CORNERSTONES OF MANAGERIAL ACCOUNTING

INTERNATIONAL STUDENT EDITION CORNERSTONES OF MANAGERIAL ACCOUNTING "hird Edition y-i Pi BMW mi..-. Mowen / Hansen / Heitger B09-1302

CHAPTER 1 Introduction to Managerial Accounting 2 The Meaning of Managerial Accounting 4 Information Needs of Managers and Other Users 5 Managerial Accounting and Financial Accounting 6 Current Focus of Managerial Accounting 8 New Methods of Costing Products and Services 8, Customer Orientation 8, Cross-Functional Perspective 10, Total Quality Management 10, Time as a Competitive Element 11, Efficiency 11 The Role of the Managerial Accountant 12 Structure of the Company 12, Sarbanes-Oxley Act of 2002 13 Managerial Accounting and Ethical Conduct 14 Ethical Behavior 14, Company Codes of Ethical Conduct,15, Standards of Ethical Conduct for Managerial Accountants 15 Certification 16 The Certified Management Accountant 18, The Certified Public Accountant 18, The Certified Internal Auditor 18 CHAPTER 2 Basic Managerial Accounting Concepts 26 The Meaning and Uses of Cost 28 Cost 28, Accumulating and Assigning Costs 28, Cost Objects 29, Assigning Costs to Cost Objects 30 Product and Service Costs 32 Determining Product Cost 32, HOW TO Calculate Product Cost in Total and Per Unit 3 5, Period Costs 3 5, HOW TO Calculate Prime Cost and Conversion Cost in Total and Per Unit 36 Preparing Income Statements 37 Cost of Goods Manufactured 38, HOW TO Calculate the Direct Materials Used In Production 38, Cost of Goods Sold 39, HOW TO Calculate Cost of Goods Manufactured 39, HOW TO Calculate Cost of Goods Sold 40, Income Statement: Manufacturing Firm 40, HOW TO Prepare an Income Statement for a Manufacturing Firm 41, HOW TO Calculate the Percentage of Sales Revenue for Each Line on the Income Statement 42, Income Statement: Service Firm 43, HOW TO Prepare an Income Statement for a Service Organization 43 CHAPTER 3 Cost Behavior 66 Basics of Cost Behavior 68 Measures of Output and the Relevant Range 68, Fixed Costs 69, Variable Costs 72, The Reasonableness of Straight- Line Cost Relationships 72 Mixed Costs and Step Costs 74 Mixed Costs 74, Step Cost Behavior 74, Accounting Records and Mixed Costs 76, Need for Cost Separation 76 Methods for Separating Mixed Costs into Fixed and Variable Components 77 HOW TO Create and Use a Cost Formula 77, The High-Low Method 78, HOW TO Use the High-Low Method to Calculate Fixed Cost and the Variable Rate and to Construct a Cost Formula 80, HOW TO Use the High-Low Method to Calculate Predicted Total Variable Cost and Total Cost for Budgeted Output 81, Scattergraph Method 81, HOW TO Use the High-Low Method to Calculate Predicted Total Variable Cost and Total Cost for a Time Period that Differs from the Data Period 82, The Method of Least Squares 86,

Contents XI Managerial Judgment 87, HOW TO Use the Regression Method to Calculate Fixed Cost and the Variable Rate and to Construct a Cost Formula and to Determine Budgeted Cost 88 Appendix: Using the Regression Programs 91 Goodness of Fit 93 CHAPTER 4 Cost-Volume-Profit Analysis: A Managerial Planning Tool 114 Break-Even Point in Units and in Sales Dollars 116 Using Operating Income in Cost-Volume-Profit Analysis 116, Break-Even Point in Units 117, HOW TO Prepare a Contribution Margin Income Statement 118, HOW TO Solve for the Break-Even Point in Units 120, Break-Even Point in Sales Dollars 120, HOW TO Calculate the Variable Cost Ratio and the Contribution Margin Ratio 122, HOW TO Solve for the Break-Even Point in Sales Dollars 123 Units and Sales Dollars Needed to Achieve a Target Income 123 Units