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Fundamentals of

Cost Accounting
2e
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Fundamentals of
Cost Accounting
2e
William N. Lanen
University of Michigan
Shannon W. Anderson
Rice University
Michael W. Maher
University of California at Davis
Boston Burr Ridge, IL Dubuque, IA 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
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FUNDAMENTALS OF COSTACCOUNTING
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 WCK/WCK 0 9 8 7
ISBN 978-0-07-352672-0
MHID 0-07-352672-X
Editorial director: Stewart Mattson
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Library of Congress Cataloging-in-Publication Data
Lanen, William N.
Fundamentals of cost accounting / William N. Lanen, Shannon W. Anderson,
Michael W. Maher.2e.
p. cm.
First ed. has Michael Mahar as rst author.
Includes index.
ISBN-13: 978-0-07-352672-0 (alk. paper)
ISBN-10: 0-07-352672-X (alk. paper)
1. Cost accounting. I. Anderson, Shannon W. II. Maher, Michael, 1946-
III. Maher, Michael, 1946-Fundamentals of cost accounting. IV. Title.
HF5686.C8M224 2008
657'.42dc21
2007022813
www.mhhe.com
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Dedication
To my wife, Donna, and my children, Cathy and Tom, for
encouragement, support, patience, and general good cheer
throughout the years.
Bill
I dedicate this book to my husband Randy, my children
Evan and David, and my parents, Max and Nina Weems.
Your support and example motivate me to improve. Your
love and Gods grace assure me that it isnt necessary.
Shannon
I dedicate this book to my children, Krista and Andrea, and
to my extended family, friends, and colleagues, who have
provided their support and wisdom over the years.
Michael
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Assurance of Learning Ready
Many educational institutions
today are focused on the notion
of assurance of learning, an im-
portant element of some accred-
itation standards. Fundamentals of Cost Accounting is designed
specically to support your assurance of learning initiatives with a
simple, yet powerful, solution.
McGraw-Hill Companies is a proud corporate member of AACSB
International. Recognizing the importance and value of AACSB
accreditation, the authors of Fundamentals of Cost Accounting,
2e, have sought to recognize the curricula guidelines detailed in
AACSB standards for business accreditation by connecting se-
lected questions in Fundamentals of Cost Accounting with the
general knowledge and skill guidelines found in the AACSB stan-
dards. It is important to note that the statements contained in
Fundamentals of Cost Accounting are provided only as a guide for
the users of this text.
The AACSB leaves content coverage and assessment clearly
within the realm and control of individual schools, the mission of
the school, and the faculty. The AACSB does also charge schools
with the obligation of doing assessment against their own content
and learning goals. While Fundamentals of Cost Accounting and
its teaching package make no claim of any specic AACSB qual-
ication or evaluation, we have, within the Instructors Manual
and Test Bank that accompany Fundamentals of Cost Accounting
identied selected questions according to the six general knowl-
edge and skills areas. There are, of course, many more within the
test bank, text, and the teaching resources that might be used as a
standard for your course. However, the labeled questions are
suggested for your consideration.
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Letter from the Authors
As the second edition of Fundamentals of Cost Accounting goes to press, we want to
take a moment to thank you for the success of the rst edition, and to introduce our new
coauthor, Shannon Anderson.
Our mission in writing Fundamentals of Cost Accounting is to help students develop
an intuition about how to think about decisions using cost information. If they do so, they
will be better consumers of cost information (as managers) and better preparers of cost
information (as accountants). We believe Fundamentals of Cost Accounting helps instruc-
tors convey the usefulness of cost accounting information in decision making through
examples, illustrations, problems, and cases based on actual experience.
In the rst edition, our goal was to bring a fresh and contemporary approach to present-
ing cost accounting concepts. We wrote a text that would engage students with modern
examples reective of how business is done today and not forty years ago. We were hum-
bled that so many of our colleagues agreed with us and selected Fundamentals of Cost
Accounting for their students. We were cited for clarity of writing, focus on the concepts that
students needed, and good problemmaterial. In preparation for the second edition, over 100
of you participated in reviews of the rst and second edition manuscript, and many also par-
ticipated in the focus group we held. We are truly grateful for the generous amount of time
that our users and reviewers gave us to help create an even better second edition.
In our second edition, we are thrilled to welcome our new coauthor, Shannon
Anderson. Shannon is an Associate Professor of Management at the Jesse H. Jones
Graduate School of Management at Rice University and a Principle Fellow at the Univer-
sity of Melbourne. She is both a valued friend and respected colleague and she brings to
the team her extensive experience in cost management systems from both research and
practice. Her research in companies of various industries and in many countries is
reected throughout the book, adding to the relevance of the text to todays students and
managers. Shannon previously taught at the University of Michigan and worked as an
engineer at General Motors Corporation. She received a doctorate and masters degree
in business economics at Harvard University and a BSE in civil engineering with a con-
centration in operations research at Princeton University.
With the success of the rst edition, your excellent feedback, and the addition of
Shannon Anderson, we are condent that our second edition provides a clear, modern,
and practical view of cost accounting that will help your students become informed and
intelligent consumers and preparers of cost information.
Best wishes for a good semester,
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William N. Lanen
viii
William Lanen is Professor of Accounting at the
University of Michigan Business School. He holds
degrees in economics from the University of
California, Berkeley, and Purdue University and
earned a PhD in accounting from the Wharton
School of the University of Pennsylvania.
Bill teaches management accounting in both the BBA
and MBA programs at the University of Michigan. He
also teaches management accounting in Global MBA
Programs and Executive Education Programs in Asia,
Europe, and Latin America. Before coming to the
University of Michigan, Bill was on the faculty at the
Wharton School of the University of Pennsylvania,
where he taught various nancial and managerial
accounting courses at the undergraduate, MBA, and
Executive MBA levels. He has received teaching
awards at both the University of Michigan and the
Wharton School.
Bill serves on the Editorial Board of the Journal of
Management Accounting Research. He has published
in Journal of Accounting Research; Journal of
Accounting and Economics; Accounting,
Organizations and Society; and The Accounting
Review. Bill is past-president of the Management
Accounting Section of the American Accounting
Association.
William N. Lanen
About
the
Authors
About
the
Authors
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Michael W. Maher Shannon W. Anderson
ix
Michael Maher is a Professor of Management at the
University of California-Davis. He previously taught at
the University of Michigan, the University of Chicago,
and the University of Washington. He also worked on
the audit staff at Arthur Andersen & Company and
was a self-employed nancial consultant for small
businesses. He received his BBA from Gonzaga
University, which named him Distinguished Alumnus
in 1989, and his MBA and PhD from the University of
Washington, and he earned the CPA from the state of
Washington.
Michael is a past-president of the Management
Accounting Section of the American Accounting
Association and has served on the editorial boards of
The Accounting Review, Accounting Horizons,
Journal of Management Accounting Research, and
Management Accounting. He is coauthor of two
leading textbooks, Principles of Accounting and
Managerial Accounting. Maher has coauthored
several additional books and monographs, including
Internal Controls in U.S. Corporations and Manage-
ment Incentive Compensation Plans, and published
articles in many journals, including Management
Accounting, The Journal of Accountancy, The
Accounting Review, Journal of Accounting Research,
Financial Executive, and The Wall Street Journal.
For his research on internal controls, Michael was
awarded the American Accounting Associations
Competitive Manuscript Award and the AICPA
Notable Contribution to Literature Award. He also
received the award for the Outstanding Tax
Manuscript. He received the Annual Outstanding
Teacher Award three times from his students at
the University of Californias Graduate School of
Management and has twice received a special award
for outstanding service. Mahers current research
includes studies in health care costs and corporate
corruption.
