Cost Management

A Strategic Emphasis

Cost Management
A Strategic Emphasis Fourth Edition

Edward J. Blocher
University of North Carolina at Chapel Hill Kenan-Flagler Business School

David E. Stout
Youngstown State University Williamson College of Business Administration

Gary Cokins
Strategist, Performance Management Solutions SAS/Worldwide Strategy

Kung H. Chen
University of NebraskaLincoln School of Accountancy

Boston Burr Ridge, IL Dubuque, IA Madison, WI New York San Francisco St. Louis Bangkok Bogot Caracas Kuala Lumpur Lisbon London Madrid Mexico City Milan Montreal New Delhi Santiago Seoul Singapore Sydney Taipei Toronto

COST MANAGEMENT: A STRATEGIC EMPHASIS Published by McGraw-Hill/Irwin, a business unit of The McGraw-Hill Companies, Inc., 1221 Avenue of the Americas, New York, NY, 10020. Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved. No part of this publication may be reproduced or distributed in any form or by any means, or stored in a database or retrieval system, without the prior written consent of The McGraw-Hill Companies, Inc., including, but not limited to, in any network or other electronic storage or transmission, or broadcast for distance learning. Some ancillaries, including electronic and print components, may not be available to customers outside the United States. This book is printed on acid-free paper. 1 2 3 4 5 6 7 8 9 0 CCW/CCW 0 9 8 7 6 ISBN: 978-0-07-312815-3 MHID: 0-07-312815-5 Editorial director: Stewart Mattson Executive editor: Tim Vertovec Developmental editor: Daryl Horrocks Executive marketing manager: Krista Bettino Senior media producer: Victor Chiu Project manager: Bruce Gin Production supervisor: Gina Hangos Designer: Cara David Supplement producer: Ira C. Roberts Media project manager: Matthew Perry Cover design: Dave Seidler Typeface: 10/12 Times Roman Compositor: Laserwords Private Limited, Chennai, India Printer: Courier Westford Library of Congress Cataloging-in-Publication Data Cost management: a strategic emphasis/Edward J. Blocher . . . [et al.].4th ed. p. cm. Includes index. ISBN: 978-0-07-312815-3 (alk. paper) MHID: 0-07-312815-5 (alk. paper) 1. Cost accounting. 2. Managerial accounting. I. Blocher, Edward. HF5686.C8B559 2008 658.15'52dc22 2006017239

www.mhhe.com

We dedicate this edition . . . To my wife Sandy, and our children Joseph and David

Ed Blocher
To my wife Anne, and our children David John and Kevin Michael

David E. Stout
To my wife Pam Tower, and my mentor Robert A. Bonsack, a true craftsman in the field of cost management

Gary Cokins
To my wife Mary, and our children Robert and Melissa

Kung Chen

Meet the Authors

Edward J. Blocher is Professor of Accounting at the Kenan-Flagler Business School
at the University of North Carolina. He received his bachelors degree in economics from Rice University, his MBA degree from Tulane University, and his PhD in accounting from the University of Texas at Austin. He has been a faculty member at the University of North Carolina since 1976. He has also been on the faculty of Northwestern University. Professor Blocher presents regularly on strategic cost management at the national meetings of both the American Accounting Association and the Institute of Management Accountants. While he is involved in a number of accounting organizations, Professor Blocher has been most continually active in the Institute of Management Accountants (IMA), where he is now a trustee of the IMA/FAR (Foundation for Applied Research). He is a Certied Management Accountant (CMA), has taught review courses for the CMA exam, and has served on the Institutes national education committee. He also presents regularly at the annual national conference of the IMA. Professor Blocher is the author or coauthor of several articles appearing in various journals. Putting research and teaching into practice is important to Professor Blocher, who has worked closely with other rms and organizations in developing products, publications, and teaching materials. He was the principal designer of an accounting analysis system developed by Financial Audit Systems, Inc. Also, he has worked with Blue Cross and Blue Shield of North Carolina, the American Institute of CPAs, KPMG Peat Marwick, Grant Thornton, and the Chancellors Ofce at the University of North Carolina at Chapel Hill, among others.

David E. Stout is the John S. and Doris M. Andrews Professor of Accounting, Williamson College of Business Administration, Youngstown State University. Previously, he held the position of the John M. Cooney Professor of Accounting, College of Commerce & Finance, Villanova University. David earned his PhD (1982) from the University of Pittsburgh and teaches primarily in the cost/managerial accounting area. He served previously as editor of Issues in Accounting Education and serves currently as an associate editor of the Journal of Accounting Education and as a member of the editorial board of: Issues in Accounting Education; the Journal of International Accounting, Auditing & Taxation; China Finance and Accounting Review, and Management Accounting Quarterly/Strategic Finance. In addition, he serves as a member of the editorial advisory board of Accounting Education: An International Journal. Professor Stout has published over 60 articles in numerous professional and academic journals including Advances in Accounting Education, Issues in Accounting Education, the Journal of Accounting Education, The Accounting Educators Journal, Advances in Accounting Education, Behavioral Research in Accounting, Educational and Psychological Measurement, Management Accounting, Management Accounting Quarterly, Financial Practice and Education, Strategic Finance, and Advances in Accounting. David is past president of the Teaching and Curriculum (T&C) Section of the AAA, and president-elect of the Academy of Business Education (ABE).

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Meet the Authors

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Gary Cokins is a strategist in performance management solutions with SAS, the worlds
largest privately owned software vendor. He is an internationally recognized expert, speaker, and author in advanced cost management and performance improvement systems. Gary received a BS degree with honors in Industrial Engineering/Operations Research from Cornell University in 1971. He received his MBA from Northwestern Universitys Kellogg School of Management in 1974. Gary serves on activity-based information committees including CAM-I, APICS, the Supply Chain Council, the Council for Logistics Management (CLM), the Institute of Management Accountants (IMA), the American Society for Quality (ASQ), the Purchasing Management Association of Canada (PMAC), the Institute of Industrial Engineers (IIE), Association for Management Information in Financial Services (AMI/fs), and the American Institute of CPAs (AICPA).

Kung H. Chen is the Steinhardt Foundation Professor of Accounting and the Director of Graduate Programs in the School of Accountancy at the University of Nebraska-Lincoln. A graduate of National Taiwan University, he earned his MBA degree from West Virginia University and a PhD from the University of Texas-Austin. Professor Chen has published his research in various journals, including The Accounting Review, Encyclopedia of Accounting, Internal Auditor, Journal of Business Finance and Accounting, Behavioral Research in Accounting, Journal of Accounting Literature, Advances in Accounting, Financial Management, and the International Journal of Accounting and has presented research papers to audiences in several countries including the United States, New Zealand, Japan, Taiwan, Korea, and China.

