THE ACCOUNTANT S ROLE

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1 Because of permissions issues, some material (e.g., photographs) has been removed from this chapter, though reference to it may occur in the text. The omitted content was intentionally deleted and is not needed to meet the University's requirements for this course. CHAPTER 1 THE ACCOUNTANT S ROLE IN THE ORGANIZATION LEARNING OBJECTIVES 1. Describe how cost accounting supports management accounting and financial accounting 2. Understand how management accountants affect strategic decisions 3. Describe the set of business functions in the value chain 4. Identify the dimensions of performance that customers are expecting of companies 5. Distinguish between the planning and control decisions of managers 6. Distinguish among the problem-solving, scorekeeping, and attention-directing roles of management accountants 7. Describe three guidelines management accountants follow in supporting managers 8. Understand how management accounting fits into an organization s structure 9. Understand what professional ethics mean to management accountants NOT AVAILABLE FOR ELECTRONIC VIEWING Lord of the Rings. Pirates of the Caribbean. Finding Nemo. What do these movies have in common? Each was a major box office hit, generating hundreds of millions of dollars in revenue. What we saw on the big screen, however, did not come without cost. Behind the scenes, studio accountants weren t just watching the action on the set; they used modern cost accounting techniques to carefully track where the money was spent and why. At the end of each movie s run, the studios could tell just how successful the project had been. The entertainment industry isn t the only one concerned about costs. Whether their products are automobiles, restaurants, or the latest designer fashions, managers must understand the cost behaviors of their operations or risk losing control. Cost accounting information is used for strategy formulation, research and development, budgeting, production planning, pricing, and more. Consider Naomi Crawford, manager of the Daily News, a newspaper in Denver, Colorado. Her desk is regularly papered with more than just the morning news. For example, she receives monthly performance reports containing strategic cost information that helps direct her attention to critical issues facing the newspaper operation. During one morning s report review, she hears a knock at her door from Ramon Sandoval, the management accountant. Ramon: Hi, Naomi. Got a minute? I d like to discuss some new initiatives I m undertaking that you might find useful. Naomi: Sure. I was just reviewing the latest round of performance reports, so your timing is perfect. You ve certainly done a good job of streamlining the reports so that I can see how well we are doing relative to our strategic plans. The way the reports direct my attention to critical areas is a real time-saver. Ramon: Glad you like them. I ve recently started collecting data on how we spend money in the different business functions here at the paper design and layout, production, marketing, distribution, and customer service to get a better idea of how each function adds value to the company. I m also trying to measure how well we re doing with our cost-reduction program and with the initiatives dealing with efficiency, quality, and innovation. Naomi: That s great. Would you be able to add in a survey of the functional line managers you re working with to get their reactions? I m guessing they ll be as excited as I am with the information you uncover. This vignette illustrates how modern cost accounting provides the information managers need to make decisions that can lead to outstanding performances. The study of modern cost accounting yields insights into how managers and accountants contribute to operations, and it also prepares them for leadership roles. Many large companies, such as Teva Sport Sandals, Sony Pictures, and Nike, have senior executives with accounting backgrounds. Managers use management accounting information to choose a strategy, communicate it, and determine how best to implement it. This chapter describes how management accounting provides the financial and nonfinancial information that helps managers deal with these challenges. 1

2 CHAPTER 1 2 The Margin Notes aid your understanding of cost accounting. They consist of key points to think about, examples, questions with answers, and study tips. Study Tip: The Student Guide that accompanies this book has several valuable features. One is the Highlights for each chapter, which you can use as a preview before you read the chapter or as a quick review after you read it. Go to and print Chapter 1. Use the Highlights (pp.1 3) to preview the chapter. Unlike the remainder of the book, Chapter 1 has no number crunching. It emphasizes the accountant s role in providing information for managers. 1 Describe how cost accounting supports management accounting and financial accounting... cost accounting measures costs of acquiring or using resources In financial accounting courses, the product costs used to calculate cost of goods sold are given. In this book you will learn how to calculate these product costs. Managers use cost-management information (for example, product costs and number and type of customer complaints) for decision making. Management Accounting, Financial Accounting, and Cost Accounting Accounting systems take economic events and transactions, such as sales and materials purchases, and process the data into information helpful to managers, sales representatives, production supervisors, and others. Processing any economic transaction means collecting, categorizing, summarizing, and analyzing. For example, costs are collected by category, such as materials, labor, and shipping. These costs are then summarized to determine total costs by month, quarter, or year. The results are analyzed to evaluate, say, how costs have changed relative to revenues from one period to the next. Accounting systems provide the information found in the income statement, the balance sheet, and the statement of cash flow and in performance reports, such as an investigation into the cost of operating a plant or of providing a service. Managers use accounting information to administer the activities or functional areas they oversee and to coordinate those activities or functions within the framework of the organization. This book focuses on how accounting assists managers in these tasks. Individual managers often require the information in an accounting system to be presented or reported differently. Consider, for example, sales order information. A sales manager may be interested in the total dollar amount of sales to determine the commissions to be paid. A distribution manager may be interested in the sales order quantities by geographic region and by customer-requested delivery dates to ensure timely deliveries. A manufacturing manager, to schedule production, may be interested in the quantities of various products and their desired delivery dates. An ideal database sometimes called a data warehouse or infobarn consists of small, detailed bits of information that can be used for multiple purposes. For instance, the sales order database will contain detailed information about product, quantity ordered, selling price, and delivery details (place and date) for each sales order. The database stores information in a way that allows each manager to access the information that he needs. Many companies are building their own Enterprise Resource Planning (ERP) systems, single databases that collect data and feed it into applications that support each company s business activities, such as purchasing, production, distribution, and sales. Management accounting and financial accounting have different goals. Management accounting measures, analyzes, and reports financial and nonfinancial information that helps managers make decisions to fulfill the goals of an organization. Managers use management accounting information to choose, communicate, and implement strategy. They also use management accounting information to coordinate product design, production, and marketing decisions. Management accounting focuses on internal reporting. Financial accounting focuses on reporting to external parties such as investors, government agencies, banks, and suppliers. It measures and records business transactions and provides financial statements that are based on generally accepted accounting principles (GAAP). Managers compensation is often directly affected by the numbers in these financial statements. Consequently, managers are interested in both management accounting and financial accounting. Exhibit 1-1 summarizes the major differences between management accounting and financial accounting. Note, however, that reports such as balance sheets, income statements, and statements of cash flows are common to both management accounting and financial accounting. Cost accounting provides information for management accounting and financial accounting. Cost accounting measures, analyzes, and reports financial and nonfinancial information relating to the costs of acquiring or using resources in an organization. For example, calculating the cost of a product is a cost accounting function that answers financial accounting s inventory-valuation needs and management accounting s decisionmaking needs (such as choosing products to offer). Modern cost accounting takes the perspective that collecting cost information is a function of the management decisions being made. Thus, the distinction between management accounting and cost accounting is not so clear-cut, and we often use these terms interchangeably in the book. We frequently hear business people use the term cost management. Unfortunately, that term has no uniform definition. We use cost management to describe the approaches and activities of managers in short-run and long-run planning and control decisions that

3 Management Accounting Financial Accounting Purpose of information Help managers make decisions Communicate organization s financial to fulfill an organization s goals position to investors, banks, regulators, and other outside parties Primary users Managers of the organization External users such as investors, banks, regulators, and suppliers Focus and emphasis Future-oriented (budget for Past-oriented (reports on prepared in 2005) performance prepared in 2006) Rules of measurement Internal measures and reports Financial statements must be prepared and reporting do not have to follow GAAP but in accordance with GAAP and be are based on cost-benefit analysis certified by external, independent auditors Time span and type of Varies from hourly information Annual and quarterly financial reports, reports to 15 to 20 years, with financial primarily on the company as a whole and nonfinancial reports on products, departments, territories, and strategies Behavioral implications Designed to influence the behavior Primarily reports economic events of managers and other employees but also influences behavior because manager s compensation is often based on reported financial results EXHIBIT 1-1 Major Differences Between Management Accounting and Financial Accounting increase value for customers and lower the costs of products and services. For example, managers make decisions regarding the amounts and kinds of materials being used, changes in plant processes, and changes in product designs. Information from accounting systems helps managers to manage costs, but the information and the accounting systems themselves are not cost management. Cost management has a broad focus and should not be interpreted to mean only continuous reduction in costs. Planning and control of costs are usually inextricably linked with revenue and profit planning. As part of cost management, managers often deliberately incur additional costs, for example in advertising and product modifications, to enhance revenues and profits. Cost management is not practiced in isolation. It s an integral part of general management strategies and their implementation. Examples include programs that enhance customer satisfaction and quality, as well as research and development (R&D) and marketing programs to promote blockbuster new products. Strategic Decisions and the Management Accountant The key to a company s success lies in creating value for customers while distinguishing itself from competitors. Identifying how a company will get this done is what strategy is all about. However, a chosen strategy (such as lowering the costs of a company s major products) is only as good as its implementation (for example, training workers to improve quality and reduce waste). The management accountant provides input that aids in developing and implementing strategy. To understand the management accountant s role, we must first understand these tasks in more detail. Strategy specifies how an organization matches its own capabilities with the opportunities in the marketplace to accomplish its objectives. In other words, strategy describes how an organization will compete and the opportunities its employees should seek and pursue. Businesses follow one of two broad strategies. Some companies, such as Southwest Airlines and Vanguard (the mutual fund company), have been profitable and have grown over the years on the basis of providing quality products or services at low prices. Other companies such as EMC Corporation, the manufacturer of data-storage equipment, and Pfizer, the pharmaceutical giant, generate their profits and growth on the basis of their ability to offer unique products or services that are often priced higher than the products or services of their competitors. Deciding between these strategies is a critical part of what managers do. Management accountants work closely with managers in formulating strategy by providing information about the sources of competitive advantage for example, the cost, productivity, or effi- 2 Understand how management accountants affect strategic decisions... they provide information about competitive advantages and resources Surveys cite strategic planning as a critical success factor for management accountants. See Global Surveys of Company Practice, p. 12. The Accountant s Role in the Organization 3