Shannon Anderson is an Associate Professor of
Management at the Jesse H. Jones Graduate School
of Management of Rice University and a Principle
Fellow at the University of Melbourne. She previously
taught at the University of Michigan and worked as
an engineer at General Motors Corporation. She
received a doctorate and masters degree in business
economics at Harvard University and a BSE in civil
engineering with a concentration in operations
research at Princeton University.
Shannons research, which focuses on the design and
implementation of performance measurement and
cost control systems, spans the elds of management
accounting and operations research. Her research
on activity-based costing won the 2006 American
Accounting Associations Notable Contribution Award
and the 2003 AAA Management Accounting Sections
Notable Contribution to the Literature Award. She
and Bill won the 2006 AAA Management Accounting
Sections Notable Contribution to the Literature
Award for their study of the performance impact of
electronic data interchange (EDI) systems.
Shannon currently serves on the Editorial Boards of
the Accounting Review; Accounting, Organizations
and Society; Production and Operations Manage-
ment; Management Science; Management Accounting
Research; and the Journal of Management
Accounting Research. She has also served on
numerous committees for the American Accounting
Association and the Management Accounting Section
of the American Accounting Association. Her research,
which has been funded in part by competitive grants
from the AICPA, the Institute of Internal Auditors, and
the Institute of Management Accountants, has been
published by the Accounting Review, Accounting
Organizations and Society, Production and Opera-
tions Management, Management Science, and the
Journal of Management Accounting Research. She is
also coauthor of the award-winning book,
Implementing Management Innovations.
Shannon W. Anderson Michael W. Maher
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Navigating through information systems,
ambiguous situations, and value- and
nonvalue-added activities can
be a challenge for students
entering the business world.
Fundamentals of Cost Accounting gives
students a clear view by providing them
with the tools they need to be successful
in a concise, readable, and logical
manner. We want students to discover the
development of cost accounting tools and
techniques as a natural response to deci-
sion making. We emphasize the intuition
behind concepts and work to minimize
the need to memorize. We present the
material from the perspective of both the
preparer of information as well as those
who will use the information. We do this
so that accounting majors as well as stu-
dents who are planning other careers can
become intelligent and informed produc-
ers and consumers of cost accounting
data.
Cost
Accounting:
A Clear
View
Cost
Accounting:
A Clear
View
For years I have considered changing texts, looking for a
one semester text that was easy enough, both in the text and
the end of chapter material, and I nally found it
Norman Sunderman
Angelo State University
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xi
To be effective problem solvers, students
need to learn to ask the right questions.
Fundamentals of Cost Accounting and the
accompanying Web-based Homework
Manager provide a wide range of challeng-
ing and thought-provoking end-of-chapter
material for students to practice their
decision-making skills. Problem material
has been written to precisely match the
presentation of concepts in each chapter;
there are no inconsistent terms or conict-
ing requirements, making homework
seamless for students.
McGraw-Hills Homework Manager and
Homework Manager Plus, the online
homework management solution, contains
end-of-chapter material from the text, in
both static and algorithmic formats, allow-
ing problem material to be used to its full
potential without losing consistency.
Students can practice anytime, anywhere,
with Homework Manager and Homework
Manager Plus.
Each chapter of Fundamentals of Cost
Accounting opens with a real dilemna
faced by a manager in a variety of service
and manufacturing companies. New in the
2nd edition is the Debrief feature that
closes each chapter. The Debrief links the
topics in the chapter to the decision
dilemma faced by the manager in the
opening vignette. In Action boxes in
the text highlight the authors own
experiences with companies where they
have worked or conducted research.
Throughout each chapter, students are
also directed to the texts Online Learning
Center, a free online McGraw-Hill
resource, where they can gain access to a
wealth of audio, video, and digital assets
designed to help bring key topics to life
and provide a real world view of the role
accounting plays in the business world.
Fundamentals of Cost Accountings
chapters are brief and to the point. With
such a concise book, students spend less
time trying to memorize details and more
time analyzing and applying fundamental
principles.
C
larity of
C
larity of
P
roblem-
S
S
kills
olving
P
roblem-
S
S
kills
olving
R
elevant to the
R
W
orld
eal
R
elevant to the
R
W
orld
eal
W
riting
W
riting
Students are successful when they can
augment their studies with materials that
t their personal learning style. As an
instructor, you can point your students to
a wide range of audio, visual, and
kinesthetic resources that accompany this
text, including multimedia content created
for the iPod and other MP3/MP4 devices,
interactive Web resources such as narrated
PowerPoints, videos, and quizzing, and
even an e-book.
D
ifferent Students
D
ifferent Students
D
ifferent Learning
Styles
D
ifferent Learning
Styles
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Chapter Opening Cases
Do your students sometimes wonder how
the course connects with their future? Each
chapter opens with a case featuring a real
organization using cost accounting principles.
This sets the stage for the rest of the chapter
and encourages students to think of concepts
in a business context.
Step into the
Real World
Step into the
Real World
3
Chapter Three
Fundamentals of
Cost-Volume-Prot
Analysis
LEARNING OBJECTIVES
After reading this chapter, you should be able to:
L.O.1 Use cost-volume-prot (CVP) analysis to analyze decisions.
L.O.2 Understand the effect of cost structure on decisions.
L.O.3 Use Microsoft Excel to perform CVP analysis.
L.O.4 Incorporate taxes, multiple products, and alternative cost structures into
the CVP analysis.
L.O.5 Understand the assumptions and limitations of CVP analysis.
I opened U-Develop because I love photography and I
wanted to own my own business. I now get to spend most
of my day working with employees and customers mak-
ing sure that the photos they take are the best they can
be. It also gives me a chance to encourage younger peo-
ple who have an interest in photography, because I work
with many of the school groups and after-school clubs
here in town. Thats the fun part of the job.
But I also have to think about the nancial side of
the business. I need a systematic way to understand the
relation between my decisions and my prots.
Jamaal Kidd was discussing the photo-nishi
owns and operates. Starting out ve years a
storefront in the mall offering only photo dev
expanded the business and moved to a larg
town, where he now offers a wide range o
services, some made in his own workshop.
Our theme in this book is that the cost accounting system serves man-
agers by providing them with information that supports good decision making. In this
chapter and the next, we develop two common tools that managers can use to analyze
situations and make decisions that will increase the value of the rm. We begin in this
chapter by developing the relations among the costs, volumes, and prots of the rm. In
the next chapter, we use these relations to make pricing and production decisions that
increase prot.
The Debrief
Ivan Pirov discusses his next steps in rening the cost
accounting system at InShape:
I understand job costing much better after studying
this chapter. I have known the basics for some time,
but there are several things I learned. I am going to
collect some data from the past two or three years and
analyze the costs of our jobs more thoroughly. I am
not sure we are applying overhead in the best way.
Perhaps we might consid
tion bases. I thought abo
makes me consider cha
I worked based on the tw
the difference in revenue
allocate overhead makes
doing the right thing, bo
InShape.
New Debrief
Do your students understand how to apply
the concepts in each chapter to become
better decision makers? All chapters now
end with a Debrief feature that links the
topics in the chapter to the decision-
problem faced by the manager in the
opening vignette.
The Debrief is an excellent addition. I can see myself
using it in class as a way to pull the material together at
the end of a chapter and to show students how much theyve
learned.