Blocher/Stout/Cokins/Chen:
Clarity of vision and the proper perspective can often mean the difference between confusion and understanding. Viewed up close, the eye chart featured on the cover of Cost Management: A Strategic Emphasis appears like a normal examination tool. Taken at a distance, though, the message is clear. Bringing the big picture into focus is a guiding principle not only in this textbook, but also in the business of cost management. The function of cost accounting is to organize unclear data and use sound judgment to supply managers with useful and timely information. The goal of Cost Management is to provide cost accountants with the tools they need to make this happen. Cost Management by Blocher, Stout, Cokins, and Chen uses a strategic emphasis to make the connections between concepts and procedures clear to students. Making students see the relevance of cost management concepts and procedures, and demonstrating how they will use this information in the future, is a recurring theme of each chapter. Once viewed simply as technical experts in accounting methods and procedures, accountants now play a critical role as participants on multifunctional management teams. Along with the important traditional cost management methods and procedures, Cost Management provides a context for students by using a unique strategic framework. This organization helps students gain an understanding of how learning cost accounting techniques can better serve the company as a whole:

Strategic Framework

Part I: Introduction to Cost Management

Part II: Planning and Decision Making

The introductory chapters develop important strategic concepts like strategy development and implementation, the Value Chain, Cost Concepts, the Balanced Scorecard, and Activity-Based Costing (ABC)

Part II examines how cost estimation, budgeting, and decision making help companies maintain a competitive advantage

Part III: Process Costing and Cost Allocation

Parts IV and V: Operational Control and Management Control

Part III examines how process costing and cost allocation are used to determine product costs and to evaluate a companys operations

Parts IV and V examine performance measurement at the operational and managerial level, with the goal of linking management incentives to strategy

Part VI: Advanced Topics in Cost Management

Part VI examines three strategically important advanced areas in cost management: executive compensation, business valuation, and capital budgeting

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Bringing the Big Picture into

Focus for Your Students

REAL-WORLD FOCUS

Commodities and Cost Leadership: PCs, Cell Phones, and Airlines

tain its growth in prots and sales by moving successfully into new markets (China) and product lines (television sets and digital music players). As in the PC industry, where prices have fallen as product performance has risen, prices and cost competition have increased in the cell phone industry as new manufacturers have entered the market and regulatory changes in the United States make it easier for users to switch providers. The airline industry continues to move in the direction of the lowcost carriers, as shown by the trend by the carriers to charge for once-free items such as pillows, meals, and headsets.
Source: Thomas L. Friedman, The World Is Flat: A Brief History of the TwentyFirst Century, Farrar, Straus, and Giroux, New York 2005; Less Friendly Skies, BusinessWeek, July 11, 2005, p. 16; Pricing Pressure Squeezes Cellphone Makers World-Wide, The Wall Street Journal, January 15, 2005, p. B1; Dell Effect Is under Strain as PC Maker Swells, by Gary McWilliams, The Wall Street Journal, August 17, 2005, p. C1; For Dell, Success in China Tells Tale of Maturing Market, The Wall Street Journal, July 5, 2005, p. 1; PC Makers: More Sales, Fewer Prots, BusinessWeek, September 3, 2003, pp. 4647; Pete Engardio, The Future of Outsourcing, BusinessWeek, January 30, 2006, pp. 5064.

Real-World Focus. All firms strive to have a competitive

edgefor some it may be low cost, for others it might be high quality or unique product features. Cost Management, 4e teaches how accounting systems can add value to the organization by providing relevant data for planning, control, and decision-making. The Real-World Focus boxes take real companies and demonstrate strategy in action.

A commodity is a product or service that is difcult to differentiate and, as a result, becomes a natural for cost leadership competition. Examples include building materials, many consumer electronics products, and many of the things we buy in supermarkets. Thomas L. Friedman, award-winning columnist and author, has addressed the issue of commodities in the current business environment in his new book, The World Is Flat. One reason the world is at is because any product or service that is a commodity will nd its low-cost supply anywhere in the worldwherever there is the lowest cost. Commenting on Indias growth in outsourcing work from other countries, Friedman notes that the portion of work that can be digitized is a good candidate for outsourcing. He provides examples from the accounting profession (tax return preparation) and journalism (press releases, company reports); these activities are being outsourced to the low-cost supplier. The accountant or journalist instead provides value-adding services to the customer (such as tax planning, nancial analysis, and news analysis). Some parts of the work are in effect commoditized. Other examples of commodities include personal computers (PCs), cell phones, and airlines. The PC industry, dominated by Dell Computer, has seen sales rise while prots fall. Dell manages to main-

Cost Management in Action

A Case in Competitive Strategy: Wal-Mart and Target

2. Recently Wal-Mart has begun to advertise in the high-fashion magazine Vogue. How does this t the rms strategy, or does it? 3. While customers are pleased with Wal-Marts low prices, there is ongoing controversy about the rms negative effect on other retailers where Wal-Marts are located. For example, the closing of 30 supermarkets in Oklahoma City in recent years has been attributed to Wal-Marts arrival. What are your thoughts on the controversy? Are the ethical principles and standards of the management accountant relevant in this context?

To augment this coverage, the Blocher team encourages students to further explore real-world companies through

Cost Management in Action boxes. This feature

poses important questions that make students think critically about how cost accounting affects management strategy. The authors then supply their comments for the Cost Management in Action boxes at the end of each chapter.

Wal-Mart and Target are two of the most successful retailers in the United States Wal-Mart bears the slogan, Always Low Prices, while Target stores say Expect More, Pay Less. If you have shopped at either of these stores you will likely have formed an opinion about the stores and how they compete.

Required
1. Based on your experience, explain what you think are the competitive strategies of these retailers. Are they key competitors, targeting the same customers? Do you think each rm has adopted the most effective strategy? Why or why not?

In areas related to the management accounting function, the Financial Executives Institute (FEI) provides services much like those provided by the IMA for nancial managers, including controllers and treasurers. Because one of the management control responsibilities of the management accountant is to develop effective systems to detect and prevent errors and fraud in the accounting records, the management accountant commonly has strong ties to the control-oriented organizations such as the Institute of Internal Auditors (IIA).
Even if youre on the right track, youll get run over if you just sit there. Will Rogers

Problem Material.
blo28155_ch01.indd 16

The Blocher team has taken great care to develop problems and cases that effectively demonstrate the strategic issues presented in each chapter. Included is a variety of exercises and problems that deal with strategic, international, service, and ethics issues. All problems are marked appropriately for easy identification, including problems that require the use of Excel:
6/30/06 7:42:44 PM

Strategy

International

Service

Ethics

Excel

Clear and concise exhibits help illustrate basic and complicated topics throughout the book.

blo28155_ch01.indd 19

The supplemental Cases and Readings manual challenges students to think about and use cost management information in a real-world setting. The longer articles in the manual help integrate case studies and articles into more detailed discussions about cost management.
6/30/06 7:42:45 PM

y, g p p , y g packers work full-time on that jacket, the rm could manufacture only 36,000 units of because of limited capacity on the sewing machine. The production planner can determine the best production mix by examining all of th sible production possibilities in the darker shaded area, from 36,000 on the Gale axis to A where the constraints intersect, and then to the point 22,400 on the Windy axis. The mix with the highest contribution must be one of these three points: 36,000 of Gale, po or 22,400 units of Windy. The solution, called the corner point analysis, is obtained by the total contribution at each point and then choosing the point with the highest contrib

