published articles in The Accounting Review, Management Accounting, and other professional journals. Innovation in the classroom has earned

Professor Garrison the Karl G. Maeser Distinguished Teaching Award from Brigham

Young University.

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Focus on the Future Manager

with Noreen/ Brewer/Garrison

In Managerial Accounting for Managers, the authors have crafted a streamlined managerial accounting book that is perfect for non-

accounting majors who intend to move into managerial positions. Topics

such as process costing, the statement of cash flows, and financial state-

ment analysis have been dropped to enable instructors to focus their attention on the bedrocks of managerial accounting—planning, control, and decision making. Noreen/Brewer/Garrison focuses on the

fundamentals, allowing students to develop the conceptual framework

managers need to succeed.

In its second edition, Managerial Accounting for Managers continues to adhere to three core standards:

FOCUS. Noreen/Brewer/Garrison pinpoints the key managerial concepts students will need in their future careers. With no journal

entries or financial accounting topics to worry about, students can focus

on the fundamental principles of managerial accounting.

RELEVANCE. With its insightful Business Focus features to begin each chapter, current In Business examples throughout the text,

and tried-and-true end-of-chapter material, a student will always see the

real-world applicability of Noreen/Brewer/Garrison.

BALANCE. There is more than one type of business, and so Noreen/Brewer/Garrison covers a variety of business models, including

nonprofit, retail, service, wholesale, and manufacturing organizations.

Service company examples are highlighted with icons in the margins of

the text.

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Noreen’s Powerful Pedagogy Managerial Accounting for Managers is full of pedagogy designed to make studying productive and hassle free.

Opening Vignette Each chapter opens with a Business Focus

feature that provides a real-world example

for students, allowing them to see how

the chapter’s information and insights apply

to the world outside the classroom.

Learning Objectives alert students to what they should expect as they progress

through the chapter.

“Many concepts in accounting are rather abstract if not given some type of context to understand them in. The

business focus features help to provide this context and can lead to discussions

in class if the instructor wishes.” —Jeffrey Wong, University of Nevada, Reno

B U

S IN

E S

S F

O C

U S

367367

Learning Objectives

After studying Chapter 10, you should be able to:

LO1 Explain how direct materials standards and direct labor standards are set.

LO2 Compute the direct materials price and quantity variances and explain their significance.

LO3 Compute the direct labor rate and efficiency variances and explain their significance.

LO4 Compute the variable manufacturing overhead rate and efficiency variances.

LO5 Compute delivery cycle time, throughput time, and manufacturing cycle efficiency (MCE).

LO6 (Appendix 10A) Compute and interpret the fixed overhead budget and volume variances.

Standard Costs and Operating Performance Measures Managing Materials and Labor

Schneider Electric’s Oxford, Ohio, plant manufactures busways that transport electricity from its point of entry into a building to remote locations throughout the building. The plant’s managers pay close attention to direct material costs because they are more than half of the plant’s total manufacturing costs. To help control scrap rates for direct materials such as copper, steel, and aluminum, the

accounting department prepares direct materials quantity variances. These variances compare the standard quantity of direct materials that should have been used to make a product (according to computations by the plant’s engineers) to the amount of direct materials that were actually used. Keeping a close eye on these differences helps to identify and deal with the causes of excessive scrap, such as an inadequately trained machine operator, poor quality raw material inputs, or a malfunctioning machine.

Because direct labor is also a significant component of the plant’s total manufac- turing costs, the management team daily monitors the direct labor efficiency variance. This variance compares the standard amount of labor time allowed to make a product to the actual amount of labor time used. When idle workers cause an unfavorable labor efficiency variance, managers temporarily move workers from departments with slack to departments with a backlog of work to be done. ■

Source: Author’s conversation with Doug Taylor, plant controller, Schneider Electric’s Oxford, Ohio, plant.

10 C h a p t e r

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In Business Boxes These helpful boxed features offer a glimpse

into how real companies use the managerial

accounting concepts discussed within the

chapter. Each chapter contains from three to

fourteen of these current examples.

Managerial Accounting in Action Vignettes These vignettes depict cross-functional

teams working together in real-life

settings, working with the products and

services that students recognize from

their own lives. Students are shown

step-by-step how accounting concepts

are implemented in organizations and

how these concepts are applied to solve

everyday business problems. First, “The

Issue” is introduced through a dialogue;

the student then walks through the

implementation process; finally, “The

Wrap-up” summarizes the big picture.

“I love these. Again, a connection to real world that adds credence to the course.”

—Larry N. Bitner, Shippensburg University

“This element is exceptional. The situations truly reflect real life issues business people would

face—not just “textbook” manufactured examples that always have black/white answers.”

—Ann E. Selk, University of Wisconsin – Green Bay

IS THIS REALLY A JOB? VBT Bicycling Vacations of Bristol, Vermont, offers deluxe bicycling vacations in the United States, Canada, Europe, and other locations throughout the world. For example, the company offers a 10-day tour of the Puglia region of Italy—the “heel of the boot.” The tour price includes international airfare, 10 nights of lodging, most meals, use of a bicycle, and ground transportation. Each tour is led by at least two local tour leaders, one of whom rides with the guests along the tour route. The other tour leader drives a “sag wagon” that carries extra water, snacks, and bicycle repair equip- ment and is available to shuttle guests back to the hotel or up a hill. The sag wagon also transports guests’ luggage from one hotel to another.

Each specific tour can be considered a job. For example, Giuliano Astore and Debora Trippetti, two natives of Puglia, led a VBT tour with 17 guests over 10 days in late April. At the end of the tour, Giuliano submitted a report, a sort of job cost sheet, to VBT headquarters. This report detailed the on the ground expenses incurred for this specific tour, including fuel and operating costs for the van, lodging costs for the guests, the costs of meals provided to guests, the costs of snacks, the cost of hiring additional ground transportation as needed, and the wages of the tour leaders. In addition to these costs, some costs are paid directly by VBT in Vermont to vendors. The total cost incurred for the tour is then compared to the total revenue collected from guests to determine the gross profit for the tour.

Sources: Giuliano Astore and Gregg Marston, President, VBT Bicycling Vacations. For more information about VBT, see www.vbt.com .

I N B U S I N E S S

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338 Chapter 9

Victoria: How is the budgeting going? Rick: Pretty well. I didn’t have any trouble putting together the budget for March. I also

prepared a report comparing the actual results for March to the budget, but that report isn’t giving me what I really want to know.

