CORNERSTONES. of Managerial Accounting. Dan L. Heitger. Maryanne M. Mowen. Don R. Hansen. Miami University ~ Oxford. Oklahoma State University

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1 FUNDAMENTAL CORNERSTONES of Managerial Accounting Dan L. Heitger Miami University ~ Oxford Maryanne M. Mowen Oklahoma State University ;... ^.. _ ;... Don R. Hansen Oklahoma State University THOMSON SOUTH-WESTERN A u s t r a l i a B r a z i l C a n a d a M e x i c o S i n g a p o r e S p a i n U n i t e d K i n g d o m U n i t e d S t a t e s

2 Chapter 1 Managerial Accounting Concepts and Decision-Making Support 2 The Meaning and Purpose of Managerial Accounting 4 ' Information Needs of Managers and Other Users 5 Financial Accounting and Managerial Accounting 6 Emerging Trends in Managerial Accounting and the Role of Managerial Accountants in an Organization 7 New Methods of Estimating the Profitability of Products and Services 8, Customer Orientation 8, Cross-Functional Perspective 9, Total Quality Management 10, The Role of Managerial Accountant Preparing and Communicating Information 11, Sarbanes-Oxley Act of The Meaning and Uses of Cost 12 Accumulating and Assigning Costs 13, Cost Objects 14, Assigning Costs to Cost Objects 14 Products and Service Costs 16 Determining Product Cost 17, Determining Period Costs 19 Preparing Income Statements 22 Cost of Goods Manufactured 22, HOW TO Calculate the Direct Materials Used in Production 23, HOW TO Calculate Cost of Goods Manufactured 23, Cost of Goods Sold 24, Income Statement: Manufacturing Firm 24, HOW TO Calculate Cost of Goods Sold 24, HOW TO Prepare and Income Statement for a Manufacturing Firm 25, HOW TO Calculate the Percentage of Sales Revenues for Each Line on the Income Statement 26, Income Statement: Service Organization 27 Managerial Accounting and Ethical Conduct 28 Ethical Behavior 28, Company Codes of Ethical Conduct 28 Chapter 2 Cost Behavior 52 Basics of Cost Behavior 54 Measures of Output and the Relevant Range 54, Fixed Costs 55, Variable Costs 57, The Reasonableness of Straight- Line Cost Relationships 59 Mixed Costs and Step Costs 60 Mixed Costs 60, Step-Cost Behavior 60, Accounting Records and Mixed Costs 62, Need for Cost Separation 62 Methods for Separating Mixed Costs into Fixed and Variable Components 62 HOW TO Create and Use a Cost Formula 63, The High-Low Method 64, HOW TO Use the High-Low Method to Calculate Fixed Cost and the Variable Rate and to Construct a Cost Formula 65, HOW TO Use the High-Low Method to Calculate Predicted Total Variable Cost and Total Cost for Budgeted Output 66, HOW TO Use the High-Low Method to Calculate Predicted Total Variable Cost and Total Cost for a Time Period that Differs from the Data Period 67, Scattcrgraph Method 68, The Method of Least Squares 70, HOW TO Use the Regression Method to