EXHIBIT 9.22
Windbreakers Production and Sales Possibilities Two Production Constraints Sewing Machine and Inspection
67,200 Units of Sales for Gale Production constraint for inspection and packaging

36,000

Production constraint for sewing machine

A (4,800 Gale, 20,800 Windy)

24,000 22,400 Units of Sales for Windy

blo28155_ch09.indd 334

7/7/06 4:14:45 PM

Whats NEW about the 4th edition of

In this edition, the authors made extensive changes to nearly every chapter. They increased focus on the strategic role of cost management, both in the text and in the exercises and problems for each chapter. Careful revisions were made in each chapter to enhance the clarity and exposition, with the goal of presenting the content in a student-friendly manner. Numerous Real-World Focus items were added or revised in each chapter, along with additional Cost Management in Action boxes. The Blocher team also made these critical changes for this edition:
New brief exercises (1012 per chapter) provide a valuable resource for the instructor to ask short questions, most of which require a short calculation. These can be used to assess student preparation of the material or to begin the class discussion with some focused questions on the chapter material. In contrast to the questions, the brief exercises focus on calculation; in contrast to the exercises, brief exercises can be used in class without prior assignment to the students. A new supplement, the Excel Solutions Manual, is provided for all end-of-chapter problems and exercises. This manual is provided in two versions: an instructor version (containing both data inputs and solutions) and a student version (containing data inputs only). Instructors now have the exibility to make assignments where students prepare Excel solutions to any exercise or problem in the text. Because all input data are provided to students, data-entry errors on the part of students are minimizedall students begin each spreadsheet assignment with the same set of data. At the instructors discretion, completed spreadsheets can be printed or posted to the Web for access by students. A signicantly enhanced Test Bank features new multiple-choice questions and problems linked to learning objectives and level of difculty. New cases are provided for use with the activity-based casting software of SAS Institute; improvements in the tutorials and materials have been made for increased ease-of-use, by students and instructors alike.

Chapter 1
New Real-World Focus examples, including surveys of current practice Update of section on ethics for new IMA Code of Professional Conduct New self-study question, and new exercises and problems focusing on strategy and on ethics

New Real-World Focus examples, including an extensive example of cost terms used in agriculture New discussion of the cost of capacity New exercises and problems

the strategic role of ABC/M is enhanced and moved to the front of the chapter All new illustrations in the text, including examples in service and governmental organizations New exhibits to clarify the two-stage procedure under volume-based and activity-based costing Several new Real-World Focus examples, including surveys of current practice New coverage of the cost of capacity and the role of ABC costing in managing the cost of capacity Several new exercises and problems, with a focus on the cost of capacity New exercises and problems that include resource-consumption as well as activity-consumption cost drivers New coverage of time-driven ABC costing New coverage of multiple-activity ABC costing New exercises and problems focusing on strategy, the cost of capacity, resource consumption cost drivers, and ethics

Chapter 4
Coverage of departmental overhead rates moved from Chapter 5; related exercise and problem material added on departmental overhead rates Clarification of accounting for normal spoilage with the addition of an example in the text New Real-World Focus examples New exercises and problems with a focus on service industries

Chapter 2
New Real-World Focus examples, including surveys of current practice Enhanced material on implementing the balanced scorecard (BSC) New exercises and problems with an emphasis on strategy and the balanced scorecard

Chapter 5
Significant revision to shorten and focus this chapter; customer profitability analysis has been shortened and is now more focused Coverage of departmental overhead rates is moved to Chapter 4; learning objectives are condensed and focused;

Chapter 3
Clarification of the discussion on cost drivers Coverage of risk preferences removed from Chapter 3 and now enhanced in Chapter 17

Cost Management?
David E. Stout has joined the Blocher author team for the fourth edition. Dr. Stout brings years of teaching experience at Rider University, Villanova University, and most recently Youngstown State University, to this new edition. David earned his PhD degree (1982) from the University of Pittsburgh and teaches primarily in the cost/managerial accounting area.

Chapter 6
New discussion of simple vs. multiple linear regression New coverage of time-series vs. cross-sectional regression Several new Real-World Focus examples Expanded coverage of the learning curve, with discussion of the general learning model New exercises and problems with a focus on interpreting regression results, including those from crosssectional regression analysis

Chapter 9
Updated Real-World Focus examples New exercises and problems with a focus on strategy and on applications in the service industries

Chapter 13
Expanded introductory discussion of control systems in general and operational control systems in particular Expanded discussion of the difference between standard costs and a standard cost system Presentation of a general model for analyzing variable cost variances (Exhibit 13.7) Broader mix of end-of-chapter assignment material (including additional Excel-based assignments, ethics, and behavioral considerations) Movement of journal-entry material to an appendix

Chapter 10
New coverage of quality function deployment (QFD), including several illustrations New and updated Real-World Focus examples New exercises and problems with a focus on strategy and on service industries Additional coverage of Takt time with a new illustration and problem material

Chapter 7
Notation is clarified and changed to closely correspond with symbols used in Chapter 6 New Real-World Focus examples New problems and examples Expanded coverage of Excels Goal Seek option for conducting sensitivity analysis Clarification of the coverage of activity-based CVP and multipleproduct CVP

Chapter 14
New discussion of the difference between the product-costing and control purposes of standard costs for factory overhead Expanded discussion of the variancedisposition question New diagrammatical approach for overhead variance analysis (Exhibits 14.4 and 14.5), and associated end-ofchapter assignment material New alternative diagrammatical approach for overhead variance analysis (Exhibit 14.18) Expanded set of Excel-based end-ofchapter assignment material Significant expansion of Real-World Focus items

Chapter 11
Additional coverage of backflush costing with a new illustration and problem material New problem material with a focus on service industries

Chapter 8
Completely new set of Real-World Focus examples Additional end-of-chapter material dealing with ethical considerations, budgeting for not-for-profit organizations, and sensitivity analysis Explicit linkage to financial accounting (accounting for sales discounts) Inclusion of additional Excel-based assignments

Chapter 12
New Real-World Focus examples New problems

Chapter 15
Significant revision including new material and a new focus on the flexible budget; the chapter is now integrated into the flexible budget concept used in the prior two chapters, and there is a new emphasis on the strategic role of the analysis of sales performance and productivity The coverage of strategic profitability analysis has been removed and replaced by a framework that is consistent with the flexible budget approach Duplication between Chapters 15 and 13 removed for the new edition New Real-World Focus examples New end-of-chapter exercise and problem material with a focus on the application of the flexible budget concept in the analysis of productivity and sales performance

