Management AC66iirifin 9 :

I nformation that Creates Value

QUESTIONS

1-1 The three broad classes of organization decision making are planning, organizing, and controlling. Planning includes strategy development (which requires information about the organization's competitive environment, including information about its target customers), production planning (which requires information about production capabilities and resources required for various products), and product planning (often based on prospective cost and revenue information). Organizing refers to activities that focus on how an organization will implement its plans by developing systems to develop, produce, and deliver the organization's goods or services. Common information requirements include prospective data on costs, efficiency, and quality associated with alternative ways to produce or provide goods or services. Controlling activities focus on assessing how well the organization is achieving its objectives. Common information requirements include costs, quality,

A company's operators, managers, and executives need information for their operational control and improvement activities, as well as on the performance of their individual processes, products, services, and customers. This

information is important to direct managers' attention to areas where improvement is needed, to provide feedback on activities, and to monitor and evaluate the performance of operators, departments, divisions, and business units and their managers. This information should be created and produced based on the internal need for operational and strategic information.

Shareholders and external suppliers of capital are not involved in managing the business or establishing and validating the company's strategy. Therefore, they do not need the timely and dis aggregate information generated for internal managerial uses. External capital suppliers will receive less timely (typically quarterly for shareholders, monthly for creditors) and more aggregate

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Atkinson, Solution Manual t/a Management Accounting, 5£

information. Also the form and accounting procedures used to prepare these external reports are constrained by regulation-such as by the country's standard setting authorities and governmental regulatory agencies. This information may also have to be audited by independent accountants, whereas the data for internal uses do not have to be subjected to external auditing review.

Another constraint on information supplied externally is the risk of competitors seeing and acting upon a company's disclosed information. Therefore, while internal information should be highly relevant about the success of the company's strategy, such information disclosed externally could harm the company.

1-3 Operators need direct measures on variables they can influence and control.

These generally are physical measures of outputs produced and input resources used to produce the outputs (including productivity measures such as percentage of good units produced). In addition, operators should be seeing measures of the quality of their output (defects, scrap, and rework) and the time required to produce the output. In this way, they can become problem solvers and attempt to improve quality, productivity, and cycle times of their tasks and activities. Financial measures are a summary of the effectiveness and efficiency (or lack thereof) of operators' actions, but by themselves do not direct attention to the drivers of improved financial performance or the root causes of poor financial performance. Operators need leading measures of performance, and financial measures tend to be lagging measures of performance.

Middle managers, while generally seeing more financial information than operators, will also need to see summary measures about outputs produced (first-pass yields, productivity), quality (scrap, rework, defect rates) and cycle times if they are going to motivate employees for continuous improvement of yields, quality and production process times. The middle managers will also want to see operating summaries of the performance of their operations from their customers' perspectives (including internal customers), such as measures of on-time delivery, quoted and actual lead times for delivery, returns due to defects or dissatisfaction, and customer satisfaction. They may also want periodic summaries about their employees' attitude, skills, number of suggestions made, absenteeism, turnover, etc.

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1-6

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Chapter 1: Management Accounting: Information that Creates Value The four generic elements of an organization's value proposition are:

• Price-the price paid by the customer

• Quality-the degree of conformance between what the customer is promised and what the customer receives

• Functionality and features-the performance of the product

• Service-all other elements of the product relevant to the customer

1-7 An effective management accounting system should capture, track, and report value proposition measures that are leading indicators of financial performance. Examples of such measures include percentage of on-time deliveries, percentage of customer complaints, and defect rates.

1-8

Basically, little difference exists in the information needs between manufacturing and service organizations. Both require information for cost control and efficiency improvements; and both require accurate information about the cost and profitability of their outputs. The difference in information needs is perhaps mainly that service organizations need to be especially customer focused since customers deal directly with the organization. For example, it may not be sufficient to just know the costs and profitability of an individual service-like a checking account, a residential phone line, an overnight delivery, or an outpatient visit. Different customers can use the same basic service in many different ways, creating quite different demands on the organization's resources. Therefore, the company should really try to

ll.fl.d~r~t~~~..:~~ ~.?~t~l,l4J3~8ilt5l1:?Jli~ .. ~Q¥~,jndi¥idualcustomer or, at least,

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Also because customers deal directly with the organization, it becomes even more important to have customer-based operating measures. These could include customer satisfaction surveys, complaint incidents and percentages, order lead times, and process cycle times. In many service organizations (retailers, hotels, car rental agencies, some transportation companies, and retail banks, for example), customers come into contact with some of the organization's lowest paid employees. Therefore, employee morale, employee training, and employee skill measures will be critical indicators of service companies' long-run success.