3 Calculate Fixed Cost and the Variable Rate and to Construct a Cost Formula and to Determine Budgeted Cost 73, Managerial Judgment 74 Appendix: Using the Regression Programs 76 Chapter 3 Cost-Volume-Profit Analysis: A Managerial Planning Tool 98 Break-Even Point in Units and in Sales Dollars 100 Using Operating Income in CVP Analysis 100, Break-Even Point in Units 101, HOW TO Prepare a Contribution Margin Income Statement 102, Break-Even Point in Sales Dollars 103, HOW TO Solve for the Break-Even Point in Units 104, HOW TO Calculate the Variable Cost Ratio and the Contribution Margin Ratio 105, HOW TO Solve for the Break-Even Point in Sales Dollars 106 Units and Sales Dollars Needed to Achieve a Target Income 107 Units to Be Sold to Achieve a Target Income 107, HOW TO Solve for the Number of Units to Be Sold to Earn a Target Operating Income 108, Sales Revenue to Achieve a Target Income 108, HOW TO Solve for the Sales Needed to Earn a Target Operating Income 109 Graphs of CVP Relationships 109 The Profit-Volume Graph 110, The Cost-Volume-Profit Graph 110, Assumptions of Cost-Volume-Profit Analysis 112 Multiple-Product Analysis 113 Break-Even Point in Units 113, HOW TO Calculate the Break-Even Units for a Multiple-Product Firm 115, Break- Even Point in Sales Dollars 116, HOW TO Calculate the Break-Even Sales Dollars for a Multiple-Product Firm 116 CVP Analysis and Risk and Uncertainty 117 Introducing Risk and Uncertainty 119, HOW TO Compute the Margin of Safety 121, HOW TO Compute the Degree of Operating Leverage 121, HOW TO Compute the Impact of Increased Sales on Operating Income Using the Degree of Operating Leverage 123, Sensitivity Analysis and CVP 124 Making the Connection 142 Chapter 4 Job-Order Costing 144 The importance of Cost Systems 146 Characteristics of the Job-Order Environment 146 Job-Order Production and Costing 146, Process Production and Costing 147, Production Costs in Job-Order Costing 147 Normal Costing and Overhead Application 147 Actual Costing versus Normal Costing 148, Importance of Unit Costs to Manufacturing Firms 149, Importance of Unit Costs to Service Firms 149, Normal Costing and Estimating Overhead 149, Applying Overhead to Production 150, HOW TO Calculate the Predetermined Overhead Rate and Apply Overhead to Production 150, Reconciling Applied Overhead with Actual Overhead 151, HOW TO Reconcile Actual Overhead with Applied Overhead 152, Departmental Overhead Rates 152, HOW TO Calculate Predetermined Departmental Overhead Rates and Apply Overhead to Production 153, HOW TO Convert Departmental Data to Plantwide Data to Calculate the Overhead Rate and Apply Overhead to Production 154, Unit Costs in the Job-Order System 154 Keeping Track of Job Costs with Source Documents 155 Job-Order Cost Sheet 155, Materials Requisitions 156, Time Tickets 157, Source Documents for Other Activity 157 The Flow of Costs through the Accounts 158 Accounting for Materials 158, Accounting for Direct Labor Cost 159, Accounting for Overhead 000, Accounting for Actual Overhead Costs 160, Accounting for Finished Goods 161, Accounting for Cost of Goods Sold 161, HOW TO Prepare Brief Job-Order Cost Sheets 164, Accounting for Nonmanufacturing Costs 165 Appendix: Journal Entries Associated with Job-Order Costing 167 Chapter 5 Process Costing 188 Characteristics of Process Manufacturing 190 Types of Processes 190, How Costs Flow through the Accounts in Process Costing 191, HOW TO Calculate

4 XI Cost Flows without WIP 192, Accumulating Costs in the Production Report 193, Service and Manufacturing Firms 193 The Impact of Work-in-Process Inventories on Process Costing 194 Equivalent Units of Production 194, HOW TO Calculate Equivalent Units of Production: No Beginning Work in Process 195, HOW TO Measure Output and Assign Costs: No Beginning Work in Process 196, Two Methods of Treating Beginning Work-in-Process Inventory 197 Weighted Average Costing Overview of the Weighted Average Method 197, HOW TO Measure Output and Assign Costs: Weighted Average Method 198, Five Steps in Preparing a Production Report 199, HOW TO Prepare a Physical Flow Schedule 200, Production Report 201, Evaluation of the Weighted Average Method 201, HOW TO Prepare a Production Report: Weighted Average Method 202 Multiple Inputs and Multiple Departments 203 Nonuniform Application of Manufacturing Inputs 203, HOW TO Calculate Equivalent Units, Unit Costs, and Value Inventories with Nonunifofm Inputs 204, Multiple Departments 205, HOW TO Calculate the Physical Flow Schedule, Equivalent Units, and Unit Costs with Transferred-In Goods 206 Appendix: Production Report Fifo Costing Differences between the FIFO and Weighted Average Methods 209, Example of the FIFO Method 209, HOW TO Calculate Output and Cost Assignments: FIFO Method 209, HOW TO Prepare a Production Report: FIFO Method 212 Chapter 6 Activity-Based Costing and Management 236 Limitations of Functional-Based Cost Accounting Systems 238 Nonunit-Related Overhead Costs 238, Product Diversity 240, Illustrating the Failure of Unit-Based Overhead Rates 240, HOW TO Calculate Consumption Ratios 242, HOW TO Calculate Activity Rates 243, HOW TO Calculate Activity-Based Unit Costs 243 Activity-Based Product Costing: Detailed Description 245 Identifying Activities and Their Attributes 245, Assigning Costs to Activities 248, HOW TO Assign Resource Costs by Using Direct Tracing and Resource Drivers 248, Assigning Cost to Products 249 Activity-Based Customer and Supplier Costing 250 Activity-Based Customer Costing 251, HOW TO Calculate Activity-Based Customer Costs 252, Activity-Based Supplier Costing 252, HOW TO Calculate Activity-Based Supplier Costs 253 Process-Value Analysis 254 Driver Analysis: The Search for Root Causes 254, Activity Analysis: Identifying and Assessing Value Content 255, HOW TO Assess Nonvalue Added Costs 258, Activity Performance Measurement 259, HOW TO Calculate Cycle Time and Velocity 259, Environmental Costs Management 260 Chapter 7 Profit Planning 290 Description of Budgeting 292 Budgeting and Planning and Control 292, Advantages of Budgeting 293, The Master Budget 293 Preparing the Operating Budget 294 Sales Budget 295, Production Budget 296, HOW TO Prepare a Sales Budget 296, HOW TO Prepare the production Budget 298, Direct Materials Purchases Budget 297, HOW TO Prepare a Direct Materials Purchases Budget 299, Direct Labor Budget 300, Overhead Budjet 300, HOW TO Prepare a Direct Labor Budget 300, HOW TO Prepare an Overhead Budget 301, Ending Finished Goods Inventory Budget 301, HOW TO Prepare the Ending Finished Goods Inventory Budget 301, Cost of Goods Sold Budget 302, Selling and Administrative Expenses Budget 302, Budgeted Income Statement 302, HOW TO Prepare a Cost of Goods Sold Budget 303, HOW TO Prepare a Selling and Administrative Expenses