Chapter 17
Coverage of risk preferences repositioned to this chapter from Chapter 3; this material, including related assignment material, has been updated and enhanced New and updated Real-World Focus examples, including surveys from practice New coverage of the role of strategy in the determination of the cost, profit, or revenue SBU, with new exhibit to illustrate the differences across these responsibility units Extended coverage of the implementation of the balanced scorecard (BSC) for performance measurement

Chapter 20
Expanded discussion of the strategic role of capital budgeting New discussion of the role of the management accountant in the capital budgeting process Reference to the analytic hierarchy process (AHP) in conjunction with the capital budgeting process Consistent with the revisions in Chapter 19, reorientation of material to provide greater focus on discounted cash flow (DCF) decision models Expanded discussion of the calculation of the weighted-average cost of capital (WACC) Many new Real-World Focus examples pertaining to the capital budgeting process New discussion regarding sensitivity analysis Integration of Excel-based financial formulas for solving capital budgeting problems Advanced issues in capital budgeting analysis are repositioned to an appendix Expanded discussion of behavioral considerations associated with the capital-budgeting process

Chapter 18
New coverage and illustration of the relationship between the components of return on assets: return on sales and asset turnover New Real-World Focus examples New exercises and problems with a focus on economic profit, residual income, and EVA New coverage of intangible assets and the use of ROA for innovative companies

Chapter 16
Development of a comprehensive framework (Exhibit 16.3) for managing and controlling quality, which is used to anchor the discussion of all topics covered in the chapter New discussion regarding the role of management accounting in the management and control of quality Expanded discussion of nonfinancial performance indicators New discussion of Six Sigma, including implementation issues and the application of Six Sigma to the accounting/finance function Many new Real-World Focus items New discussion of the application of COQ to environmental quality Greatly expanded mix of end-ofchapter assignment material Repositioning of Taguchi loss function analysis to an appendix
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Chapter 19
New and updated Real-World Focus examples, including surveys from practice Updated discussion of reporting requirements for stock options Significant revision of the coverage on business valuation; new focus on determining the market value of equity Expanded coverage of the discounted cash flow method (DCF) for valuing a firm

Supplements
For Instructors
Instructors Resource CD-ROM (ISBN 0073128163): Contains all essential course supplements such as the Instructors Resource Manual, Solutions Manual, Test Bank Word Files, Diploma Test Bank, PowerPoint Presentations, and Excel Solutions Manual. All instructor supplements are prepared by the authors.

Online Learning Center: www.mhhe.com/blocher4e.

The Instructor Edition of the Cost Management: A Strategic Emphasis, 4e OLC is password-protected and another convenient place for instructors to access course supplements. Resources for professors include: the Instructor and Student Solutions Manual, transparency masters, teaching notes for the casebook, links to professional resources, sample syllabi, text updates, solutions to the Instructor and Student Excel Spreadsheets, and solutions to Internet exercises.

For Students
Cases and Readings for use with Cost Management: A Strategic Emphasis, 4e (ISBN 0073128198): This manual contains an extensive set of longer cases
covering a variety of important topics. These case scenarios put students in situations that allow them to think strategically and to apply concepts theyve learned in the course. Key readings have been chosen to give students more background into the evolution of strategic cost management topics.

Study Guide (ISBN 0073128171): Prepared by Roger Doost (Clemson University), the Study Guide reviews the highlights of each chapter in Cost Management: A Strategic Emphasis, 4e and includes a variety of self-study questions for student review. Every chapter includes short-answer questions organized by learning objective, multiple-choice questions, and thorough exercises. Suggested answers to all questions and exercises are included. Online Learning Center: www.mhhe.com/blocher4e.
The Student Edition of the Cost Management: A Strategic Emphasis, 4e OLC contains many tools designed to help students study including: check gures, text updates, links to professional resources, chapter overviews, chapter objectives, multiple-choice quizzes, ashcard key term review, Internet exercises, Excel spreadsheets with data only (for use by students with Excel assignments), and PowerPoint presentations.

SAS Software: SASs Activity-Based Costing (ABC) software is used worldwide for
performance management functions and analysis. Cost Management fully incorporates SAS Software in its case material to prepare students for calculating ABC costs, creating cost driver assignments, and organizing cost information in an electronic environment. Visit the Blocher OLC today to learn more!

Acknowledgments
Our Sincerest Thanks . . . In writing this book, we were fortunate to have received extensive feedback from a number of accounting educators. We want to thank our colleagues for their careful and complete review of our work. The comments that we received were invaluable in helping us to shape the manuscript. We believe that this collaborative development process helped us to create a text that will truly meet the needs of todays students and instructors. We are sincerely grateful to the following individuals for their participation in the process: Reviewers for 4e: Stephen Makar, University of WisconsinOshkosh Michael Flores, Wichita State University Jay D. Forsyth, Central Washington University Jay Holmen, University of WisconsinEau Claire Jennifer Niece, Assumption College David R. Honodel, University of Denver Dennis Caplan, Oregon State University David Eichelberger, Austin Peay State University Jerry W. Ferry, University of North Alabama Laurie B. McWhorter, Mississippi State University Randall E. LaSalle, West Chester University of Pennsylvania Vidya N. Awasthi, Seattle University Bambi Hora, University of Central Oklahoma Jerry Thorne, North Carolina A&T State University Olen L. Greer, Southwest Missouri State University Marvin L. Bouillon, Iowa State University Bea Chiang, The College of New Jersey Alan B. Czyzewski, Indiana State University Judith A. Harris, Nova Southeastern University Aleecia Hibbets, University of LouisianaMonroe Sanford R. Kahn, University of Cincinnati Mehmet C. Kocakulah, University of Southern Indiana Laura Jean Kreissl, University of WisconsinParkside Dan Law, Gonzaga University Brian L. McGuire, University of Southern Alabama Yaw M. Mensah, Rutgers University Kenneth P. Sinclair, Lehigh University Larry N. Killough, Virginia Polytechnic Institute and State University Sandra S. Lang, McKendree College Mike Grayson, Jackson State University

xiv

Acknowledgments

xv

Previous Edition Reviewers: K.R. Balachandran, New York University Mohamed E. Bayou, School of ManagementUniversity of MichiganDearborn Wayne Bremser, Villanova University Robert J. DePasquale, Saint Vincent College Robert W. Duron, Chadron State College Donald C. Gribbin, Southern Illinois University Linda Holmes, University of WisconsinWhitewater Norma C. Holter, Towson University Paul Juras, Wake Forest University

Brian L. McGuire, University of Southern Indiana Cheryl E. Mitchem, Virginia State University Margaret OReilly-Allen, Rider University Chei M. Paik, George Washington University Hugh Pforsich, University of Idaho Shirley Polejewski, University of St. Thomas Jenice Prather-Kinsey, University of MissouriColumbia Dennis Shanholtzer, Metropolitan State University John L. Stancil, Florida Southern College Ronald A. Stunda, Birmingham-Southern College