4 ciency advantage of their company relative to competitors or the premium prices a company can charge relative to the costs of adding features that make its products or services distinctive. Management accountants also help formulate strategy by helping managers answer questions such as: Who are our most important customers, and how do we deliver value to them? How sensitive are their purchases to price, quality, and service? What substitute products exist in the marketplace, and how do they differ from our product in terms of price and quality? What is our most critical resource? Is it technology, production, or marketing? What demands will be made on this critical resource by the new strategic initiatives? Will adequate cash be available to fund the strategy, or will additional funds need to be raised? Strategic cost management describes cost management that specifically focuses on strategic issues. In designing its strategy, a company must match the opportunities and threats it sees in the marketplace with its resources and capabilities. Sometimes a company may see opportunities and threats that require it to build capabilities. For example, after Amazon.com s success in selling books online, Barnes and Noble also developed capabilities to sell online by building its information and technology infrastructure. Toyota has built flexible computer-integrated manufacturing (CIM) plants that enable it to use the same equipment to produce a variety of cars, in response to changing customer tastes. Companies can also use their existing capabilities to create new opportunities. For example, Kellogg Company uses the reputation of its brand to introduce new types of cereal. However, the best-designed strategies and the best-developed capabilities are useless unless they are effectively executed. The Management Accountant s Role in Implementing Strategy CHAPTER Describe the set of business functions in the value chain... R&D, design, production, marketing, distribution, and customer service Understand the distinctions between R&D and design. R&D is basic research and idea generation. Design turns research and ideas into reality. It encompasses prototype development and specifications of the manufacturing process. Managers implement strategy by translating it into actions. In building action plans, managers seek input from customers and evaluate and assess how competitors will react. They ask questions such as, Are the right executives in place to execute the plans? Do the executives have the necessary cash and human and physical resources to implement the plans? Should the company sell more products to existing customers or find new customers? What can go wrong? What contingency plans does the company have if things do go wrong? Generating an open forum in which questions such as these can be freely debated is essential for good strategic planning and implementation. Creating value for customers is also an important part of planning and implementing strategy. Value is the usefulness a customer gains from a company s product or service. We now discuss how a company goes about creating this value. Value-Chain Analysis Value chain refers to the sequence of business functions in which customer usefulness is added to products or services. Exhibit 1-2 shows six business functions: R&D, design, production, marketing, distribution, and customer service. We illustrate these business functions using SONY Corporation s television division. 1. Research and development Generating and experimenting with ideas related to new products, services, or processes. At SONY, this function includes research on alternative television signal transmission (analog, digital, high-definition) and on the clarity of different shapes and thicknesses of television screens. 2. Design of products, services, or processes Detailed planning and engineering of products, services, or processes. Design at Sony includes determining the number of component parts in a television set and the effect of alternative product designs on quality and manufacturing costs. 3. Production Acquiring, coordinating, and assembling resources to produce a product or deliver a service. Production of a SONY television set includes the acquisition and assembly of the electronic parts, the cabinet, and the packaging used for shipping.

5 EXHIBIT 1-2 Managers in Different Parts of the Value Chain Research and Development Design of Products, Services, or Processes Production Marketing Distribution Customer Service Management Accounting 4. Marketing Promoting and selling products or services to customers or prospective customers. SONY markets its televisions through trade shows, advertisements in newspapers and magazines, and on the Internet. 5. Distribution Delivering products or services to customers. Distribution for SONY includes shipping to retail outlets, catalog vendors, direct sales via the Internet, and other channels through which customers purchase televisions. 6. Customer service Providing after-sale support to customers. SONY provides customer service on its televisions in the form of customer-help telephone lines, support on the Internet, and warranty repair work. Each of these business functions is essential to SONY satisfying its customers and keeping them satisfied (and loyal) over time. Companies use the term customer relationship management (CRM) to describe a strategy that integrates people and technology in all business functions to enhance relationships with customers, partners, and distributors. CRM initiatives use technology to coordinate all customer-facing activities (such as marketing, sales calls, distribution, and post-sales support) and the design and production activities necessary to get products to customers. Exhibit 1-2 depicts the usual order in which different business-function activities physically occur. Do not, however, interpret Exhibit 1-2 as implying that managers should proceed sequentially through the value chain when planning and managing their activities. Companies gain (in terms of cost, quality, and the speed with which new products are developed) if two or more of the individual business functions of the value chain work concurrently as a team. For example, inputs into design decisions by production, marketing, distribution, and customer service managers often lead to design choices that reduce total costs of the company. Management accountants track the costs incurred in each value-chain category. Their goal is to reduce costs in each category and to improve efficiency. Cost information also helps managers make cost-benefit tradeoffs. For example, is it cheaper to buy products from outside vendors or to do manufacturing in-house? Is it worthwhile to invest more resources in design and manufacturing if it reduces costs in marketing and customer service? The value chain in Exhibit 1-2 could be expanded to highlight costs implicitly included in each business function. Examples include administrative costs and future cash outlays for environmental cleanup costs associated with actions of the current period. Supply-Chain Analysis Companies can also implement strategy, cut costs, and create value by enhancing their supply chain. The term supply chain describes the flow of goods, services, and information from the initial sources of materials and services to the delivery of products to consumers, regardless of whether those activities occur in the same organization or in other organizations. Consider the soft drinks, Coke and Pepsi. Many companies play a role in bringing these products to consumers. Exhibit 1-3 presents an overview of the supply chain. Cost management emphasizes integrating and coordinating activities across all companies in the supply chain, as well as across each business function in an individual company s value Accounting helps managers coordinate the business functions of the value chain for example, by analyzing whether more money spent on R&D and design will reduce subsequent production and customer-service costs. Study Tip: The Student Guide includes at least one Featured Exercise and accompanying solution for each chapter. To check your understanding of the business functions in the value chain, see the Featured Exercise on p. 4 of the Student Guide. The solution is on p. 5. Some companies subcontract one or more of the six business functions. For example, Nike subcontracts its production (manufacturing) function. Even with subcontracting, the challenge of coordinating all of the business functions remains. The Accountant s Role in the Organization 5

6 EXHIBIT 1-3 Supply Chain for a Cola Bottling Company Suppliers of Cola-Concentrate Ingredients Manufacturer of Concentrate Bottling Company Distribution Company Retail Company Final Consumer Suppliers of Non-Concentrate Materials/Services chain, to reduce costs. For example, both Coca-Cola Company and Pepsi Bottling Group contract with their suppliers (such as plastic and aluminum companies and sugar refiners) to frequently deliver small quantities of materials directly to the production floor to reduce materials-handling costs. Consider another example: To reduce inventory levels in the supply chain, Wal-Mart is asking its suppliers such as Coca-Cola to be responsible for and to manage inventory at both the Coca-Cola warehouse and Wal-Mart. CHAPTER Identify the dimensions of performance that customers are expecting of companies... cost and efficiency, quality, time, and innovation Toyota often loans its engineers to suppliers to help suppliers streamline their production processes. In return, Toyota expects to receive a share of the suppliers cost savings in the form of reduced prices. Key Success Factors Customers want companies to use the value chain and supply chain to deliver everimproving levels of performance regarding several (or even all) of the following: Cost and efficiency Companies face continuous pressure to reduce the cost of the products or services they sell. To calculate and manage the cost of products, the management accountant tries to understand the tasks or activities (such as setting up machines or distributing products) that cause costs to arise. Managers monitor the marketplace to determine prices that customers are willing to pay for products or services. Management accountants calculate a target cost for a product by subtracting the operating income per unit of product that the company thinks it can earn from the target price. Managers work with management accountants to achieve the target cost by eliminating some activities (such as rework) and by reducing the costs of performing activities in all value-chain functions from initial R&D to customer service. Increased global competition is placing even more pressure on companies to lower costs. U.S. companies are cutting costs by outsourcing some of their business functions. Nike, for example, has moved its manufacturing operations to China and Mexico. Citigroup and America Online are increasingly doing their software development in Spain, Eastern Europe, and India. Quality Customers expect high levels of quality. Total quality management (TQM) is a philosophy in which management improves operations throughout the value chain to deliver products and services that exceed customer expectations. TQM encompasses designing the product or service to meet the needs and wants of customers, as well as making products with zero (or minimal) defects and waste and with low inventories. Management accountants evaluate the costs and revenue benefits of TQM initiatives. Time Time has many components. New-product development time is the time it takes for new products to be created and brought to market. The increasing pace of technological innovation has led to shorter product life cycles and the need for companies to bring new products to market more rapidly. The management accountant measures the costs and benefits of a product over its life cycle. Customer-response time describes the speed at which an organization responds to customer requests. To increase customer satisfaction, organizations must complete activities faster and meet promised delivery dates reliably. Delays or bottlenecks occur when the work to be performed exceeds the available capacity. To increase output in these situations, managers need to increase the capacity of the bottleneck operation. The management accountant s role is to quantify the costs and benefits of relieving the bottleneck constraints.

