ill Seal, Ray H. Garrison, Eric-W. Noreen

Management Accountin Third Edition ill Seal, Ray H. Garrison, Eric-W. Noreen p= ' $- Lcn.ci6n* 6oston Bun Ridge, IL Dubuque, IA " "Madi'sorfg W! New York,'^a.n :$ Franciscp s St.. Louis EJor.gkok Bogota Caracas Kuala Lumpur.Lisbon* Madncf // Mexico'City Milan Montreal New Delhi Santiago \Sebul " ^Singapore 'Sy&pEyi iaicei i'orontc,- c-.

;' Brief tflsie of contents" * *- Part I: An introduction to management and cost accounting: cost terms, systems design and cost behaviour l 1 Management accounting and the business environment 3 2 An introduction to cost terms, concepts and classifications 21 3 Systems design: job-order costing ' 61 4 Systems design: process costing 119 5 Cost behaviour: analysis and use 155 Part II: Information for decision making 197 6 Profit reporting under variable costing and absorption costing 199 7 Cost-volume-profit relationships 229 8 Activity-based costing 275 9 Relevant costs for decision making 323 10 Capital investment decisions 371 Part III: Planning and control 431 11 Profit planning and the role of budgeting 433 12 Standard costs and variance analysis 471 13 Flexible budgets and overhead analysis 515 14 Segment reporting and decentralization 575 15 Pricing and intra-company transfers 629 Part IV: Value metrics and performance management in a strategic context 673 16 Value-based management and strategic management accounting 675 17 Performance management management control and corporate governance 713 18 Business process management: towards the lean operation 745 19 Strategic perspectives on cost management 793

Detail eatable of contents Preface xvi Acknowledgements Guided tour XVlll xvu Technology to enhance teaching and learning xx Part I: An introduction to management and cost accounting: cost terms, systems design and cost behaviour l 1 Management accounting and the business environment 3 The work of management and the need for management accounting information 4 Planning 4 Directing and motivating 5 Controlling 5 The end results of managers' activities 5 The planning and control cycle 6 Comparison of financial and management accounting 6 Emphasis on the future 6 Relevance and flexibility of-data 7 Less emphasis on precision 7 Segments of an organization 8 International Financial Reporting Standards (IFRS) 8 Management accounting - not mandatory / 8 Basic organizational structure 8 Decentralization 8 * Line and staff relationships 9 Expanding and changing role of management accounting 10 International diversity in management accounting traditions 10 Globalization and international competition 11 Changes in the business environment and management accounting 11 New business processes and technologies 11 Enterprise resource planning systems 12 Deregulation and privatization 12 The increased importance of service sector management 13 Managing for value 13 Managing for environmental sustainability 13 Corporate governance, professional and business ethics 14 Some implications for the roles of management accountants: a first look 14 2 An introduction to cost terms, concepts and classifications 21 General cost classifications 22 Manufacturing costs 22 Non-manufacturing costs 23 Product costs versus period costs 24 Cost classifications on financial statements 25 The balance sheet 26 The profit and loss account 26 Schedule of cost of goods manufactured 28 Product costs - a closer look 29 Stock-related costs 30 An example of cost flows 31 Costing in service organizations: a first look 32 Cost classifications for predicting cost behaviour 32 Variable cost 33 Fixed cost 34 Cost classifications for assigning costs to cost objects 35 Direct cost 35

Management accounting Indirect cost 36 Cost classifications for decision making 36 Differential cost and revenue 36 Opportunity cost 37 Sunk cost 37 3 Systems design: job-order costing 61 Process and job-order costing 62 Process costing - 62 Job-order costing 63 Job-order costing - an overview 63 Measuring direct materials cost 64 Job cost sheet 64 Measuring direct labour cost 65' Application of manufacturing overhead 67 Choice of an allocation base for overhead cost 69 Computation of unit costs 70 Summary of document flows 70 Job-order costing - the flow of costs 71 The purchase and issue of materials 71 Labour cost 72 Manufacturing overhead costs 73 The application of manufacturing overhead 74, Non-manufacturing costs 76 Cost of goods manufactured 77 Cost of goods sold 77 Summary of cost flows 78 Problems of overhead application 78 Underapplied and overapplied overhead 78 Disposition of under- or overapplied overhead balances 83 i A general model of product cost flows 85 Multiple predetermined overhead rates 85 Job-order costing in service companies 85 The predetermined overhead rate and capacity 86 Appendix*3A: Service department costing 93 i l > ( Allocations using the direct and step methods 93 Selecting allocation bases 93 Interdepartmental^ services 93 Effect of allocations on operating departments 97 Some cautions in allocating service department costs 97 4 Systems design: process costing 119 Comparison of job-order and process costing 120 Similarities between job-order and process costing 120 Differences between job-order and process costing 121 A perspective of process cost flows 121 Processing departments 121 The flow of materials, labour and overhead costs 122 Materials, labour and overhead cost entries 124 Equivalent units of production 126 Weighted-average method 127 Production report - weighted-average method 128 Step 1: prepare a quantity schedule and compute the-equivalent 131 Step 2: compute costs per equivalent *" unit 131 Step 3: prepare a cost reconciliation 132 A comment about rounding errors 135 Operation costing 135 Appendix 4A: FIFO method 137 Equivalent units - FIFO method 137 Comparison of equivalent units of production under the weighted-average and FIFO methods 137 Production report - FIFO method 138 A comparison of costing methods 141 5 Cost behaviour: analysis and use 155 Types of cost behaviour patterns 156 Variable costs 156 The activity base 157 True variable versus step-variable costs 159