We also want to recognize the special efforts of: Daniel Flaningan Keith Folken Kristin Hawkins Taylor Henry Jessie Kinsley Andrew Stulce Finally, we are most appreciative of the outstanding assistance and support provided by the professionals of McGraw-Hill/Irwin: Stewart Mattson, our editorial director, and Tim Vertovec, Executive Editor, for their guidance; our developmental editor, Daryl Horrocks, for his invaluable suggestions; Krista Bettino, our marketing manager, for her signicant promotional efforts; Bruce Gin, our project manager, for his attention to detail; Cara David, for the outstanding presentation of the text; Ira Roberts, our supplements coordinator, for his timeliness and accuracy in delivering the support material; and Victor Chiu, our media producer, and Matthew Perry, our media project manager, for their technical expertise in delivering our multimedia material. An added thanks to Beth Woods and Alice Sineath for their signicant contributions to the accuracy of our text. Ed Blocher David E. Stout Gary Cokins Kung Chen

Brief Contents
PART ONE
Introduction to Cost Management 1 Cost Management and Strategy: An Overview 2 2 Implementing Strategy: The Balanced Scorecard and the Value Chain 30 3 Basic Cost Management Concepts 4 Job Costing 84 120 54 2

PART FOUR
Operational Control 494 13 The Flexible Budget and Standard Costing: Direct Materials and Direct Labor 494 14 The Flexible Budget: Factory Overhead 15 The Flexible Budget: Further Analysis of Productivity and Sales 610 16 The Management and Control of Quality 648 550

5 Activity-Based Costing and Management

PART FIVE PART TWO

Planning and Decision Making 6 Cost Estimation 170 218 254 18 7 Cost-Volume-Prot Analysis 170 Management Control 17 698 Management Control and Strategic Performance Measurement 698 Strategic Investment Units and Transfer Pricing 742

8 Strategy and the Master Budget

9 Decision Making with Relevant Costs and a Strategic Emphasis 316 10 Cost Planning for the Product Life Cycle: Target Costing, Theory of Constraints, and Strategic Pricing 360

PART SIX
Advanced Topics in Cost Management 19 20 784 Management Compensation, Business Analysis, and Business Valuation 784 Capital Budgeting 818

PART THREE
Process Costing and Cost Allocation 11 12 Process Costing 404 404

PRESENT VALUE TABLES GLOSSARY INDEX 882 872

870

Cost Allocation: Service Departments and Joint Product Costs 454

xvi

Contents
PART ONE
INTRODUCTION TO COST MANAGEMENT 2 Chapter 1 Cost Management and Strategy: An Overview 2
The Uses of Cost Management 3
6 The Four Functions of Management 4 Strategic Management and Strategic Cost Management Types of Organizations 6

Problems 26 Solution to Self-Study Problem

29

Chapter 2 Implementing Strategy: The Balanced Scorecard and the Value Chain 30
Strengths-Weaknesses-Opportunities-Threats (SWOT) Analysis 31 Execution 33 Value-Chain Analysis 35
Value-Chain Analysis in Computer Manufacturing 37

The Contemporary Business Environment 7

The Global Business Environment 7 Manufacturing Technologies 8 The New Economy: Use of Information Technology, the Internet, and E-Commerce 8 Focus on the Customer 8 Management Organization 9 Social, Political, and Cultural Considerations 9

The Balanced Scorecard

38

The Balanced Scorecard Reects Strategy 39 The Strategy Map 40 Expanding the Balanced Scorecard Sustainability

42

The Strategic Focus of Cost Management 10 Contemporary Management Techniques 10

Benchmarking 10 Total Quality Management 11 Business Process Improvement 11 Activity-Based Costing and Management Reengineering 11 The Theory of Constraints 11 Mass Customization 12 Target Costing 12 Life-Cycle Costing 12 The Value Chain 12 The Balanced Scorecard 12 Strategic Measures of Success 14

Summary 43 Key Terms 43 Comments on Cost Management in Action Self-Study Problems 44 Questions 44 Brief Exercises 45 Exercises 45 Problems 45 Solutions to Self-Study Problems 52

43

11

Chapter 3 Basic Cost Management Concepts

Cost Drivers, Cost Pools, and Cost Objects 55
Cost Assignment and Cost Allocation: Direct and Indirect Costs 55 Cost Drivers and Cost Behavior 58 Activity-Based Cost Drivers 58 Volume-Based Cost Drivers 59 Structural and Executional Cost Drivers 63

54

How a Firm Succeeds: The Competitive Strategy Developing a Competitive Strategy: Strategic Positioning 15
Cost Leadership 15 Differentiation 16 Other Strategic Issues

13

Cost Concepts for Product and Service Costing

64

Cost Accounting for Products and Services 64 Product Costs and Period Costs 64 Manufacturing, Merchandising, and Service Costing

65

16

Cost Concepts for Planning and Decision Making 17

68

The Professional Environment of Cost Management

Professional Organizations 17 Professional Certications 19 Professional Ethics 20

Relevant Cost 68 Attributes of Cost Information for Decision Making 69

Cost Concepts for Management and Operational Control 70

Controllability 70

Summary 21 Appendix A: More about Strategy 22 Key Terms 23 Comments on Cost Management in Action Self-Study Problem 24 Questions 24 Brief Exercises 25 Exercises 25

23

Summary 70 Key Terms 71 Comments on Cost Management in Action Self-Study Problem 71 Questions 72 Brief Exercises 72 Exercises 73

71

xvii

xviii Contents

Problems 78 Solution to Self-Study Problem

Activity-Based Management 82

130
130

Chapter 4 Job Costing

Product Costing Systems

84
84

What Is Activity-Based Management? Activity Analysis 131 Value-Added Analysis 131

Cost Accumulation: Job or Process Costing? 85 Cost Measurement: Actual, Normal, or Standard Costing 85 Overhead Assignment under Normal Costing: Volume-Based or Activity-Based? 85

Activity-Based Costing/Management (ABC/M) Applications 133

ABC/M in Manufacturing: Industrial Air Conditioner Units 133 ABC/M Application in the Service Industry: A Retirement and Assisted Living Community 135 ABC/M Applications in Government 136

The Strategic Role of Product Costing Job Costing: The Cost Flows 86
Direct Materials Costs 87 Direct Labor Costs 89 Factory Overhead Costs 91 Actual Costing 91 Normal Costing 91

86

Customer Protability Analysis

138

Customer Cost Analysis 139 Customer Protability Analysis 140 Customer Value Assessment 141

Implementation Issues

142

The Application of Factory Overhead in Normal Costing 93

Cost Drivers for Factory Overhead Application 93 Applying Factory Overhead Costs 93 Departmental Overhead Rates 94 Disposition of Underapplied and Overapplied Overhead

