Ninth edition

Creating Value in a Dynamic Business Environment Ninth edition ... and a Shifting Business Model 54 The Outsourcing Action Team 55 ... Process Costing...

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Managerial Accounting Creating Value in a Dynamic Business Environment Ninth edition

Ronald W. Hilton Cornell University

Me Grain/ Hill

McGraw-Hill Irwin

Management of Capacity and Capacity Costs 18 Evolution and Adaptation in Managerial Accounting 20 M.A.P. The Internet as a Lifeline

1 The Changing Role of Managerial Accounting in a Dynamic Business Environment 2 Managerial Accounting: A Business Partnership with Management 5 Managing Resources, Activities, and People 5 Decision Making 5 Planning 6 Directing Operational Activities Controlling 6

6

How Managerial Accounting Adds Value to the Organization 6 Objectives of Managerial Accounting Activity 6 The Balanced Scorecard

22

Cost Management Systems 25 Strategic Cost Management and the Value Chain 25 The Ethical Climate of Business and the Role of the Accountant 27 Managerial Accounting as a Career 28 Professional Organizations 28 Professional Certification 29 Professional Ethics 29 Focus on Ethics: IMA Statement of Ethical Professional Practice 29 Chapter Summary 30 Key Terms 31 Review Questions 31 Exercises 32 Problems 33 Case 35

9

M.A.P. The Balanced Scorecard

10

Managerial versus Financial Accounting 11 Managerial Accounting in Different Types of Organizations 12 Where Are Managerial Accountants Located in an Organization? 13 Organization Chart 13 Cross-Functional Deployment Physical Location

16

16

Major Themes in Managerial Accounting 17 Information and Incentives

17

Behavioral Issues 18 Costs and Benefits

18

Basic Cost Management Concepts and Accounting for Mass Customization Operations 36 What Do We Mean by a Cost? 38 Product Costs, Period Costs, and Expenses 39 Costs on Financial Statements 40 Income Statement 40 Balance Sheet 42

Note: Entries printed in blue denote topics that emphasize contemporary issues in managerial accounting and cost management.

xxiii

Contents

xxiv

Manufacturing Operations and Manufacturing Costs 43 M.A.P. Mass Customization 44

Mass-Customization Manufacturing 44 Manufacturing Costs 45 Manufacturing Cost Flows 47 Production Costs in Service Industry Firms and Nonprofit Organizations 48 Basic Cost Management Concepts: Different Costs for Different Purposes 50 The Cost Driver Team 50 Variable and Fixed Costs 51 The Cost Management and Control Team 52

Process-Costing Systems

Summary of Alternative Product-Costing Systems 86 Accumulating Costs in a Job-Order Costing System 86 Job-Cost Record

86

Direct-Material Costs Direct-Labor Costs

Manufacturing-Overhead Costs

Illustration of Job-Order Costing Purchase of Material

Use of Direct Labor

Review Problems on Cost Classifications 62 Key Terms 64 Review Questions Exercises 65 Problems 68 Cases 77

64

90

Summary of Event Sequence in Job-Order Costing 91

The Outsourcing Action Team 55 Costs and Benefits of Information 59

62

89

M.A.P. Supply Chain Management

Use of Direct Material

Chapter Summary

87 89

M.A.P. Airline Industry: Cost Structure, Cost Drivers, and a Shifting Business Model 54

Costs in the Service Industry 59 Focus on Ethics: Was WorldCom's Controller Just Following Orders? 61

86

91

93 93

Use of Indirect Material

93

94

Use of Indirect Labor

94

Incurrence of Manufacturing-Overhead Costs 94 Application of Manufacturing Overhead 95 Summary of Overhead Accounting

96

Selling and Administrative Costs

96

Completion of a Production Job

97

Sale of Goods

97

Underapplied and Overapplied Overhead 97 Schedule of Cost of Goods Manufactured 99 Schedule of Cost of Goods Sold

99

Posting Journal Entries to the Ledger Further Aspects of Overhead Application Actual and Normal Costing