Cynthia Phipps
Lake Land College
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Excel Spreadsheet Practice
Problems
Do your students know how to use
the tools they will use after they
graduate? Many businesses expect
students to know Excel. An icon
denotes selected end-of-chapter
items that come with Excel spread-
sheet templates for students to use
while solving them. The Excel prob-
lems throughout the book help
students practice using the tools
they will be using in the future.
In Action
Do your students
need help connect-
ing theory to appli-
cation? The In Ac-
tion examples are
drawn from contem-
porary journals and
the authors own ex-
periences and illus-
trate how to apply
cost accounting
methods and tools.
(L.O. 5)
(L.O. 3)
Problems Available with McGraw-Hills Homework Manager
1-19. Responsibility for Ethical Action
Dewi Hartono is an assistant controller at Giant Engineering, which contracts with the Defense
Department to build and maintain roads on military bases. Dewi recently determined that the company
was including the direct costs of work for private clients in overhead costs, some of which are charged
to the government. She also discovered that several members of management appeared to be involved
in altering accounting invoices to accomplish this. She was unable to determine, however, whether her
superior, the controller, was involved. Dewi considered three possible courses of action. She could
discuss the matter with the controller, anonymously release the information to the local newspaper, or
discuss the situation with an outside member of the board of directors whomshe knows personally.
Required
a. Does Dewi have an ethical responsibility to take a course of action?
b. Of the three possible courses of action, which are appropriate and which are inappropriate?
(CMA adapted)
1-20. Cost Data for Managerial Purposes
Tops Tools has offered to supply the Department of the Army with screwdrivers at cost plus
20 percent. Tops Tools operates a manufacturing plant that can produce 220,000 cases of screw-
drivers per year, but it normally produces 200,000. The costs to produce 200,000 cases of
screwdrivers follow:
mhhe.com/lanen2e
End-of-Chapter
Material
Being able to assign
end-of-chapter material
with condence is
important. The authors
have tested the end-of-
chapter material over
time to ensure quality
and consistency with
the chapter content.
Integrative Cases
Cases can generate classroom
discussion or be the basis for
good team projects. These
involving cases ask students
to apply the different tech-
niques they have learned to
a realistic situation.
Critical Analysis and Discussion Questions
2-11. Materials and labor are always direct costs, and supply costs are always indirect. What is
your opinion of this statement?
2-12. The cost per seat-mile for a major U.S. airline is 13.7. Therefore, to estimate the cost of
ying a passenger from Detroit to Los Angeles, we should multiply 1,980 miles by 13.7.
Do you agree?
2-13. In evaluating product protability, we can ignore marketing costs because they are not con-
sidered product costs. Do you agree?
2-14. You and two friends drive your car to Texas for spring break. A third friend asks if you
can drop her off in Oklahoma. How would you allocate the cost of the trip among the four
of you?
2-15. Pick a unit of a hospital (for example, intensive care or maternity). Name one example of
a direct materials cost, one example of a direct labor cost, and one example of an indirect
cost.
Exercises Available with McGraw-Hills Homework Manager
2-16. Basic Concepts
For each of the following statements, indicate whether it is true, false, or uncertain. Explain why.
Give examples in your answer.
(L.O. 1, 5)
Different cost structures lead to different decisions that rms
make concerning operations and investments. Consider the
following two statements:
1. Ahold now has about $23 billion in sales among its six
U.S. supermarket chainslarge but uncomfortably be-
hind giants such as Wal-Mart, Kroger, and Albertsons.
The logic of consolidation is that, in a business with
such slim prot margins, bigger companies gain impor-
tant competitive advantage by being able to negotiate
better terms and prices from suppliers, better rents from
landlords and better advertising deals from media out-
lets (Washington Post, February 8, 2004).
2. Many experts say the airlines throw planes on a route
to grab market share from rivals. Robert L. Crandall, the
former chief executive of American Airlines, said that
airlines added planes because growth spreads xed
costs over more passenger miles. If everybody is grow-
ing to keep their costs down, then theres constantly a
great deal of capacity in the market, Mr. Crandall said.
So long as theres lots of capacity, people have an in-
centive to cut prices (New York Times, December 9,
2003).
In the case of rms with low operating leverage, such as gro-
cery chains, the prot margins are small, so rms do what
they can to improve those marginseven small savings
translate to large improvements in prots. In the case of
rms with high operating leverage, such as airlines, each
additional unit (seat-mile) sold provides a large contribution
to prot, so the emphasis is on increasing volume.
Effect of Cost Structure on Operating
and Investing Decisions
In Action
S
Integrative Case
13-41. Prepare Cash Budget for Service Organization
The board of directors of the Cortez Beach Yacht Club (CBYC) is developing plans to acquire
more equipment for lessons and rentals and to expand club facilities. The board plans to purchase
about $50,000 of new equipment each year and wants to begin a fund to purchase a $600,000 piece
of property for club expansion.
The club manager is concerned about the clubs capability to purchase equipment and expand
its facilities. One club member has agreed to help prepare the following nancial statements and
help the manager ascertain whether the plans are realistic. Additional information follows the
nancial statements.
(L.O. 4, 5, 6, 7)
CORTEZ BEACH YACHT CLUB
Statement of Income (Cash Basis)
For the Year Ended October 31
Year 9 Year 8
Cash revenues
Annual membership fees . . . . . . . . . . . . . . . . . . . . . $ 710,000 $600,000
Lesson and class fees . . . . . . . . . . . . . . . . . . . . . . . 468,000 360,000
Miscellaneous . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4,000 3,000
_________ ________
Total cash received . . . . . . . . . . . . . . . . . . . . . . . . . . . $1,182,000 $963,000
_________ ________
(Continued)
S
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Each chapter of Fundamentals of Cost
Accounting clearly establishes learning
objectives, highlights numerous real-world
examples, and identies where ethical issues
arise and how to think about these issues. The
most noticeable revision to the 2nd edition is that
we have split Chapter 3 of the rst edition into
two chapters. In the second edition, Chapter 3
discusses cost-volume-prot analysis and Chapter
4 discusses cost analysis for decision making.
This facilitates teaching these two topics at
different points in the course.
We have added material that discusses the use
of Microsoft Excel and presented many of the
tables throughout the text using Excel. We have
introduced over 100 new items in the end-of-
chapter practice material and revised the
remaining material. Throughout the revision
process, we retained the clear writing style that
was frequently cited as a strength of the rst
edition.
1 Cost Accounting: Information for Decision
Making
Enhanced development of the role of the value
chain in value creation.
Signicantly revised topics in cost accounting
linked to the stages of the value chain,
including how cost accounting is used in:
R&D
Design
Purchasing
Production
Marketing
Distribution
Customer service
Added discussion on ethics and cost
accounting.
Added end-of-chapter assignments on ethics.
Whats New
in the Second
Edition?
2 Cost Concepts and Behavior
New In Action feature related to how
organizations are a mix of both manufacturing-
type and service-type activities, illustrating how
cost accounting information is important for
both.
Revised exhibit illustrating prime and
conversion costs clearly.
Added three new end-of-chapter problems
dealing with service rms and revised 25 other
questions.
3 Fundamentals of Cost-Volume-Prot
Analysis
Revised the approach to CVP analysis by
starting with the break-even problem and then
extending the analysis to cases where the target
prot is different from zero.
Expanded coverage of operating leverage and
margin of safety.
Added illustration showing how to use Excel to
solve CVP problems.
Added discussion on CVP analysis with
alternative cost structures, such as step-xed
costs.
Added discussion on the assumptions and
limitations of CVP analysis.
Added 25 new end-of-chapter questions,
exercises, and problems, including problems
using Excel and revised 10 other exercises and
problems.
4 Fundamentals of Cost Analysis for
Decision Making
Added new discussion on legal issues and the
pricing decision.