Multiple-Stage Activity-Based Costing 143 Time-Driven Activity-Based Costing 143

96

Job Costing in Service Industries 97 Operation Costing 98 Summary 100 Appendix A: Spoilage, Rework, and Scrap in Job Costing 101 Key Terms 103 Comments on Cost Management in Action 103 Self-Study Problem 103 Questions 104 Brief Exercises 104 Exercises 105 Problems 108 Solution to Self-Study Problem 118

Summary 144 Key Terms 144 Comments on Cost Management in Action 145 Self-Study Problem 145 Questions 146 Brief Exercises 146 Exercises 147 Problems 153 Solution to Self-Study Problem 167

PART TWO
PLANNING AND DECISION MAKING 170 Chapter 6 Cost Estimation
Strategic Role of Cost Estimation

170
170

Using Cost Estimation to Predict Future Costs 171 Using Cost Estimation to Identify Cost Drivers 171

Chapter 5 Activity-Based Costing and Management 120

The Strategic Role of Activity-Based Costing Role of Volume-Based Costing 121 Activity-Based Costing 122 120

Six Steps of Cost Estimation

172

Resources, Activities, Resource Consumption Cost Drivers, and Activity Consumption Cost Drivers 122 What Is Activity-Based Costing? 122 The Two-Stage Cost Assignment Procedure 123

Step 1: Dene the Cost Object to Be Estimated 172 Step 2: Determine the Cost Drivers 172 Step 3: Collect Consistent and Accurate Data 172 Step 4: Graph the Data 172 Step 5: Select and Employ the Estimation Method 173 Step 6: Assess the Accuracy of the Cost Estimation 173

Cost Estimation Methods

173

Steps in Developing an Activity-Based Costing System 124

Step 1: Identify Resource Costs and Activities 124 Step 2: Assign Resource Costs to Activities 125 Step 3: Assign Activity Costs to Cost Objects 126

An Illustration of Cost Estimation 173 High-Low Method 173 Work Measurement 176 Regression Analysis 176 Using Spreadsheet Software for Regression Analysis

182

Data Requirements and Implementation Problems 126

Data Accuracy 183 Selecting the Time Period 183 Nonlinearity Problems 184

183

Benets and Limitations of Activity-Based Costing

Benets 126 Limitations 127

A Comparison of Volume-Based and Activity-Based Costing 128

Volume-Based Costing 128 Activity-Based Costing 129

Summary 185 Appendix A: Learning Curve Analysis 186 Appendix B: Regression Analysis 189 Key Terms 195

Contents xix

Comments on Cost Management in Action Self-Study Problem 196 Questions 197 Brief Exercises 198 Exercises 199 Problems 202 Solutions to Self-Study Problems 214

195

Master Budget

263

Chapter 7 Cost-Volume-Prot Analysis 218

Cost-Volume-Prot Analysis 218
Contribution Margin and Contribution Income Statement 219

Sales Budget 263 Manufacturing Budgets 265 Merchandise Purchases Budget 269 Selling and General Administrative Expense Budget Cash Receipts (Collections) Budget 272 Cash Budget 272 Budgeted Income Statement 274 Budgeted Balance Sheet 274

271

Budgeting in Service Companies and International Firms, and Not-for-Prot Organizations 276
Budgeting in Service Industries 276 Budgeting in Not-for-Prot Organizations Budgeting in International Settings 278 278

Strategic Role of CVP Analysis 220 CVP Analysis for Breakeven Planning

222

Equation Method: For Breakeven in Units 222 Equation Method: For Breakeven in Dollars 222 Contribution Margin Method 223

Alternative Budgeting Approaches

279

CVP Analysis for Prot Planning

225

Revenue Planning 225 Cost Planning 225 Including Income Taxes in CVP Analysis 228

Zero-Base Budgeting (ZBB) 279 Activity-Based Budgeting (ABB) 280 Kaizen (Continuous Improvement) Budgeting

281

Computer Software in Budgeting and Planning 282 Ethical and Behavioral Issues in Budgeting 284
Ethics in Budgeting 284 Goal Congruence 284 Difculty Level of the Budget Target 285 Authoritative or Participative Budgeting? 286 Role of the Budget Department or Controller 286

CVP Analysis for Activity-Based Costing 229 Sensitivity Analysis of CVP Results 231
What-If Analysis of Sales: Contribution Margin and Contribution Margin Ratio 231 Margin of Safety 231 Operating Leverage 232

CVP Analysis with Two or More Products 234 CVP Analysis for Not-for-Prot Organizations 236 Assumptions and Limitations of CVP Analysis 236
Linearity and the Relevant Range 236 Identifying Fixed and Variable Costs for CVP Analysis 236

Summary 238 Key Terms 239 Comments on Cost Management in Action Self-Study Problem 239 Questions 239 Brief Exercises 240 Exercises 240 Problems 242 Solution to Self-Study Problem 253

239

Summary 287 Key Terms 287 Comments on Cost Management in Action Self-Study Problems 288 Questions 289 Brief Exercises 290 Exercises 291 Problems 299 Solutions to Self-Study Problems 313

287

Chapter 9 Decision Making with Relevant Costs and a Strategic Emphasis 316
The Decision-Making Process Relevant Cost Analysis 318 317

Chapter 8 Strategy and the Master Budget

Role of Budgets 255 Strategy, the Long-Term Plan, and the Master Budget 256
Importance of Strategy in Budgeting 256 Formulation of Strategy 258 Strategic Goals and Long-Term Objectives 258 Short-Term Objectives and the Master Budget 258

254

Relevant Cost Information 318 Batch-Level Cost Drivers 319 Fixed Costs and Depreciation 320 Other Relevant Information: Opportunity Costs

320

Strategic Cost Analysis 321 Special-Order Decisions 322 Cost Analysis 322 Strategic Analysis 323
Is TTS Now Operating at Full Capacity? Excessive Relevant Cost Pricing 324 Other Important Factors 325 323

Budgeting Process

260

Budget Committee 260 Budget Period 261 Budget Guidelines 262 Initial Budget Proposal 262 Negotiation, Review, and Approval Revision 263

262

Make, Lease, or Buy Decision 325 Cost Analysis 325 Strategic Analysis 327 Sell Before or After Additional Processing Cost Analysis 327 Strategic Analysis 328

327

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Contents

Protability Analysis 329 Protability Analysis: Keep or Drop a Product Line 329
Strategic Analysis 330

Protability Analysis: Evaluating Programs 331 Protability Analysis: Service and Not-for-Prot Organizations 331 Multiple Products and Limited Resources 332 Case 1: One Production Constraint 332 Case 2: Two or More Production Constraints 333 Behavioral and Implementation Issues 335 Consideration of Strategic Objectives 335 Predatory Pricing 335 Replacement of Variable Costs with Fixed Costs 336 Proper Identication of Relevant Factors 336 Summary 337 Appendix A: Linear Programming and the Product Mix Decision 337 Key Terms 340 Comments on Cost Management in Action 340 Self-Study Problems 340 Questions 341 Brief Exercises 341 Exercises 342 Problems 346 Solutions to Self-Study Problems 358