to Be Sold to Achieve a Target Income 123, HOW TO Solve for the Number of Units to Be Sold to Earn a Target Operating Income 125, Sales Revenue to Achieve a Target Income 125, HOW TO Solve for the Sales Needed to Earn a Target Operating Income 126 Graphs of Cost-Volume-Profit Relationships 126. The Profit-Volume Graph 126, The Cost-Volume-Profit Graph 128, Assumptions of Cost-Volume-Profit Analysis 129 Multiple-Product Analysis 130 Break-Even Point in Units 130, HOWTO Calculate the Break-Even Units for a Multiple-Product Firm 132, Break- Even Point in Sales Dollars 133 Cost-Volume-Profit Analysis and Risk and Uncertainty 133 HOW TO Calculate the Break-Even Sales Dollars for a Multiple-Product Firm 134, Introducing Risk and Uncertainty 136, HOWTO Compute the Margin of Safety 138, HOW TO Compute the Degree of Operating Leverage 138, HOWTO Compute the Impact of Increased Sales on Operating Income Using the Degree of Operating Leverage 140, Sensitivity Analysis and Cost-Volume-Profit 140 MAKING THE CONNECTION 162 CHAPTER 5 Job-Order Costing 164 Characteristics of the Job-Order Environment 166 Job-Order Production and Costing 166, Process Production and Costing 166, Production Costs in Job-Order Costing 167 Normal Costing and Overhead Application 167 Actual Costing versus Normal Costing 167, Importance of Unit Costs to Manufacturing Firms 168, Importance of Unit Costs to Service Firms 168, Normal Costing and Estimating Overhead 169, Applying Overhead to Production 170, Reconciling Applied Overhead with Actual Overhead 170, HOW TO Calculate the Predetermined Overhead Rate and Apply Overhead to Production 170, HOWTO Reconcile Actual Overhead with Applied Overhead 172, Departmental Overhead Rates 172, HOWTO Calculate Predetermined Departmental Overhead Rates and Apply Overhead to Production 173, HOW TO Convert Departmental Data to Plantwide Data to Calculate the Overhead Rate and Apply Overhead to Production 174, Unit Costs in the Job-Order System 174, Keeping Track of Job Costs with Source Documents 175 Job-Order Cost Sheet 175, Materials Requisitions 176, Time Tickets 177, Source Documents for Other Activity 177 The Flow of Costs through the Accounts 178 Accounting for Materials 178, Accounting for Direct Labor Cost 178, Accounting for Overhead 180, Accounting for Actual Overhead Costs 180, Accounting for Finished Goods 180, Accounting for Cost of Goods Sold 182, Accounting for Nonmanufacturing Costs 183, HOWTO Prepare Brief Job-Order Cost Sheets 184 Appendix 5A: Journal Entries Associated with Job-Order Costing 187 Appendix 5B: Support Department Cost Allocation 189 Types of Departments 189, Methods of Support Department Cost Allocation 190, HOW TO Assign Support Department

XII Contents Costs by Using the Direct Method 192, HOW TO Assign Support Department Costs by Using the Sequential Method 194 CHAPTER 6 Process Costing 220 Characteristics of Process Manufacturing 222 Types of Processes 222, How Costs Flow through the Accounts in Process Costing 223, HOW TO Calculate Cost Flows without Work in Process 224, Accumulating Costs in the Production Report 225, Service and Manufacturing Firms 226 The Impact of Work-in-Process Inventories on Process Costing 226 Equivalent Units of Production 226, HOWTO Calculate Equivalent Units of Production: No Beginning Work in Process 227, HOW TO Measure Output and Assign Costs: No Beginning Work in Process 228, Two Methods of Treating Beginning Work-in-Process Inventory 229 Weighted Average Costing 229 Overview of the Weighted Average Method 229, HOW TO Measure Output and Assign Costs: Weighted Average