Victoria: Because your actual level of activity didn’t match your budgeted activity? Rick: Right. I know the level of activity shouldn’t affect my fixed costs, but we had

more client-visits than I had expected and that had to affect my other costs. Victoria: So you want to know whether the higher actual costs are justified by the

higher level of activity you actually had in March? Rick: Precisely. Victoria: If you leave your reports and data with me, I can work on it later today, and by

tomorrow I’ll have a report to show you.

How a Flexible Budget Works A flexible budget approach recognizes that a budget can be adjusted to show what costs should be for the actual level of activity. To illustrate how flexible budgets work, Victoria prepared the report in Exhibit 9–4 that shows what the revenues and costs should have been given the actual level of activity in March. Preparing the report is straightforward. The cost formula for each cost is used to estimate what the cost should have been for 1,100 client- visits—the actual level of activity for March. For example, using the cost formula $1,500 � $0.10q, the cost of electricity in March should have been $1,610 (� $1,500 � $0.10 � 1,100).

We can see from the flexible budget that the net operating income in March should have been $30,510, but recall from Exhibit 9–2 that the net operating income was actually only $21,230. The results are not as good as we thought. Why? We will answer that question shortly.

To summarize to this point, Rick had budgeted for a profit of $16,800. The actual profit was quite a bit higher—$21,230. However, given the amount of business the salon had in March, the profit should have been even higher—$30,510. What are the causes of these discrepancies? Rick would certainly like to build on the positive factors, while working to reduce the negative factors. But what are they?

To answer Rick’s questions concerning the discrepancies between budgeted and actual costs, we will need to break down the variances shown in Exhibit 9–3 into two types of variances— activity variances and revenue and spending variances. We do that in the next two sections.

Flexible Budget Variances

MANAGERIAL ACCOUNTING IN ACTION The Issue

Rick’s Hairstyling Flexible Budget

For the Month Ended March 31

Actual client-visits (q) .................................................. 1,100

Revenue ($180.00q) ................................................... $198,000 Expenses: Wages and salaries ($65,000 � $37.00q) ............... 105,700 Hairstyling supplies ($1.50q) ................................... 1,650 Client gratuities ($4.10q) ......................................... 4,510 Electricity ($1,500 � $0.10q) .................................. 1,610 Rent ($28,500) ........................................................ 28,500 Liability insurance ($2,800) ...................................... 2,800 Employee health insurance ($21,300) ..................... 21,300 Miscellaneous ($1,200 � $0.20q) ........................... 1,420 Total expense .............................................................. 167,490 Net operating income .................................................. $ 30,510

E X H I B I T 9 – 4 Flexible Budget Based on Actual Activity

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“This text is a clear, succinct presentation of appropriate

managerial accounting topics for an introductory course. The

management focus makes the text more relevant to the

introductory accounting course in which the majority of students

are non-accounting majors.” —Darlene Coarts, University of

Northern Iowa

“This text is very thorough and has lots of rich current examples and applications. It has exceptional supplements of all types. It is a very user oriented book and

very appropriate for courses for non-accounting majors as a second accounting course.” —Dana Carpenter, Madison Area

Technical College

“Clear, concise, covers the most relevant topics for students in all concentrations of business and a great text for students that are going into Cost Accounting.” —Shirley Polejewski, University of

St. Thomas

“This is a very comprehensive Managerial Accounting textbook

with an excellent use of examples within the text.”

—Tammy Metzke, Milwaukee Area Technical College-West Allis

Utilizing the Icons

To reflect our service-based economy,

the text is replete with examples from

service-based businesses. A helpful icon

distinguishes service-related examples in

the text.

Ethics assignments and examples serve

as a reminder that good conduct is vital

in business. Icons call out content that

relates to ethical behavior for students.

Media integrated icons throughout the

text link content back to chapter-specific

quizzes, audio lectures, and visual

presentations; all of which can be

downloaded to an MP3 player. This gives

students access to a portable, electronic

learning option to support their classroom

instruction.

The writing icon denotes problems that

require students to use critical thinking

as well as writing skills to explain their

decisions.

An Excel© icon alerts students that

spread sheet templates are available for

use with select problems and cases.

The IFRS icon highlights content that

may be affected by the impending change

to IFRS and possible convergence

between U.S. GAAP and IFRS.

I FRS

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End-of-Chapter Material Building on Garrison/Noreen/Brewer’s reputation for

having the best end-of-chapter review and

discussion material of any text on the

market, Noreen’s problem and case material

continues to conform to AACSB, AICPA,

and Bloom’s Taxonomy Categories and

makes a great starting point for class

discussions and group projects.

“The end of the chapter problems... are excellent and are varied enough so that the student is not performing

the same problem over and over again.”

—Peter Woodlock, Youngstown State University

Author-Written Supplements Unlike other managerial accounting texts, Noreen, Brewer, and Garrison

write all of the text’s major supplements, ensuring a perfect fit between

text and supplement. For more information on Managerial Accounting for Managers’s supplements package, see page xvi.

• Instructor’s Resource Guide

• Testbank

• Solutions Manual

• Workbook/Study Guide

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hhe.com /noreen2

e

Multiple-choice questions are provided on the text website at www.mhhe.com/noreen2e .

EXERCISE 4–1 Preparing a Contribution Format Income Statement [ LO1 ] Whirly Corporation’s most recent income statement is shown below:

Total Per Unit

Sales (10,000 units) ........................... $350,000 $35.00 Variable expenses ............................. 200,000 20.00

Contribution margin ........................... 150,000 $15.00 Fixed expenses 135 000

Exercises

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The questions in this exercise are based on the Benetton Group, a company headquartered in Italy and known in the United States primarily for one of its brands of fashion apparel—United Colors of Benetton. To answer the questions, you will need to download the Benetton Group’s 2004 Annual Report at www.benetton.com/investors . Once at this website, click on the link toward the top of the page called “Site Map” and then scroll down to the heading called “Financial Reports” and click on the year 2004. You do not need to print this document to answer the questions.

Required: 1. How do the formats of the income statements shown on pages 33 and 50 of Benetton’s

annual report differ from one another (disregard everything beneath the line titled “income from operations”)? Which expenses shown on page 50 appear to have been reclassified as variable selling costs on page 33?

2. Why do you think cost of sales is included in the computation of contribution margin on page 33?

3. Perform two separate computations of Benetton’s break-even point in euros. For the first computation, use data from 2003. For the second computation, use data from 2004. Why do the numbers that you computed differ from one another?