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Chapter 1: Management Accounting: Information that Creates Value Organizational leadership plays a pivotal role in developing a culture of high ethical standards. In further support of high ethical standards, companies can

;''''''''i.''''''''~-·· _. .usebeliefs systems .and boundary systems, A belief system is descriptive and

__ -,-pwvides_anexplicitsetofstatements, communicated to employees, of the broad goals for organization behavior. Because belief systems may not effectively communicate what behavior and actions are unacceptable, organizations also

,.,·.:iiq=:::::.:;.::.;.. ;;;:.:.'" need boundary systems that are stated in negative terms, or in minimal

standards of behavior. Boundary systems communicate what actions are .. ' ... , .. ":""' __ ''''_ ..forbidden, such as violations of customers' or clients' privacy, and spying on --·· .... · .. '··-"-::·~:~~.~.·~QQmpetitors. Boundary systems also communicate the laws under which the

~~~~. '-'-" -----organization operates. Belief systemsarrdboumlary systems should be clearly communicated throughout the organization, and management should respond decisively when standards are violated.

Corporate governance deals with promoting achievement of the organization's stated objectives. Partly in response to recent corporate frauds and financial

r~1~~~~~~~~~;:;;c,:; .. ,;.<scandals, senior management must now ensure that it focuses attention on a r' """"FP1T1 of good internal controls, including controls that promote and monitor

compliance with the organization's stated code of ethics. Management accounting includes control, that is, focus on assessing how well the organization is achieving its objectives. Therefore, management accountants will increasingly become involved in designing systems these systems of

f=;;~?:::;:~1.,~i:Z2~:222:--=-~.:'~ i control and monitoring compliance with the controls.

~1~~~~~J~~~~~~~~~i~~i~~~~1~~I~~~~J;~~~i~~~~:;~~:~~~:~~:~~~scope of

~.; ... .L.L.~uEo information, cross-functional interaction

u."""~F.UH.lF. management accounting information systems, and the range of

needed skills and knowledge in today's business environment.

.

= .... _, .. ·, .. ,,····,,":Accounting" conveys a notion of recording and reporting for stewardship, or

accountability for use of assets or incurrence of expenses. Accurate, timely, and relevant information about the economics and performance of organizations is crucial to organizational success or good stewardship over entrusted assets. Management accounting information is one of the . primary informational sources for decision making, improvement, and control in organizations. Effective management accounting systems can' create considerable value to organizations by providing timely and accurate information about the activities required for their success. Traditionally, management accounting information that helped support decision making and efficient use of resources was primarily financial. In recent times, management accounting information has

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Chapter 1: Management Accounting: Information that Creates Value have a clear defmition of its mission and its targeted customer base. With such a mission and a targeted set of constituencies, it can then formulate objectives and measures to motivate and focus employees towards achieving organizational obj.edives.,Exp-ost,_the,agency,canmeasure the outcomes from its activities to see whether it has delivered on its mission and objectives.

A comprehensive performance measurement system for a government or nonprofit agency can include such financial measures as operating expenses as a targeted percentage of total funds raised or disbursed. For nonprofits, the financial perspective could also include measurement of funds raised relative to targeted amounts, and increases in contributions per donor.