7 Innovation A constant flow of innovative products or services is the basis for ongoing company success. The management accountant helps managers evaluate alternative investment decisions and R&D decisions. Management accountants help managers track performance on the chosen key success factors vis-à-vis the performance of competitors on the same factors. Tracking what is happening in other companies serves as a benchmark and alerts managers to the changes their own customers are observing and evaluating. The goal is for a company to continuously improve its critical operations for example, on-time arrival for Southwest Airlines, customer access for online auctions at ebay, and cost reduction at Sumitomo Electric. Sometimes more-fundamental changes in operations such as redesigning a manufacturing process to reduce costs may be necessary. The Concepts in Action (p. 8) describes how companies choose their e-business strategies to reduce costs, improve quality, innovate, and grow. However, successful strategy implementation requires more than value-chain and supply-chain analysis and execution of key success factors. Companies must also look to planning and control systems to help them to fully integrate, develop, and implement their strategies. Planning and Control Systems Planning comprises selecting organization goals, predicting results under various alternative ways of achieving those goals, deciding how to attain the desired goals, and communicating the goals and how to attain them to the entire organization. Management accountants serve as business partners in these planning activities by helping to develop strategies, improve business processes, and build teamwork and commitment. Because of their understanding of what creates value and the key success factors, management accountants help managers make better decisions and improve performance. The most important planning tool is a budget. A budget is the quantitative expression of a proposed plan of action by management and is an aid to coordinating what needs to be done to implement that plan. The information used to project budgeted amounts includes past financial and nonfinancial information routinely recorded in accounting systems. The budget expresses the strategy by describing the sales goals; the production, distribution and customer-service costs that would be needed to achieve sales goals; the anticipated cash flows; and the potential financing needs. Because the process of preparing a budget crosses business functions, it forces coordination and communication throughout the company, as well as with the company s suppliers and customers. Management accountants play a valuable role in the budgeting process because they have an overview of the organization as a whole and understand the financial consequences of different actions. Excellent implementation requires follow-through on how well the plans are materializing. This is the role of control. Control comprises taking actions that implement the planning decisions, deciding how to evaluate performance, and providing feedback that will help future decision making. When taking actions, individuals pay attention to how they are measured. Performance measures tell managers how well they and their subunits are doing. Linking rewards to performance helps motivate managers. These rewards are both intrinsic (selfsatisfaction for a job well done) and extrinsic (salary, bonuses, and promotions linked to performance). A budget serves as much as a control tool as a planning tool. Why? Because a budget is a benchmark against which actual performance can be compared. Although budgets are primarily financial, managers use both financial and nonfinancial information in planning and control systems to help implement their strategies. For example, action plans often include targets for market share, quality, new-product development, and employee satisfaction. When exercising control, managers compare actual and targeted nonfinancial measures and take corrective actions. Feedback: Linking Planning and Control Planning and control are linked by feedback: Feedback involves managers examining past performance (the control function) and systematically exploring alternative ways to make better-informed decisions and plans in the future. Feedback can lead to changes in goals, 5 Distinguish between the planning decisions... planning decisions help managers achieve the organization s goals and the control decisions of managers... control decisions aid managers in implementing decisions and using feedback Planning and control are distinct activities, but they go hand in hand. Managers maximize the benefit of a plan when they use it for control. It is difficult to control a cost without a plan. The Accountant s Role in the Organization 7

8 NOT AVAILABLE FOR ELECTRONIC VIEWING CHAPTER 1 8

9 changes in the ways decision alternatives are identified, changes in the range of information collected when making predictions, and changes in managers. In their role as business partners, management accountants play an active role in linking control to future planning. An Example: Planning and Control and the Management Accountant The Daily News has a strategy to differentiate itself from its competitors by focusing on in-depth analyses of news by its highly rated journalists, using color to enhance attractiveness to readers and advertisers, and developing its Web site to deliver up-to-theminute news, interviews, and analyses. It has substantial capabilities to deliver on this strategy. It owns an automated, computer-integrated, state-of-the-art printing facility and has developed a Web-based information technology infrastructure. Its distribution network is one of the best in the newspaper industry. As part of its strategy, the Daily News wants to increase its revenues. Let s see how the Daily News will implement its strategy. Consider first the planning decisions. To increase revenues and be consistent with its strategy, two main alternatives were evaluated: 1. Increase the selling price per newspaper 2. Increase the rate per page charged to advertisers After consulting with potential advertisers and Ramon Sandoval, the management accountant, the Daily News s manager, Naomi Crawford, decided to increase advertising rates by 4%, to $5,200 per page in March She then communicated the new advertising rate schedule to the sales representatives and advertisers. Ramon budgeted advertising revenues to be $4,160,000 ($5,200 per page 800 pages predicted to be sold in March 2007). The left side of Exhibit 1-4 provides an overview of the planning and control decisions at the Daily News. The right side of the exhibit highlights how the management accounting system aids in decision making. Example of a Management Decision at Daily News PLANNING Increase advertising rates by 4% Management Accounting System Budgets Expected advertising pages sold, rates per page, and revenue Financial representation of plans EXHIBIT 1-4 How Accounting Aids Planning and Control at the Daily News Feedback CONTROL Action Implement a 4% increase in advertising rates Performance Evaluation and Feedback Advertising revenues 7.2% lower than budgeted Accounting System Source documents (invoices to advertisers indicating pages sold, rates per page, and payments received) Recording in general and subsidiary ledgers Performance Reports Comparing actual advertising pages sold, average rate per page, and revenue to budgeted amounts Recording transactions and classifying them in accounting records Reports comparing actual results to budgets The Accountant s Role in the Organization 9

10 EXHIBIT 1-5 Performance Report of Advertising Revenues at the Daily News for March 2007 Difference: Difference as a Actual Budgeted (Actual Result Percentage of Result Amount Budgeted Amount) Budgeted Amount (1) (2) (3) = (1) (2) (4) = (3) (2) Advertising pages sold 760 pages 800 pages 40 pages Unfavorable 5.0% Unfavorable Average rate per page $5,080 $5,200 $120 Unfavorable 2.3% Unfavorable Advertising revenues $3,860,800 $4,160,000 $299,200 Unfavorable 7.2% Unfavorable CHAPTER Distinguish among the problem-solving,... analyzing for making decisions scorekeeping,... reporting results and attention-directing...focusing managers on issues roles of management accountants Consider the Daily News s control decisions. One control decision is performance evaluation, such as a monthly performance report in which Ramon compares actual results for a period with amounts budgeted for that period. During March 2007, the newspaper sold advertising, issued invoices, and received payments. These invoices and receipts were recorded in the accounting system. Advertising revenues for March are the aggregate of the advertising done that month for the individual accounts. Exhibit 1-5 shows the Daily News s performance report of advertising revenues for March This report indicates that 760 pages of advertising (40 pages fewer than the budgeted 800 pages) were sold. The average rate per page was $5,080, compared with the budgeted $5,200 rate, yielding actual advertising revenues of $3,860,800. The actual advertising revenues were $299,200 less than the budgeted $4,160,000. The performance report in Exhibit 1-5 spurs investigation and more decisions. For example, did the marketing and sales department make sufficient efforts to convince advertisers that, even with the new higher rate of $5,200 per page, advertising in the Daily News was a good buy? Why was the actual average rate per page $5,080 instead of the budgeted rate of $5,200? Did some sales representatives offer discounted rates? Did economic conditions cause the decline in advertising revenues? Are revenues falling because editorial and production standards have declined? Answers to these questions could prompt the newspaper s publisher to take subsequent actions, including, for example, adding more sales personnel or making changes in editorial policy. Good implementation requires the marketing, editorial, and production departments to coordinate their actions. One final point: A plan must be flexible enough so that managers can seize sudden opportunities unforeseen at the time the plan is formulated. In no case should control mean that managers cling to a plan when unfolding events (such as a sensational news story) indicate that actions not encompassed by that plan (such as spending more money to cover the story) would offer better results for the company (from higher newspaper sales). Problem-Solving, Scorekeeping, and Attention-Directing Roles Management accountants contribute to the company s decisions about strategy, planning, and control, by problem solving, scorekeeping, and attention directing. Problem solving Of the several alternatives available, which is the best? An example of problem solving is the Daily News comparing the expected revenues and costs of proposals from three different companies to develop a new Internet version of the Daily News. Scorekeeping How are we doing? Accumulating data and reporting results to management describing how the organization is doing and how well it is implementing its strategies. At the Daily News, for example, the management accountant records actual revenues and purchases of newsprint paper relative to budgeted amounts. Attention directing What opportunities and problems should managers focus on? At the Daily News, the management accountant prepares reports analyzing the days on which an excessive number of unsold papers were returned and when the daily utility costs of operating the printing presses were high. These reports direct managers attention to situations that need to be resolved. The management accountant not only directs attention to problems but also sometimes alerts managers to opportunities that would add value to the company, such as a creative newspaper subscription policy that might increase sales.