RESEARCH AND APPLICATION 4-34 [ LO3 , LO4 , LO5 , LO6 , LO7 , LO8 , LO9 ]

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PROBLEM 4–19 Basics of CVP Analysis [ LO1 , LO3 , LO4 , LO6 , LO8] Feather Friends, Inc., distributes a high-quality wooden birdhouse that sells for $20 per unit. Variable costs are $8 per unit, and fixed costs total $180,000 per year.

Required: Answer the following independent questions: 1. What is the product’s CM ratio? 2. Use the CM ratio to determine the break-even point in sales dollars. 3. Due to an increase in demand, the company estimates that sales will increase by $75,000 during the

next year. By how much should net operating income increase (or net loss decrease) assuming that fixed costs do not change?

4. Assume that the operating results for last year were:

Sales .......................................................................... $400,000 Variable expenses ..................................................... 160,000

Contribution margin ................................................... 240,000 Fixed expenses .......................................................... 180,000

Net operating income ................................................ $ 60,000

Problems

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New to the Second Edition

Faculty feedback helps us continue to improve Managerial Accounting for Managers. In response to reviewer suggestions we have:

• Reordered variances in Chapters 9 and 10. Both chapters have been extensively rewritten to follow a more logical flow.

• Added coverage of corporate social responsibility to Chapter 1 to introduce students to an important and relevant topic in today’s

business world.

• Moved the coverage of balanced scorecard to Chapter 11 where it more naturally belongs.

• Added International Financial Reporting Standards (IFRS) icons throughout the text to highlight topics that may be affected should the

U.S. adopt IFRS in the future.

Specific changes were made in the following chapters:

• In Business boxes updated throughout.

• All end-of-chapter items tagged to Bloom’s Taxonomy categories as well as AACSB and AICPA standards.

Chapter 1 • New material on corporate social responsibility has been added.

• Materials dealing with the distinction between financial and

managerial accounting have been moved to Chapter 2.

Chapter 2 • The schedule of cost of goods manufactured has been simplified by

eliminating the list of the elements of manufacturing overhead. This

removes a discrepancy that had existed between the coverage of

the schedule of cost of goods manufactured in Chapter 2 and in

Chapter 3.

Chapter 4 • The basic equations used in target profit analysis and break-even

analysis have been revised to be more intuitive.

• Break-even analysis has been moved to follow target profit analysis

because break-even analysis is just a special caser of target profit

analysis.

• Profit graphs are covered in addition to CVP graphs.

Chapter 5 • Portions of the chapter have been rewritten to enhance clarity.

• The appendix has been rewritten to highlight its assumptions.

Chapter 6 • The chapter has been extensively revised with the overall objective

of making the material more user-friendly. Tables have been

simplified and computing cost of goods sold is streamlined.

Chapter 9 • This chapter has been completely rewritten to follow a logical path

leading from budgeting to performance evaluation comparing

budgets to actual results and then on to standard cost analysis.

Flexible budgets are used to prepare performance reports with

activity variances and revenue and spending variances. This chapter

contains some of the material that used to be in Chapter 11.

Chapter 10 • This chapter now covers all standard cost variances—including

fixed manufacturing overhead variances in an appendix. The

material in this chapter has been extensively rewritten—particularly

the materials dealing with manufacturing overhead.

Chapter 11 • The balanced scorecard has been moved to this chapter, where it

more naturally belongs.

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McGraw-Hill Connect TM Accounting Less Managing. More Teaching. Greater Learning. McGraw-Hill Connect Accounting is an online assignment and assessment solution that connects students with the tools and resources they’ll need to achieve success.

McGraw-Hill Connect Accounting helps prepare students for their future by enabling faster learning, more efficient studying, and higher retention of knowledge.

McGraw-Hill Connect Accounting features Connect Accounting offers a number of powerful tools and features to make managing assignments easier so faculty can spend more time teaching. With Connect Accounting, students can engage with their coursework anytime and anywhere, making the learning process more accessible and efficient. Connect Accounting offers you the features described below.

Simple assignment management With Connect Accounting, creating assignments is easier than ever, so you can spend more time teaching and less time managing. The assignment management function enables you to:

• Create and deliver assignments easily with selectable end-of-chapter questions and testbank items.

• Streamline lesson planning, student progress reporting, and assignment grading to make classroom management

more efficient than ever.

• Go paperless with the eBook and online submission and grading of student assignments.

Smart grading When it comes to studying, time is precious. Connect Accounting helps students learn more efficiently by providing feedback and practice material when they need it, where they need it. When it comes to teaching, your time also is

precious. The grading function enables you to:

• Have assignments scored automatically, giving students immediate feedback on their work and side-by-side

comparisons with correct answers.

• Access and review each response; manually change grades or leave comments for students to review.

• Reinforce classroom concepts with practice tests and instant quizzes.

Instructor library The Connect Accounting Instructor Library is your repository for additional resources to improve student engage- ment in and out of class. You can select and use any asset that enhances your lecture. The Connect Accounting Instructor Library includes:

Connect Your Students to Learning and Success

accounting

• PowerPoints • Transparency Masters • Instructor’s Resource Guide

• Assignment Topic Grids • Testbank Topic Grids

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Student Study Center The Connect Accounting Student Study Center is the place for students to access additional resources. The Student Study Center:

• Offers students quick access to lectures, practice materials, eBooks, and more.

• Provides instant practice material and study questions, easily accessible on the go.

• Gives students access to the Personal Learning Plan described below.

Personal Learning Plan The Personal Learning Plan (PLP) connects each student to the learning resources needed for success in the course.

For each chapter, students:

• Take a practice test to initiate the Personal Learning Plan.

• Immediately upon completing the practice test, see how their performance compares to chapter learning

objectives.

• Receive a Personal Learning Plan that recommends specific readings from the text, supplemental study mate-

rial, and practice work that will improve their understanding and mastery of each learning objective.

Diagnostic and adaptive learning of concepts: LearnSmart Students want to make the best use of their study time. The LearnSmart adaptive self-study technology within

Connect Accounting provides students with a seamless combination of practice, assessment, and remediation for every concept in the textbook. LearnSmart’s intelligent software adapts to every student response and automatically

delivers concepts that advance the student’s understanding while reducing time devoted to the concepts already

mastered. The result for every student is the fastest path to mastery of the chapter concepts. LearnSmart:

• Applies an intelligent concept engine to identify the relationships between concepts and to serve new concepts

to each student only when he or she is ready.

• Adapts automatically to each student, so students spend less time on the topics they understand and practice

more those they have yet to master.

• Provides continual reinforcement and remediation but gives only as much guidance as students need.

• Integrates diagnostics as part of the learning experience.