The performance measurement system can also include measures of interest to the specific beneficiaries of the agency or the donors who provide funds for the agency. Consider a group like the Nature Conservancy or the Sierra Club. From the perspective of donors to these organizations (the customers), performance on objectives can be measured, for example, by acres preserved and species protected. United Way organizations may measure improvements in the local community served by the number of agencies supported by United Way. One would need to think about objectives and measures for both the providers of funds to the organization (taxpayers or donors) and the recipients of the services provided by the organization.

The performance measurement system can also include measures to monitor the business processes required to meet the objectives of donors (or taxpayers) and beneficiaries. Such objectives could include high quality delivery of services,

<"'~"""""""'T"T"'TF§P.~¥d,yc .' .and, .... ze!Q.,.":d~~J~,ct.,,~r~e.$.:nQ,I).sM~7JQC',,,q.qIlQ~~~anci~beIle,fiqiaries., innovative .C' ••. '." .•••...• ,;J;;i~tJf.LIi.;i,;)~'~;;;,":;,';·',;1;get;Vic:es',to"r~riecIpients,"'anarec'ognItl0nof dOllors 'and" vo lunteers.

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Finally, the performance measurement system can include measures on learning, growth, and innovation. Relevant objectives include improving the skills and motivation of employees, and improving access to information about donors, beneficiaries, and volunteers.

1-27 (a) The article's reported improprieties include the following:

..

Booking sales to fake companies for products that did not exist Booking revenue on products sold but shipped after the close of the fiscal period

Booking revenue for products shipped before customers wanted them Failure to reverse sales when customers returned goods

..

..

..

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Atkinson, Solution Manual tla Management Accounting, 5E

• Paying distributors "handling fees" to accept products that sometimes had unlimited rights of return, and then booking the products. as sales.

.. .' BackdatrrrgJune paperwork to May (in anticipation that the

auditors would only be concerned with June, the last month of the fiscal year)

(b) The article reports the improprieties were widely known, from managers to "low-level workers." It was known that memos titled "delayed shipment" referred to fake sales. Even low-level workers joked about the fraud. The credit accountant said management directed her to destroy documents and prepare false documents. Ultimately, managerial alarm at the magnitude of fake revenue led to the large write-off of accounts receivable.

(c) The article reports that the former auditor informed management of the company's material internal control weaknesses. Management accountants and ether members of the management team have responsibility for ensuring appropriate internal controls are in place, including procedures for properly recording revenue. In a related vein, the audit committee is best composed of outside directors, unlike the company's previous situation with the company chairman on the audit committee.

The management team faces the challenge of developing strategies and goals that support the company's mission. In meeting this challenge, management must develop performance measurements and goals with an

:.''':"C7'''=CC;::;''::7c=~ .. '.' .•• '> Ul1,cl~rs.t8:IldBlgg~~~~~~if:".,119s~.tg!,~..-~~g!g.1g~ti.()p,~~~!!~.!g.i~. case, pressure

.:;.,,;.t.:,:;;,;;:;t;::~···;·:~~;:~:;;:~:;~':'·!g¢pera:tea:';fu)F '''th:i:t':; repOrtect·····aggressive .. revenue goals apparently

contributed to "ever-easier definitions of a sale."

Top management should clearly communicate its ethical standards through explicit beliefs systems that specify the company's values. Managers should model the company's desired ethical standards. In addition, the company should develop boundary systems that specify actions that must not be taken. In this case, specified prohibited actions should include falsifying documents and resumes.

1-28 (a) One recent example is reported in "Ex-Executives Charged in Ahold

Case: Vendors of Food, Supplies Allegedly Inflated Rebates to Aid Accounting Scheme," by K. Scannell and D. Solomon (The Wall Street Journal, January.l-i, 2005), p. A3. The article reports that U.S. Foodservice inflated promotional allowances from vendors by millions of dollars, thereby reducing U.S. Foodservice's cost of goods sold and inflating earnings. The fraud was made