Detailed table of contents The linearity assumption and the relevant range 159 Fixed-costs 160 Types of fixed costs 160 The trend toward fixed costs 162 Is labour a variable or a fixed cost? 162 Fixed costs and the relevant range 163 Mixed costs 163 { The analysis of mixed costs 165 The high-low method 166 The scattergraph method 168 The least-squares regression method 171 Multiple regression analysis 772 The contribution-format 173 Why a new profit and loss statement format? 173 The contribution approach 173 Appendix 5A: Least-squares regression calculations i75 Appendix 5B: Non-linear cost functions and the learning curve 177 Appendix 5C: Cost measurement in service industries 178 Part II: Information for decision. making 197 6 Profit reporting under variable costing and absorption costing 199 Overview of absorption and variable costing 200 Absorption costing 200 Variable costing 200 Unit cost computations 201 Profit comparison of absorption and variable costing 202 Extended comparison of profit data 205 Effect of changes in production on profit 209 Variable costing 209 Absorption costing 213 The impact on the manager 213 Choosing a costing method 214 Decision making 214 External reporting 214 Advantages of variable costing and the contribution approach 215 Impact of JIT methods 215 7 Cost-volume-profit relationships 229 The basics of cost-volume-profit (CYP) analysis 231 Contribution margin 231 Contribution margin ratio (CM ratio) 233 Some applications of CVP concepts' 234 Importance of the contribution margin 238 Break-even analysis 238 Break-even computations 238 CVP relationships in graphic form 240 Preparing the CVP graph 240 Target profit analysis 241 The CVP equation 241 The contribution margin approach 242 The margin of safety 242 CVP considerations in choosing a cost structure 243 Cost structure and profit stability 243 Operating leverage 245 Automation: risks and rewards from a CVP perspective 246 Structuring sales commissions 246 The concept of sales mix 248 The definition of sales mix 248 Sales mix and break-even analysis 248 Assumptions of CVP analysis 250 8 Activity-based costing 275 How costs are treated under activity-based costing 277 Non-manufacturing costs and activity-based costing 277 Manufacturing costs and activity-based costing 277 The costs of idle capacity in activity-based costing 278

Management accounting - Designing an activity-based costing (ABC) system 278 Identifying activities to include in the ABC system 281 The mechanics of activity-based costing 282 Tracing overhead costs to activities and cost objects, 282 Assigning costs to activity cost pools 283 Computation of activity rates 286 Targeting process improvements: activitybased management 286 Assigning costs to cost objects 287 Overhead costs computed using the ABC. system 288 Product margins and customer profitability computed using the ABC system 291 Comparison of traditional and ABC product costs 292 Product margins computed using the traditional cost system 292 The differences between ABC and traditional product costs 292 ABC product costs - an action analysis 293 Ease of adjustment codes 293 The action analysis view of the ABC data 294 Service costing and management: the benefits of an ABC approach 297 Activity-base'd costing and external reports 298 A simplified approach to activity-based costing 299 9 Relevant costs for decision making 323 Cost concepts for decision making 324 Identifying relevant costs and benefits 324 Different costs for different purposes 325 ' Sunk costs are not relevant costs 325 Book value of old equipment 326 Future costs that do not differ are not relevant costs 328 An example of irrelevant future costs 328 Why isolate relevant costs? 330 Adding and dropping product lines and other segments 330 An illustration of cost analysis 330 A comparative format 332 Beware of allocated fixed costs 332 The make or buy decision 334 An example of make or buy 334 The matter of opportunity cost 335 Special orders 336 Utilization of a constrained resource 337 Contribution in relation to a constrained resource 337 Joint product costs and the contribution approach 339 The pitfalls of allocation 340 Sell or process further decisions 340 Activity-based costing and relevant costs 341 10 Capital investment decisions 371 Capital budgeting - planning investments 372 Typical capital budgeting decisions 372 The time value of money 373 Discounted cash flows - the net present value method 373 The net present value method illustrated 373 Emphasis on cash flows 374 Recovery of the original investment 375 Simplifying / assumptions 376 Choosing a discount rate 377 An extended example of the net present value method 377 Discounted cash flows'- the internal rate of return method 378 The internal rate of return method illustrated 378 Salvage value and other cash flows 379 The process of interpolation 379 Using the internal rate of return 380 The cost of capital as a screening tool 380 Comparison of the net present value and the internal rate of return methods 381