5 Budget 303, HOW TO Prepare a Budgeted Income Statement 304 Preparing the Financial Budget 305 Cash Budget 305, HOW TO Prepare a Cash Budget 307, Budgeted Balance Sheet 309, HOW TO Prepare the Budgeted Balance Sheet 309 Appendix: Accounting For Variances 356 Entries for Direct Materials Variances 357, Entries for Direct Labor Variances 357, Disposition of Materials and Labor Variances 358 Making the Connection 376 Using Budgets for Performance Evaluation 311 Frequent Feedback on Performance 311, Monetary and Nonmonetary Incentives 311, Participative Budgeting 311, Realistic Standards 313, Controllability of Costs 313, Multiple Measures of Performance 313 Chapter 8 Standard Costing: A Managerial Control Tool 336 Unit Standards 338 How Standards Are Developed 338, Types of Standards 339, Why Standard Cost Systems Are Adopted 339 Standard Product Costs 341 / Variance Analysis: General Description 3^2 Price and Usage Variances 344, The Decision to Investigate 344, HOW TO Use Control Limits to Trigger a Variance Investigation 346, HOW TO Compute Standard Quantities Allowed (SQ and SH) 343 Variance Analysis: Materials 347 Direct Materials Variances 347, HOW TO Calculate the Total Variance for Materials 347, HOW TO Calculate Materials Variances: Formula and Columnar Approaches 348, Using Materials Variance Information 349 Variance Analysis: Direct Labor 351 Direct Labor Variances 351, HOW TO Calculate the Total Variance for Labor 351, HOW TO Calculate Labor Variances: Formula and Columnar Approaches 352, Using Labor Variance Information 353, Additional Cost Management Practices: Kaitzen Costing and Target Costing 354 Chapter 9 Flexible Budgets and Overhead Analysis 378 Using Budgets for Performance Evaluation 380 Static Budgets versus Flexible Budgets 380, HOW TO Prepare a Performance Report Based on a Static Budget (Using Budgeted Production) 381, HOW TO Prepare a Flexible Production Budget 383, HOW TO Prepare a Performance Report Using a Flexible Budget 384 Variable Overhead Analysis 384 Total Variable Overhead Variance 384, HOW TO Calculate the Total Variable Overhead Variance 385, HOW TO Calculate Variable Overhead Variances: Columnar and Formula Approaches 386, Comparison of the Spending Variance with the Price Variances of Materials and Labor 387, Responsibility for the Variable Overhead Spending Variance 388, Responsibility for the Variable Overhead Efficiency Variance 388, A Performance Report for the Variable Overhead Spending and Efficiency Variances 388, HOW TO Prepare a Performance Report for the Variable Overhead Variances 389 Fixed Overhead Analysis 389 Total Fixed Overhead Variances 390, HOW TO Calculate the Total Fixed Overhead Variance 390, Responsibility for the Fixed Overhead Spending Variance 391, Analysis of the Fixed Overhead Spending Variance 391, HOW TO Calculate Fixed Overhead Variances: Columnar and Formula Approaches 391, Responsibility for the Fixed Overhead Volume Variance 392, Analysis of the Volume Variance 392 Activity-Based Budgeting 393 Static Activity Budgets 394, HOW TO Prepare a Static Budget for an Activity 394, Activity Flexible

