Chapter One

Introduction

McGraw-Hill/Irwin

Copyright 2011 by The McGraw-Hill Companies, Inc. All rights reserved.

Decision Making - Product Management

Examples
  

Add new product Terminate an existing product line Accept or reject special order

Related Topics
  

Operations management Budgeting - capital and operating Just-in-time (JIT)

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Decision Making - Pricing

Examples
 

Set selling price to achieve desired profits Set selling price to achieve positive cash flow

Related Topics
  

Marketing Microeconomics - Price Theory Corporate Finance

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Decision Making - Cost Control

Examples
  

Add new equipment Change production process Make internally versus buy externally (outsource)

Related Topics
  

Process engineering Management information systems Activity-based costing (ABC)

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Control - Incentives
Assumptions
  

Individuals maximize their own self-interest Owners of firm want to maximize firm value Maximizing firm profits maximizes firm value

Incentives


Design performance incentives based on internal accounting measures to motivate employees to take actions that will maximize firm value

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Control - Performance Evaluation

Examples
 

Performance bonuses depend on accounting results Benchmarking: comparisons to industry leaders

Related Topics
 

Organizational behavior Human resources management

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Design - Multiple Roles of Accounting

Study Figure 1-1. Main point:
Accounting reports are used for multiple purposes.

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Design - External Reports

Users of external reports
   

Shareholders, bondholders, banks, and analysts (SEC, FASB) Taxing authorities (IRS, states, etc.) Regulatory authorities (GASB, etc.) Board of directors

Objectives in external reporting

  

Comparability between firms Historical accounting Auditors can verify reports

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Design - Internal Reports

Users of internal reports


Managers at all levels

Objectives of internal reporting

  

Useful for decision making about future activities Measure performance that is relevant to the firm Focus on projects or processes within a firm

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Design - Conflicting Goals

Control
 

Incentives to motivate behavior changes Tendency to ignore information not specifically included in incentive system Report good numbers to satisfy top management

Decision making
 

Want to avoid distorted information Estimates useful to plan future activities

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Design - Evolution
Economic Darwinism: Over the long term systems survive in competitive markets when the benefits exceed or equal the costs of maintaining those systems. Survival does not imply optimality. Better systems may exist, but have not yet been discovered.
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Design - Figure 1-2

Study Figure 1-2. Main Point:
In a typical corporation, the corporate controller is responsible for all internal and external accounting reports. There are also controllers in the operating divisions.

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Design - Organizational Structure

Controller
    

Reports to chief financial officer (CFO) Administers internal and external accounting Budget planning Controls financial data collection and reporting Growing role as internal consultants or business analysts to the point of being viewed as business partners

Balance providing information to other managers for decision making against providing monitoring information used to control behavior of lowerlevel managers.
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Evolution of Management Accounting: A Framework for Change

Business Environment Business Strategy Organizational Architecture Decision-Right Assignment Performance Evaluation Reward System Incentives and Actions Firm Value

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Example - Vortec Special Order With no overtime and congestion

Current Units produced and sold Total Revenue and Costs Sales ($5.00 regular, $4.00 special) Cost of sales ($4.50, $4.47) Administrative expenses Net profit before taxes Incremental revenue (2,000 units x $4.00) Total cost @ 102,000 units (102,000 x $4.47) Total cost @ 100,000 units (100,000 x $4.50) Incremental cost of 2,000 units Incremental profit of 2,000 units $455,940 450.000 -5,940 $2,060
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With Order 102,000 $508,000 455.940 27,500 $ 24,560

Incremental 2,000 8,000 8,000 0 $ 2,060 $8,000

100,000 $ 500,000 450,000 - 27,500 $ 22,500

Example - Vortec Special Order With overtime and congestion

Current Units produced and sold Total Revenue and Costs Sales ($5.00 regular, $4.00 special) Cost of sales ($4.50, $4.08 on additional 2,000) Administrative expenses Net profit before taxes Incremental revenue (2,000 units x $4.00) Total cost @ 102,000 units (102,000 x $4.50) plus (2,000 x $4.08) Total cost @ 100,000 units (100,000 x $4.50) Incremental cost of 2,000 units Incremental profit of 2,000 units 100,000 $ 500,000 450,000 - 27,500 $ 22,500 With Order 102,000 $508,000 458,160 27,500 $ 22,340 $8,000 $458,160 450.000 -8,160 -160
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Incremental 2,000 8,000 -8,160 0 $ -160

Example - Beware of Average Costs

Average cost per unit at current production volume is usually not an accurate estimate of the cost per unit at other levels of production. Average costs include:
 

fixed costs that do not change with volume variable costs per unit that can change with volume

Cost per unit may increase when production volume is near or above normal operating capacity.
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Example - Consider Opportunity Costs



Opportunity costs measure what the firm forgoes when it chooses a specific action Consider what a firm forgoes by accepting a special order

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Example - Supplement Accounting Data



Supplement historical cost accounting data with other knowledge Could include:
expected customer demands competitors plans future technology government regulation

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Example - Accounting Data for Evaluation

When managers have incentives to maximize performance on one particular accounting measure, firm profits are not necessarily maximized.


Reducing average manufacturing costs per unit does not always maximize profit Maximizing total revenue does not always maximize profit

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