11 Different decisions place different emphases on these three roles. For strategic decisions and planning decisions, the problem-solving role is most prominent. Consider the Daily News s strategic decision to try to increase revenues by increasing advertising rates per page (Exhibit 1-4). The newspaper s management accountant serves as a problemsolver to help make this strategic decision by providing information about past increases or decreases in advertising rates and the subsequent changes in advertising revenues, as well as by collecting and analyzing information on advertising rates charged by competing media outlets (including other newspapers). The manager and the management accountant work together to make a better decision about whether to increase the advertising rate per page, and, if so, the magnitude of the increase. For control decisions at the Daily News (which include both actions to implement planning decisions and decisions about performance evaluation), the management accountant s scorekeeping and attention-directing roles are most prominent because they provide feedback to managers. For example, recording the details of advertising revenues and writing up a summary in the monthly income statement show how scorekeeping aids control. An example of control via attention directing is a report highlighting the reduced March 2007 advertising revenues, with details of the specific advertisers that cut back or stopped advertising after the rate increase went into effect. This feedback helps managers decide which advertisers to target for intensive follow-up by sales representatives. Feedback from scorekeeping and attention directing often leads managers to revise planning decisions and sometimes to make new strategic decisions. Information that prompts a planning decision is frequently reanalyzed and supplemented by the management accountant in the problem-solving and business-partner roles. The ongoing interaction among strategic decisions, planning decisions, and control decisions means that management accountants often are simultaneously doing problem-solving, scorekeeping, and attention-directing activities. The Global Surveys of Company Practice (p. 12) indicate the increasingly important roles management accountants are playing in helping managers develop and implement strategy. Key Management Accounting Guidelines Three guidelines help management accountants provide the most value to their companies in planning and control activities: Employ a cost-benefit approach, give full recognition to behavioral considerations as well as technical considerations, and use different costs for different purposes. Cost-Benefit Approach Management accountants continually face resource-allocation decisions, such as whether to purchase a new software package or hire a new employee. The cost-benefit approach should be used in making these decisions: Resources should be spent if they are expected to better attain company goals in relation to the expected costs of those resources. The expected benefits from spending should exceed the expected costs. The expected benefits and costs may not be easy to quantify. Nevertheless, the cost-benefit approach is useful for making resource-allocation decisions. Consider the installation of a company s first budgeting system. Previously, the company used historical recordkeeping and little formal planning. A major benefit of installing a budgeting system is that it compels managers to plan ahead, compare actual to budgeted information, and take corrective action. These actions lead to different decisions that create more profits than the decisions that would have been made using the historical system. The expected benefits exceed the expected costs of the new budgeting system. These costs include investments in physical assets, in training managers and others, and in ongoing operations. Behavioral and Technical Considerations The cost-benefit approach is the criterion that assists managers in deciding whether, say, to install a proposed budgeting system instead of continuing to use an existing historical system. Consider the human (the behavioral) side of why budgeting is used. Budgets 7 Describe three guidelines management accountants follow in supporting managers... employing a costbenefit approach, recognizing behavioral as well as technical considerations, and calculating different costs for different purposes Although it is difficult to quantify the costs and benefits of a budgeting system, the question is, Will costs and benefits be considered implicitly (as part of a gut feeling ) or examined explicitly (as estimated amounts)? It is better to be as explicit as feasible, but using some gut feeling may be unavoidable. The Accountant s Role in the Organization 11

12 GLOBAL SURVEYS OF COMPANY PRACTICE Today s Management Accountant What do management accountants do? The following table, based on a survey of U.S. certified management accountants, a shows the percentage of respondents who named a particular work activity in their top five work activities (out of 29 activities identified to them) in terms of time devoted to the activity. Accounting systems and financial reporting 62% Managing the accounting/ finance function 42% Internal consulting 42% Short-term budgeting 37% Long-term strategic planning 25% Financial and economic analysis 24% Computer systems and operations 21% Process improvement 20% Performance evaluation 17% Tax compliance 14% Accounting policy 13% Consolidations 11% But to what end are management accountants using their time and skills? In recent years, management accounting has reached a critical juncture. Shifts in perceptions have caused management accountants to be increasingly seen as business partners focusing more and more on key strategic issues, well beyond the boundaries of the traditional finance functions. A recent survey of 2,000 Institute of Management Accountants members identified the following seven priorities facing today s management accountants. b 1. Generating cost information 5. Setting standards 2. Cost reduction 6. Reducing risk 3. Improving processes 7. Automating processes 4. Contributing to core strategy Similar changes are also occurring globally within the profession. One survey of United Kingdom accounting professionals predicted the following tasks would be the most vital to the management accountant s job in the next five years: c 1. Business performance evaluation 5. Planning/managing budgets 2. Cost/financial control 6. Strategic planning and decision making 3. Interpreting/presenting management accounts 7. Implementing business strategy 4. Profit improvement Another survey of Irish accountants noted several trends within management accounting practice. d Among these were management reliance on traditional accounting techniques (with only supplemental use of new methods) and movement toward accountants as business partners. Similarly, U.S. respondents identified the demand for actionable cost information and continued use of traditional management accounting tools. a Siegel, G., and J. Sorensen, The Practice Analysis of Management Accounting. b Ernst & Young, 2003 Survey of Management Accounting. c Burns, J., and H. Yazdifar, Tricks or Treats? d Pierce, B., Management Accounting Without Accountants? Full citations are in Appendix A at the end of the book. CHAPTER 1 12 induce a different set of decisions within an organization because of better collaboration, planning, and motivation. A management accounting system has two simultaneous missions, one technical and one behavioral. The technical considerations help managers make wise economic decisions by providing them with the desired information (for example, costs in various value-chain categories) in an appropriate format (for example, actual results versus budgeted amounts) and at the preferred frequency (for example, weekly versus monthly). The behavioral considerations motivate managers and other employees to aim for goals of the organization. Both accountants and managers should always remember that management is not confined exclusively to technical matters. Management is primarily a human activity that should focus on how to help individuals do their jobs better for example, by helping them

13 to understand the activities that add value and those that do not. Moreover, when workers underperform, behavioral considerations suggest that managers should personally discuss with workers ways to improve performance and not just send them a report highlighting their underperformance. Different Costs for Different Purposes This book examines alternative ways to compute costs. That s because there are different costs for different purposes. This theme is the management accountant s version of the one size does not fit all notion. A cost concept used for the external-reporting purpose of accounting may not be an appropriate concept for internal, routine reporting to managers. Consider the advertising costs associated with Microsoft Corporation launching a major new product. The product is expected to have a useful life of two years or more. For external reporting to shareholders, television advertising costs for this product are fully expensed in the income statement in the year they are incurred. GAAP requires this immediate expensing for external reporting. In contrast, for internal purposes of evaluating management performance, the television advertising costs could be capitalized and then amortized, or written off as expenses over several years. Microsoft could capitalize these advertising costs if it believes doing so results in a more accurate and fairer measure of the performance of the managers that launched the new product. We now discuss how organization structure affects the reporting responsibilities of the management accountant. Organization Structure and the Management Accountant We focus first on broad management functions and then look at the accounting and finance functions in more detail. Line and Staff Relationships Most organizations distinguish between line management and staff management. Line management, such as production, marketing, and distribution management, is directly responsible for attaining the goals of the organization. For example, managers of manufacturing divisions may target particular levels of budgeted operating income, certain levels of product quality and safety, and compliance with environmental laws. Similarly, the pediatrics department in a hospital is responsible for patient billings, costs, and quality of service. Staff management, such as management accountants and information technology and human-resources management, exists to provide advice and assistance to line management. A plant manager (a line function) may be responsible for investing in new equipment. A management accountant (a staff function) works as a business partner of the plant manager by preparing detailed operating-cost comparisons of alternative pieces of equipment. Increasingly, organizations such as Toyota and Dell are using teams to achieve their objectives. These teams include both line and staff management so that all inputs into a decision are available simultaneously. As a result, the traditional distinctions between line and staff have become less clear-cut than they were a decade ago. The Chief Financial Officer and the Controller The chief financial officer (CFO) also called the finance director in many countries is the executive responsible for overseeing the financial operations of an organization. The responsibilities of the CFO vary among organizations, but they usually include the following areas: Controllership includes providing financial information for reports to managers and shareholders, and overseeing the overall operations of the accounting system Treasury includes banking and short- and long-term financing, investments, and cash management 8 Understand how management accounting fits into an organization s structure... for example, the responsibilities of the controller The Accountant s Role in the Organization 13