Questions 385 Brief Exercises 385 Exercises 386 Problems 391 Solution to Self-Study Problem

401

PART THREE
PROCESS COSTING AND COST ALLOCATION 404 Chapter 11 Process Costing
Equivalent Units 405 Flow of Costs in Process Costing Steps in Process Costing 407 Process Costing Methods 408

404
405

Characteristics of Process Costing Systems

406

Illustration of Process Costing

408
412

Weighted-Average Method 409 First-In, First-Out (FIFO) Method

Comparison of Weighted-Average and FIFO Methods Process Costing with Multiple Departments 419
Transferred-In Costs 420 Weighted-Average Method 420 The FIFO Method 422

419

Chapter 10 Cost Planning for the Product Life Cycle: Target Costing, Theory of Constraints, and Strategic Pricing 360
Target Costing 362
Value Engineering 363 Target Costing and Kaizen 365 An Illustration: Target Costing in Health Product Manufacturing 366 An Illustration Using Quality Function Deployment (QFD) 367 Benets of Target Costing 368

Journal Entries for Process Costing 425 Implementation and Enhancement of Process Costing
Activity-Based Costing and the Theory of Constraints Just-in-Time Systems and Backush Costing 427

426

426

The Theory of Constraints

369

The Use of the Theory of Constraints Analysis in Health Product Manufacturing 370 Steps in the Theory of Constraints Analysis 370 Theory of Constraints Reports 375 Activity-Based Costing and the Theory of Constraints 375

Summary 428 Appendix A: Spoilage in Process Costing 428 Key Terms 432 Comments on Cost Management in Action 432 Self-Study Problems 432 Questions 433 Brief Exercises 434 Exercises 434 Problems 437 Solutions to Self-Study Problems 448

Chapter 12 Cost Allocation: Service Departments and Joint Product Costs 454
The Strategic Role of Cost Allocation 455 The Ethical Issues of Cost Allocation 456 Cost Allocation to Service and Production Departments 456
Departmental Approach 457

Life-Cycle Costing

376
378

The Importance of Design 377 The Use of Life-Cycle Costing in a Software Firm

Strategic Pricing Using the Product Life Cycle

379

Pricing Using the Cost Life Cycle 379 Strategic Pricing for Phases of the Sales Life Cycle 381 The Use of the Sales Life Cycle in Computer Manufacturing 381

Cost Allocation in Service Industries Joint Product Costing 470

468
471

Methods for Allocating Joint Costs to Joint Products

Summary 382 Appendix A: Using the Flow Diagram to Identify Constraints 382 Key Terms 384 Comments on Cost Management in Action 384 Self-Study Problem 384

Summary 475 Appendix A: By-Product Costing 475 Key Terms 478 Comments on Cost Management in Action 478 Self-Study Problem 478 Questions 478

Contents xxi

Brief Exercises 479 Exercises 480 Problems 481 Solution to Self-Study Problem

492

Fixed Overhead Cost Analysis 555 Interpretation of Fixed Factory Overhead Variances 558 Alternative Analyses of Factory Overhead Variances 559 Summary of Factory Overhead Variances 561

Recording Standard Factory Overhead Costs

562

PART FOUR
OPERATIONAL CONTROL 494 Chapter 13 The Flexible Budget and Standard Costing: Direct Materials and Direct Labor 494
Management Accounting and Control Systems Evaluating Operating Performance 495
Effectiveness 495

Journal Entries and Variances for Factory Overhead Costs 562 Variance Disposition 563

Standard Costs in Service Organizations 565 Overhead Variances in ABC Systems 568
ABC-Based Flexible Budgets for Control 569

495

Investigation of Variances 572

Type of Standard 572 Expectations of the Organization 572 Magnitude, Pattern, and Impact of a Variance Causes and Controllability 573 Company Practices 576

Standard Costs

497
497

572

Standard Costs versus a Standard Cost System Types of Standards 498 Selection of Standards 499 Sources of Standards 499 Standard-Setting Procedures 501 Establishing Standard Costs 501 Standard Cost Sheet 502

Flexible Budgets and Operational Control 504

The Flexible Budget 504 Assessing Efciency 505 Breakdown of the Total Flexible Budget Variance 507 Selling Price Variance 508 Variable Cost Flexible Budget Variances 508 Further Analysis of the Total Variable Cost Flexible Budget Variance 509

Summary 576 Appendix A: Variance Investigation Decisions Under Uncertainty 578 Key Terms 580 Comments on Cost Management in Action 580 Self-Study Problems 581 Questions 582 Brief Exercises 583 Exercises 583 Problems 593 Solutions to Self-Study Problems 606

General Model for Analysis of Variable Cost Variances 509

Direct Materials Variances 510 Direct Labor Variances 513 Timing of Variance Recognition 515 Effect of the New Manufacturing Technology 516

Chapter 15 The Flexible Budget: Further Analysis of Productivity and Sales 610
The Strategic Role of the Flexible Budget in Analyzing Sales and Productivity 610 Analyzing Productivity 612
Partial Productivity 613 Total Productivity 618

Behavioral and Implementation Issues 516 Summary 517 Appendix A: Recording Cost Flows and Variances in a Standard Cost System 519 Key Terms 522 Comments on Cost Management in Action 522 Self-Study Problems 523 Questions 524 Brief Exercises 525 Exercises 526 Problems 534 Solutions to Self-Study Problems 547

Analyzing Sales: Comparison with the Master Budget 619

Sales Volume Variance Decomposed: Sales Quantity and Sales Mix Variances 620 Sales Quantity Variance Decomposed: Market Size and Market Share Variances 624

Analyzing Sales: Comparison with Prior Year Results 627

Analysis of Selling Price and Volume Variances Analysis of Mix and Quantity Variances 629 Analysis of Variable Cost Variances 629 628

Chapter 14 The Flexible Budget: Factory Overhead 550

Standard Overhead Costs: Planning versus Control 551 Variance Analysis for Factory Overhead Costs 552
Variable Overhead Cost Analysis 552 Interpretation and Implications of Variable Overhead Variances 554

Summary 630 Key Terms 631 Comments on Cost Management in Action Self-Study Problems 631 Questions 632 Brief Exercises 633 Exercises 634 Problems 636 Solutions to Self-Study Problems 634

631

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Contents

Chapter 16 The Management and Control of Quality 648

The Strategic Importance of Quality 649
Baldrige Quality Award 649 ISO 9000 and ISO 14000 649 Quality and Protability: Conceptual Linkage 650 Empirical EvidenceDoes TQM Matter? 651

Problems 687 Solutions to Self-Study Problems

696

PART FIVE
MANAGEMENT CONTROL 698 Chapter 17 Management Control and Strategic Performance Measurement 698
Performance Evaluation and Control 699
Operational Control versus Management Control 699 Objectives of Management Control 699 Employment Contracts 700