• Enables you to assess which concepts students have efficiently learned on their own, thus freeing class time

for more applications and discussion.

Student progress tracking Connect Accounting keeps instructors informed about how each student, section, and class is performing, allow- ing for more productive use of lecture and office hours. The progress-tracking function enables you to:

• View scored work immediately and track individual or group performance with assignment and grade reports.

• Access an instant view of student or class performance relative to learning objectives.

• Collect data and generate reports required by many accreditation organizations, such as AACSB and AICPA.

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McGraw-Hill Connect™ Plus Accounting McGraw-Hill reinvents the textbook learning experience for the modern student with Connect Plus Accounting. A seamless integration of an eBook and Connect Accounting, Connect Plus Accounting provides all of the Connect Accounting features plus the following:

• An integrated eBook, allowing for anytime, anywhere access to the textbook.

• Dynamic links between the problems or questions you assign to your students and the location in the eBook

where that problem or question is covered.

• A powerful search function to pinpoint and connect key concepts in a snap.

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Authored by Janice L. Cobb of Texas Christian University, Doing the Job of the Managerial Accountant is a real-world application for the introductory Managerial Accounting student. The case is

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must make, yet simple enough that a sophomore student can easily

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Acknowledgments Suggestions have been received from many of our colleagues throughout the world. Each of those who have

offered comments and suggestions has our thanks.

The efforts of many people are needed to develop and improve a text. Among these people are the reviewers and

consultants who point out areas of concern, cite areas of strength, and make recommendations for change. In this

regard, the following professors provided feedback that was enormously helpful in preparing the second edition

of Managerial Accounting for Managers:

Second Edition Reviewers: Linda Abernathy, Kirkwood Community College

James Andrews, Central New Mexico Community College

Kashi R. Balachandran, New York University

Larry N. Bitner, Shippensburg University

Jorja Bradford, Alabama State University

Rusty Calk, New Mexico State University

Dana Carpenter, Madison Area Technical College

Robert Clarke, Brigham Youg University-Idaho

Darlene Coarts, University of Northern Iowa

Elizabeth Connors, University of Massachusetts-Boston

David L. Doyon, Southern New Hampshire University

J. Marie Gibson, University of Nevada Reno

Richard O. Hanson, Southern New Hampshire University

Iris Jenkel, St. Norbert College

Cynthia Khanlarian, University of North Carolina-Greensboro

Leon Korte, The University of South Dakota

Chuo-Hsuan Lee, SUNY-Plattsburgh

Natasha Librizzi, Milwaukee Area Technical College

William R. Link, University of Missouri-St. Louis

Mary Loretta Manktelow, James Madison University

Tammy Metzke, Milwaukee Area Technical College-West Allis

Tim Mills, Eastern Illinois University

Mark E. Motluck, Anderson University

Gerald M. Myers, Pacific Lutheran University

Joseph M. Nicassio, Westmoreland County Community College

Shirley Polejewski, University of St. Thomas

Luther L. Ross, Sr., Central Piedmont Community College

Ann E. Selk, University of Wisconsin-Green Bay

Vic Stanton, University of California-Berkeley

Samantha Ternes, Kirkwood Community College

Kiran Verma, University of Massachusetts-Boston

Jeffrey Wong, University of Nevada, Reno

Peter Woodlock, Youngstown State University

Ronald Zhao, Monmouth University

Previous Edition Reviewers: Frank Aquilino, Montclair State University

Kashi R. Balachandran, New York University

Surasakdi Bhamornsiri, University of North Carolina-Charlotte

Janet Butler, Texas State University-San Marcos

Rusty Calk, New Mexico State University

Cathy Claiborne, Texas Southern Univiversity

Nancy Coulmas, Bloomsburg University of Pennsylvania

Jean Crawford, Alabama State University

Andrea Drake, University of Cincinnati-Cincinnati

Jan Duffy, Iowa State University

Cindy Easterwood, Virginia Tech

Janice Fergusson, University of South Carolina

Ananda Ganguly, Clairmont College

Olen Greer, Missouri State University

Ken Harmon, Kennesaw State University

Kathy Ho, Niagara University

Maggie Houston, Wright State University

Tom Hrubec, Franklin University

Robyn Jarnagin, Montana State University

Randy Johnston, Michigan State University

Nancy Jones, California State University

Carl Keller, Indiana Purdue University/Fort Wayne

James Kinard, Ohio State University-Columbus

Kathy Long, University of Tennessee at Chattanooga

Patti Lopez, Valencia Comm College East

Jim Lukawitz, University of Memphis

Anna Lusher, Slippery Rock University

Laurie Mcwhorter, Mississippi State University

James Meddaugh, Ohio University

Alfonso R. Oddo, Niagara University

Tamara Phelan, Northern Illinois University

Les Price, Pierce College

Kamala Raghavan, Robert Morris University

Raul Ramos, Lorain County Community College

John Reisch, East Carolina University

Michelle Reisch, East Carolina University

Pamela Rouse, Butler University

Amy Santos, Manatee Community College

Ellen Sweatt, Georgia Perimeter College

Rick Tabor, Auburn University

Diane Tanner, University of North Florida

Chuck Thompson, University of Massachusetts

Marjorie E. Yuschak, Rutgers Business School

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We are grateful for the outstanding support from McGraw-Hill. In particular, we would like to thank Stewart Mattson, Editorial Director; Tim Vertovec, Publisher; Emily Hatteberg, Developmental Editor;

Kathleen Klehr., Marketing Manager; Pat Frederickson, Lead Project Manager; Carol Bielski, Production

Supervisor; Mary Sander, Senior Designer; Jennifer Lohn, Media Project Manager; and Lori Kramer, Photo

Research Coordinator.

Finally, we would like to thank Beth Woods for working so hard to ensure an error-free second edition. The

authors also wish to thank Linda and Michael Bamber for inspiring the creation of the 10-K Research and

Application exercises that are included in the end-of-chapter materials throughout the book.