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I"

L!i

CostManaqement Concepts and Cost Behavior

QUESTIONS

2-1 Cost information is used in deciding whether to introduce a new product or discontinue an existing prod.uct (given the price and cost structure), assessing the efficiency of a particular operation, and budgeting. Cost information is also used for the valuation of inventory and cost of goods sold.

2-2 Different types of cost information are needed for different managerial purposes and decisions. For example, product cost information is used for product mix and pricing decisions. The cost of serving customer segments will include the cost of activities that support customer service. For management control purposes, an organization may compare actual costs to budgeted (standard) costs.

2-3 A cost object is something for which it is desired to compute a cost. Examples ~~~~~~~~~~~~~~n~~~r~0~~z~~'oohru~ ~ "Co':; "'~I:: .. :':.~:.'.':-.:-~H;~t:;:;~;2~f·\tks;tNe,?6ill;j\b~htertH~t'iesp()nds to customers' phone calls.

2-4 A direct cost is a cost of a resource or activity that is acquired for or used by a single cost object and is easily traced to the cost object, such as a product manufactured or service rendered. An indirect cost is the cost of a resource that was acquired to be used by more than one cost object. Indirect costs cannot be easily identified with individual cost objects.

2-5 Variable costs are the costs of variable resources, whose costs are proportional to the amount of the resource used. Fixed costs are the costs of capa.city-related resources, which are acquired and paid for in advance of when the work is done. Fixed costs depend on how much of the resource (capacity) is acquired, rather. than on how much is used. Depreciation on machinery is an example of a fixed cost.

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Atkinson, Solution Manual tla Management Accounting, 5E Variable

Fixed or variable (if number of production workers can vary in the short run)

Fixed

Variable

Fixed

Fixed

Variable

Variable

Fixed

Fixed

2-26 (a)
(b)
, (c)
(d)
(e)
(f)
(g)
(h)
(i)
U)
2-27 (a) Let P = charges per patient-day.

(2,300 x P) - (45.70 x 2,300) - 91,000) = 0 P = $196,110) 2,300 = $85.27

(b) Let X = the average number of patient days per month necessary to generate a target profit of $45,000 per month

Revenue - Costs = Income

(Price x Quantity) - Variable costs - Fixed costs = Income $100X - $45.70X - $91,000 = $45,000

$54.30X= $91,000 + $45,000 = $136,000

X = 2,505 patient days (rounded)

Contribution margin per unit = $30 - $19.50 = $10.50

(b) LetX= the number of units sold to break even Sales revenue - Costs = Income

(Price x Quantity) - Variable costs - Fixed costs = Income $30X - $19.50X - $147,000 = $0

$10.50X - $147,000 = °

X = 14,000 units

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2-30 (a) Alligators Do12hins Total
Units sold 140,000 60,000 200,000
Sales mix
percentage* .7 .3
fl'" Sum of
..... ",. Weighted Weighted weighted
average * * average * * averages
Sales price
per unit $20.00 $14.00 $25.00 $7.50 $21.50
Variable costs
per unit $ 8.00 $ 5.60 $10.00 $3.00 $ 8.60
UnitCM $12.00 $ 8.40 $15.00 $4.50 $12.90 * 140,000/(140,000 + 60,000) = .7; 60,0001(140,000 + 60,000) =.3 ** $20 x .7 = $14; $8 x .7 = $5.60; $25 x .3 = $7.50; $10 x .3 = $3

:1'

Breakeven units = $1,290,0001$12.90 = 100,000 units. Of these, 100,000 x .7 = 70,000 will be alligators and 100,000 x .3 = 30,000 will be dolphins.

Total
140, 200,000
Sales mix
percentage* .3 .7
Sum of
Weighted Weighted weighted
average * * average** averages
Sales price
per unit $20.00 $6.00 $25.00 $17.50 $23.50
Variable costs
per unit $ 8.00 $2.40 $10.00 $ 7.00 i.2..40
UnitCM $12.00 $3.60 $15.00 $10.50 $14.10 * 60,000/(140,000 + 60,000) = .3; 140,000/(140,000 + 60,000) = ,7 ** $20 x .3 = $6; $8 x .3 = $2.40; $25 x .7 = $17.50; $10 x .7 = $7

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Chapter 2: Cost Management Concepts and Cost Behavior

Breakeven units = $1,290,000/$14.10 = 91,489.36, which we round up to 91,490 units. Of these, 91,490 x .3 = 27,447 will be alligators and 91,490 x .7= 64,043 will be dolphins.