Method 230, Five Steps in Preparing a Production Report 231, HOW TO Prepare a Physical Flow Schedule 232, Production Report 233, HOW TO Prepare a Production Report: Weighted Average Method 234, Evaluation of the Weighted Average Method 234 Multiple Inputs and Multiple Departments 235 Nonuniform Application of Manufacturing Inputs 235, HOWTO Calculate Equivalent Units, Unit Costs, and Value Inventories with Nonuniform Inputs 236, Multiple Departments 238, HOWTO Calculate the Physical Flow Schedule, Equivalent Units, and Unit Costs with Transferred- In Goods 238 Appendix: Production Report First-In, First-Out Costing 241 Differences between the First-In, First-Out and Weighted Average Methods 241, Example of the First-In, First-Out Method 241, HOWTO Calculate Output and Cost Assignments: First-In, First-Out Method 242, HOW TO Prepare a Production Report: First-In, First-Out Method 244 CHAPTER 7 Activity-Based Costing and Management 272 Limitations of Functional-Based Cost Accounting Systems 274 Nonunit-Related Overhead Costs 274, Product Diversity 276, Illustrating the Failure of Unit-Based Overhead Rates 276, HOWTO Calculate Consumption Ratios 278, HOW TO Calculate Activity Rates 278, HOW TO Calculate Activity-Based Unit Costs 279 Activity-Based Product Costing: Detailed Description 280 Identifying Activities and Their Attributes 281, Assigning Costs to Activities 283, HOW TO Assign Resource Costs to Activities by Using Direct Tracing and Resource Drivers 284, Assigning Costs to Products 285 Activity-Based Customer Costing and Activity-Based Supplier Costing 285 Activity-Based Customer Costing 286, Activity-Based Supplier Costing 287, HOW TO Calculate Activity-Based Customer Costs 288, HOWTO Calculate Activity-Based Supplier Costs 289 Process-Value Analysis 290 Driver Analysis: The Search for Root Causes 290, Activity Analysis: Identifying and Assessing Value Content 291, HOW TO Assess Nonvalue-Added Costs 294, Activity Performance Measurement 295, HOWTO Calculate Cycle Time and Velocity 295, Quality Cost Management 296, Environmental Cost Management 296 CHAPTER 8 Absorption and Variable Costing, and Inventory Management 330 Measuring the Performance of Profit Centers by Using Variable and Absorption Income Statements 332 Inventory Valuation 332, HOWTO Compute Inventory Cost under Absorption Costing 333, HOWTO Compute Inventory Cost under Variable Costing 334, Income Statements Using Variable and Absorption Costing 334, HOW TO Prepare an Absorption-Costing Income Statement 335, HOWTO Prepare a Variable-Costing Income Statement 336, Production, Sales, and Income Relationships 336, Evaluating Profit-Center Managers 337

Contents Segmented Income Statements Using Variable Costing 337 HOW TO Prepare a Segmented Income Statement 338 Decision Making for Inventory Management 339 Inventory-Related Costs 339, Economic Order Quantity: The Traditional Inventory Model 341, HOW TO Calculate Ordering Cost, Carrying Cost, and Total Inventory-Related Cost 341, The Economic Order Quantity 343, HOWTO Calculate the Economic Order Quantity (EOQ) 343, Reorder Point 344, HOWTO Calculate the Reorder Point When Usage Is Known with Certainty 344, HOW TO Calculate Safety Stock and the Reorder Point with Safety Stock 345, Economic Order Quantity and Inventory Management 345, Just-in-Time Approach to Inventory Management 345 CHAPTER 9 Profit Planning 368 Description of Budgeting 370 Budgeting and Planning and Control 370, Advantages of Budgeting 371, The Master Budget 371 Preparing the Operating Budget 373, Sales Budget 373, HOWTO Prepare a Sales Budget 