14 You may not be aware of the variety of jobs available to accountants. Exhibit 1-6 illustrates the diverse areas that report to the CFO. An understanding of accounting is essential in many of those areas. Risk management includes managing the financial risk of interest-rate and exchange-rate changes and derivatives management Taxation includes income taxes, sales taxes, and international tax planning Investor relations responding to and interacting with shareholders Internal audit includes reviewing and analyzing financial and other records to attest to the integrity of the organization s financial reports and to adherence to its policies and procedures The controller (also called the chief accounting officer) is the financial executive primarily responsible for management accounting and financial accounting. This book focuses on the controller as the chief management accounting executive. Modern controllers do not do any controlling in terms of line authority except over their own departments. Yet, the modern concept of controllership maintains that the controller does control in a special sense. That is, by reporting and interpreting relevant data (problem-solving and attention-directing roles), the controller exerts a force or influence that impels line managers toward making better-informed decisions as they implement their strategies. Exhibit 1-6 is an organization chart of the CFO and the corporate controller at Nike, the leading footwear and apparel company. The CFO is a staff manager who reports to the chief operating officer (COO), who reports to the chief executive officer (CEO). As in most organizations, the corporate controller at Nike reports to the CFO. Nike also has regional controllers for the major geographic regions in which it operates, such as the United States, Asia Pacific, Latin America, and Europe. Individual countries sometimes have a country controller. Organization charts such as the one in Exhibit 1-6 show formal reporting relationships. In most organizations, there also are informal relationships that must be understood when managers attempt to implement their decisions. Examples of informal relationships are friendships among managers (friendships of a professional or personal kind) and the personal preferences of top management about the type of managers they choose to rely on in decision making. Ponder what managers do to design and implement strategies and the organization structures within which they operate. Then think about the management accountants and controllers roles. It should be clear that the successful management accountant must have technical and analytical competence as well as behavioral and interpersonal skills. The Focus box on p. 15 lists some desirable values and behaviors. We will elaborate on these values and behaviors as we discuss different topics in subsequent chapters of this book. At no time has the focus on ethical conduct been sharper than it is today. Corporate scandals at Enron, WorldCom, Arthur Andersen, Ahold, Health South, and Tyco have seri- EXHIBIT 1-6 Nike: Reporting Relationships for the CFO and the Corporate Controller President Chief Operating Officer (COO) Chairperson Chief Executive Officer (CEO) Chief Financial Officer (CFO) Board of Directors Controller Tax Treasury Risk Management Investor Relations Financial Planning Internal Audit CHAPTER 1 14 Examples of Functions Global Financial Planning/Budgeting Operations Administration Profitability Reporting Inventory Royalties General Ledger Accounts Payable and Receivable Subsidiary and Liaison Accounting

15 F CUS ON VALUES AND BEHAVIORS MANAGEMENT ACCOUNTING BEYOND THE NUMBERS When you hear the job title accountant, what comes to mind? The CPA who does your tax return each year? High-level managers at Enron or Tyco? To people outside the profession, it may seem like accountants are just numbers people. It s true that most accountants are adept financial managers, yet their skills don t stop there. To be successful in the accounting profession, management accountants must possess certain values and behaviors that reach well beyond basic analytical abilities. Working in cross-functional teams and as a business partner of managers. It is not enough that management accountants simply be technically competent about management accounting. They need to be able to work in teams, to learn about business issues, to understand the motivations of different individuals, to respect the views of their colleagues, and to show empathy and trust. At Krispy Kreme, the North Carolina based doughnut franchise, management accountants exhibit these values and behaviors when working on teams that make product pricing, store location and design, and cost management decisions. When the company chooses a new franchise out of hundreds of applicants who inquire each week, it doesn t just take the $2 million in store start-up fees and turn the new owners loose. Krispy Kreme management teams up with the new owners to be sure that each franchise is on the path to success. Promoting fact-based analysis and making tough-minded, critical judgments without being adversarial. Management accountants must raise tough questions for managers to consider, especially when preparing budgets. They must do so thoughtfully and with the intent of improving plans and decisions. Sometimes, as in the case of Enron, the once-thriving energy company that went bankrupt, management accountants apparently did not raise the questions they should have about the company s complex business model. In Enron s energy services division, executives were compensated based on internal estimates of company worth, so executives were motivated to inflate contract values even though no actual cash flow was generated. The company also took on longerterm, high-risk contracts with lower liquidity and set up related party entities run by senior Enron officials to hide much of its financial manipulation. When the company finally started to come clean about its financial statements, nearly five years worth of consolidated financial reports were restated, reducing earnings by almost $600 million. Enron eventually filed for bankruptcy, costing many people their jobs and retirement savings and causing its stock price to plummet. Leading and motivating people to change and be innovative. Implementing new ideas, however good they may be, is seldom easy. When Kanthal, the Swedish manufacturer of heating elements, introduced its innovative product-costing system, the controller and his team of management accountants made sure that the vision for the change was well understood and that all managers were educated and trained in the new methods. The managers who achieved short-term successes served as champions for the new system. Communicating clearly, openly, and candidly. Communicating information is a large part of what management accountants do. Consider Pitney Bowes, Inc. (PBI), a $4 billion global provider of integrated mail and document management solutions and a leader in the communications industry for over 10 years. In 1993, the company s Mailing Systems president championed a reporting initiative to give managers feedback in key areas. The initiative succeeded because it was clearly designed and openly communicated by PBI s team of management accountants. By 2000, the initiative was used across all of Pitney Bowes and is still in wide use today. Having a strong sense of integrity and of doing the right things. Management accountants must never succumb to pressure from managers to manipulate financial information. They must always remember that their primary commitment is to the organization and its shareholders. At WorldCom, under pressure from senior managers, members of the accounting staff concealed billions of dollars in costs. Because the accounting staff lacked the integrity and courage to do what was right, WorldCom landed in bankruptcy. Members of the accounting staff now face prison terms for their actions. Source: Andy Serwer, The Hole Story. Fortune, July 7, 2003.; Mark Green, Jeannine Garrity, Andrea Gumbus and Bridget Lyons, Pitney Bowes Calls for New Metrics, Strategic Finance, May ously eroded the public s confidence in corporations. All employees in a company, whether in line management or staff management, must comply with the organization s and more broadly, society s expectations of ethical standards. Professional Ethics Accountants have special obligations regarding ethics, given that they are responsible for the integrity of the financial information provided to internal and external parties. The Sarbanes Oxley legislation in the United States, passed in 2002 in response to a series of corporate scandals, focuses on improving internal control, corporate governance, monitoring of managers, and disclosure practices of public corporations. These regulations legislate tough ethical standards on managers and accountants and provide a process for employees to report violations of illegal and unethical acts. 9 Understand what professional ethics mean to management accountants... for example, management accountants must maintain integrity and objectivity in every aspect of their jobs The Accountant s Role in the Organization 15

16 Ethical Guidelines Professional accounting organizations promote high ethical standards. Professional accounting organizations representing management accountants exist in many countries. Appendix D at the end of the book discusses professional organizations in the United States, Canada, Australia, Japan, and the United Kingdom. Each of these organizations provides certification programs. For example, the Institute of Management Accountants (IMA) the largest association of management accountants in the United States provides programs leading to the Certified Management Accountant (CMA) certificate and the Certified in Financial Management (CFM) certificate. These certificates indicate that NOT AVAILABLE FOR ELECTRONIC VIEWING CHAPTER 1 16