We are grateful to the Institute of Certified Management Accountants for permission to use questions and/

or unofficial answers from past Certificate in Management Accounting (CMA) examinations. Likewise, we

thank the American Institute of Certified Public Accountants, the Society of Management Accountants of

Canada, and the Chartered Institute of Management Accountants (United Kingdom) for permission to use

(or to adapt) selected problems from their examinations. These problems bear the notations CPA, SMA,

and CIMA respectively. Eric W. C. Noreen • Peter Brewer • Ray H. Garrison

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Brief Contents

Chapter One Managerial Accounting and the Business Environment 1

Chapter Two Managerial Accounting and Cost Concepts 30

Chapter Three Cost Behavior: Analysis and Use 74

Chapter Four Cost-Volume-Profit Relationships 118

Chapter Five Systems Design: Job-Order Costing 164

Chapter Six Variable Costing: A Tool for Management 206

Chapter Seven Activity-Based Costing: A Tool to Aid Decision Making 234

Chapter Eight Profit Planning 287

Chapter Nine Flexible Budgets and Performance Analysis 334

Chapter Ten Standard Costs and Operating Performance Measures 367

Chapter Eleven Segment Reporting, Decentralization, and the Balanced Scorecard 419

Chapter Twelve Relevant Costs for Decision Making 487

Chapter Thirteen Capital Budgeting Decisions 534

Appendix A Pricing Products and Services 591

Appendix B Profitability Analysis 607

Credits 620 Index 621

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C h a p t e r 2 Managerial Accounting and Cost Concepts 30

The Work of Management and the Need for Managerial Accounting Information 31

Planning 31

Directing and Motivating 32

Controlling 32

The End Results of Managers’ Activities 33

The Planning and Control Cycle 33

Comparison of Financial and Managerial Accounting 33

Emphasis on the Future 34

Relevance of Data 34

Less Emphasis on Precision 35

Segments of an Organization 35

Generally Accepted Accounting Principles (GAAP) 35

Managerial Accounting—Not Mandatory 35

General Cost Classifications 36

Manufacturing Costs 36 Direct Materials 36 Direct Labor 37 Manufacturing Overhead 37

Nonmanufacturing Costs 38

Product Costs versus Period Costs 38

Product Costs 38

Period Costs 39

Prime Cost and Conversion Cost 39

C h a p t e r 1 Managerial Accounting and the Business Environment 1

Globalization 2

Strategy 4

Organizational Structure 5

Decentralization 5

The Functional View of Organizations 5

Process Management 7

Lean Production 8 The Lean Thinking Model 8

The Theory of Constraints (TOC) 10

Six Sigma 11

The Importance of Ethics in Business 12

Code of Conduct for Management Accountants 14

Company Codes of Conduct 14

Codes of Conduct on the International Level 17

Corporate Governance 17

The Sarbanes-Oxley Act of 2002 18

Enterprise Risk Management 19

Identifying and Controlling Business Risks 19

Corporate Social Responsibility 21

The Certified Management Accountant (CMA) 22

Summary 23 Glossary 24 Questions 25 Exercises 25 Problems 26 Research and Application 29

Contents

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Fixed Costs 80

Types of Fixed Costs 81 Committed Fixed Costs 81 Discretionary Fixed Costs 82 The Trend toward Fixed Costs 82 Is Labor a Variable or a Fixed Cost? 83

Fixed Costs and the Relevant Range 84

Mixed Costs 85

The Analysis of Mixed Costs 86

Diagnosing Cost Behavior with a Scattergraph Plot 88

The High-Low Method 90

The Least-Squares Regression Method 94

Multiple Regression Analysis 96

The Contribution Format Income Statement 96

Why a New Income Statement Format? 96

The Contribution Approach 96

Summary 97 Review Problem 1: Cost Behavior 98 Review Problem 2: High-Low Method 99 Glossary 100 Questions 100 Exercises 101 Problems 104 Cases 109 Research and Application 110

Appendix 3A: Least-Squares Regression Computations 111

C h a p t e r 4 Cost-Volume-Profit Relationships 118

The Basics of Cost-Volume-Profit (CVP) Analysis 119

Contribution Margin 120

CVP Relationships in Equation Form 122

CVP Relationships in Graphic Form 123 Preparing the CVP Graph 123

Contribution Margin Ratio (CM Ratio) 125

Cost Classifications on Financial Statements 41

The Balance Sheet 41

The Income Statement 42

Schedule of Cost of Goods Manufactured 44

Product Cost Flows 45

Inventoriable Costs 46

An Example of Cost Flows 46

Cost Classifications for Predicting Cost Behavior 46

Variable Cost 48

Fixed Cost 49

Cost Classifications for Assigning Costs to Cost Objects 51

Direct Cost 51

Indirect Cost 51

Cost Classifications for Decision Making 52

Differential Cost and Revenue 52

Opportunity Cost 53

Sunk Cost 54

Summary 54 Review Problem 1: Cost Terms 55 Review Problem 2: Schedule of Cost of Goods Manufactured and Income Statement 56 Glossary 57 Questions 58 Exercises 59 Problems 64 Cases 71 Research and Application 73

C h a p t e r 3 Cost Behavior: Analysis and Use 74

Types of Cost Behavior Patterns 75

Variable Costs 75 The Activity Base 76 Extent of Variable Costs 76

True Variable versus Step-Variable Costs 77 True Variable Costs 77 Step-Variable Costs 77 The Linearity Assumption and the Relevant Range 79

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Job-Order Costing—An Overview 166

Measuring Direct Materials Cost 167

Job Cost Sheet 168

Measuring Direct Labor Cost 169

Applying of Manufacturing Overhead 170 Using the Predetermined Overhead Rate 171

The Need for a Predetermined Rate 171

Choice of an Allocation Base for Overhead Cost 172

Computation of Unit Costs 173

Summary of Document Flows 173

An Extended Example of Job-Order Costing 175

Direct and Indirect Materials 175

Labor Cost 176

Manufacturing Overhead Cost 176

Applying Manufacturing Overhead 177

Underapplied or Overapplied Overhead 178

Disposition of Underapplied or Overapplied Overhead 179

Prepare an Income Statement 180

Cost of Goods Sold 180 The Direct Method of Determining Cost of Goods Sold 180 The Indirect Method of Determining Cost of Goods Sold 180

Income Statement 182

Multiple Predetermined Overhead Rates 182

Job-Order Costing in Service Companies 183

Summary 183 Review Problem: Job-Order Costing 184 Glossary 185 Questions 186 Exercises 186 Problems 191 Cases 196 Research and Application 198

Appendix 5A: The Predetermined Overhead Rate and Capacity 199

Some Applications of CVP Concepts 127 Change in Fixed Cost and Sales Volume 127 Change in Variable Costs and Sales Volume 128 Change in Fixed Cost, Sales Price, and Sales Volume 129 Change in Variable Cost, Fixed Cost, and Sales Volume 130 Change in Selling Price 131

Target Profit and Break-Even Analysis 131

Target Profit Analysis 131 The Equation Method 131 The Formula Method 131 Target Profit Analysis in Terms of Sales Dollars 132