Detailed table of contents Expanding the net present value method 381 The total-cost approach 382 The incremental-cost approach 383 Least-cost decisions 383 Capital budgeting and non-profit organizations 385 Preference decisions - the ranking of investment projects 385 Internal rate-of return method 386 Net present value method 386 Other approaches to capital budgeting decisions 387 The payback method 387 " The simple rate of return method 390 Postaudit of investment projects 391 Appendix 10A: Inflation and capital budgeting 396 Appendix 10B: Future value and present value tables 398 Appendix 10C: The impact of corporate taxation 401 Appendix 10D: Investment decision making and risk 403 Risk and uncertainty 403 Investment decision making and risk 403 Interrelated risks: the decision tree 405 The value of extra information 408 Pay-off strategies 408 Part III: Planning and control 431 11 Profit planning and the role of budgeting 433 The basic framework of budgeting 434 Definition of budgeting 434 Personal budgets 434 "> Differences between planning and control 434 "Advantages of budgeting 435 Responsibility accounting 436 Choosing a budget period 436 The self-imposed or participative budget *437 The matter of human relations 438 The budget committee 438 The master budget inter-relationships 439 Sales forecasting - a critical step 440 Preparing the master budget 440 The sales budget 442 The production budget 442 The direct materials budget 444 The direct labour budget 445 The manufacturing overhead budget 445 The ending finished goods stock budget 446 The selling and administrative expense budget 446 The cash budget 446 The budgeted profit and loss account 449 The budgeted balance sheet 450 Expanding the budgeted profit and loss account 454 12 Standard costs and variance analysis 471 Standard costs - management by exception 473 Who uses standard costs? 473 Setting standard costs 473 Ideal versus practical standards 473 Setting direct materials standards 474 Setting direct labour standards 475 Setting variable manufacturing overhead standards 476 Are standards the same as budgets? 476 A general model for variance analysis 477 Price and quantity variances 477 Using standard costs - direct materials, variances 478 Materials price variance - a closer look 480 Materials quantity variance - a closer look 481 Using standard costs - direct labour variances 482 Labour rate variance - a closer look 483 Labour efficiency variance - a closer look 484 Using standard costs - variable manufacturing overhead variances 485

Management accounting Manufacturing overhead variances - a closer look 486 Structure of performance reports 487 Variance analysis and management by exception 487 Evaluation of controls based on standard costs 489 Advantages of standard costs 489 Potential problems with the use of standard costs 490 Appendix 12A: General ledger entries to record variances 494 Direct materials variances 494 Direct labour variances 494 Variable manufacturing overhead variances 495 Cost flows in a standard cost system 495 13 Flexible budgets and overhead analysis 515 Flexible budgets 516 Characteristics of a flexible budget 516 Deficiencies of the static budget 576 How a flexible budget works 519 Using the flexible budgeting concept in performance evaluation 519 The measure of activity - a critical choice 521 Variable overhead variances - a closer look 522 The problem of actual versus standard hours 522 Spending variance alone 523 Both spending and efficiency variances 524 Overhead rates and fixed overhead analysis 526 Flexible budgets and overhead rates 526 Overhead application in a standard cost system 528 * The fixed overhead variances 529 The.budget variance - a closer look 530 The volume variance - a closer look 531 Graphic analysis of fixed overhead variances 531 Cautions in fixed overhead analysis 531 Overhead variances and under- or overapplied overhead cost 532 Activity-based budgeting 533 Appendix 13A: Sales mix, quantity variances, production mix and yield variances 538 Sales mix variances with multiple products 538 Production mix and yield variances 541 Appendix 13B: Variance analysis in service setting's 543 14 Segment reporting and decentralization 575 Decentralization in organizations 576 Advantages and disadvantages of decentralization 576 Decentralization and segment reporting 577 Cost, profit and investment centres 577 Responsibility centres 578 Segment reporting and'profitability analysis 578 Levels of segmented statements 580 Sales and contribution margin 582 Traceable and common fixed costs 582 Traceable costs can become common costs 584' Segment margin 584 There is more than one way to segment a company 585 Hindrances to proper cost assignment 586 Omission of costs 587 Inappropriate methods for allocating costs among segments 587 Arbitrarily dividing common costs among segments 588 Rate of return for measuring managerial performance 588 The return on investment (ROI) formula 588 Net operating profit and operating assets defined 588 Plant and equipment: net book value or gross cost"? 589 Controlling the rate of return 589