Added discussion illustrating the use of Excel to
solve differential cost problems.
Added discussion illustrating the use of Excel to
solve product mix problems.
Revised and moved discussion on Theory of
Constraints to the chapter body.
Added 18 new end-of-chapter questions,
exercises, and problems and added a new
integrative case.
5 Cost Estimation
Added new discussion on data problems in
regression analysis.
Added new discussion on the learning
phenomenon and cost estimation.
Added an appendix on learning curves and
costs.
Added 16 new end-of-chapter questions,
exercises, and problems.
Whats New
in the Second
Edition?
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6 Fundamentals of Product and Service
Costing
Added new material to motivate this overview
chapter.
Added seven new end-of-chapter questions,
exercises, and problems and revised 10 other
exercises and problems.
7 Job Costing
Added new learning objective on ethical issues
in job costing.
Revised ow of development of chapter
illustration.
Added new discussion of alternative methods of
recording and applying overhead.
Added material on misrepresenting costs and
ethical issues.
Added ve new end-of-chapter questions,
exercises, and problems.
8 Process Costing
Added new In Action item on equivalent units
and fraud.
Added new illustration of process costing using
a series of Excel worksheets.
Added new end-of-chapter problem/short case
on ethics and process costing.
9 Activity-Based Costing
Added new exhibits illustrating ABC using Excel
worksheets.
Added new problem on ethics and ABC.
Added new end-of-chapter case on activity-
based costing.
10 Fundamentals of Cost Management
Added new In Action item on the cost of
customers at Best Buy.
Added eight new end-of-chapter exercises,
problems, and cases.
11 Service Department and Joint Cost
Allocation
Expanded discussion of net realizable value and
terminology.
Added two new end-of-chapter problems.
12 Fundamentals of Management Control
Systems
Added new learning objective on internal
controls.
Added new material to motivate this overview
chapter.
Added material for the In Action item Beware
of the Kink, which describes the effect of
performance evaluation on a broad sample of
rms.
Added 10 new end-of-chapter exercises and
problems and a new case on ethics at PepsiCo
and GE.
13 Planning and Budgeting
Added new illustration of the development of
budgets using a series of Excel worksheets.
14 Business Unit Performance Measurement
Added new In Action item on EVA at Best Buy.
Added new end-of-chapter case.
15 Transfer Pricing
Expanded discussion of how to determine the
optimal transfer price.
16 Fundamentals of Variance Analysis
Added new In Action item on how favorable
variances might not be good news, based on
events at a for-prot health care company.
Added new illustration of variances using Excel
worksheets.
Updated 45 end-of-chapter exercises and
problems.
17 Additional Topics in Variance Analysis
Revised chapter illustration so actual production
is no longer the same as the master budget.
Updated 22 end-of-chapter exercises and
problems.
18 Nonnancial and Multiple Measures
of Performance
Added new discussion of strategy maps tied to
the balanced scorecard.
Added new In Action item on the use of
scorecards for evaluating suppliers and tying
back to the value chain.
Added new end-of-chapter exercises, problems,
and a case, and updated some existing exercises
and problems.
lan26720_fm.qxd 8/9/07 3:47 PM Page xv
xvi
Total Teaching
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Instructors
Use These McGraw-Hill Digital
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Students can do a lot online as they prepare for
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lan26720_fm.qxd 8/9/07 3:47 PM Page xvi
Topic Tackler Plus
Topic Tackler Plus is a complete
multimedia tutorial focusing on the
most difcult cost accounting topics
in each chapter. It combines video
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exercises, and self-grading quizzes
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or after class, to get ready for your lecture or to
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on the move. . . .
Instructors Resource CD-ROM:
ISBN-13: 978-007-352672-0 ISBN-10: 007-320547-8
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usefulness of specic assignment material
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Solutions to all Discussion Questions, Exercises,
Problems, Cases, and Comprehensive Problems,
made available on the texts Online Learning Center:
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Prepared by Sanjay Gupta, Valdosta State
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With an abundance of objective questions and
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and password-protected on the
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at Chicago
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xviii
Imagine being able to create and access your test anywhere,
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xix
Total Study
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Students
Use These McGraw-Hill Digital
and Print Resources to Help
You Get a Good Grade in Cost
Accounting
Online Learning Center
www.mhhe.com/lanen2e
Go online and nd Chapter Summaries, Online
Quizzing, Key Term Reviews, Internet Exercises,
PowerPoint Presentations, Excel Templates, Home-
work Manager, Topic Tackler Plus, NY Times,
Links to Professional Resources, and Text Updates.
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mhhe.com/lanen2e
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Prepared by Dr. Betty Harper, Middle Tennessee
State University
ISBN-13: 978-007 320554-0
ISBN-10: 007-320554-0
This resource provides chapter-by-chapter self-
testing questions and answers and a summary of
each chapters key points.
McGraw-Hills Homework
Manager
See page xvi for details.
McGraw-Hills
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Plus
This optional online resource
uses an intelligent algorithm to generate an
innite number of problems, based on problem
structures from the text. It enables students to
practice particular types of problems repeatedly
until they master key concepts.
Excel Spreadsheet Templates
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lan26720_fm.qxd 8/9/07 3:54 PM Page xix
xx
cknowledgments
A
cknowledgments
A
A special thank you
to the following individuals who helped develop
and critique the ancillary package: Chiaho Chang,
Montclair State University; Jeannie Folk, College of
DuPage; Lisa Gillespie, Loyola University at
Chicago; Sanjay Gupta, Valdosta State University;
Betty Harper, Middle Tennessee State University;
Gloria McVay, Winona State University; Barbara
Schnathorst, The Write Solution, Inc.; Beth Woods,
Accuracy Counts; Alice Sineath, Forsyth Technical
Community College; Rodger Brannan,
University of Minnesota at Duluth; and Debra
Smidt, Cerritos College.
We are grateful for the outstanding support of
McGraw-Hill/Irwin. In particular, we would like to
thank Stewart Mattson, Editorial Director; Alice
Harra, Senior Sponsoring Editor; Kimberly Hooker,
Senior Developmental Editor; Scott Bishop, Market-
ing Manager; Dana Pauley, Project Manager;
Artemio Ortiz, Designer; Carol Bielski, Senior Pro-
duction Supervisor; Gregory Bates and Xin Zhu,
Media Producers; Susan Lombardi and Matthew
Perry, Media Project Managers; Jeremy Cheshareck,
Senior Photo Research Coordinator; and Keri
Johnson, Photo Researcher.