100 100

100

Choosing the Cost Driver for Overhead Application 103

Product Costing and Cost Accumulation in a Batch Production Environment 80 Product and Service Costing 82 Product Costing in Nonmanufacturing Firms 83 Flow of Costs in Manufacturing Firms 83 Types of Product-Costing Systems 85 Job-Order Costing Systems 85

Departmental Overhead Rates Two-Stage Cost Allocation

103

104

Project Costing: Job-Order Costing in Nonmanufacturing Organizations 705 Changing Technology in Manufacturing Operations 107 EDI and XML

107

Use of Bar Codes

108

M.A.P. Radio Frequency Identification Systems (RFID) 108

/

Contents Focus on Ethics: Did Boeing Exploit Accounting Rules to Conceal Cost Overruns and Production Snafus? 709 Chapter Summary 7 70 Review Problem on Job-Order Costing 7 70 Key Terms 772 Review Questions 712 Exercises 772 Problems 718 Cases 730

XXV

Activity-Based Costing and Management 168 Traditional, Volume-Based Product-Costing System 7 77 Trouble in Denver 171 Activity-Based Costing System 7 72 ABC Stage One 173 ABC Stage Two 174 Interpreting the ABC Product Costs 178 The Punch Line 179

Process Costing and Hybrid Product-Costing Systems 134

Why Traditional, Volume-Based Systems Distort Product Costs 180

Comparison of Job-Order Costing and Process Costing 736 Flow of Costs 136

M.A.P. Cost Distortion at Rockwell International 182

Activity-Based Costing: Some Key Issues 782

Differences Between Job-Order and Process Costing 138 / Equivalent Units: A Key Concept Equivalent Units 138

M.A.P. Cost Distortion at DHL

Cost Drivers

738

Activity-Based Management

142

747 147

Illustration of Customer-Profitability Analysis 189

Other Cost Drivers for Overhead Application 147 Subsequent Production Departments Hybrid Product-Costing Systems 748

786

Two-Dimensional ABC 186 Using ABM to Identify Non-Value-Added Activities and Costs 186 Customer-Profitability Analysis 789

Weighted-Average Method of Process Costing 143 Other Issues in Process Costing Actual versus Normal Costing

183

Collecting ABC Data 184 Activity Dictionary and Bill of Activities 185

Illustration of Process Costing 740 Basic Data for Illustration 141 M.A.P. New York Wine Industry

183

748

Operation Costing for Batch Manufacturing Processes 148 Chapter Summary 752 Review Problem on Process Costing 752 Key Terms 754 Review Questions 754 Exercises 754 Problems 757 Cases 765

M.A.P. Customer Profitability Analysis at Bank One Corp. 191

Activity-Based Costing in the Service Industry 792 M.A.P. Customer Profitability Analysis at Best Buy 193

Activity-Based Costing at Delaware Medical Center 194 Interpreting the Primary Care Unit's ABC Information 195 Focus on Ethics: Ethical Issues Surrounding Activity-Based Costing 797

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Contents Chapter Summary 798 Review Problems on Cost Drivers and Product-Cost Distortion 799 Key Terms 200 Appendix to Chapter 5: Just-in-Time Inventory and Production Management 207 Review Questions 202 Exercises 203 Problems 209 Cases 227

6

Activity Analysis, Cost Behavior, and Cost Estimation 232 Cost Behavior Patterns 235 Variable Costs 235 Step-Variable Costs 236 Fixed Costs 237 Step-Fixed Costs 237 Semivariable Cost 239 Curvilinear Cost 240 Using Cost Behavior Patterns to Predict Costs 241 M.A.P. Is Direct Labor a Variable or a Fixed Cost? 242

Engineered, Committed, and Discretionary Costs 243 Cost Behavior in Other Industries 244 Cost Estimation 244 Account-Classification Method 244 Visual-Fit Method 245 High-Low Method 247 Least-Squares Regression Method 248 Multiple Regression 250 Data Collection Problems 250 Engineering Method of Cost Estimation 251 Effect of Learning on Cost Behavior 257 Focus on Ethics: Cisco Systems, Walmart, Taco Bell, Starbucks, U-Haul, General Dynamics, and Farmer's Insurance: Is Direct Labor a Variable Cost? 253