Detailed table of contents. Increase sales 592 Reduce expenses 592 Reduce operating assets 592 Criticisms of ROI 593 Residual income - another measure of performance 593 Motivation and residual income 594 Divisional comparison and residual income 595 ROI, Rl and the balanced scorecard 596 The problem of single period metrics: the bonus bank approach 596 15 Pricing and intra-company transfers 629 The economists' approach to pricing 630 Elasticity of demand 630 The profit-maximizing price 631 The absorption costing approach to costplus pricing 633 Setting a target selling price using the absorption costing approach 633 Determining the mark-up percentage 634 Problems with the absorption costing approach 634 Target costing 635 An example of target costing 636 Service companies - time and material pricing 637 Time component 637 Material component 637 An example of time and material pricing 637 Revenue and yield management 639 Transfer pricing 639 Negotiated transfer prices 640 Transfers at the cost to the selling division 643 Transfers at market price 644 ^Divisional autonomy and suboptimization 644 International aspects of transfer pricing 645 Part IV: Value metrics and performance management in a strategic context 673 16 Value-based management and strategic management accounting 675 Profit planning with a given industry and product: cost structure and business orientation 677 Value-based management 677 Some basic techniques of strategic management accounting 679 SMA and the concept of strategic positioning 680 Strategic investment appraisal: investment appraisal with strategic 'bolt-ons'? 680 The Mavis Machines case 681 Strategic investment appraisal: an iterative model 681 Strategy as collision: lean enterprises and business process re-engineering 683 Modelling and monitoring strategy: the balanced scorecard and other non-financial measures 684 Common characteristics of balanced scorecards 685 Strategy as an emergent process: interactive control systems and the learning organization 691 Some obstacles to SMA 691 17 Performance management, management control and corporate governance 713 Some criticisms of budgeting as a performance management system 714 Reform or abandon budgeting? 715 General models of performance measurement and management control 716 The levers of control approach to strategy implementation 717 Corporate governance: a financial perspective 718 Management accounting and the integrity of financial information 720

Management accounting Management accounting and regulatory approaches to corporate governance 720 Corporate governance and risk management 722 Wealth creation and good corporate governance: the role of boundary systems 722 Enterprise governance 722 A broader view on corporate governance: stakeholders, social and environmental responsiveness 725 The Performance Prism 725 Environmental management accounting 726 An example of environmental management accounting 728 Organizational control and service delivery in the public sector: beyond incrementalism? 729 New political and management structures 730 The introduction of policy-led budgeting 730 Informal versus formal control systems 732 18 Business process management: towards the lean operation 745 Optimizing stock: the economic order quantity (EOQ) and the reorder point 74.7 Costs associated with stock 747 Computing the economic order quantity (EOQ) 747 Just-in-time (JIT) and the economic order quantity (EOQ) 750 Production lot size 750 Reorder point and safety stock 757 Reducing stock: Just-in-time (JIT) 752 The JIT concept 753 N Benefits of a JIT system 756.Stock control and enterprise resource planning (ERP) 756 E-commerce: new challenges for ~ management accounting 757 Quality and business processes: measurement and management 758 The cost of quality model 758 Prevention costs 758 Appraisal costs 760 Internal failure costs 760 External failure costs 760 Distribution of quality costs 767.Quality cost reports 767 From modelling the costs of quality to quality management 764 Total quality management (TQM) 764 The plan-do-check-act cycle 764 Some criticisms of TQM 765 Benchmarking 765 Some problems with benchmarking 766 Business process re-engineering (BPR) 766 What does a re-engineered process look like? 767 Some criticisms of re-engineering 767 BPR: activity-based management revisited? 768 Some problems with ABM 768 Obstacles to organizational change and the advantages of a fresh start 769 19 Strategic perspectives on cost management 793 The problem of multiple constraints in the short run: linear programming 794 Sensitivity analysis 796 Shadow prices 797 The limitations of the linear programming model as a management accounting technique 797 Managing constraints 797 The theory of constraints 798 TOC and continuous improvement 798 An example of TOC 799 The impact of TOC on management accounting 799 Throughput accounting 800 Strategic approaches to cost management: life-cycle costing and the supply chain 800 Life-cycle costing 800 Target costing and design 802

Some problems with target and life-cycle s ; Detailed table of contents The shared service centre model 870 costing 802 Variable costs 872 The make or buy decision from a Fjxed costs 812 strategic perspective: supply chain Should actual or bud eted costs be management 5 803 allocated? 873 Integration versus sub-contracting 803 Service outsourcing 873 Traditional supply relationships 804 Strategic partnering.805 Glossary 827 The implications for management Bibliography 847 accounting of strategic approaches to make or buy 806 lndex S5i Corporate unbundling: shared service centres and service outsourcing 8J0