Break-Even Analysis 133 Break-Even in Unit Sales 133 Break-Even in Sales Dollars 134

The Margin of Safety 135

CVP Considerations in Choosing a Cost Structure 136

Cost Structure and Profit Stability 136

Operating Leverage 138

Structuring Sales Commissions 140

Sales Mix 140

The Definition of Sales Mix 140

Sales Mix and Break-Even Analysis 141

Assumptions of CVP Analysis 143

Summary 143 Review Problem: CVP Relationships 144 Glossary 146 Questions 147 Exercises 147 Problems 152 Cases 160 Research and Application 162

C h a p t e r 5 Systems Design: Job-Order Costing 164

Process and Job-Order Costing 165

Process Costing 165

Job-Order Costing 165

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Manufacturing Costs and Activity-Based Costing 236

Cost Pools, Allocation Bases, and Activity-Based Costing 236

Designing an Activity-Based Costing (ABC) System 239

Steps for Implementing Activity-Based Costing 241

Step 1: Define Activities, Activity Cost Pools, and Activity Measures 241

The Mechanics of Activity-Based Costing 243

Step 2: Assign Overhead Costs to Activity Cost Pools 243

Step 3: Calculate Activity Rates 246

Step 4: Assign Overhead Costs to Cost Objects 247

Step 5: Prepare Management Reports 250

Comparison of Traditional and ABC Product Costs 253

Product Margins Computed Using the Traditional Cost System 253

The Differences between ABC and Traditional Product Costs 254

Targeting Process Improvements 257

Activity-Based Costing and External Reports 259

The Limitations of Activity-Based Costing 259

Summary 260 Review Problem: Activity-Based Costing 261 Glossary 262 Questions 263 Exercises 263 Problems 271 Research and Application 275

Appendix 7A: ABC Action Analysis 275

C h a p t e r 8 Profit Planning 287

The Basic Framework of Budgeting 288

Advantages of Budgeting 288

Responsibility Accounting 288

Choosing a Budget Period 289

C h a p t e r 6 Variable Costing: A Tool for Management 206

Overview of Absorption and Variable Costing 207

Absorption Costing 207

Variable Costing 207

Selling and Administrative Expenses 207 Summary of Differences 207

Absorption Costing Income Statement 209

Variable Costing Contribution Format Income Statement 210

Reconciliation of Variable Costing with Absorption Costing Income 211

Choosing a Costing Method 214

The Impact on the Manager 214

CVP Analysis and Absorption Costing 215

Decision Making 215

External Reporting and Income Taxes 215

Advantages of Variable Costing and the Contribution Approach 216

Variable Costing and the Theory of Constraints 217

Impact of Lean Production 217

Summary 218 Review Problem: Contrasting Variable and Absorption Costing 218 Glossary 220 Questions 220 Exercises 221 Problems 225 Cases 231

C h a p t e r 7 Activity-Based Costing: A Tool to Aid Decision Making 234

Activity-Based Costing: An Overview 235

How Costs Are Treated under Activity-Based Costing 236

Nonmanufacturing Costs and Activity-Based Costing 236

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Performance Reports in Nonprofit Organizations 343

Performance Reports in Cost Centers 344

Flexible Budgets with Multiple Cost Drivers 344

Some Common Errors 346

Summary 347 Review Problem: Variance Analysis Using a Flexible Budget 348 Glossary 349 Questions 350 Exercises 350 Problems 358 Cases 363

C h a p t e r 10 Standard Costs and Operating Performance Measures 367

Standard Costs—Management by Exception 369

Who Uses Standard Costs? 370

Setting Standard Costs 370

Ideal versus Practical Standards 371

Setting Direct Materials Standards 372

Setting Direct Labor Standards 373

Setting Variable Manufacturing Overhead Standards 374

A General Model for Variance Analysis 374

Price and Quantity Variances 374

Using Standard Costs—Direct Materials Variances 375

Materials Price Variance—A Closer Look 378 Isolation of Variances 378 Responsibility for the Variance 378

Materials Quantity Variance—A Closer Look 379

Using Standard Costs—Direct Labor Variances 380

Labor Rate Variance—A Closer Look 381

Labor Efficiency Variance—A Closer Look 381

Using Standard Costs—Variable Manufacturing Overhead Variances 382

Manufacturing Overhead Variances—A Closer Look 383

The Self-Imposed Budget 290

Human Factors in Budgeting 291

The Budget Committee 292

The Master Budget: An Overview 293

Preparing the Master Budget 294

The Sales Budget 296

The Production Budget 296

Inventory Purchases—Merchandising Company 298

The Direct Materials Budget 299

The Direct Labor Budget 301

The Manufacturing Overhead Budget 302

The Ending Finished Goods Inventory Budget 303

The Selling and Administrative Expense Budget 303

The Cash Budget 304

The Budgeted Income Statement 308

The Budgeted Balance Sheet 309

Summary 311 Review Problem: Budget Schedules 311 Glossary 313 Questions 313 Exercises 314 Problems 318 Cases 330 Research and Application 332

C h a p t e r 9 Flexible Budgets and Performance Analysis 334

Flexible Budgets 335

Characteristics of a Flexible Budget 335

Deficiencies of the Static Planning Budget 335

How a Flexible Budget Works 338

Flexible Budget Variances 338

Activity Variances 339

Revenue and Spending Variances 340

A Performance Report Combining Activity and Revenue and Spending Variances 341

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Traceable Costs Can Become Common Costs 429

Segment Margin 430

Segmented Financial Information in External Reports 431

Hindrances to Proper Cost Assignment 431

Omission of Costs 431

Inappropriate Methods for Assigning Traceable Costs among Segments 432

Failure to Trace Costs Directly 432 Inappropriate Allocation Base 432

Arbitrarily Dividing Common Costs among Segments 432

Evaluating Investment Center Performance—Return on Investment 433

The Return on Investment (ROI) Formula 434

Net Operating Income and Operating Assets Defined 434

Understanding ROI 434

Criticisms of ROI 436

Residual Income 437

Motivation and Residual Income 438

Divisional Comparison and Residual Income 439

Balanced Scorecard 440

Common Characteristics of Balanced Scorecards 441

A Company’s Strategy and the Balanced Scorecard 443

Tying Compensation to the Balanced Scorecard 445

Advantages of Timely and Graphic Feedback 445

Summary 446 Review Problem 1: Segmented Statements 446 Review Problem 2: Return on Investment (ROI) and Residual Income 448 Glossary 448 Questions 449 Exercises 449 Problems 456 Cases 463 Research and Applications 466

