Accounting Dec Making HI

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publishing as Prentice Hall 1-1

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Learning Why Accounting is Essential for
Objective 1
Decision Makers and Managers
Accounting information is used in

decision making for planning and
control.
Control is the process

Planning
of implementing plans
describes how the
and evaluating if
organization will
objectives are
achieve its
achieved.
objectives.
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Users of Accounting Information
Management Financial
Accounting Accounting
Develops
Process of identifying, information for
measuring, accumulating, external decision
analyzing, preparing, makers:
interpreting, and
communicating
Stockholders,
information used by:
Suppliers,
Banks, Government
Managers Authorities

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Learning
Objective 2 Roles of Accounting Information
Accounting Information System
Process of gathering, organizing, and

communicating financial information

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Roles of Accounting Information
Scorekeeping:
Evaluate
organizational
performance Attention Directing:
Compare actual
results to expected
Problem Solving:
Assess possible
courses of action

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Planning and Control
Accounting information helps managers

plan and control the organization’s operations.
Planning: Control:
Setting objectives Implementing plans
and outlining how and using feedback to
the objectives evaluate the attainment
will be obtained. of objectives.

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The Nature of Planning and Controlling

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Learning
Objective 3 Budget and Performance Reports
Budget: quantitative expression of a plan of action
Performance reports:
 compare actual results with budgeted amounts
 provide feedback by comparing results with plans
 highlight variances
Variances: deviations from plans

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Performance Reports
Mayfair Starbucks Store, March 31, 20X1
Budget Actual Variance

Sales $50,000 $50,000 0
Less:
Ingredients 22,000 24,500 $2,500 U
Store labor 12,000 11,600 400 F
Other labor 6,000 6,050 50 U
Utilities, etc. 4,500 4,500 0
Total expenses $44,500 $46,650 $2,150 U
Operating income $ 5,500 $ 3,350 $2,150 U
U= Unfavorable – actual exceeds budget

F – Favorable – actual is less than budget

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Influences on Accounting Systems
Generally accepted accounting principles (GAAP)
Foreign Corrupt Practices Act
Internal controls
Internal auditors Sarbanes-Oxley Act
Management audits
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Learning Cost-Benefit and Behavioral
Objective 4
Considerations
Cost-benefit Behavioral
balance implications
The system must provide accurate, timely budgets

and performance reports in a form useful to managers.
Managers must use accounting

Weigh estimated
reports, or the reports
costs against
create no benefits.
probable benefits.

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Product Life Cycle
Product life cycle refers to the various

stages through which a product passes.
No Sales Sales Growth Stable Sales Level Low sales  No sales
Product Introduction Phase out

Development to Market Mature Market Product

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Learning
Objective 5 The Value Chain
Product
Research
And
and
Service
Customer Development
or
Service Process
Design
Customer
Focus
Distribution Production
Marketing

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Accounting’s Position in the Organization
Management accountant’s role as consultant
Collects Prepares
and compiles standardized
information reports
Interprets and Is involved

analyzes information in decision making

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Line and Staff Authority
Line managers:
directly involved with Staff managers: Advisory –
making and selling support line managers.
products or services.
Cross-functional teams: Found in

modern, “flatter” organizations;
Functional areas work together
in decision-making process.

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Controller and Treasurer Function
Chief Financial Officer (CFO)
Controller Functions Treasurer Functions
 Provision of capital
 Planning for control
 Investor relations
 Reporting and interpreting
 Short-term financing
 Evaluating and consulting
 Banking and custody
 Tax administration
 Credits and collections
 Government reporting
 Investments
 Protection of assets
 Risk management
 Economic appraisal
(insurance)
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Learning Current Trends in
Objective 6
Management Accounting
Adaption to changes:
Shifting from a manufacturing-based

to a service-based economy
Increased global competition
Advances in technology
Changes in business processes

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Current Trends in Management
Accounting
The service sector now accounts for more

than 80% of the employment in the United
States.
Common characteristics of service

organizations
1. Labor is a major component of costs.
2. Output is usually difficult to measure.
3. Service organizations cannot store their
major inputs and outputs.