17 the holder has demonstrated the competency of technical knowledge required by the IMA in management accounting and financial management, respectively. The IMA has issued a Standards of Ethical Conduct for Management Accountants. Exhibit 1-7 presents the IMA s guidance on issues relating to competence, confidentiality, integrity, and objectivity. The IMA provides its members with an ethics hotline service. Members can call professional counselors at the IMA s Ethics Counseling Service to discuss their ethical dilemmas. The counselors help identify the key ethical issues and possible alternative ways of resolving them, and confidentiality is guaranteed. Typical Ethical Challenges Ethical issues can confront management accountants in many ways. Here are two examples: Case A: A management accountant, knowing that reporting a loss for a software division will result in yet another rightsizing initiative (a gentler term than layoffs ), has concerns about the commercial potential of a software product for which development costs are currently being capitalized as an asset rather than being shown as an expense for internal reporting purposes. The division manager argues that showing development costs as an asset is justified because the new product will generate profits. However, he presents little evidence to support his argument. The last two products from this division have been unsuccessful. The management accountant has many friends in the division and wants to avoid a personal confrontation with the division manager. Case B: A packaging supplier, bidding for a new contract, offers the management accountant of the purchasing company an all-expenses-paid weekend to the Super Bowl. The supplier does not mention the new contract when giving the invitation. The accountant is not a personal friend of the supplier. He knows cost issues are critical in approving the new contract and is concerned that the supplier will ask for details about bids by competing packaging companies. In each case the management accountant is faced with an ethical dilemma. Case A involves competence, objectivity, and integrity. The management accountant should request that the division manager provide credible evidence that the new product is commercially viable. If the manager does not provide such evidence, expensing development costs in the current period is appropriate. Case B involves confidentiality and integrity. Details of the IMA s guidance on ethical issues, including its ethics hotline service, are available at NOT AVAILABLE FOR ELECTRONIC VIEWING The Accountant s Role in the Organization 17

18 Ethical issues are not always clear-cut. The supplier in Case B may have no intention of raising issues associated with the bid. However, the appearance of a conflict of interest in Case B is sufficient for many companies to prohibit employees from accepting favors from suppliers. Exhibit 1-8 on page 19 presents the IMA s guidance on Resolution of Ethical Conflict. The accountant in Case B should discuss the invitation with his immediate supervisor. If the visit is approved, the supplier should be informed that the invitation has been officially approved subject to his following corporate policy (which includes the confidentiality of information). Most professional accounting organizations around the globe issue statements about professional ethics. These statements include many of the same issues discussed by the IMA in Exhibits 1-7 and 1-8. For example, the Chartered Institute of Management Accountants (CIMA) in the United Kingdom identifies the same four fundamental principles as in Exhibit 1-7: competency, confidentiality, integrity, and objectivity. PROBLEM FOR SELF-STUDY Campbell Soup Company incurs the following costs: a. Purchase of tomatoes by a canning plant for Campbell s tomato-soup products b. Materials purchased for redesigning Pepperidge Farm biscuit containers to make biscuits stay fresh longer c. Payment to Backer, Spielvogel, Bates, the advertising agency, for advertising work on Healthy Request line of soup products d. Salaries of food technologists researching feasibility of a Prego pizza sauce that has minimal calories e. Payment to Safeway for redeeming coupons on Campbell s food products f. Cost of a toll-free telephone line used for customer inquiries about using Campbell s soup products g. Cost of gloves used by line operators on the Swanson Fiesta breakfast-food production line h. Cost of handheld computers used by Pepperidge Farm delivery staff serving major supermarket accounts Required Classify each cost item (a h) as one of the business functions in the value chain shown in Exhibit 1-2 (p. 5). SOLUTION a. Production b. Design of products, services, or processes c. Marketing d. Research and development e. Marketing f. Customer service g. Production h. Distribution DECISION POINTS CHAPTER 1 18 The following question-and-answer format summarizes the chapter s learning objectives. Each decision presents a key question related to a learning objective. The guidelines are the answer to that question. Decision Guidelines 1. What information does cost Cost accounting measures, analyzes, and reports financial and nonfinancial information accounting provide? relating to the cost of acquiring or using resources in an organization. Cost accounting provides information to both management accounting and financial accounting.

19 2. How do management accountants Management accountants contribute to strategic decisions by providing information about support strategic decisions? the sources of competitive advantage. 3. How do companies add value? Companies add value through R&D; design of products, services, or processes; production; marketing; distribution; and customer service. Managers in all of these value-chain business functions are customers of management accounting information. 4. What are the dimensions Customers are expecting that companies deliver performance through cost and efficiency, of performance that customers quality, time, and innovation. are expecting of companies? 5. How do managers implement strategy? Managers implement strategy by making planning decisions and control decisions. Planning decisions include deciding on organization goals, predicting results under various alternative ways of achieving those goals, and then deciding how to attain the desired goals. Control decisions include taking actions to implement the planning decisions and deciding on performance evaluation and feedback that will help future decision making. 6. What roles do management In most organizations, management accountants perform multiple roles to implement accountants perform? strategies: problem solving (comparative analyses for decision making and planning), scorekeeping (accumulating data and reporting reliable results), and attention directing (helping managers properly focus on problems and opportunities). 7. What guidelines do management Three guidelines that help management accountants increase their value to managers are accountants use? (a) employ a cost-benefit approach, (b) recognize behavioral as well as technical considerations, and (c) identify different costs for different purposes. 8. Where does the management Management accounting is an integral part of the controller s function in an organization. In accounting function fit into most organizations, the controller reports to the chief financial officer, who is a key member an organization s structure? of the top management team. 9. What are the ethical responsibilities Management accountants have ethical responsibilities that are related to competence, of management accountants? confidentiality, integrity, and objectivity. TERMS TO LEARN Each chapter will include this section. Like all technical terms, accounting terms have precise meanings. Learn the definitions of new terms when you initially encounter them. The meaning of each of the following terms is given in this chapter and in the Glossary at the end of this book. attention directing (p. 10) budget (p. 7) Certified in Financial Management (CFM) (p. 16) Certified Management Accountant (CMA) (p. 16) chief financial officer (CFO) (p. 13) control (p. 7) controller (p. 14) cost accounting (p. 2) cost-benefit approach (p. 11) cost management (p. 2) customer service (p. 5) design of products, services, or processes (p. 4) distribution (p. 5) feedback (p. 7) finance director (p. 13) financial accounting (p. 2) Institute of Management Accountants (IMA) (p. 16) line management (p. 13) management accounting (p. 2) marketing (p. 5) Prentice Hall Grade Assist (PHGA) Your professor may ask you to complete selected exercises and problems in Prentice Hall Grade Assist (PHGA). PHGA is an online tool that can help you master the chapter s topics. It provides you with multiple variations of exercises and problems designated by the PHGA icon. You can rework these exercises and problems each time with new data as many times as you need. You also receive immediate feedback and grading. ASSIGNMENT MATERIAL planning (p. 7) problem solving (p. 10) production (p. 4) research and development (p. 4) scorekeeping (p. 10) staff management (p. 13) strategic cost management (p. 4) strategy (p. 3) supply chain (p. 5) value chain (p. 4) Questions 1-1 How does management accounting differ from financial accounting? 1-2 Management accounting should not fit the straitjacket of financial accounting. Explain and give an example. The Accountant s Role in the Organization 19

20 1-3 How can a management accountant help formulate a strategy? 1-4 Describe the business functions in the value chain. 1-5 Explain the term supply chain and its importance to cost management. 1-6 Management accounting deals only with costs. Do you agree? Explain. 1-7 How can management accountants help improve quality and achieve timely product deliveries? 1-8 Distinguish planning decisions from control decisions. 1-9 What are three roles that management accountants perform? 1-10 What three guidelines help management accountants provide the most value to managers? 1-11 Knowledge of technical issues such as computer technology is a necessary but not sufficient condition to becoming a successful management accountant. Do you agree? Why? 1-12 As a new controller, reply to this comment by a plant manager: As I see it, our accountants may be needed to keep records for shareholders and Uncle Sam, but I don t want them sticking their noses in my day-to-day operations. I do the best I know how. No bean counter knows enough about my responsibilities to be of any use to me As used in accounting, what do IMA and CMA stand for? 1-14 Name the four areas in which standards of ethical conduct exist for management accountants in the United States. What organization sets forth these standards? 1-15 What steps should a management accountant take if established written policies provide insufficient guidance on how to handle an ethical conflict? Exercises 1-16 Value chain and classification of costs, computer company. Compaq Computer incurs the following costs: a. Electricity costs for the plant assembling the Presario computer line of products b. Transportation costs for shipping the Presario line of products to a retail chain c. Payment to David Kelley Designs for design of the Armada Notebook d. Salary of computer scientist working on the next generation of minicomputers e. Cost of Compaq employees visit to a major customer to demonstrate Compaq s ability to interconnect with other computers f. Purchase of competitors products for testing against potential Compaq products g. Payment to television network for running Compaq advertisements h. Cost of cables purchased from outside supplier to be used with Compaq printers Classify each of the cost items (a h) into one of the business functions of the value chain shown in Exhibit 1-2 (p. 5) Value chain and classification of costs, pharmaceutical company. Merck, a pharmaceutical company, incurs the following costs: a. Cost of redesigning blister packs to make drug containers more tamperproof b. Cost of videos sent to doctors to promote sales of a new drug c. Cost of a toll-free telephone line used for customer inquiries about drug usage, side effects of drugs, and so on d. Equipment purchased to conduct experiments on drugs yet to be approved by the government e. Payment to actors for a television infomercial promoting a new hair-growth product for balding men f. Labor costs of workers in the packaging area of a production facility g. Bonus paid to a salesperson for exceeding a monthly sales quota h. Cost of Federal Express courier service to deliver drugs to hospitals Classify each of the cost items (a h) as one of the business functions of the value chain shown in Exhibit 1-2 (p. 5) Management accounting system and its customers. A recent annual report of Ford Motor Company included the following comments: Delivering great value to our customers. That s our passion. Throughout Ford Motor Company, we re focused on improving the quality and value of our products and speeding delivery to market. 1. Who are the customers of management accounting? 2. How may the value of management accounting systems to the customers of management accounting systems be enhanced? 1-19 Value chain, supply chain, and key success factors. A survey on the ways organizations are changing their management accounting systems reported the following: a. Company A now prepares a value-chain income statement for each brand it sells. Required Required CHAPTER 1 20 Required