(c) In part (b), the sales mix percentage for the higher-Clvl product (dolphins) is greater than in part (a). Consequently, fewer total units are required to break even (91,490 in part (b) versus 100,000 in part (a)).

2 .. 31 (a) Healthy Hearth hassufficient excess capacity to handle the one-time (short-run) order for 1,000 meals next month. Consequently, the analysis focuses on incremental revenues and costs associated with the order:

Incremental revenue per meal Incremental cost per meal

Incremental contribution margin per meal Number of meals

Increase in contribution margin and operating income

$3.50 3.00 $0.50 x 1,000 $ 500

Healthy Hearth will be better off by $500 with this. one-time order. Note that total fixed costs remain unchanged, so it is sufficient to evaluate the change in the contribution margin. If the order had been long-term, Healthy Hearth would need to evaluate whether the price provides the desired profitability considering the fixed costs and whether filling the' government order might require giving up higher-priced regular sales.

(b) Healthy Hearth has insufficient excess capacity to handle the one-time

""'"",.".,.r;;:i'ZC'~;~~~:+t9t).ft:;~~~?~:;m~~~i~:fJl!;~~t~imQl1tb"'rand."'FnlJst-.:gi¥e,uf},·regular sales of 500

,,"; ··ffi~:al§'t:~¥;i$2r.;5d·;e~dh, resulting in an opportunity cost.

Incremental contribution margin from one-time order Incremental revenue per meal

Incremental cost per meal

Incremental contribution margin per meal Number of meals

Increase in operating income from one-time order

$3.50

3.00 $0.50 1,000 $ 500

r

i

Opportunity cost

Lost contribution margin on regular sales: 500 x ($4.50 - $3.00) $(750)

Change in contribution margin and operating income

$(250)

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2-35 (a)

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Chapter 2: Cost Management Concepts and Cost Behavior

Direct material cost:

• Cost of fabric used in dresses Direct Iaborcost;

• Wages of dressmakers

• Wages of dress designers Manufacturing support:

• Wages of the employee who repairs the shop's pattern and sewing machines

• Cost of electricity used in the Pattern Department

• Depreciation on pattern machines and sewing Machines

• Cost of insurance for the production employees (could instead be included under direct labor cost)

• Rent for the building (6,000 x 112) Selling costs:

• Wages of sales personnel

• Rent for the building (6,000 x 114) Marketing costs:

• Cost of new sign in front of retail shop

• Cost of advertisements in local media

• Cost of hiring a plane and a pilot to advertise R& D costs:

• Wages of designers who experiment with new

;';';~:-~~hgt~f~~aa~i~f!~TI~!;~~~ts-:"'-"";-;:;~7-

• Salary of the owner's assistant

• Rent for the building (6,000 x 114)

Total costs

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$5,000 4,000

2,000

200

10,000

2,000 3,000

1,000 1,500

400 800 1,400

1,200 1,500

$60,000

9,000

17,200

2,500

2,600

3,000

2,700 $97,000

Atkinson, Solution Manual t/a Management Accounting, 5E

(b) Classifications in this question may depend on the interpretation of the production and selling processes, and assumptions about how various costs are related to activities.

U nit-related cost:
• Cost of fabric used in dresses $60,000
• 'WCiges ofdress1l1a.kers 5,000
• Wages of dress designers 4,000
• Depreciation on pattern machines and sewing
machines (depreciation on pattern machines
could be included in product-sustaining
cost) 101000 79,1000
Batch-related cost:
e Wages of sales personnel (could also be
classified as unit-related if customers
generally purchase only one dress at a time) 1,1000
Product-sustaining cost:
• Cost of electricity used in the Pattern
Department 200
• Wages of designers who experiment with
new fabrics and dress designs 3,000 3,200
Business-sustaining cost:
• Wages of the employee who repairs the
pattern and sewing machines 2,000
• Salary of the owner's assistant 1,200
• Cost of new sign in front of retail shop 400
• Cost of advertisements in local media 800
• Cost of hiring a plane and a pilot to advertise 1,400
• Cost of insurance for the production
Employees 2,000
• Rent for the building 61000 131800
Total costs $971000 -42-