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Major Influences on Management
Accounting
Advances in technology:
E-commerce
Enterprise resource planning (ERP)
B2C and B2B
Business process reengineering:

Just-in-time (JIT) philosophy
Lean manufacturing
Computer-integrated manufacturing
Six sigma

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Five-Step Decision Process
1 Gathering information
2 Making predictions
3 Choosing an alternative
4 Implementing the decision
5 Evaluating performance
20
The Meaning of Relevance
 Relevant costs and relevant revenues are

expected future costs and revenues that differ
among alternative courses of action.
 Sunk costs are irrelevant because they are past
costs.
 Common fixed costs are irrelevant because
they are non-differential costs.
21
Quantitative and Qualitative
Relevant Information
 Quantitative factors are outcomes that are

measured in numerical terms:
– Financial
– Nonfinancial
 Qualitative factors are outcomes that cannot
be measured in numerical terms:
– Nonfinancial
22
One-Time-Only Special Order
 Decision criteria:
Accept the order if the revenue differential
is greater than the cost differential.
23
Make or Buy Decision
 Opportunity costs are not recorded in formal

accounting records since they do not generate
cash outlays.
 These costs also are not ordinarily
incorporated into formal reports.
24
Product-Mix Decisions Under
Capacity Constraints
 Decision criteria:
Aim for the highest contribution margin per
unit of the constraining factor.
 When multiple constraints exist, optimization
techniques such as linear programming can be
used in making decisions.
25
Equipment Replacement
 The book value of existing equipment is

irrelevant since it is neither a future cost nor
does it differ among any alternatives (sunk
costs never differ).
26
Decisions and Performance
Evaluation
 Managers often behave consistent with their short-run
interests and favor the alternative that yields best
performance measures in the short run.
 When conflicting decisions are generated, managers
tend to favor the performance evaluation model.
 Top management faces a challenge – that is, making
sure that the performance-evaluation model of
subordinate managers is consistent with the decision
model.
27
Time Horizon of
Pricing Decisions
 Two key differences when pricing for the

long run relative to the short run:
1 Costs that are often irrelevant for short-run
pricing decisions (fixed costs) are often
relevant in the long run.
2 Profit margins in long-run pricing decisions
are often set to earn a reasonable return on
investment.
28
Alternative Long-Run
Pricing Approaches
– Market-based
– Cost-based (also called cost-plus)
29
Target Price is...
– the estimated price for a product (or service)

that potential customers will be willing to pay.
 The target price, calculated using customer
and competitors inputs, forms the basis for
calculating target costs.
30
Target Costs
 Target sales price per unit

– Target operating income per unit
= Target cost per unit
31
Implementing Target Pricing
and Target Costing
 Steps in developing target prices and target

costs:
1 Develop a product that satisfies the needs of
potential customers.
2 Choose a target price.
3 Derive a target cost per unit.
4 Perform value engineering to achieve target
costs.
32
Value-Added Costs
 A value-added cost is a cost that customers

perceive as adding value, or utility, to a
product or service:
– Adequate memory
– Pre-loaded software
– Reliability
– Easy-to-use keyboards
33
Nonvalue-Added Costs
 A nonvalue-added cost is a cost that

customers do not perceive as adding value, or
utility, to a product or service.
– Cost of expediting
– Rework
– Repair
34
SHORT RUN PRODUCTION DECISIONS
 Managers have to make short-term production decisions on a continual

basis. Some of those production decisions are:
 Adding or dropping a product line. E.g. should GM add a new line of

SUV-Truck hybrids; should it drop its line of Pontiac-Aztek SUVs?
 Making or buying a component part. E.g. should Daimler-Chrysler

make the seats for its cars or should it outsource the seats to a supplier?
 Accepting or rejecting a special order. E.g. should Ford accept/reject a

special order from Hertz for a number of stripped down Ford Escorts?
 Deciding which product to make when facing an input/capacity

constraint. E.g. when there is a shortage of skilled labor, which type of
cars should GM primarily manufacture?
Identifying Relevant Costs
A relevant cost is a cost that differs between

alternatives.
An avoidable cost can be eliminated (in whole
or in part) by choosing one alternative over
another. Avoidable costs are relevant costs.
Unavoidable costs are irrelevant costs.
Two broad categories of costs are never relevant in

any decision and include:
Sunk costs.
Future costs that do not differ between the
alternatives.
Relevant Cost Analysis: A Two-Step Process
Step 1 Eliminate costs and benefits that do not differ

between alternatives.
Step 2 Use the remaining costs and benefits that do
differ between alternatives in making the
decision. The costs that remain are the
differential, or avoidable, costs.
Adding/Dropping Segments
One of the most important decisions managers

make is whether to add or drop a business
segment, such as a product or a store.
Let’s see how relevant costs should be
used in this type of decision.
Due to the declining popularity of digital watches,
Lovell Company’s digital watch line has not
reported a profit for several years. Lovell is
considering dropping this product line.
A Contribution Margin Approach
DECISION RULE
Lovell should drop the digital watch segment only if its
profit would increase. This would only happen if the
fixed cost savings exceed the lost contribution
margin.
Let’s look at this solution.