21 b. Company B now presents in a single report all costs related to achieving high quality levels in its products. c. Company C now presents in its performance reports estimates of the manufacturing costs of its two most important competitors, in addition to its own manufacturing costs. d. Company D now contracts with its suppliers to frequently deliver small quantities of materials directly to the production floor. e. Company E now reports the percentage of times it fails to meet delivery dates that it has promised to customers. Link each of these changes to value-chain or supply-chain analysis or to the key success factors that are important to managers Planning and control decisions. Barnes & Noble is a book retailing company. Most of its sales are made at its own stores, which are located in shopping malls or in central business districts. A small but increasing percentage of sales is made via BarnesandNoble.com, whose major competitor is Amazon.com. The following five reports were recently prepared by the management accounting group at Barnes & Noble: 1. Annual financial statements 2. Weekly report to vice president of operations for each Barnes & Noble store (includes revenues and operating costs) 3. Study for vice president of new business development of the expected revenues and costs of BarnesandNoble.com, selling music products (CDs, cassettes, etc.) as well as books 4. Weekly report to book publishers and trade magazines on the sales of the 10 top-selling fiction and nonfiction books at both its own stores and BarnesandNoble.com 5. Report to insurance company on losses Barnes & Noble suffered at three of its North Carolina stores due to a hurricane For each report, identify both a planning decision and a control decision used by a Barnes & Noble manager. Required Required 1-21 Problem solving, scorekeeping, and attention directing. For each of the following activities, identify the main role the accountant is performing problem solving, scorekeeping, or attention directing. a. Preparing a statement of the past year s monthly sales for the vice president of marketing at IBM b. Preparing a statement indicating products for which sales declined relative to the past year for the vice president of marketing at IBM c. Identifying alternative strategies to reduce warranty costs for the manager of the Lighting Division at GE d. Preparing a report for the manager of the Lighting Division at GE regarding the warranty policies and estimated warranty costs of leading lighting companies e. Analyzing the impact on product costs of design changes in the headlights used in Subaru cars f. Preparing a report recording actual costs incurred during the first year of production (actual costs can then be compared to the planned or budgeted costs) g. Preparing a report about how the unit costs of a new product are anticipated to decline over time as the plant gains experience in producing it h. Preparing a performance report for the shipping department at Xerox Corporation i. Developing alternative strategies to reduce costs for the shipping department at Xerox Corporation j. Analyzing for the manager of global business development at General Motors the costs and benefits of having some parts made in Korea 1-22 Problem solving, scorekeeping, and attention directing. For each of the following activities, identify the main role the accountant is performing problem solving, scorekeeping, or attention directing. 1. Interpreting differences between actual results and budgeted amounts in a shipping manager s performance report at a Daewoo distribution center 2. Preparing a report showing the benefits of leasing motor vehicles rather than owning them 3. Preparing journal entries for depreciation on the personnel manager s office equipment at Citibank 4. Preparing a customer s monthly statement for a Sears store 5. Processing the weekly payroll for the Harvard University Maintenance Department 6. Explaining the product-design manager s performance report at a Chrysler division 7. Analyzing the costs of different ways to blend materials in the foundry of a General Electric plant 8. Tallying sales, by branches, for the sales vice president of Unilever 9. Analyzing for the president of Microsoft the impact of a contemplated new product on net income 10. Interpreting why an IBM sales district did not meet its sales quota 1-23 Professional ethics and reporting division performance. Marcia Miller is division controller and Tom Maloney is division manager of the Ramses Shoe Company. Miller has line responsibility to Maloney, but she also has staff responsibility to the company controller. Maloney is under severe pressure to achieve the budgeted division income for the year. He has asked Miller to book $200,000 of revenues on December 31. The customers orders are firm, but the shoes are still in the The Accountant s Role in the Organization 21

22 CHAPTER 1 22 Required Required Required production process. They will be shipped on or about January 4. Maloney says to Miller, The key event is getting the sales order, not shipping the shoes. You should support me, not obstruct my reaching division goals. 1. Describe Miller s ethical responsibilities. 2. What should Miller do if Maloney gives her a direct order to book the sales? Problems 1-24 Planning and control decisions, Internet company. WebNews.com offers its subscribers several services, such as an annotated TV guide and local-area information on weather, restaurants, and movie theaters. Its main revenue sources are fees for banner advertisements and fees from subscribers. Recent data are: Actual Number of Monthly Fee per Month/Year Advertising Revenues Subscribers Subscriber June 2004 $ 400,988 28,642 $14.95 December ,158 54, June ,034 58, December ,478,072 86, June ,916, , The following decisions were made from June through October 2006: a. June 2006: Raised subscription fee to $24.95 per month from July 2006 onward. The budgeted number of subscribers for this monthly fee is shown in the following table. b. June 2006: Informed existing subscribers that from July onward, monthly fee would be $ c. July 2006: Offered service to subscribers and upgraded other online services. d. October 2006: Dismissed the vice president of marketing after significant slowdown in subscribers and subscription revenues, based on July through September 2006 data in table. e. October 2006: Reduced subscription fee to $21.95 per month from November 2006 onward. Results for July September 2006 are: Budgeted Number of Actual Number Monthly Fee Month/Year Subscribers of Subscribers per Subscriber July , ,933 $24.95 August , , September , , Classify each of the decisions (a) to (e) as a planning or a control decision. 2. Give two examples of other planning decisions and two examples of other control decisions that may be made at WebNews.com Problem solving, scorekeeping, attention directing, and feedback, Internet company (continuation of 1-24). Consider the five decisions made in Problem For each of the five decisions (a e), provide an example of pertinent information that an accountant could provide, and indicate whether the accountant would be acting in a problem-solving, scorekeeping, or attention-directing role. 2. Identify one decision that WebNews.com made as a result of feedback from the control system. 3. What further action might WebNews.com take based on the feedback from the July through September 2006 subscriber information? 1-26 Management accounting guidelines. For each of the following items, identify which of the management accounting guidelines applies: cost-benefit approach, behavioral and technical considerations, or different costs for different purposes. 1. Analyzing whether to keep the billing function within an organization or outsource it 2. Deciding to give bonuses for superior performance to the employees in a Japanese subsidiary and extra vacation time to the employees in a Swedish subsidiary 3. Including costs of all the value-chain functions before deciding to launch a new product, but including only its manufacturing costs in determining its inventory valuation 4. Considering the desirability of hiring one more salesperson 5. Giving each salesperson the compensation option of choosing either a low salary and a high-percentage sales commission or a high salary and a low-percentage sales commission 6. Selecting the costlier computer system after considering two systems 7. Installing a participatory budgeting system in which managers set their own performance targets, instead of top management imposing performance targets on managers 8. Recording research costs as an expense for financial reporting purposes (as required by U.S. GAAP) but capitalizing and expensing them over a longer period for management performance-evaluation purposes 9. Introducing a profit-sharing plan for employees