Chapter Summary 253 Review Problems on Cost Behavior and Estimation 254 Key Terms 255 Appendix to Chapter 6: Least-Squares Regression Using Microsoft® Excel 256 Review Questions 258 Exercises 258 Problems 263 Cases 277

Cost-Volume-Profit Analysis

274

Illustration of Cost-Volume-Profit Analysis Projected Expenses and Revenue The Break-Even Point

278

Contribution-Margin Approach Equation Approach

277

279

279

Graphing Cost-Volume-Profit Relationships 280 Interpreting the CVP Graph

281

Alternative Format for the CVP Graph 283 Profit-Volume Graph Target Net Profit

283

284

Contribution-Margin Approach Equation Approach

284

Graphical Approach

285

Applying CVP Analysis Safety Margin

284

285

285

Changes in Fixed Expenses

285

Changes in the Unit Contribution Margin 286 Predicting Profit Given Expected Volume 287 Interdependent Changes in Key Variables 288 CVP Information in Published Annual Reports 289

277

xxvii

Contents M.A.P. Airlines Keep a Close Eye on BreakEven Load Factors 289

Absorption-Costing Income Statements 328

CVP Analysis with Multiple Products 290 Assumptions Underlying CVP Analysis 292

Variable-Costing Income Statements 328

Role of Computerized Planning Models and Electronic Spreadsheets 292 CVP Relationships and the Income Statement 293

Reconciling Income under Absorption and Variable Costing 329

Traditional Income Statement Contribution Income Statement

Cost- Volume-Profit Analysis 331 Evaluation of Absorption and Variable Costing 332

293 293

M.A.P. IRS: Unique Product Packaging Is an Inventoriable Cost 333

Comparison of Traditional and Contribution Income Statements 294

Throughput Costing

Cost Structure and Operating Leverage 295 Operating Leverage 296

333

Throughput-Costing Income Statements 334

M.A.P. Operating Leverage Helps Web Companies Become Profitable 297

Focus on Ethics: Incentive to Overproduce Inventory 335

Cost Structure and Operating Leverage: A Cost-Benefit Issue 298

Chapter Summary

335

Review Problem on Absorption and Variable Costing 336

M.A.P. Cost Structure and Operating Leverage 299

Key Terms

CVP Analysis, Activity-Based Costing, and Advanced Manufacturing Systems 299 A Move toward JIT and Flexible Manufacturing 300 • Chapter Summary 302 /

337

Review Questions

338

Exercises 338 Problems Cases

340

344

Review Problem on Cost-Volume-Profit Analysis 303 Key Terms 304 Appendix to Chapter 7: Effect of Income Taxes 304 Review Questions 307 Exercises 308 Problems 370 Cases 327

9

Profit Planning and Activity-Based Budgeting 346 Purposes of Budgeting Systems Types of Budgets

348

349

The Master Budget: A Planning Tool 350 Sales of Services or Goods

8 Absorption and Variable Costing 324 Product Costs

326

Illustration of Absorption and Variable Costing 327

Sales Forecasting

350

350

Operational Budgets

351

Budgeted Financial Statements Nonprofit Organizations 352

352

xxviii

Contents M.A.P. Activity-Based Budgeting (ABB) at American Express and AT&T Paradyne 353

Activity-Based Budgeting

353

Using Activity-Based Budgeting to Prepare the Master Budget 355 Sales Budget

355

Production Budget

356

Direct-Material Budget Direct-Labor Budget

10 Standard Costing, Operational Performance Measures, and the Balanced Scorecard 404

356 358

Manufacturing-Overhead Budget

359

Selling, General, and Administrative (SG&A) Expense Budget 360 Cash Receipts Budget

362

Cash Disbursements Budget

Cash Budget: Combining Receipts and Disbursements 364 Budgeted Schedule of Cost of Goods Manufactured and Sold 365 366