Segment Income Statement
Digital Watches
Sales $ 500,000
Less: variable expenses
Variable manufacturing costs $ 120,000
Variable shipping costs 5,000
Commissions 75,000 200,000
Contribution margin $ 300,000
Less: fixed expenses
General factory overhead $ 60,000
Salary of line manager 90,000
Depreciation of equipment 50,000
Advertising - direct 80,000
Rent - factory space 70,000
General admin. expenses 30,000 380,000
Net operating loss $ (80,000)
Investigation has revealed that total fixed general factory overhead
and general administrative expenses would not be affected if the
digital watch line is dropped. The fixed general factory overhead and
general administrative expenses assigned to this product would be
reallocated to other product lines.
The equipment used to manufacture digital watches has no resale value or

alternative use.
Should Lovell retain or drop the digital watch segment?

A Contribution Margin Approach
Contribution Margin
Solution
Contribution margin lost if digital
watches are dropped ?
Less fixed costs that can be avoided

Salary of the line manager ?
Advertising - direct ?
Rent - factory space ? -
Net (dis)advantage $ -
Comparative Income Approach
The Lovell solution can also be obtained by preparing

comparative income statements showing results with
and without the digital watch segment.
Let’s look at this second approach.

Comparative Income Approach
Comparative Income ApproachSolution
Keep Drop
Digital Digital
Watches Watches Difference
Sales $ 500,000 $ -
Less variable expenses: -
Manufacturing expenses 120,000 -
Shipping 5,000 -
Commissions 75,000 -
Total variable expenses 200,000 - -
Contribution margin 300,000 - -
Less fixed expenses:
General factory overhead 60,000
Salary of line manager 90,000
Depreciation 50,000
Advertising - direct 80,000
Rent - factory space 70,000
General admin. expenses 30,000
Total fixed expenses 380,000
Net operating loss $ (80,000)
The Make or Buy Decision
A decision to carry out one of the activities in

the value chain internally, rather than to
buy externally from a supplier is called a
“make or buy” decision.
The Make or Buy Decision: An
Example
 Essex Company manufactures part 4A that is used
in one of its products.
 The unit product cost of this part is:
Direct materials $ 9
Direct labor 5
Variable overhead 1
Depreciation of special equip. 3
Supervisor's salary 2
General factory overhead 10
Unit product cost $ 30
 The special equipment used to manufacture part 4A has

no resale value.
 The total amount of general factory overhead, which is
allocated on the basis of direct labor hours, would be
unaffected by this decision.
 The $30 unit product cost is based on 20,000 parts
produced each year.
 An outside supplier has offered to provide the 20,000
parts at a cost of $25 per part.
Should we accept the supplier’s offer?

Cost
Per
Unit Cost of 20,000 Units
Make Buy
Outside purchase price $ 25
Direct materials $ 9
Direct labor 5
Variable overhead 1
Depreciation of equip. 3
Supervisor's salary 2
General factory overhead 10 -
Total cost $ 30 $ - $ -
Should we make or buy part 4A?

Opportunity Cost
An opportunity cost is the benefit that is foregone as a result of

pursuing some course of action.
Opportunity costs are not actual dollar outlays and are not recorded
in the formal accounts of an organization.
How would this concept potentially relate to the Essex Company?

Decision To Make/Buy An Input
Problem – Berta Inc. is a manufacturer of quality mattresses with an annual production and
sales of 10,000 units. Berta currently makes it own spring assemblies but has received an
offer from a supplier to furnish the springs for $48. Berta’s costs of production are as
follows:
Cost per Total costs

spring set
Direct materials $16.00 $160,000
Direct labor $3.50 $35,000
Variable overhead $4.50 $45,000
Fixed overhead $28.00 $280,000
TOTAL $52.00 $520,000
30% of the fixed overhead is traceable to the spring assemblies and the rest is general
overhead that is allocated to each unit.
1. Suppose the company has no alternative use for and cannot rent out the production space
used for making the springs. Should it outsource the springs?
2. Suppose the company can use the production space for springs as a warehouse, replacing
the warehouse it currently rents for $180,000. Should it outsource the springs?
Decision To Make/Buy An Input
Make part Buy part