Accountings Role in the Management and Control of Quality 652

Chapter Preview 652

Total Quality Management (TQM)

652

The Meaning of Quality 652 Characteristics of Total Quality Management 654 The Need for a New Accounting System 654

Design of Management Control Systems for Motivation and Evaluation 702

Informal Control Systems 703 Formal Control Systems 704

Comprehensive Framework for Managing and Controlling Quality 654

Knowledge of Business Processes 654 Role of the Customer 655 Financial Component 656 Nonnancial Performance Indicators 656 Feedback Loops 656 Relevant Cost Analysis 656 Link to Operations Management 656 Breadth of the System 656

Strategic Performance Measurement

Decentralization 704 Types of Strategic Business Units The Balanced Scorecard 706 705

704

Cost Strategic Business Units

706
706

Setting Quality-Related Expectations

657

Strategic Issues Related to Implementing Cost SBUs Implementing Cost SBUs in Departments 708 Outsourcing Cost SBUs 710 Cost Allocation 710

Setting Quality Expectations: A Six Sigma Approach 657 Setting Quality Expectations: Goalpost versus Absolute Conformance Standards 659 Goalpost Conformance 659 Absolute Quality Conformance 660 Goalpost or Absolute Conformance? 660

Revenue Strategic Business Units 711 Prot Strategic Business Units 712
Strategic Role of Prot SBUs 712 The Contribution Income Statement 713 Variable Costing versus Full Costing 714

Financial Measures and Costs of Quality

661

Relevant Cost Analysis 661 Cost of Quality (COQ) Reporting 662 Quality Cost Reports 664 Data Denition, Sources, and Collection 664 Report Format 665 Illustration of a Cost of Quality Report 665 COQ and Activity-Based Costing (ABC) 666

Nonnancial Quality Indicators

666

Internal Nonnancial Quality Metrics 666 External (Customer Satisfaction) Quality Metrics 667 Role of Nonnancial Performance Measures 667

Strategic Performance Measurement and the Balanced Scorecard 716 Management Control in Service Firms and Not-for-Prot Organizations 720 Summary 722 Key Terms 722 Comments on Cost Management in Action 722 Self-Study Problem 723 Questions 723 Brief Exercises 724 Exercises 725 Problems 727 Solution to Self-Study Problem 740

Detecting and Correcting Poor Quality

Detecting Poor Quality 668 Taking Corrective Action 670

668

Summary 673 Appendix A: Taguchi Quality Loss Functions 673 Key Terms 676 Comments on Cost Management in Action 677 Self-Study Problems 677 Questions 678 Brief Exercises 679 Exercises 680

Chapter 18 Strategic Investment Units and Transfer Pricing 742

Part One: Strategic Investment Units 743 The Strategic Role of Investment Units 743 Return on Investment 744
ROI Equals Return on Sales Times Asset Turnover 744 Illustration of Evaluation Using Return on Investment 744 Use of Return on Investment 747 Strategic Issues in Using Return on Investment 751

Contents xxiii

Residual Income

753
754

Limitations of Residual Income

Economic Value Added 755 Using Average Total Assets 755 Part Two: Transfer Pricing 756 When Is Transfer Pricing Important? Objectives of Transfer Pricing 757 Transfer Pricing Methods 758

756

International Transfer Pricing Objectives 757 Choosing the Right Transfer Pricing Method 758

Summary 801 Key Terms 801 Comments on Cost Management in Action Self-Study Problems 802 Questions 802 Brief Exercises 803 Exercises 803 Problems 807 Solutions to Self-Study Problems 816

801

International Tax Issues in Transfer Pricing

The Arms-Length Standard 761 Advance Pricing Agreements 762

761

Chapter 20 Capital Budgeting

818
819

Strategy and the Capital Budgeting Process

Summary 763 Key Terms 763 Comments on Cost Management in Action Self-Study Problems 764 Questions 764 Brief Exercises 764 Exercises 765 Problems 771 Solutions to Self-Study Problems 782

763

Underlying Nature of Capital Expenditures 819 Organizational Strategy and the Nature of Capital Investment Analysis 819 Effect of Capital Expenditures on Strategic Cost Drivers Chapter OverviewWhere Are We Headed? 821

820

The Role of Accounting in the Capital Budgeting Process 821

Linkage to Master Budget 821 Linkage to the Balanced Scorecard (BSC) 821 Generation of Relevant Financial Data for Decision-Making Purposes 823 Conducting Post-Audits 823

PART SIX
ADVANCED TOPICS IN COST MANAGEMENT 784 Chapter 19 Management Compensation, Business Analysis, and Business Valuation 784
Part One: Management Compensation 784 Types of Management Compensation 785 Strategic Role and Objectives of Management Compensation 786
Design the Compensation Plan for Existing Strategic Conditions 786 Risk Aversion and Management Compensation 786 Ethical Issues 787 Objectives of Management Compensation 787

Identication of Relevant Cash-Flow Data for Capital Expenditure Analysis 824

Why Focus on Cash Flows? 824 Cash FlowsA Framework for Analysis 825 Sample Data Set: Mendoza CompanyEquipment Replacement Decision 825 Determining After-Tax Cash Flows for Capital Investment Analysis 827 RecapCash Flow Information for the Mendoza Company Investment Proposal 832

Discounted Cash Flow (DCF) Capital Budgeting Decision Models 832

Types of Capital Budgeting Decision Models 832 DCF Models: Specifying the Discount Rate 832 Estimating the WACC 834 Net Present Value (NPV) Decision Model 836 Internal Rate of Return (IRR) Decision Model 837 Comparison of NPV and IRR Methods: Which to Use?

Bonus Plans 788

Bases for Bonus Compensation 788 Bonus Compensation Pools 790 Bonus Payment Options 790

839

Sensitivity Analysis 793

839

Tax Planning and Financial Reporting 792 Management Compensation in Service Firms Part Two: Business Analysis and Business Valuation 794 Business Analysis 795
The Balanced Scorecard 795 Financial Ratio Analysis 795

What-If Analyses 839 Scenario Analysis 841 Monte Carlo Simulation

841

Other Capital Budgeting Decision Models

Payback Period 842 Accounting (Book) Rate of Return 844

842

Behavioral Issues in Capital Budgeting

798

846

Business Valuation

798

The Discounted Cash Flow Method Multiples-Based Valuation 800 Enterprise Value 800

Common Behavioral Problems: Cost Escalation, Incrementalism, and Uncertainty Intolerance 846 Goal-Congruency Issues 847 Addressing the Goal-Congruency Problem 847

xxiv

Contents

Summary 848 Appendix A: DCF Models: Some Advanced Considerations 848 Key Terms 851 Comments on Cost Management in Action 851 Self-Study Problem 852 Questions 853 Brief Exercises 854 Exercises 855

Problems 858 Solution to Self-Study Problem

866

Present Value Tables Glossary Index 872 882

870

Cost Management
A Strategic Emphasis