We also want to recognize the valuable
input of all those dedicated instructors
who helped guide our editorial and
pedagogical decisions:
Editorial Board, Second Edition
Gary Adna Ames, Brigham Young UniversityIdaho
Nas Ahadiat, California State Polytechnic
University, Pomona
Sepeedeh Ahadiat, California State Polytechnic
University, Pomona
Michael Alles, Rutgers University
Felix Amenkhienan, Radford University
Kashi Balachandran, New York University
Daniel Bayak, Northampton Community College
Joseph Berry, Campbell University
Charles Betts, Delaware Technical and
Community College
Michael Blackett, National American University
Marvin Bouillon, Iowa State University
lan26720_fm.qxd 8/9/07 3:47 PM Page xx
xxi
Michelle Cannon, Ivy Tech Community College
Roberta Cable, Pace University
Chiaho Chang, Montclair State University
Bea Chiang, The College of New Jersey
D. Douglas Clinton, Northern Illinois University
Carlos Colon, Valencia Community College
Joan Cook, Milwaukee Area Tech College
Sue Cullers, Tarleton State University
Alan Czyzewski, Indiana State University
Lee Daugherty, Lorain County Community
College
Fara Elikai, University of North Carolina
Wilmington
Terry Elliott, Morehead State University
Robert Elmore, Tennessee Tech University
Timothy Farmer, University of MissouriSt. Louis
Michael Fedoryshyn, St. John Fisher College
Jerry Ferry, University of North Alabama
Benjamin Foster, University of Louisville
Kenneth Fowler, Santa Clara University
John Garlick, Fayetteville State University
Lisa Gillespie, Loyola University, Chicago
Lorraine Glasscock, University of North Alabama
Sylwia Gornik-Tomaszewski, St. Johns University
Marina Grau, Houston Community College
Mary Green, University of Virginia
Ralph Greenberg, Temple University
Robert Gruber, University of Wisconsin-
Whitewater
Aundrea Kay Guess, St. Edwards University
Sanjay Gupta, Valdosta State University
Michael R. Hammond, Missouri State University
Betty Harper, Middle Tennessee State University
Jeannie Harrington, Middle Tennessee State
University
Geoffrey Heriot, Greenville Technical College
Aleecia Hibbets, University of LouisianaMonroe
Jonathan Hidalgo, Montclair University
Jay Holmen, University of WisconsinEau Clair
Bob Holtfreter, Central Washington University
Bikki Jaggi, Rutgers University
Agatha Jeffers, Montclair State University
Thomas Kam, Hawaii Pacic University
Larry Killough, Virginia Polytechnic University
Mehmet Kocakulah, University of Southern
Indiana
Thomas Krissek, Northeastern Illinois University
Daniel Law, Gonzaga University
Minwoo Lee, Western Kentucky University
Joan Luft, Michigan State University
Janet Mabon, University of Oregon
Suneel Maheshwari, Marshall University
Linda Mallory, Central Virginia Community College
Mark Martinelli, De Anza College
Maureen Mascha, Marquette University
Raj Mashruwala, Washington University, St. Louis
Michele Matherly, University of North Carolina
at Charlotte
Barbara Mcelroy, Susquehanna University
Gloria McVay, Winona State University
Pam Meyer, University of LouisianaLafayette
David Morris, North Georgia College
Ann Murphy, Metropolitan State College of Denver
Rosemary Nurre, College of San Mateo
Carolyn Ogden, University of Massachusetts, Boston
Tamara Phelan, Northern Illinois University
Cynthia Phipps, Lake Land College
Jo Ann Pinto, Montclair State University
Paul Polinski, Case Western Reserve University
Judy Ramage, Christian Brothers University
Roy Regel, University of MontanaMissoula
David Remmele, University of Wisconsin
Whitewater
Gerald Rosson, Lynchburg College
David Satava, University of Houston
Kathy Sauer, Aakers Business College
Richard Sauoma, University of California, Los
Angeles
Margaret Shackell-Dowell, University of Notre Dame
Karen Shastri, University of Pittsburgh
Donald Simmons, Frostburg State University
Kenneth Sinclair, Lehigh University
James Smith, Saint Cloud State University
Toni Smith, University of New Hampshire
Carol Springer, Georgia State University
Scott Steinkamp, College of Lake County
Dennis Stovall, Grand Valley University
Ronald Stunda, Birmingham-Southern College
Norman Sunderman, Angelo State University
Kim Tan, California State UniversityStanislaus
James Thompson, Oklahoma City University
lan26720_fm.qxd 8/9/07 3:47 PM Page xxi
xxii
Robin Turner, Rowan-Cabarrus Community College
Michael Tyler, Barry University
Karen Varnell, Tarleton State University
Stephen Wehner, Columbia College
Randi Whitney, University of Oregon
Michael Wilson, Metropolitan State University
Priscilla Wisner, Montana State University
Raymond Zingsheim, Moraine Park Technical
University
Editorial Board, First Edition
Rowland Atiase, University of Texas at Austin
Timothy B. Biggart, University of North Carolina
Rodger Brannan, University of Minnesota at
Duluth
Wayne Bremser, Villanova University
Chiaho Chang, Montclair State University
Kerry Colton, Aims Community College
William Cready, Louisiana State University
Patricia Derrick, George Washington University
Robert Elmore, Tennessee Tech University
John Giles, North Carolina State University
Penelope Sue Greenberg, Widener University
Jeannie Harrington, Middle Tennessee State
University
Michael Haselkorn, Bentley College
Daniel A. Hinchliffe, Florida Atlantic University
M. Zafar Iqbal, Cal State Poly UniversityPomona
Richard Kelsey, NOVA Southeastern University
Larry N. Killough, Virginia Tech
Larissa Kyj, Rowan University
Randall E. LaSalle, West Chester University of
Pennsylvania
P. Michael McLain, Hampton University
Kathleen Metcalf, Muscatine Community
College
Karen Nunez, North Carolina State University
Marge OReilly-Allen, Rider University
Tamara Phelan, Northern Illinois University
Jeanette Ramos-Alexander, New Jersey City
University
Anwar Salimi, Cal State Poly UniversityPomona
Kathleen Sevigny, Bridgewater State College
Kenneth Sinclair, Lehigh University
Ola Smith, Western Michigan University
Cynthia Sneed, Jacksonville State University
Swaminathan Sridaran, Northwestern University
Verlindsey Stewart, J.F. Drake State Technical
College
Kim Tan, California State University
Stanislaus
Debra Warren, Chadron State College
Thomas Zeller, Loyola University at Chicago
lan26720_fm.qxd 8/9/07 3:47 PM Page xxii
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Brief Contents
Introduction and Overview
One Cost Accounting: Information for Decision Making 2
Two Cost Concepts and Behavior 34
Cost Analysis and Estimation
Three Fundamentals of Cost-Volume-Prot Analysis 76
Four Fundamentals of Cost Analysis for Decision Making 102
Five Cost Estimation 142
Cost Management Systems
Six Fundamentals of Product and Service Costing 184
Seven Job Costing 210
Eight Process Costing 246
Nine Activity-Based Costing 286
Ten Fundamentals of Cost Management 326
Eleven Service Department and Joint Cost Allocation 360
Management Control Systems
Twelve Fundamentals of Management Control Systems 400
Thirteen Planning and Budgeting 432
Fourteen Business Unit Performance Measurement 472
Fifteen Transfer Pricing 504
Sixteen Fundamentals of Variance Analysis 536
Seventeen Additional Topics in Variance Analysis 580
Eighteen Nonnancial and Multiple Measures of Performance 610
Appendix Capital Investment Decisions: An Overview A-1
Glossary G-1
Photo Credits C-1
Index I-1
xxiii
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xxiv
Contents
1
Cost Accounting: Information for Decision
Making 2
Value Creation in Organizations 3
Why Start with Value Creation? 3
Value Chain 3