371

Participation in Setting Standards

373 374

Behavioral Impact of Budgets 375

Perfection versus Practical Standards: A Behavioral Issue 408 Use of Standards by Service Organizations 409 409 410 410

Standard Costs Given Actual Output

M.A.P. Parker Hannifin Corporation's Brass Products Division 415

Multiple Types of Direct Material or Direct Labor 415 Allowing for Spoilage or Defects Significance of Cost Variances

Participative Budgeting

Behavioral Impact of Standard Costing 479

376

Focus on Ethics: Is Padding the Budget Unethical? 376 377

Review Problem on Preparing Master Budget Schedules 377 Review Questions Exercises 380 Problems

384

Cases 398

380

411

Analysis of Cost Variances 411

Budgetary Slack: Padding the Budget 375

Key Terms 379

408

Direct-Labor Variances 413

M.A.P. Budget Administration at Cornell University 373

Chapter Summary

407

Direct-Material Variances 411

372

International Aspects of Budgeting

407

407

Direct-Labor Standards

Assumptions and Predictions Underlying the Master Budget 369

Budgeting Product Life-Cycle Costs

Setting Standards

Direct-Material Standards

Budgeted Balance Sheet 368

Budget Administration

Management by Exception

Cost Variance Analysis

Budgeted Statement of Cash Flows 367

Financial Planning Models

406

Methods for Setting Standards

363

Budgeted Income Statement

Managing Costs

A Statistical Approach

415

476

418

Controllability of Variances

479

Interaction among Variances 420 Standard Costs and Product Costing

427

Evaluation of Standard Costing Systems 422 Advantages of Standard Costing

422

Criticisms of Standard Costing in Today's Manufacturing Environment 422 M.A.P. Cost of Ownership

424

xxix

Contents Operational Performance Measures in Today's Manufacturing Environment 424 Gain-Sharing Plans 427 The Balanced Scorecard 427 Lead and Lag Measures: The Key to the Balanced Scorecard 430 Linking the Balanced Scorecard to Organizational Strategy 431 M.A.P. Linking the Balanced Scorecard to Organizational Strategy 432

Focus on Ethics: Sacrificing Quality to Cut Standard Costs 434 Chapter Summary 434 Review Problems on Standard Costing and Operational Performance Measures 435 Key Terms 437 Appendix to Chapter 10: Use of Standard Costs for Product Costing 438 Review Questions 440 Exercises 440 > Problems 443 Cases 454

11 Flexible Budgeting and the Management of Overhead and Support Activity Costs 458 Overhead Budgets

460

Flexible Budgets 461 Advantages of Flexible Budgets 461 The Activity Measure 462 Flexible Overhead Budget Illustrated 463 Formula Flexible Budget 463 Overhead Application in a Standard-Costing System 465 Choice of Activity Measure 466 Criteria for Choosing the Activity Measure 466 Cost Management Using Overhead Cost Variances 467 Variable Overhead 468 Fixed Overhead 471

Overhead Cost Performance Report

473

M.A.P. Cost Management Systems in Germany 474

Activity-Based Flexible Budget 474 Flexible Budgeting in the Service Industry 476 Focus on Ethics: Misstated Standards Affect Accuracy of Reports 478 Chapter Summary 479 Review Problem on Overhead Variances 480 Key Terms 487 Appendix A to Chapter 11: Standard Costs and Product Costing 487 Appendix B to Chapter 11: Sales Variances 483 Review Questions Exercises 485 Problems 488 Cases 500

484

12 Responsibility Accounting, Quality Control, and Environmental Cost Management 504 Responsibility Centers

506

Illustration of Responsibility Accounting 507 Performance Reports

570

Budgets, Variance Analysis, and Responsibility Accounting 512 Cost Allocation 512 Cost Allocation Bases 512 Allocation Bases Based on Budgets Activity-Based Responsibility Accounting 514 Behavioral Effects of Responsibility Accounting 574 Information versus Blame 514 Controllability 514 Motivating Desired Behavior 515