Appendix 11A: Transfer Pricing 467

Appendix 11B: Service Department Charges 479

Variance Analysis and Management by Exception 385

International Uses of Standard Costs 386

Evaluation of Controls Based on Standard Costs 387

Advantages of Standard Costs 387

Potential Problems with the Use of Standard Costs 387

Operating Performance Measures 388

Delivery Cycle Time 388

Throughput (Manufacturing Cycle) Time 388

Manufacturing Cycle Efficiency (MCE) 389

Summary 390 Review Problem: Standard Costs 391 Glossary 393 Questions 393 Exercises 394 Problems 397 Cases 404

Appendix 10A: Predetermined Overhead Rates and Overhead Analysis in a Standard Costing System 406

C h a p t e r 11 Segment Reporting, Decentralization, and the Balanced Scorecard 419

Decentralization in Organizations 420

Advantages and Disadvantages of Decentralization 420

Responsibility Accounting 421

Cost, Profit, and Investment Centers 421 Cost Center 421 Profit Center 421 Investment Center 422

An Organizational View of Responsibility Centers 422

Decentralization and Segment Reporting 423

Building a Segmented Income Statement 424

Levels of Segmented Statements 425

Sales and Contribution Margin 427

Traceable and Common Fixed Costs 427 Identifying Traceable Fixed Costs 428 Activity-Based Costing 428

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C h a p t e r 13 Capital Budgeting Decisions 534

Capital Budgeting—Planning Investments 535

Typical Capital Budgeting Decisions 535

The Time Value of Money 535

Discounted Cash Flows—The Net Present Value Method 536

The Net Present Value Method Illustrated 536

Emphasis on Cash Flows 538 Typical Cash Outflows 538 Typical Cash Inflows 538

Recovery of the Original Investment 538

Simplifying Assumptions 539

Choosing a Discount Rate 540

An Extended Example of the Net Present Value Method 541

Discounted Cash Flows—The Internal Rate of Return Method 542

The Internal Rate of Return Method Illustrated 542

Salvage Value and Other Cash Flows 543

Using the Internal Rate of Return 543

The Cost of Capital as a Screening Tool 543

Comparison of the Net Present Value and Internal Rate of Return Methods 543

Expanding the Net Present Value Method 544

The Total-Cost Approach 544

The Incremental-Cost Approach 545

Least-Cost Decisions 546

Uncertain Cash Flows 548

An Example 548

Real Options 549

Preference Decisions—The Ranking of Investment Projects 549

Internal Rate of Return Method 550

Net Present Value Method 550

C h a p t e r 12 Relevant Costs for Decision Making 487

Cost Concepts for Decision Making 488

Identifying Relevant Costs and Benefits 488

Different Costs for Different Purposes 489

An Example of Identifying Relevant Costs and Benefits 490

Reconciling the Total and Differential Approaches 492

Why Isolate Relevant Costs? 493

Adding and Dropping Product Lines and Other Segments 494

An Illustration of Cost Analysis 495

A Comparative Format 497

Beware of Allocated Fixed Costs 497

The Make or Buy Decision 498

Strategic Aspects of the Make or Buy Decision 499

An Example of Make or Buy 499

Opportunity Cost 500

Special Orders 501

Utilization of a Constrained Resource 502

Contribution Margin per Unit of the Constrained Resource 503

Managing Constraints 504

The Problem of Multiple Constraints 506

Joint Product Costs and the Contribution Approach 506

The Pitfalls of Allocation 506

Sell or Process Further Decisions 508

Activity-Based Costing and Relevant Costs 509

Summary 510 Review Problem: Relevant Costs 510 Glossary 511 Questions 511 Exercises 512 Problems 519 Cases 527

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The Absorption Costing Approach to Cost-Plus Pricing 596

Setting a Target Selling Price Using the Absorption Costing Approach 596

Determining the Markup Percentage 597

Problems with the Absorption Costing Approach 598

Target Costing 599

Reasons for Using Target Costing 599

An Example of Target Costing 600

Summary 600 Glossary 601 Questions 601 Exercises 601 Problems 602

A p p e n d i x B Profitability Analysis 607

Introduction 608

Absolute Profitability 608

Relative Profitability 608

Volume Trade-Off Decisions 611

Managerial Implications 613

Summary 614 Glossary 614 Questions 615 Exercises 615 Problems 616 Cases 619

Credits 620 Index 621

Other Approaches to Capital Budgeting Decisions 551

The Payback Method 551

Evaluation of the Payback Method 552

An Extended Example of Payback 553

Payback and Uneven Cash Flows 554

The Simple Rate of Return Method 554

Criticisms of the Simple Rate of Return 556

Postaudit of Investment Projects 556

Summary 557 Review Problem: Comparison of Capital Budgeting Methods 558 Glossary 559 Questions 560 Exercises 560 Problems 564 Cases 573

Appendix 13A: The Concept of Present Value 575

Appendix 13B: Present Value Tables 581

Appendix 13C: Income Taxes in Capital Budgeting Decisions 583

A p p e n d i x A Pricing Products and Services 591

Introduction 592

The Economists’ Approach to Pricing 592

Elasticity of Demand 592

The Profit-Maximizing Price 593

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11

Learning Objectives

After studying Chapter 1, you should be able to:

LO1 Understand the role of management accountants in an organization.

LO2 Understand the basic concepts underlying Lean Production, the Theory of Constraints (TOC), and Six Sigma.

LO3 Understand the importance of upholding ethical standards.

Managerial Accounting and the Business Environment Management Accounting: It’s More Than Just Crunching Numbers

“Creating value through values” is the credo of today’s manage- ment accountant. It means that management accountants should maintain an unwavering commit- ment to ethical values while using their knowledge and skills to influ- ence decisions that create value for organizational stakeholders. These skills include managing risks and implementing strategy through planning, budgeting and

forecasting, and decision support. Management accountants are strategic business partners who understand the financial and operational sides of the business. They not only report and analyze financial measures, but also nonfinancial measures of process performance and corporate social performance. Think of these responsibilities as prof- its (financial statements), process (customer focus and satisfaction), people (employee learning and satisfaction), and planet (environmental stewardship). ■

Source: Conversation with Jeff Thomson, president and CEO of the Institute of Management Accountants.

1 C h a p t e r

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2 Chapter 1

T hroughout this book you will study how management accounting functions within organizations. However, before embarking on the study of management accounting, you need to develop an appreciation for the larger business environment within which it operates. This chapter is divided into

nine sections: (1) globalization, (2) strategy, (3) organizational structure, (4) process man- agement, (5) the importance of ethics in business, (6) corporate governance, (7) enterprise risk management, (8) corporate social responsibility, and (9) the Certified Management Accountant (CMA). Other business classes provide greater detail on many of these topics. Nonetheless, a broad discussion of these topics is useful for placing management account- ing in its proper context.