373, Production Budget 374, HOW TO Prepare a Production Budget 375, Direct Materials Purchases Budget 376, Direct Labor Budget 376, HOW TO Prepare a Direct Materials Purchases Budget 377, HOW TO Prepare a Direct Labor Budget 378, Overhead Budget 378, Ending Finished Goods Inventory Budget 378, HOW TO Prepare an Overhead Budget 379, HOW TO Prepare an Ending Finished Goods Inventory Budget 379, Cost of Goods Sold Budget 380, Selling and Administrative Expenses Budget 380, Budgeted Income Statement 380, HOW TO Prepare a Cost of Goods Sold Budget 380, HOW TO Prepare a Selling and Administrative Expenses Budget 381, HOWTO Prepare a Budgeted Income Statement 381 Preparing the Financial Budget 382 Cash Budget 382, HOWTO Prepare an Accounts Receivable Aging Schedule 383, HOWTO Determine Cash Payments on Accounts Payable 384, HOWTO Prepare a Cash Budget 385, Budgeted Balance Sheet 387 Using Budgets for Performance Evaluation 388 Frequent Feedback on Performance 388, Monetary and Nonmonetary Incentives 388, Participative Budgeting 389, Realistic Standards 390, Controllability of Costs 390, Multiple Measures of Performance 390 CHAPTER 10 Standard Costing: A Managerial Control Tool 416 Unit Standards 418 How Standards Are Developed 418, Types of Standards 419, Why Standard Cost Systems Are Adopted 419 Standard Product Costs 421 HOW TO Compute Standard Quantities Allowed (SQ and SH) 422 Variance Analysis: General Description 423 Price and Usage Variances 423, The Decision to Investigate 424, HOW TO Use Control Limits to Trigger a Variance Investigation 425 Variance Analysis: Materials 426 HOW TO Calculate the Total Variance for Materials 427, Direct Materials Variances 427, HOWTO Calculate Materials Variances: Formula and Columnar Approaches 428, Using Materials Variance Information 429 Variance Analysis: Direct Labor 430 HOW TO Calculate the Total Variance for Labor 431, Direct Labor Variances 431, HOW TO Calculate Labor Variances: Formula and Columnar Approaches 432, Using Labor Variance Information 433, Additional Cost Management Practices: Kaizen Costing and Target Costing 434 Appendix: Accounting for Variances 437 Entries for Direct Materials Variances 437, Entries for Direct Laber Variances 437, Disposition of Materials and Labor Variances 438 MAKING THE CONNECTION 458 CHAPTER 11 Flexible Budgets and Overhead Analysis 460 Using Budgets for Performance Evaluation 462 Static Budgets versus Flexible Budgets 462, HOWTO Prepare a Performance Report Based on a Static Budget

xiv Contents (Using Budgeted Production) 463, HOW TO Prepare a Flexible Production Budget 464, HOW TO Prepare a Performance Report Using a Flexible Budget 466 Variable Overhead Analysis 467 Total Variable Overhead Variance 467, HOW TO Calculate the Total Variable Overhead Variance 467, HOW TO Calculate Variable Overhead Spending and Efficiency Variances: Columnar and Formula Approaches 469, Comparison of the Variable Overhead Spending Variance with?the Price Variances of Materials and Labor 469, Responsibility for the Variable Overhead Spending Variance 470, Responsibility for the Variable Overhead Efficiency Variance 470, A Performance Report for the Variable Overhead Spending and Efficiency Variances 471, HOW TO Prepare a Performance Report for the Variable Overhead Variances 471 Fixed Overhead Analysis 472 Total Fixed Overhead Variances 472, HOW TO Calculate the Total Fixed Overhead Variance 473, HOW TO Calculate Fixed Overhead Variances: Columnar and Formula Approaches 474, Responsibility for the Fixed Overhead Spending Variance 474, Analysis of the Fixed Overhead