Revenues: we don’t know anything about the revenues,
though we can assume they are the same in both
cases. We will focus on the costs.
Costs
Costs of purchase
DM
DL
VOH
FOH
Total costs
Key Terms and Concepts
A special order is a one-time order that is not

considered part of the company’s normal ongoing
business.
When analyzing a special order, only the

incremental costs and benefits are relevant.
Accept or Reject Special Order
Note: In the decision making problems that follow we will ignore: (1) all factors not
explicitly given in the problem, (2) the time value of money
Decision To Accept/Reject A Special Order
Problem – Vince Pasta Inc. makes a fancy variety of fresh pasta which it sells for $3/lb.
Vince currently uses 50% of its capacity, producing 150,000 pounds of pasta annually. Vince
recently received an offer from a chain restaurant to supply 100,000 pounds of pasta at $2.20
per pound. Vince budgeted production costs at 150,000 and 250,000 pounds are as follows:
Production quantity 150,000 lb. 250,000 lb.
Direct materials ($0.8/lb.) $120,000 $200,000

Direct labor (0.6/lb.) $90,000 $150,000
Factory overhead* $210,000 $250,000
TOTAL COSTS $420,000 $600,000
Cost per pound $2.8/lb. $2.4/lb.

*
Variable factory OH is $0.4/lb. and fixed factory overhead is $150,000
The company does not expect to receive any additional orders in the near future. The sales
manager wants Vince to accept the order but the production manager does not. The
production manager argues that the order would cause a loss of $0.20 per pound. Should
Vince accept the special order?
 Incremental Approach:
Status quo: making 150,000 lb. egg noodles
New project/activity: special order to make
100,000 lb. of additional noodles.
 Incremental benefits:
 Incremental costs:
Additional DM
Additional DL
Additional VOH
Total:
If Vince had a maximum capacity of 200,000 lb., should it accept the special
order? Assume this is an all or nothing order; Vince either provides all of the
100,000 pounds or none.
Note that now we have opportunity costs. The opportunity costs are the
benefits forgone from not selling 50,000 lb. to regular customers.
 Incremental Approach:
Status quo: making 150,000 lb. egg noodles
New project/activity: special order to make 100,000 lb. of additional
noodles.
 Incremental benefits:
increase in revenue:
 Incremental costs:
Additional DM
Additional DL
Additional VOH
Opportunity costs of 50,000 lb.
Total:
Utilization of a Constrained Resource
Key Terms and Concepts
• When a limited resource of some type restricts the

company’s ability to satisfy demand, the company is said to
have a constraint.
• The machine or process that is limiting overall output is
called the bottleneck – it is the constraint.
 When a constraint exists, a company should select a product
mix that maximizes the total contribution margin earned
since fixed costs usually remain unchanged.
 A company should not necessarily promote those products
that have the highest unit contribution margin.
 Rather, it should promote those products that earn the
highest contribution margin in relation to the constraining
resource.
An Example
Ensign Company produces two products

and selected data are shown below:
Product
1 2
Selling price per unit $ 60 $ 50
Less variable expenses per unit 36 35
Contribution margin per unit $ 24 $ 15
Current demand per week (units) 2,000 2,200
Contribution margin ratio 40% 30%
Processing time required
on machine A1 per unit 1.00 min. 0.50 min.
An Example
 Machine A1 is the constrained resource and is being

used at 100% of its capacity.
 There is excess capacity on all other machines.
 Machine A1 has a capacity of 2,400 minutes per
week.
Should Ensign focus its efforts on

Product 1 or 2?
An Example
The key is the contribution margin per unit of the

constrained resource.
An Example
The key is the contribution margin per unit of the

constrained resource.
Product
1 2
Contribution margin per unit $ 24 $ 15
Time required to produce one unit ÷ min. ÷ min.
Contribution margin per minute
An Example
Alloting Our Constrained Resource (Machine A1)
Weekly demand for Product 2 2,200 units

Time required per unit × 0.50 min.
Total time required to make
Product 2 min.
Total time available min.