Supply Chain and Distribution
Chain 5
Using Cost Information to Increase
Value 5
In Action: Palliative Care Unit 5
Accounting and the Value Chain 5
Accounting Systems 6
Financial Accounting 6
Cost Accounting 6
Cost Accounting and GAAP 7
Customers of Cost Accounting 7
Our Framework for Assessing Cost
Accounting Systems 8
The Managers Job Is to Make
Decisions 9
Decision Making Requires Information 9
Finding and Eliminating Activities That Dont
Add Value 9
Identifying Strategic Opportunities Using
Cost Analysis 9
Owners Use Cost Information to Evaluate
Managers 10
Cost Data for Managerial Decisions 10
Costs for Decision Making 10
Costs for Control and Evaluation 11
Different Data for Different Decisions 14
Trends in Cost Accounting throughout
the Value Chain 14
Cost Accounting in Research and Development
(R&D) 14
Cost Accounting in Design 14
Cost Accounting in Purchasing 15
Cost Accounting in Production 15
Cost Accounting in Marketing 16
Cost Accounting in Distribution 16
Cost Accounting in Customer Service 16
Enterprise Resource Planning 17
Creating Value in the Organization 17
Key Financial Players in the Organization 17
Choices: Ethical Issues for Accountants 18
What Makes Ethics So Important? 18
In Action: Channel Stufng 19
Ethics 20
Sarbanes-Oxley Act of 2002 and Ethics 20
Cost Accounting and Other Business
Disciplines 21
The Debrief 22
Summary 22
Key Terms 22
Appendix: Institute of Management Accountants Code
of Ethics 23
Review Questions 24
Critical Analysis and Discussion Questions 25
Exercises 25
Problems 27
Solutions to Self-Study Questions 33
2
Cost Concepts and Behavior 34
What Is a Cost? 36
Cost versus Expenses 36
lan26720_fm.qxd 8/9/07 3:47 PM Page xxiv
Contents xxv
Presentation of Costs in Financial Statements 37
In Action: A New Manufacturing Mantra 37
Service Organizations 38
Retail and Wholesale Companies 38
Manufacturing Companies 40
Direct and Indirect Manufacturing (Product)
Costs 40
Prime Costs and Conversion Costs 41
Nonmanufacturing (Period) Costs 41
In Action: Indirect Costs in Banking 42
Cost Allocation 42
Direct versus Indirect Costs 43
Details of Manufacturing Cost Flows 44
How Costs Flow through the Statements 45
Income Statements 45
Cost of Goods Manufactured and Sold 45
Direct Materials 46
Work in Process 46
Finished Goods Inventory 47
Cost of Goods Manufactured and Sold
Statement 47
An Interim Debrief 48
Cost Behavior 48
Fixed versus Variable Costs 49
Components of Product Costs 51
Unit Fixed Costs Can Be Misleading for
Decision Making 51
How to Make Cost Information More Useful
for Managers 55
Gross Margin versus Contribution Margin
Income Statements 56
Developing Financial Statements for
Decision Making 56
The Debrief 58
Summary 58
Key Terms 59
Review Questions 59
Critical Analysis and Discussion Questions 60
Exercises 60
Problems 67
Solutions to Self-Study Questions 73
3
Fundamentals of Cost-Volume-Prot
Analysis 76
Cost-Volume-Prot Analysis 77
Prot Equation 77
CVP Example 78
Graphic Presentation 81
Prot-Volume Model 82
Use of CVP to Analyze the Effect of Different
Cost Structures 82
In Action: Effect of Cost Structure on Operating
and Investing Decisions 84
Margin of Safety 85
CVPAnalysis with Spreadsheets 85
Extensions of the CVP Model 86
Income Taxes 86
Multiproduct CVPAnalysis 87
Alternative Cost Structures 88
Assumptions and Limitations of CVP
Analysis 89
The Debrief 90
Summary 90
Key Terms 91
Review Questions 91
Critical Analysis and Discussion Questions 91
Exercises 91
Problems 95
Solutions to Self-Study Questions 100
4
Fundamentals of Cost Analysis for Decision
Making 102
Differential Analysis 103
Differential Costs versus Total Costs 104
Differential Analysis and Pricing
Decisions 104
Short-Run versus Long-Run Pricing
Decisions 105
Short-Run Pricing Decisions: Special
Orders 105
Long-Run Pricing Decisions 107
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Long-Run versus Short-Run Pricing: Is There a
Difference? 108
Cost Analysis for Pricing 108
In Action: Take Back Laws in Europe 109
Legal Issues Relating to Costs
and Sales Prices 109
Predatory Pricing 109
Dumping 110
Price Discrimination 111
Peak-Load Pricing 111
Price Fixing 111
xxvi Contents
In Action: Using Regression to Evaluate
Cost Behavior 152
Multiple Regression 153
Practical Implementation Problems 154
Learning Phenomenon 156
In Action: Learning Curves 156
Applications 157
How Is an Estimation Method Chosen? 159
Data Problems 159
Effect of Different Methods on Cost
Estimates 160
The Debrief 161
Summary 162
Key Terms 163
Appendix A: Multiple Regression 163
Appendix B: Learning Curves 167
Review Questions 168
Critical Analysis and Discussion Questions 168
Exercises 169
Problems 174
Solutions to Self-Study Questions 182
Use of Differential Analysis for Production
Decisions 112
Make-It or Buy-It Decisions 112
Make-or-Buy Decisions Involving Differential
Fixed Costs 112
Opportunity Costs of Making 115
Decision to Add or Drop a Product Line
or Close a Business Unit 117
Product Choice Decisions 118
The Theory of Constraints 122
The Debrief 124
Summary 124
Key Terms 125
Review Questions 125
Critical Analysis and Discussion Questions 126
Exercises 126
Problems 131
Integrative Case 139
Solutions to Self-Study Questions 140
5
Cost Estimation 142
Why Estimate Costs? 143
Basic Cost Behavior Patterns 143
What Methods Are Used to Estimate Cost
Behavior? 143
Engineering Method 144
Account Analysis Method 144
Statistical Cost Estimation 146
6
Fundamentals of Product and Service
Costing 184
Cost Management Systems 185
Reasons to Calculate Product or
Service Costs 185
In Action: Importance of Distinguishing between
Production Costs and Overhead Costs 186
Cost Allocation and Product Costing 186
Cost Flow Diagram 187
Fundamental Themes Underlying the Design
of Cost Systems for Managerial Purposes 187
Costing in a Single Product, Continuous Process
Industry 188
Basic Cost Flow Model 188
Costing with No Work-in-Process Inventories 188
Costing with Ending Work-in-Process
Inventories 189
Costing in a Multiple Product, Discrete
Process Industry 190
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Contents xxvii
Predetermined Overhead Rates 192
Product Costing of Multiple Products 193
Choice of the Allocation Base for Predetermined
Overhead Rate 193
Choosing among Possible Allocation
Bases 194
Multiple Allocation Bases and Two-Stage
Systems 195
Choice of Allocation Bases 196
Different Companies, Different Production
and Costing Systems 197
Operations Costing: An Illustration 199
The Debrief 200
Summary 200
Key Terms 201
Review Questions 201
Critical Analysis and Discussion Questions 201
Exercises 202
Problems 206
Solutions to Self-Study Questions 208
7
Job Costing 210
Dening a Job 211
Using Accounting Records
in a Job Shop 212
Computing the Cost of a Job 212
Production Process at InShape 212
Records of Costs at InShape 212
How Manufacturing Overhead Costs
Are Recorded at InShape 215
In Action: Effect of Overhead Rates on Production
Decisions 216
The Job Cost Sheet 218
Over- and Underapplied Overhead 218
An Alternative Method of Recording and
Applying Manufacturing Overhead 220
Multiple Allocation Bases: The Two-Stage
Approach 223
Summary of Steps in a Job Costing System 223
Using Job Costing in Service Organizations 223
Ethical Issues and Job Costing 225
Misstating Stage of Completion 226
Charging Costs to the Wrong Jobs 226
Misrepresenting the Cost of Jobs 226
Managing Projects 227
In Action: Determination of the Cost of Large
Projects and Ethical Implications 229