Spending Variance 475, Responsibility for the Fixed Overhead Volume Variance 475, Analysis of the Volume Variance 475 Activity-Based Budgeting 476 Static Activity Budgets 476, HOW TO Prepare a Static Budget for an Activity 477, Activity Flexible Budgeting 477, HOW TO Prepare an Activity Flexible Budget 478, HOW TO Prepare an Activity-Based Performance Report 479 CHAPTER 12 Performance Evaluation and Decentralization 506 Decentralization and Responsibility Centers 508 Reasons for Decentralization 508, Divisions in the Decentralized Firm 509 Measuring the Performance of Investment Centers by Using Return on Investment 511 Return on Investment 511, HOW TO Calculate Average Operating Assets, Margin, Turnover, and Return on Investment 512, Margin and Turnover 513, Advantages of Return on Investment 514, Disadvantages of the Return on Investment Measure 515 Measuring the Performance of Investment Centers by Using Residual Income and Economic Value Added 517 Residual Income 517, HOWTO Calculate Residual Income 517, Economic Value Added 519, HOW TO Calculate Economic Value Added 520 Transfer Pricing 521 Impact of Transfer Pricing on Divisions and the Firm as a Whole 521, Transfer Pricing Policies 522, HOW TO Calculate Transfer Price 523 Appendix: The Balanced Scorecard Basic Concepts 526 Strategy Translation 527, The Four Perspectives and Performance Measures 530, HOWTO Compute Cycle Time and Velocity 533, HOW TO Calculate Manufacturing Cycle Efficiency 534 CHAPTER 13 Short-Run Decision Making: Relevant Costing 554 Short-Run Decision Making 556 The Decision-Making Model 556, Step 1: Define the Problem 557, Step 2: Identify the Alternatives 557, Step 3: Identify the Costs and Benefits Associated with Each Feasible Alternative 557, Step 4: Total the Relevant Costs and Benefits for Each Feasible Alternative 558, Step 5: Assess the Qualitative Factors 558, Step 6: Make the Decision 559, Step 6: Make the Decision 559, Ethics in Decision Making 560, Relevant Costs Defined 560, Cost Behavior and Relevant Costs 562 Some Common Relevant Cost Applications 562 Make-or-Buy Decisions 563, HOW TO Structure a Make-or- Buy Problem 564, Special-Order Decisions 565, HOWTO Structure a Special-Order Problem 567, Keep-or-Drop Decisions 568, HOWTO Structure a Keep-or-Drop Product Line Problem 569, Further Processing of Joint Products 570, HOWTO Structure a Keep-or-Drop Product Line Problem with Complementary Effects 570, HOW TO Structure the Sell-or-Process-Further Decision 572 Product Mix Decisions 572 HOW TO Determine the Optimal Product Mix with One Constrained Resource 573,

Contents xv HOW TO Determine the Optimal Product Mix with One Constrained Resource and a Sales Constraint 574, Multiple Constrained Resources 574 The Use of Costs in Pricing Decisions 574 Cost-Based Pricing 575, HOWTO Calculate Price by Applying a Markup Percentage to Cost 575, Target Costing and Pricing 576, HOW TO Calculate a Target Cost 577 CHAPTER 14 Capital Investment Decisions 600 Types of Capital Investment Decisions 602 Nondiscounting Models 603 Payback Period 604, HOW TO Calculate Payback 604, Accounting Rate of Return 606, HOWTO Calculate the Accounting Rate of Return 606 Discounting Models: The Net Present Value Method 607 Net Present Value Defined 607, An Example Illustrating Net Present Value 608, HOW TO Assess Cash Flows and Calculate Net Present Value 608 Internal Rate of Return 609 Example: Multiple-Period Setting with Uniform Cash Flows 609, HOW TO Calculate Internal Rate of Return with Uniform Cash Flows 610, Multiple-Period Setting: Uneven Cash Flows 610 Postaudit of