23 1-27 Role of controller, role of chief financial officer. George Perez is the controller at Allied Electronics, a manufacturer of devices for the computer industry. He is being considered for a promotion to chief financial officer. 1. In this table, indicate which executive is primarily responsible for each activity. Activity Controller CFO Required Managing accounts payable Communicating with investors Strategic review of different lines of businesses Budgeting funds for a plant upgrade Managing the company s short-term investments Negotiating fees with auditors Assessing profitability of various products Evaluating the costs and benefits of a new product design 2. Based on this table and your understanding of the two roles, what types of training or experiences will George find most useful for the CFO position? 1-28 Software-procurement decision, ethics. Jorge Michaels is the Chicago-based controller of Fiesta Foods, a rapidly growing manufacturer and marketer of Mexican food products. Michaels is currently considering the purchase of a new cost-management package for use by each of the company s six manufacturing plants and its many marketing personnel. Four major, competing products are being considered by Michaels. Horizon is an aggressive software developer. It views Fiesta as a target of opportunity. Every six months, Horizon has a three-day users conference in a Caribbean location. Each conference has substantial time allowed for rest and recreation. Horizon offers Michaels an all-expenses-paid visit to the upcoming conference in Cancun, Mexico. Michaels accepts the offer, believing it will be very useful to talk to other users of Horizon software. He is especially looking forward to the visit because he has close relatives in the Cancun area. Prior to leaving, Michaels receives a visit from the president of Fiesta. She shows him an anonymous letter sent to her. It argues that Horizon is receiving unfair favorable treatment in Fiesta s software decisionmaking process. The letter specifically mentions Michaels upcoming all-expenses-paid package to Cancun during Chicago s cold winter. Michaels is deeply offended. He says he has made no decision, and he believes he is very capable of making a software choice on the merits of each product. Fiesta currently does not have a formal, written code of ethics. 1. Do you think Michaels faces an ethical problem in regard to his forthcoming visit to the Horizon users group meeting? Refer to Exhibit 1-7 (p. 16). Explain. 2. Should Fiesta allow executives to attend user meetings while negotiating with other vendors about a purchase decision? Explain. If yes, what conditions on attending should apply? 3. Would you recommend that Fiesta develop its own code of ethics to handle situations such as this? What are the pros and cons of having such a written code? Required 1-29 Professional ethics and end-of-year actions. Janet Taylor is the new division controller of the snack-foods division of Gourmet Foods. Gourmet Foods has reported a minimum 15% growth in annual earnings for each of the past five years. The snack-foods division has reported annual earnings growth of more than 20% each year in this same period. During the current year, the economy went into a recession. The corporate controller estimates a 10% annual earnings growth rate for Gourmet Foods this year. One month before the December 31 fiscal year-end of the current year, Taylor estimates the snack-foods division will report an annual earnings growth of only 8%. Warren Ryan, the snack-foods division president, is not happy, but he notes that the end-of-year actions still need to be taken. Taylor makes some inquiries and is able to compile the following list of end-of-year actions that were more or less accepted by the previous division controller: a. Deferring December s routine monthly maintenance on packaging equipment by an independent contractor until January of next year b. Extending the close of the current fiscal year beyond December 31 so that some sales of next year are included in the current year c. Altering dates of shipping documents of next January s sales to record them as sales in December of the current year d. Giving salespeople a double bonus to exceed December sales targets e. Deferring the current period s advertising by reducing the number of television spots run in December and running more than planned in January of next year f. Deferring the current period s reported advertising costs by having Gourmet Foods outside advertising agency delay billing December advertisements until January of next year or by having the agency alter invoices to conceal the December date g. Persuading carriers to accept merchandise for shipment in December of the current year although they normally would not have done so The Accountant s Role in the Organization 23

24 Required Required 1. Why might the snack-foods division president want to take these end-of-year actions? 2. The division controller is deeply troubled and reads the Standards of Ethical Conduct for Management Accountants in Exhibit 1-7 (p. 16). Classify each of the end-of-year actions (a g) as acceptable or unacceptable according to that document. 3. What should Taylor do if Ryan suggests that these end-of-year actions are taken in every division of Gourmet Foods and that she will greatly harm the snack-foods division if she does not cooperate and paint the rosiest picture possible of the division s results? Collaborative Learning Problem 1-30 Global company, ethical challenges. In June 2006, the government of Vartan invited bids for the construction of a cellular telephone network. ZenTel, an experienced communications company, was eager to enter the growing field of cellular telephone networks in countries with poor infrastructures for land lines. If ZenTel won a few of these early contracts, it would be sought after for its field experience and expertise. After careful analysis, it prepared a detailed bid for the Communications Ministry of Vartan, building in only half of its usual profit margin and providing a contractual guarantee that the project would be completed in two years or less. The multimillion-dollar bid was submitted before the deadline, and ZenTel received notification that it had reached the Vartan government. Then, despite repeated faxes, s, and phone calls to the ministry, there was no news on the bids or the project from the Vartan government. Steve Cheng, VP of Global Operations for ZenTel, contacted the U.S. commercial attaché in Vartan, who told him that his best chance was to go to Vartan and try to meet the deputy minister of communications in person. Cheng prepared thoroughly for the trip, rereading the proposal and making sure that he understood the details. At the commercial attaché s office in Vartan s capital, Cheng waited nervously for the deputy minister and his assistant. Cheng had come to Vartan with a clear negotiating strategy to try to win the bid. Soon the deputy minister and his staff arrived, introductions were made, and pleasantries were exchanged. The deputy minister asked a few questions about ZenTel and the bid and then excused himself, leaving his assistant to talk to Cheng. After clearly indicating that many other compelling bids had been made by firms from around the world, the assistant said, Mr. Cheng, I guarantee that ZenTel s bid will be accepted if you pay a $1 million commission. Of course, your excellent proposal doesn t have to be altered in any way. It was clear to Cheng that the commission was, in fact, a bribe. Tactfully, he pointed out that U.S. laws and ZenTel s corporate policy prohibited such a payment. The assistant wished him a good day and a pleasant flight home and left. 1. As a shareholder in ZenTel, would you prefer that ZenTel executives agree to the payment of the commission? 2. When Cheng described his experience to his friend Hank Shorn, who managed international business development for another company, Hank said that his own personal philosophy was to make such payments if they were typical in the local culture. Can you argue for Hank s point of view? 3. Why would ZenTel have a corporate policy against such payments? 4. What should Steve Cheng do next? Get Connected: Cost Accounting in the News Go to for additional online exercise(s) that explore issues affecting the accounting world today. These exercises offer you the opportunity to analyze and reflect on how cost accounting helps managers to make better decisions and handle the challenges of strategic planning and implementation. CHAPTER 1 Video Case REGAL MARINE: The Accountant s Role CHAPTER 1 24 Regal Marine is one of the United States leading luxury performance-boat manufacturers. Sales of all models in a recent year topped $100 million, with their biggest customer, Boat Tree, buying close to 90% of all boats produced by Regal Marine. Headquartered in Orlando, Florida, Regal Marine currently makes 22 different models, ranging from a 14-foot runabout sport boat to the 40-foot Commodore yacht. The product life cycle for each of Regal Marine s boats is three to five years, depending on the size of the boat, with smaller boats having shorter life cycles. These short life cycles result in a continuing stream of new products that work their way through the company s value chain. Cross-functional design teams with representatives from R&D, production, purchasing, design, accounting, marketing, customer service, upholstery, and cabinetry work together to fine-tune prototype designs. Customer feedback is gathered at boat shows, and suppliers regularly present their new product

25 innovations to the company for potential use in future boat models. To streamline manufacturing, each team attempts to use existing components and production processes, when feasible. Computer-aided design (CAD) systems are used for all designs. When the design of a new model is finished, Regal Marine makes a prototype of it before producing the new models. To make a new boat model, a foam-based carving called a plug is created. CAD system specifications are used to drive the automated carving of plugs. The plug becomes the basis for making the molds for fiberglass hulls and decks. The finished molds are then used to make thousands of fiberglass hulls and decks. Regal Marine has several hundred molds, representing their largest capital investment. Molds are kept even after production of outdated models is stopped. At the Orlando factory, production begins with coating the molds with gelcoat and then spraying the dried gelcoat with chopped fiberglass and resin. Then the fiberglass hulls and decks are popped off the molds and wheeled into assembly stations that move in synch each day. While hulls and decks are being crested, other manufacturing departments such as upholstery, cabinetry, electrical, and small-part fabrication prepare the components that will be installed in each boat during assembly. Trained workers install required components fasteners, electrical parts, upholstered seats, and cabinets, for example according to a strict schedule that assures that each assembly station s work is done each day so the lines keep moving. It takes anywhere from 2 to 20 days to complete production, depending on the boat size. In the smaller sport-boat category, for example, 10 boats a day roll off the assembly line. As soon as boats are quality-checked and approved for delivery, they are loaded onto trucks for delivery to customers such as Boat Tree. No boats are kept in finished-goods inventory. Q U E S T I O N S 1. For each of the following activities, identify the main role the accountant is performing: problem solving (P), scorekeeping (S), or attention directing (A). a. Preparing a schedule of depreciation for boat hull and deck molds b. Analyzing the desirability of using standard Volvo-Penta boat engines in a new boat model c. Preparing the daily report of the number of hull defects found during the quality check on the Sport Boat assembly line d. Explaining the Commodore Yacht Division s monthly performance report e. Interpreting differences between actual results and budgeted amounts on the Prototyping Department s monthly performance report f. Preparing a monthly statement of boat sales, by model and customer, for the company s vice president of sales g. Analyzing for the Design Team the impact on product costs of a new dashboard-odometer display h. Preparing a cost comparison of two plywood manufacturers for use by the purchasing manager 2. Classify each of the cost items (a h) into one of the business functions of the value chain. a. Cost of a toll-free telephone line used for customer inquiries about product specifications, performance, and warranty coverage b. Cost of sales and promotional materials for use at boat shows c. Labor costs of workers in the Cabinetry Department of the production facility d. Cost of an industry research report on boat industry trends e. Equipment and trucks purchased for transporting finished boats to retail outlets such as Boat Tree f. Boat hull and deck mold-fabrication costs g. Cost of a new CAD design station used by the Design Department h. Costs of upholstered seats for Commodore yachts The Accountant s Role in the Organization 25