512

Contents

XXX

Segmented Reporting 575 Segments versus Segment Managers 516 Key Features of Segmented Reporting 517 Customer-Profitability Analysis and ActivityBased Costing 517 Total Quality Management

578

Changing Views of Optimal Product Quality 520 M.A.P. Six Sigma for Quality Management and Cost Reduction 522

523

Environmental Cost Management

524

Classifying Environmental Costs 524 Managing Private Environmental Costs 525 Environmental Cost Strategies

527

Tie-In to the Responsibility-Accounting System 527 Focus on Ethics: Short-Sighted View of Cost Cutting 527 Chapter Summary

528

Review Problem on Responsibility Accounting 529 Key Terms 530 Review Questions

Return on Investment 550 Residual Income 552 Economic Value Added 555 M.A.P. Pay for Performance Based on EVA 556

Measuring Income and Invested Capital 557

Measuring and Reporting Quality Costs 518

ISO 9000 Standards

Measuring Performance in Investment Centers 550

537

Exercises 537 Problems 534 Cases 542

Invested Capital 557 Measuring Investment-Center Income 560 Inflation: Historical-Cost versus CurrentValue Accounting 561 Other Issues in Segment Performance Evaluation 567 Alternatives to ROI, Residual Income, and Economic Value Added (EVA) 561 Importance of Nonfinancial Information 562 Measuring Performance in Nonprofit Organizations 562 Transfer Pricing 563 Goal Congruence

563

General Transfer-Pricing Rule 564 Transfers Based on the External Market Price 567 Negotiated Transfer Prices 568 Cost-Based Transfer Prices 569 Standard versus Actual Costs 570 Undermining Divisional Autonomy 570 An International Perspective 570 M.A.P. Transfer Pricing and Tax Issues 571

Transfer Pricing in the Service Industry 572 Behavioral Issues: Risk Aversion and Incentives 572

13 Investment Centers and Transfer Pricing 546 Delegation of Decision Making 548 Obtaining Goal Congruence: A Behavioral Challenge 549 Adaptation of Management Control Systems 549

Goal Congruence and Internal Control Systems 573 Chapter Summary 574 Review Problems on Investment Centers and Transfer Pricing 574 Key Terms 576 Review Questions Exercises 576 Problems 579 Cases 585

576

xxxi

Contents

Focus on Ethics: Effects of Decision to Close a Department and Outsource 67 7 Chapter Summary 678 Review Problem on Relevant Costs

678

Key Terms 679 Appendix to Chapter 14: Linear Programming 620

14 Decision Making: Relevant Costs and Benefits 590

Review Questions

The Managerial Accountant's Role in Decision Making 592

Exercises

623

Problems

626

622

Cases 639

Steps in the Decision-Making Process 593 Quantitative versus Qualitative Analysis 593 Obtaining Information: Relevance, Accuracy, and Timeliness 594 Relevant Information 595 Unique versus Repetitive Decisions

595

Importance of Identifying Relevant Costs and Benefits 596 9 Identifying Relevant Costs and Benefits 596 Sunk Costs 596 Irrelevant Future Costs and Benefits Opportunity Costs Summary 600

599

599 ,

Analysis of Special Decisions

600

Accept or Reject a Special Offer 600

Major Influences on Pricing Decisions Customer Demand 645 Actions of Competitors 645 Costs 645

644

Political, Legal, and Image-Related Issues 646

Outsource a Product or Service 602 M.A.P. Outsourcing

15 Target Costing and Cost Analysis for Pricing Decisions 642

Economic Profit-Maximizing Pricing

603

646

v

Add or Drop a Service, Product, or Department 605

Total Revenue, Demand, and Marginal Revenue Curves 646

M.A.P. Adding a Service

Total Cost and Marginal Cost Curves 648 Profit-Maximizing Price and Quantity 648 Price Elasticity 651