Capital Projects 611 Honley Medical Company: An Illustrative Application 611, One Year Later 612, Benefits of a Postaudit 612 Mutually Exclusive Proj ects 613 Net Present Value Compared with Internal Rate of Return 613, Example: Mutually Exclusive Projects 614, HOWTO Calculate Net Present Value and Internal Rate of Return for Mutually Exclusive Projects 615, Special Considerations for the Advanced Manufacturing Environment 616 Appendix 14A: Present Value Concepts 620 Future Value 620, Present Value 620, Present Value of an Uneven Series of Cash Flows 621, Present Value of a Uniform Series of Cash Flows 621 Appendix 14B: Present Value Concepts 622 MAKING THE CONNECTION 644 l CHAPTER 15 Statement of Cash Flows 648 Overview of the Statement of Cash Flows 650 Cash Defined 650, Sources and Uses of Cash 650, Noncash Exchanges 650, HOW TO Classify Activities and Identify Them as Sources or Uses of Cash 651, Methods for Calculating Operating Cash Flows 651 Preparation of the Statement: Indirect Method 652 Step One: Compute the Change in Cash Flow 652, HOWTO Compute the Change in Cash Flow 653, Step Two: Compute Operating Cash Flows 653, HOWTO Calculate Operating Cash Flows: Indirect Method 654, Step Three: Compute Investing Cash Flows 656, HOW TO Compute Investing Cash Flows 656, Step Four: Compute Financing Cash Flows 657, HOWTO Compute Financing Cash Flows 657, Step Five: Prepare the Statement of Cash Flows 657, HOW TO Prepare the Statement of Cash Flows 658 The Direct Method: An Alternative Approach 658 HOWTO Calculate Operating Cash Flows by Using the Direct Method 659 Worksheet Approach to the Statement of Cash Flows 660 HOWTO Prepare a Statement of Cash Flows by Using a Worksheet Approach 661, Analysis of Transactions 662, The Final Step 664 CHAPTER 16 Financial Statement Analysis 688 Common-Size Analysis 690 Horizontal Analysis 690, HOW TO Prepare Common-Size Income Statements by Using Base Period Horizontal Analysis 691, Vertical Analysis 691, HOW TO Prepare Income Statements by Using Net Sales as the Base: Vertical Analysis 692, Percentages and Size Effects 693 Ratio Analysis 693 Standards for Comparison 693, Classification of Ratios 694 Liquidity Ratios 695 Current Ratio 695, Quick or Acid-Test Ratio 697, Accounts Receivable Turnover Ratio 697, HOWTO Calculate the Current Ratio and the Quick (or Acid-Test) Ratio 698, Inventory Turnover Ratio 699, HOWTO Calculate the

XVI Contents Average Accounts Receivable, the Accounts Receivable Turnover Ratio, and the Accounts Receivable Turnover in Days 699 Leverage Ratios 700 HOW TO Calculate the Average Inventory, the Inventory Turnover Ratio, and the Inventory Turnover in Days 700, Times-Interest-Earned Ratio 701, HOWTO Calculate the Times-Interest-Earned Ratio 701, Debt Ratio 702, HOWTO Calculate the Debt Ratio and the Debt-to-Equity Ratio 702 Profitability Ratios 703 Return on Sales 703, Return on Total Assets 703, HOWTO Calculate the Return on Sales 703, HOW TO Calculate the Average Total Assets and the Return on Assets 704, Return on Common Stockholders' Equity 704, HOW TO Calculate the Average Common Stockholders' Equity and the Return on Stockholders' Equity 705, Earnings per Share 705, HOW TO Compute Earnings per Share 706, Price-Earnings Ratio 706, HOWTO Compute the Price-Earnings Ratio 706, Dividend Yield and Payout Ratios 707, Impact of the Just-in-Time Manufacturing Environment 707, HOW TO Compute the Dividend Yield and the Dividend Payout Ratio 707, The Importance of Profitability Ratios to External Users of the Financial Statements 708 Glossary 731 Check Figures 739 Index 743