Globalization

The world has become much more intertwined over the last 20 years. Reductions in tariffs, quotas, and other barriers to free trade; improvements in global transportation systems; explosive expansion in Internet usage; and increasing sophistication in inter- national markets have created a truly global marketplace. Exhibit 1–1 illustrates this tremendous growth in international trade from the standpoint of the United States and some of its key trading partners. Panel A of the exhibit shows the dollar value of imports (stated in billions of dollars) into the United States from six countries; Panel B shows the dollar value of exports from the United States to those same six coun- tries. As you can see, the increase in import and export activity from 1995 to 2007 was huge. In particular, trade with China expanded enormously as did trade with Mexico and Canada, which participate in the North American Free Trade Agreement (NAFTA).

In a global marketplace, a company that has been very successful in its local market may suddenly find itself facing competition from halfway around the globe. For exam- ple, in the 1980s American automobile manufacturers began losing market share to Japanese competitors who offered American consumers higher quality cars at lower prices. For consumers, heightened international competition promises a greater variety of goods and services, at higher quality and lower prices. However, heightened interna- tional competition threatens companies that may have been quite profitable in their own local markets.

Although globalization leads to greater competition, it also means greater access to new markets, customers, and workers. For example, the emerging markets of China, India, Russia, and Brazil contain more than 2.5 billion potential customers and work- ers. 1 Many companies such as FedEx, McDonald’s , and Nike are actively seeking to grow their sales by investing in emerging markets. In addition, the movement of jobs from the United States and Western Europe to other parts of the world has been notable in recent years. For example, one study estimates that by the end of the decade more than 825,000 financial services and high-tech jobs will transfer from Western Europe to less expensive labor markets such as India, China, Africa, Eastern Europe, and Latin America. 2

The Internet fuels globalization by providing companies with greater access to geo- graphically dispersed customers, employees, and suppliers. While the number of Internet users continues to grow, as of 2008, more than 78% of the world’s population was still not connected to the Internet. This suggests that the Internet’s impact on global business has yet to fully develop.

1 The Economist: Pocket World in Figures 2004, Profile Books Ltd., London, U.K. 2 “Job Exports: Europe’s Turn,” BusinessWeek, April 19, 2004, p. 50.

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Managerial Accounting and the Business Environment 3

$300

$250

$200

$150

$100

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$400

$350 Im

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1995 2000 2005 2007

Canada China

Japan Mexico United Kingdom

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E X H I B I T 1 – 1 United States Global Trade Activity (in billions of U.S. dollars)

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Panel B: Exports from the United States (billions of dollars)

Source: U.S. Census Bureau, Foreign Trade Division, Data Dissemination Branch, Washington, D.C. 20233. www.census.gov/foreign-trade/balance .

Panel A: Imports to the United States (billions of dollars)

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4 Chapter 1

Strategy

Even more than in the past, companies that now face global competition must have a viable strategy for succeeding in the marketplace. A strategy is a “game plan” that enables a company to attract customers by distinguishing itself from competitors. The focal point of a company’s strategy should be its target customers. A company can only succeed if it creates a reason for customers to choose it over a competitor. These reasons, or what are more formally called customer value propositions, are the essence of strategy.

Customer value propositions tend to fall into three broad categories— customer inti- macy, operational excellence, and product leadership . Companies that adopt a customer intimacy strategy are in essence saying to their target customers, “You should choose us because we understand and respond to your individual needs better than our competi- tors.” Ritz-Carlton, Nordstrom , and Starbucks rely primarily on a customer intimacy value proposition for their success. Companies that pursue the second customer value proposition, called operational excellence, are saying to their target customers, “You should choose us because we can deliver products and services faster, more conveniently, and at a lower price than our competitors.” Southwest Airlines, Wal-Mart , and The Vanguard Group are examples of companies that succeed first and foremost because of their operational excellence. Companies pursuing the third customer value proposition, called product leadership, are saying to their target customers, “You should choose us because we offer higher quality products than our competitors.” BMW, Cisco Systems , and W.L. Gore (the creator of GORE-TEX ® fabrics) are examples of companies that succeed because of their product leadership. Although one company may offer its cus- tomers a combination of these three customer value propositions, one usually outweighs the others in terms of importance. 3

Next we turn our attention to how businesses create organizational structures to help accomplish their strategic goals.

3 These three customer value propositions were defined by Michael Treacy and Fred Wiersema in “Customer Intimacy and Other Value Disciplines,” Harvard Business Review, Volume 71 Issue 1, pp. 84–93.

THE IMPLICATIONS OF GLOBALIZATION International competition goes hand-in-hand with globalization. China’s entrance into the global market- place has highlighted this stark reality for many U.S. companies. For example, from 2000 to 2003, China’s wooden bedroom furniture exports to the United States increased by more than 233% to a total of $1.2 billion. During this same time, the number of workers employed by U.S. furniture manu- facturers dropped by about a third, or a total of 35,000 workers.

However, globalization means more than international competition. It brings opportunities for companies to enter new markets. FedEx has pushed hard to be an important player in the emerging Asian cargo market. FedEx makes 622 weekly flights to and from Asian markets, including service to 224 Chinese cities. FedEx currently has 39% of the U.S.–China express market and it plans to pursue continuous growth in that region of the world.

Sources: Ted Fishman, “How China Will Change Your Business,” Inc. magazine, March 2005, pp. 70–84; Matthew Boyle, “Why FedEx is Flying High,” Fortune, November 1, 2004, pp. 145–150.

I N B U S I N E S S

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Managerial Accounting and the Business Environment 5

Organizational Structure

Our discussion of organizational structure is divided into two parts. First, we highlight the fact that presidents of all but the smallest companies cannot execute their strategies alone. They must seek the help of their employees by empowering them to make deci- sions—they must decentralize. Next, we describe the most common formal decentralized organizational structure in use today—the functional structure.

Decentralization Decentralization is the delegation of decision-making authority throughout an organiza- tion by giving managers the authority to make decisions relating to their area of responsi- bility. Some organizations are more decentralized than others. For example, consider Good Vibrations, an international retailer of music CDs with shops in major cities scat- tered across the Pacific Rim. Because of Good Vibrations’ geographic dispersion and the peculiarities of local markets, the company is highly decentralized.