6 XIII Budgeting 395, HOW TO Prepare an Activity Flexible Budget 396, HOW TO Prepare an Activity-Based Performance Report 397 Chapter 11 Short-Run Decision Making: Relevant Costing and Inventory Management 462 Short-Run Decision Making 464 Chapter 10 Performance Evaluation, Variable Costing, and Decentralization 420 Decentralization and Responsibility Centers 422 Reasons for Decentralization 422, Divisions in the Decentralized Firm 423 Measuring the Performance of Profit Centers Using Variable and Absorption Income Statements 425 Inventory Valuation 426, HOW TO Compute Inventory Cost under Absorption and Variable Costing 427, Income Statements Using Variable and Absorption Costing 427, HOW TO -Prepare Income Statements Under Absorption and Variable Costing 428, Production, Sales, and Income Relationships 429, Evaluating Profit-Center Managers 429, Segmented Income Statements Using Variable Costing 430, HOW TO Prepare a Segmented Income Statement 431 Measuring the Performance of Investment Centers Using ROI 431 Return on Investment 431, Margin and Turnover 432, HOW TO Calculate Average Operating Assets, Margin, ^ Turnover, and ROI 433, Advantages of ROI 434, Disadvantages of ROI Measure 436 Measuring the Performance of Investment Centers Using Residual Income and Economic Value Added 437 Residual Income 437, HOW TO Calculate Residual Income 438, Economic Value Added (EVA) 439, HOW TO Calculate EVA 440 The Balanced Scorecard Basic Concepts 441 Transfer Pricing 442 Impact of Transfer Pricing on Divisions and the Firm as a Whole 443, Transfer Pricing Policies 443 The Decision-Making Model 464, Step 1: Define the Problem 465, Step 2: Identify the Alternatives 465, Step 3: Identify the Costs and Benefits Associated with Each Feasible Alternative 465, Step 4: Total the Relevant Costs and Benefits for Each Feasible Alternative 466, Step 5: Assess the Qualitative Factors 466, Step 6: Make the Decision 467, Ethics in Decision Making 467, Relevant Costs Defined 468, Cost Behavior and Relevant Costs 469 Some Common Relevant Cost Applications 470 Make-or-Buy Decisions 470, Special-Order Decisions 471, HOW TO Structure a Make-or-Buy Problem 472, HOW TO Structure a Special-Order Problem 474, Keep-or-Drop Decisions 474, HOW TO Structure a Keepor-Drop Product Line Problem 475, HOW TO Structure a Keep-or-Drop Product Line Problem with Complementary Effects 476, Further Processing of Joint Products 477, HOW TO Structure the Sell-or-Process-Further Decision 478 Product Mix Decisions 478 HOW TO Determine the Optimal Product Mix with One Constrained Resource 479, HOW TO Determine the Optimal Product Mix with One Constrained Resource and a Sales Constraint 479, Multiple Constrained Resources 480 The Use of Costs in Pricing Decisions 481 Cost-Based Pricing 481, HOW TO Calculate Price by Applying a Markup Percentage to Cost 481, HOW TO Calculate a Target Cost 482 Experience Pricing Decisions with Little Guys Home Electronics 482 Traget costing and Pricing 483 Decision Making for Inventory Management 484 Inventory-Related Costs 484, Just-in-Time Approach to Inventory Management 485

