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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


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


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 ' .:


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


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


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


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


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


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

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