607

Special Decisions in Manufacturing Firms 607 Joint Products: Sell or Process Further 607 Decisions Involving Limited Resources 609 Uncertainty 611 Activity-Based Costing and Today's Advanced Manufacturing Environment 672 Conventional Outsourcing (Make-or-Buy) Analysis 613 Activity-Based Costing Analysis of the Outsourcing Decision 614 Other Issues in Decision Making 675 Incentives for Decision Makers 615 Short-Run versus Long-Run Decisions Pitfalls to Avoid 616

Limitations of the Profit-Maximizing Model 651 Costs and Benefits of Information

Cost-Pius Pricing 652 Absorption-Cost Pricing Formulas 653 Variable-Cost Pricing Formulas 654 Determining the Markup 654 M.A.P. Price Competition and Cost Management 656

616

651

Role of Accounting Product Costs in Pricing 652

Cost-Pius Pricing: Summary and Evaluation 656

Contents

xxxii

Strategic Pricing of New Products Target Costing

657

657

M.A.P. Pricing on the Internet by "e-Tailers" 658

A Strategic Profit and Cost Management Process 658 Activity-Based Costing and Target Costing 660 Product-Cost Distortion and Pricing: The Role of Activity-Based Costing 660 Value Engineering and Target Costing 661 Time and Material Pricing 662 Competitive Bidding 664 Effect of Antitrust Laws on Pricing 666 Chapter Summary 667 Review Problem on Cost-Pius Pricing 668 Key Terms 669 Review Questions 670 Exercises 670 Problems 673 Cases 680

16 Capital Expenditure Decisions

684

Modified Accelerated Cost Recovery System (MACRS) 701 Gains and Losses on Disposal 703 Investment in Working Capital 704 Extended Illustration of Income-Tax Effects in Capital Budgeting 705 M.A.P. Capital Budgeting at Pharmaceutical Firms 708

Ranking Investment Projects 709 Section 3: Alternative Methods for Making Investment Decisions 770 Payback Method 711 Accounting-Rate-of-Return Method 712 Estimating Cash Flows: The Role of ActivityBased Costing 775 Justification of Investments in Advanced Manufacturing Systems 775 Focus on Ethics: Dysfunctional Focus on Early Cash Flows 776 Chapter Summary 778 Review Problems on Capital Expenditure Decisions 779 Key Terms 720 Appendix A to Chapter 16: Future Value and Present Value Tables 720 Appendix B to Chapter 16: Impact of Inflation 722 Review Questions 725 Exercises 725 Problems 728 Cases 735

Section 1: Discounted-Cash-Flow Analysis 687 Net-Present-Value Method

688

Internal-Rate-of-Return Method

688

Comparing the NPV and IRR Methods

691

Assumptions Underlying Discounted-CashFlow Analysis 691 Choosing the Hurdle Rate 692 Depreciable Assets 693 Comparing Two Investment Projects 693 Managerial Accountant's Role 696 Postaudit

Section 1: Service Department Cost Allocation 740

696

Real Option Analysis

697

Section 2: Income Taxes and Capital Budgeting 697 After-Tax Cash Flows

697

Accelerated Depreciation

17 Allocation of Support Activity Costs and Joint Costs 738

700

Direct Method 743 Step-Down Method 743 Reciprocal-Services Method 744 Fixed versus Variable Costs 745

Contents M.A.P. Cost Management in the Health Care Industry 747

Dual Cost Allocation 74 7 Allocate Budgeted Costs 748 Today's Advanced Manufacturing Environment 749 The Rise of Activity-Based Costing 750 Section 2: Joint Product Cost Allocation 750 Allocating Joint Costs 751 M.A.P. Joint Cost Allocation in the Petroleum Industry 752

Chapter Summary

753

Review Problem on Service Department Cost Allocation 754 Key Terms 755 Appendix to Chapter 17: Reciprocal-Services Method 755 Review Questions 757 Exercises

757

Problems

759

Cases 764

xxxiii

Appendix I: The Sarbanes-Oxley Act, Internal Controls, and Management Accounting 766 Appendix II: Compound Interest and the Concept of Present Value 772 Appendix III: Inventory Management 780 References for "In Their Own Words" 786 Glossary 789 Photo Credits

800

Index of Companies and Organizations 801 Index of Subjects

803