Time used to make Product 2 min.
Time available for Product 1 - min.
Joint Products – Sell or Process further
The decision is whether to sell the joint products at the split-

off point or to process them further and then sell
Joint costs – costs of simultaneously producing two or more
products, called joint products, that must, by the nature of
the process, be produced together.
Examples of joint products: Oil and gas, hamburger and steaks
Split-off point – the point in the production process at
which the joint products become distinct or separate items
Note: In joint products problems where a company has to
decide whether to process joint products further beyond the
split-off point, the costs incurred up to the split-off point are
sunk and hence are irrelevant. Any attempt to allocate such
costs to joint products and to consequently factor them into
the decision process would lead to imprudent production
decisions.
Example: Incur $2,000 in costs

and sell for $11,000
Get it painted and

Buy a new car Current market install new stereo
for $20,000 value is $8,000
You can sell as is
This is the
split-off point Get $8,000
Example: Incur $2,000 in costs

and sell for $11,000
Get it painted and

Buy a new car To answer
Current question of sellinstall
the market as isnew
or stereo
for $20,000 process
value
further,
is $8,000
you need to examine the
incremental costs and incremental benefits
You can sell as is
This is the
split-off point Get $8,000
Problem – Bass Chemicals Inc. produces three chemicals: Acetox, Denox, and Pectix through
one joint process costing $80,000. These chemicals can all be sold at the split-off point or
processed further and sold at a higher price.
Sales value at Additional costs of Sales value
split-off point processing further if processed further
Acetox $50,000 $23,000 $65,000
Denox $25,000 $44,000 $82,000
Pectix $85,000 $93,000 $184,000
Which of the products should be processed further and which ones should be sold at the split
of point?
If the joint processing costs were $120,000, would you change your answer?

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Accounting Dec Making HI

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Copyright © 2014 Pearson Education, Inc.

publishing as Prentice Hall 1-1

Accounting information is used in

Control is the process

Copyright © 2014 Pearson Education, Inc. publishing as Prentice Hall 1-2

Copyright © 2014 Pearson Education, Inc. publishing as Prentice Hall 1-3

Accounting Information System

Process of gathering, organizing, and

Copyright © 2014 Pearson Education, Inc. publishing as Prentice Hall 1-4

Copyright © 2014 Pearson Education, Inc. publishing as Prentice Hall 1-5

Accounting information helps managers

Copyright © 2014 Pearson Education, Inc. publishing as Prentice Hall 1-6

Copyright © 2014 Pearson Education, Inc. publishing as Prentice Hall 1-7

Budget: quantitative expression of a plan of action

Variances: deviations from plans

Copyright © 2014 Pearson Education, Inc. publishing as Prentice Hall 1-8

Mayfair Starbucks Store, March 31, 20X1

Budget Actual Variance

U= Unfavorable – actual exceeds budget

Copyright © 2014 Pearson Education, Inc. publishing as Prentice Hall 1-9

Generally accepted accounting principles (GAAP)

Foreign Corrupt Practices Act

Internal auditors Sarbanes-Oxley Act

Copyright © 2014 Pearson Education, Inc. publishing as Prentice Hall 1 - 10

The system must provide accurate, timely budgets

Managers must use accounting

Copyright © 2014 Pearson Education, Inc. publishing as Prentice Hall 1 - 11

Product life cycle refers to the various

No Sales Sales Growth Stable Sales Level Low sales  No sales

Product Introduction Phase out

Copyright © 2014 Pearson Education, Inc. publishing as Prentice Hall 1 - 12

Copyright © 2014 Pearson Education, Inc. publishing as Prentice Hall 1 - 13

Management accountant’s role as consultant

Interprets and Is involved

Copyright © 2014 Pearson Education, Inc. publishing as Prentice Hall 1 - 14

Cross-functional teams: Found in

Copyright © 2014 Pearson Education, Inc. publishing as Prentice Hall 1 - 15

Chief Financial Officer (CFO)

Controller Functions Treasurer Functions

Shifting from a manufacturing-based

Increased global competition

Changes in business processes

The service sector now accounts for more

Common characteristics of service

Copyright © 2014 Pearson Education, Inc. publishing as Prentice Hall 1 - 18

Business process reengineering:

Copyright © 2014 Pearson Education, Inc. publishing as Prentice Hall 1 - 19

 Relevant costs and relevant revenues are

 Quantitative factors are outcomes that are

 Opportunity costs are not recorded in formal

 The book value of existing equipment is

 Two key differences when pricing for the

– the estimated price for a product (or service)

 Target sales price per unit

 Steps in developing target prices and target

 A value-added cost is a cost that customers

 A nonvalue-added cost is a cost that

 Managers have to make short-term production decisions on a continual

 Adding or dropping a product line. E.g. should GM add a new line of

 Making or buying a component part. E.g. should Daimler-Chrysler

 Accepting or rejecting a special order. E.g. should Ford accept/reject a

 Deciding which product to make when facing an input/capacity

A relevant cost is a cost that differs between

Two broad categories of costs are never relevant in