The Debrief 229
Summary 229
Key Terms 230
Review Questions 230
Critical Analysis and Discussion Questions 230
Exercises 231
Problems 234
Integrative Case 244
Solutions to Self-Study Questions 245
8
Process Costing 246
Determining Equivalent Units 248
Using Product Costing in a Process
Industry 249
Step 1: Measure the Physical Flow
of Resources 249
Step 2: Compute the Equivalent Units
of Production 249
In Action: Overstating Equivalent Units to
Commit Fraud 250
Step 3: Identify the Product Costs for Which
to Account 251
Time Out! We Need to Make an Assumption
about Costs and the Work-in-Process
Inventory 251
Step 4: Compute the Costs per Equivalent Unit:
Weighted Average 252
Step 5: Assign Product Cost to Batches of Work:
Weighted-Average Process Costing 253
Reporting This Information to Managers:
The Production Cost Report 253
Sections 1 and 2: Managing the Physical Flow
of Units 255
Sections 3, 4, and 5: Managing Costs 255
lan26720_fm.qxd 8/9/07 3:47 PM Page xxvii
Assigning Costs Using First-In, First-Out (FIFO)
Process Costing 255
Step 1: Measure the Physical Flow of
Resources 256
Step 2: Compute the Equivalent Units of
Production 256
Step 3: Identify the Product Costs for Which
to Account 258
Step 4: Compute the Costs per Equivalent Unit:
FIFO 258
Step 5: Assign Product Cost: FIFO 259
How This Looks in T-Accounts 259
Determining Which Is Better: FIFO or Weighted
Average? 260
Computing Product Costs: Summary
of the Steps 260
Using Costs Transferred in from Prior
Departments 261
Who Is Responsible for Costs Transferred in from
Prior Departments? 262
Choosing between Job and Process Costing 264
Operation Costing 264
Product Costing in Operations 265
Operation Costing Illustration 265
Comparing Job, Process, and Operation
Costing 268
The Debrief 268
Summary 269
Key Terms 269
Review Questions 270
Critical Analysis and Discussion Questions 270
Exercises 271
Problems 275
Solutions to Self-Study Questions 283
9
Activity-Based Costing 286
Reported Product Costs and Decision
Making 287
Dropping a Product 287
The Death Spiral 289
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Two-Stage Cost Allocation 290
Two-Stage Cost Allocation and the Choice
of Cost Drivers 291
Plantwide versus Department-Specic Rates 293
Choice of Cost Allocation Methods:
ACost-Benet Decision 294
Activity-Based Costing 295
In Action: Activity-Based Costing in a
Not for Prot 296
Developing Activity-Based Costs 296
Cost Hierarchies 298
Activity-Based Costing Illustrated 299
Step 1: Identify the Activities 299
Step 2: Identify the Cost Drivers 300
Step 3: Compute the Cost Driver Rates 300
Step 4: Assign Costs Using Activity-Based
Costing 300
Unit Costs Compared 302
Cost Flows through Accounts 302
Choice of Activity Bases in Modern Production
Settings 304
In Action: Evidence on the Benets of
Activity-Based Costing 305
Activity-Based Costing in Administration 305
Who Uses ABC? 306
The Debrief 307
Summary 307
Key Terms 308
Review Questions 308
Critical Analysis and Discussion Questions 308
Exercises 309
Problems 314
Integrative Cases 320
Solutions to Self-Study Questions 324
10
Fundamentals of Cost Management 326
Using Activity-Based Cost Management
to Add Value 327
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Using Activity-Based Cost Information to Improve
Processes 329
Using Cost Hierarchies 330
Managing the Cost of Customers and
Suppliers 330
Using Activity-Based Costing to Determine the
Cost of Customers and Suppliers 331
Determining Why the Cost of Customers
Matters 334
Using Cost of Customer Information to Manage
Costs 334
In Action: Analyzing Customer Protability
at Best Buy 334
Determining the Cost of Suppliers 334
Capturing the Cost Savings 335
Managing the Cost of Capacity 336
Using and Supplying Resources 336
Computing the Cost of Unused Capacity 338
Assigning the Cost of Unused Capacity 340
Seasonal Demand and the Cost of Unused
Capacity 340
Managing the Cost of Quality 342
How Can We Limit Conict between Traditional
Managerial Accounting Systems and Total
Quality Management? 342
What Is Quality? 343
What Is the Cost of Quality? 343
Trade-Offs, Quality Control, and Failure Costs 345
In Action: Cost Elements Included in Reported
Quality Costs 346
The Debrief 347
Summary 347
Key Terms 348
Review Questions 348
Critical Analysis and Discussion Questions 348
Exercises 349
Problems 354
Integrative Cases 358
Solutions to Self-Study Questions 359
11
Service Department and Joint Cost
Allocation 360
Service Department Cost Allocation 361
Methods of Allocating Service Department
Costs 363
Allocation Bases 363
Direct Method 363
Step Method 366
In Action: Step Method at Stanford
University 369
Reciprocal Method 369
Comparison of Direct, Step, and Reciprocal
Methods 372
Allocation of Joint Costs 373
Joint Costing Dened 373
Reasons for Allocating Joint Costs 374
Joint Cost Allocation Methods 375
Net Realizable Value Method 375
Physical Quantities Method 377
Evaluation of Joint Cost Methods 378
Deciding Whether to Sell Goods Now or Process
Them Further 378
In Action: Different Demands for Different
Parts 379
Decision of What to Do with By-Products 379
The Debrief 381
Summary 381
Key Terms 382
Appendix: Calculation of the Reciprocal Method Using Computer
Spreadsheets 382
Review Questions 384
Critical Analysis and Discussion Questions 385
Exercises 385
Problems 389
Integrative Case 396
Solutions to Self-Study Questions 397
12
Fundamentals of Management Control
Systems 400
Why a Management Control System? 401
Alignment of Managerial and Organizational
Interests 401
Evolution of the Control Problem:
An Example 402
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Decentralized Organizations 402
Why Decentralize the Organization? 403
Advantages of Decentralization 403
Disadvantages of Decentralization 403
Framework for Evaluating Management
Control Systems 404
Organizational Environment and Strategy 404
Results of the Management Control System 405
Elements of a Management Control System 405
Balancing the Elements 406
Delegated Decision Authority: Responsibility
Accounting 406
Cost Centers 406
Discretionary Cost Centers 407
Revenue Centers 407
Prot Centers 408
Investment Centers 408
Responsibility Centers and Organization
Structure 408
Measuring Performance 408
Two Basic Questions 409
In Action: Teacher Pay and Student
Performance 409
Cost Centers 409
Revenue Centers 410
Prot Centers 410
Investment Centers 411
Evaluating Performance 411
Relative Performance versus Absolute
Performance Standards 411
Evaluating Managers Performance versus
Economic Performance of the Responsibility
Center 411
Relative Performance Evaluations in
Organizations 412
Compensation Systems 412
In Action: Beware of the Kink 413
Illustration: Corporate Cost Allocation 413
Incentive Problems with Allocated Costs 413
Effective Corporate Cost Allocation System 414
xxx Contents
Do Performance Evaluation Systems Create
Incentives to Commit Fraud? 415
Internal Controls to Protect Assets and Provide
Quality Information 416
Internal Auditing 417
The Debrief 418
Summary 418
Key Terms 419
Review Questions 419
Critical Analysis and Discussion Questions 419
Exercises 420
Problems 423
Integrative Cases 426
Solutions to Self-Study Questions 431
13
Planning and Budgeting 432
How Strategic Planning Increases
Competitiveness 433
Overall Plan 434
Organization Goals 434
Strategic Long-Range Prot Plan 434
Master Budget (Tactical Short-Range Profit
Plan): Tying the Strategic Plan to the
Operating Plan 434