7 XIV Chapter 12 Capital Investment Decisions 508 Types of Capital Investment Decisions 510 Nondiscounting Models 511 Payback Period 512, HOW TO Calculate Payback 512, Accounting Rate of Return 514, HOW TO Calculate the Accounting Rate of Return 514 Discounting Models: the Net Present Value Method 515 NPV Defined 515, An Example Illustrating Net Present Value 515, HOW TO Assess Cash Flows and Calculate NPV 516 Internal Rate of Return 517 Example: Multiple-Period Setting with Uniform Cash Flows 517, HOW TO Calculate IRR with Uniform Cash Flows 518, Multiple-Period Setting: Uneven Cash Flows 518 Postaudit of Capital Projects 519 Honley Medical Company: An Illustrative Application 519, One Year Later 519, Benefits of a Postaudit 520 Mutually Exclusive Projects 521 NPV Compared with IRR 521, Example: Mutually Exclusive Projects 522, HOW TO Calculate NPV and IRR for Mutually Exclusive Projects 523, Special Considerations for the Advanced Manufacturing Environment 524 Appendix: Present Value Concepts 528 Future Value 528, Present Value 528, Present Value of an Uneven Series of Cash Flows 529, Present Value of a Uniform Series of Cash Flows 529 Making the Connection 552 Chapter 13 Statement of Cash Flows 556 Overview of the Statement of Cash Flows 558 Cash Defined 558, Sources and Uses of Cash 558, Noncash Exchanges 558, HOW TO Classify Activities and Identify Them as Sources or Uses of Cash 559, Methods for Calculating Operating Cash Flows 559 Preparation of the Statement: Indirect Method 560 Step One: Compute the Change in Cash Flow 561, HOW TO Compute the Change in Cash Flow 562, Step Two: Compute Operating Cash Flows 562, HOW TO Calculate Operating Cash Flows: Indirect Method 563, Step Three: Compute Investing Cash Flows 564, HOW TO Compute Investing Cash Flows 565, Step Four: Cash Flows from Financing 565, Step Five: Prepare the Statement of Cash Flows 565, HOW TO Compute Financing Cash Flows 566, HOW TO Prepare the Statement of Cash Flows 566 The Direct Method: an Alternative'Approach 567 HOW TO Calculate Operating Cash Flows Using the Direct Method 568 Worksheet Approach to the Statement Of Cash Flows 569 HOW TO Prepare a Statement of Cash Flows Using a Worksheet Approach 570, Analysis of Transactions 571, The Final Step 573 Chapter 14 Financial Statement Analysis 594 Common-Size Analysis 596 Horizontal Analysis 596, HOW TO Prepare Common-Size Income Statements Using Base Period Horizontal Analysis 597, HOW TO Prepare Income Statements Using Net Sales as the Base: Vertical Analysis 598, Percentages and Size Effects 599 Ratio Analysis 599 Standards for Comparison 599, Classification of Ratios 601 Liquidity Ratios 602 Current Ratio 603, Quick or Acid-Test Ratio 603, Accounts Receivable Turnover Ratio 604, HOW TO Calculate the Current Ratio and the Quick (or Acid-Test) Ratio 604, HOW TO Calculate the Average Accounts

8 XV Receivable, the Accounts Receivable Turnover Ratio, and the Accounts Receivable Turnover in Days 605, Inventory Turnover Ratio 606, HOW TO Calculate the Average Inventory, the Inventory Ratio, and the Inventory Turnover in Days 606 Leverage Ratios 607 Times-Interest-Earned Ratio 607, HOW TO Calculate the Times-Interest-Earned Ratio 607, Debt Ratio 608, HOW TO Calculate the Debt Ratio and the Debt to Equity Ratio 608 Profitability Ratios 609 f Return on Sales 609, Return on Sales 609, Return on Total Assets 609, HOW TO Calculate the Return on Sales 609, HOW TO Calculate the Average Total Assets and the Return on Assets 610, Return on Common Stockholders' Equity 610, Earnings per Share 610, HOW TO Calculate the Average Common Stockholders' Equity and the Return on Stockholders' Equity 611, HOW TO Compute Earnings per Share 611, Price-Earnings Ratio 612, Dividend Yield and Payout Ratios 612, HOW TO Compute the Price-Earnings Ratio 612, HOW TO Compute the Dividend Yield and the Dividend Payout Ratio 613, Impact of the JIT Manufacturing Environment 613, The importance of profitability Ratios to External Users of the Financial Statements 613 Glossary 631 Check Figures 639 Index 643

anagena Accounting McGraw-Hill Irwin Ray H. Garrison, D.B.A., CPA Eric W. Noreen, Ph.D., CMA Peter C. Brewer, Ph.D., CPA

anagena Accounting McGraw-Hill Irwin Ray H. Garrison, D.B.A., CPA Eric W. Noreen, Ph.D., CMA Peter C. Brewer, Ph.D., CPA anagena Accounting r t e e n t i t i Ray H. Garrison, D.B.A., CPA Professor Emeritus Brigham Young University Eric W. Noreen, Ph.D., CMA Professor Emeritus University of Washington Peter C. Brewer, Ph.D.,