Human Element in Budgeting 435
Value of Employee Participation 436
Developing the Master Budget 436
Where to Start? 436
Sales Forecasting 437
Comprehensive Illustration 438
Forecasting Production 438
Forecasting Production Costs 439
Direct Labor 440
Overhead 440
Completing the Budgeted Cost of Goods
Sold 441
Revising the Initial Budget 443
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Marketing and Administrative Budget 444
Pulling It Together into the Income
Statement 444
Key Relationships: The Sales Cycle 446
Using Cash Flow Budgets to Estimate
Cash Needs 447
Multiperiod Cash Flows 447
In Action: The Curse of Growth 449
Planning for the Assets and Liabilities
on the Budgeted Balance Sheets 450
Big Picture: How It All Fits Together 450
Budgeting in Retail and Wholesale
Organizations 450
Budgeting in Service Organizations 453
In Action: Budget Is the Law in
Government 453
Ethical Problems in Budgeting 453
Budgeting under Uncertainty 454
The Debrief 455
Summary 455
Key Terms 456
Review Questions 456
Critical Analysis and Discussion Questions 457
Exercises 457
Problems 462
Integrative Case 467
Solutions to Self-Study Questions 468
14
Business Unit Performance
Measurement 472
Divisional Performance
Measurement 473
In Action: What Determines Whether Firms Use
Divisional Measures for Measuring Divisional
Performance? 473
Accounting Income 474
Computing Divisional Income 474
Advantages and Disadvantages of Divisional
Income 475
Some Simple Financial Ratios 475
Return on Investment 476
Performance Measures for Control:
AShort Detour 477
Limitations of ROI 477
Residual Income Measures 480
Limitations of Residual Income 481
Economic Value Added (EVA) 482
In Action: EVA at Best Buy 482
Limitations of EVA 484
In Action: Does Using Residual Income as a
Performance Measure Affect Managers
Decisions? 484
Divisional Performance Measurement:
ASummary 484
Measuring the Investment Base 485
Gross Book Value versus Net Book
Value 485
Historical Cost versus Current Cost 485
Beginning, Ending, or Average Balance 486
Other Issues in Divisional Performance
Measurement 488
The Debrief 488
Summary 489
Key Terms 489
Review Questions 489
Critical Analysis and Discussion Questions 490
Exercises 490
Problems 493
Integrative Cases 496
Solutions to Self-Study Questions 502
15
Transfer Pricing 504
What Is Transfer Pricing and Why Is It
Important? 505
Determining the Optimal Transfer Price 506
The Setting 506
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Determining Whether a Transfer Price Is
Optimal 506
Case 1: APerfect Intermediate Market for
Wood 508
In Action: Transfer Pricing in State-Owned
Enterprises 510
Case 2: No Intermediate Market 510
Optimal Transfer Price: AGeneral
Principle 513
Other Market Conditions 514
Applying the General Principle 514
How to Help Managers Achieve Their Goals
While Achieving the Organizations
Goals 515
Top-Management Intervention in Transfer
Pricing 516
Centrally Established Transfer Price
Policies 516
Establishing a Market Price Policy 516
Establishing a Cost-Basis Policy 517
Alternative Cost Measures 518
Remedying Motivational Problems of Transfer
Pricing Policies 519
Negotiating the Transfer Price 519
Imperfect Markets 520
Global Practices 520
Multinational Transfer
Pricing 521
In Action: Management Control and
Tax Considerations in Transfer
Pricing 522
Segment Reporting 522
The Debrief 523
Summary 523
Key Terms 524
Review Questions 524
Critical Analysis and Discussion Questions 524
Exercises 525
Problems 527
Integrative Cases 532
Solutions to Self-Study Questions 534
xxxii Contents
16
Fundamentals of Variance Analysis 536
Using Budgets for Performance
Evaluation 537
Prot Variance 538
In Action: When a Favorable Variance Might Not
Mean Good News 538
Why Are Actual and Budgeted Results
Different? 539
Flexible Budgeting 540
Comparing Budgets and Results 541
Sales Activity Variance 541
Prot Variance Analysis as a Key Tool for
Managers 542
Sales Price Variance 544
Variable Production Cost Variances 544
Fixed Production Cost Variance 544
Marketing and Administrative Variances 544
Performance Measurement and Control
in a Cost Center 544
Variable Production Costs 545
Variable Cost Variance Analysis 546
General Model 546
Direct Materials 547
Direct Labor 550
Variable Production Overhead 551
Variable Cost Variances Summarized in
Graphic Form 552
Fixed Cost Variances 553
Fixed Cost Variances with Variable Costing 554
Absorption Costing: The Production Volume
Variance 554
Summary of Overhead Variances 556
Key Points 557
In Action: Does Standard Costing Lead to
Waste? 557
The Debrief 557
Summary 558
Key Terms 559
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Appendix: Recording Costs in a Standard
Cost System 559
Review Questions 562
Critical Analysis and Discussion Questions 562
Exercises 563
Problems 568
Integrative Case 574
Solutions to Self-Study Questions 578
17
Additional Topics in Variance Analysis 580
Prot Variance Analysis When
Units Produced Do Not Equal Units
Sold 581
In Action: Financial Analysis and Variance
Analysis 583
Reconciling Variable Costing Budgets and Full
Absorption Income Statements 583
Materials Purchases Do Not Equal
Materials Used 584
Market Share Variance and Industry Volume
Variance 586
Sales Activity Variances with Multiple
Products 588
Evaluating Product Mix 588
Evaluating Sales Mix and Sales Quantity 588
In Action: Sales Mix and Financial
Reporting 590
Production Mix and Yield
Variances 590
Mix and Yield Variances in Manufacturing 590
Variance Analysis in Nonmanufacturing
Settings 593
Using the Prot Variance Analysis in Service and
Merchandise Organizations 593
Efciency Measures 593
Mix and Yield Variances in Service
Organizations 594
Keeping an Eye on Variances and
Standards 595
How Many Variances to Calculate 595
When to Investigate Variances 595
Updating Standards 596
The Debrief 596
Summary 597
Key Terms 597
Review Questions 597
Critical Analysis and Discussion Questions 598
Exercises 598
Problems 600
Integrative Case 605
Solutions to Self-Study Questions 607
18
Nonnancial and Multiple Measures
of Performance 610
Beyond the Accounting Numbers 611
Organizational Environment and Business
Strategy 612
Responsibilities According to Level
of Organization 612
Business Model 613
Multiple Measures or a Single Measure
of Performance? 614
Balanced Scorecard 615
Continuous Improvement and Benchmarking 618
In Action: Supplier Scorecards at Sun
Microsystems 621
In Action: Sources and Uses of Benchmarking
Data 622
Performance Measurement for
Control 623
Some Common Nonnancial Performance
Measures 623
Customer Satisfaction Performance
Measures 623
Functional Performance Measures 624
Nonnancial Performance and Activity-Based
Management 625
Objective and Subjective Performance
Measures 625
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Employee Involvement 626
Difculties in Implementing
Nonnancial Performance
Measurement Systems 627
Fixation on Financial Measures 627
Reliability of Nonnancial Measures 627
Lack of Correlation between Nonnancial
Measures and Financial Results 627
The Debrief 628
Summary 628
Key Terms 629
Review Questions 629
Critical Analysis and Discussion Questions 629
Exercises 630
Problems 631
Integrative Case 635
Solutions to Self-Study Questions 636
APPENDIX
Capital Investment Decisions:
An Overview A-1
GLOSSARY G-1
PHOTO CREDITS C-1
INDEX I-1
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Fundamentals of
Cost Accounting
2e
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