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Fundamentals of Cost Accounting

Michael W. Maher
University of California at Davis

William N. Lanen
University of Michigan

Madhav V. Rajan
Stanford University

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

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FUNDAMENTALS OF COST ACCOUNTING Published by McGraw-Hill/Irwin, a business unit of The McGraw-Hill Companies, Inc., 1221 Avenue of the Americas, New York, NY 10020. Copyright 2006 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 6 5 4 ISBN 0-07-301837-6 Editorial director: Brent Gordon Publisher: Stewart Mattson Senior sponsoring editor: Steve DeLancey Senior developmental editor: Kimberly D. Hooker Marketing manager: Marc Chernoff Media producer: Elizabeth Mavetz Project manager: Jim Labeots Production supervisor: Gina Hangos Senior designer: Adam Rooke Photo research coordinator: Kathy Shive Photo researcher: Mary Reeg Media project manager: Matthew Perry Supplement producer: Gina F. DiMartino Developer, Media technology: Brian Nacik Typeface: 10.5/12 Times New Roman Compositor: Cenveo Printer: Quebecor World Versailles Inc. Library of Congress Cataloging-in-Publication Data Maher, Michael W., 1946Fundamentals of cost accounting / Michael W. Maher, William N. Lanen, Madhav V. Rajan.1st ed. p.cm. Includes index. ISBN 0-07-301837-6 (alk. paper) 1. Cost accounting. I. Lanen, William N. II. Rajan, Madhav V. III. Title. HF5686.C8M224 2006 657'.42dc22 2004061066 www.mhhe.com

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Dedication 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 To my wife, Donna, and my children, Cathy and Tom, for encouragement, support, patience, and general good cheer throughout the years. Bill To my mentors, Stan and Srikant, for their inspiration; to my parents, for their encouragement; to my family, for their love. Madhav

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Maher Lanen Rajan

About the Authors

Michael W. Maher
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 financial 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, Cost Management, 3/e, and Managerial Accounting, 8/e. Maher has coauthored several additional books and monographs, including Internal Controls in U.S. Corporations and Management 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 twice he has received a special award for outstanding service. Mahers current research includes studies of the efficacy of online education, health care costs, and corporate corruption.

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William N. Lanen
William Lanen is Professor of Accounting and Michael and Joan Sakkinen Scholar at the Stephen M. Ross School of Business 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 financial 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 has served on the Editorial Board of The Accounting Review and 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.

Madhav V. Rajan
Madhav Rajan is Gregor G. Peterson Professor of Accounting at the Graduate School of Business, Stanford University. Madhav joined Stanford GSB in 2001, after 12 years on the faculty of the Wharton School of the University of Pennsylvania. Madhav received his MS, MBA, and PhD in Accounting from Carnegie Mellon University. His dissertation won Carnegie Mellons Alexander Henderson Award for Excellence in Economic Theory. Madhav is an editor of The Accounting Review and an associate editor for Management Science. He also serves on the editorial boards of three other academic journals. Madhavs primary area of research interest is the economicsbased analysis of issues in management accounting, using both analytical and empirical methodologies. His work has been published in leading journals in accounting, economics, finance, and operations management. In 2004, he received the American Accounting Associations Notable Contribution to Management Accounting Literature award. Madhav has taught courses in cost and managerial accounting at the undergraduate, MBA, PhD, and executive MBA levels. He has won numerous undergraduate and MBA teaching awards at Wharton and Stanford GSB, including the David W. Hauck Award, the highest undergraduate teaching honor at Wharton.

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Maher Lanen Rajan

Helping Students through the Maze

The business world presents an array of twists and turns, and getting through them successfully takes informed decision making and a perspective that takes in the whole picture, not just the view immediately ahead. Students entering the business world need to navigate a maze of information systems, ambiguous situations, and value- and nonvalueadded activities. Cost accounting gives them the skills they need to find their way through, and Fundamentals of Cost Accounting is the best choice available to help them learn the cost concepts they must know to succeed. We based this text on the needs of accounting instructors and students. In a nationwide survey of cost accounting instructors, conducted in May 2004, we asked what the greatest challenge and most difficult topics are in this course. The feedback we received from the market shaped this book. From the comments we received, it was clear that the ideal cost textbook needed to have three qualities: it needed to develop students problem solving skills, be realistic, and be concise. By accomplishing these three goals, Fundamentals of Cost Accounting helps students through the maze.

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Students learn by doing, so Fundamentals of Cost Accounting provides a wide range of challenging and thought-provoking end-of-chapter material for them to practice on. The authors have written the problem material to match precisely the presentation of concepts in each chapter; there are no inconsistent terms or conflicting requirements. Fundamentals of Cost Accounting is available with McGraw-Hills Homework Manager, the most powerful system for creating, assigning, and grading homework. With this tool, you can use the authors problem material to its full potential. McGraw-Hills Homework Manager can generate unlimited variations of the end-of-chapter material in Fundamentals of Cost Accounting, allowing you to create unique assignments, tests, or practice problems in minutes.

Realistic
Students enter the cost accounting course with varying levels of preparedness, and some lack the experience to understand how cost accounting relates to all types of businesses and organizations. For this reason, Fundamentals of Cost Accounting presents concepts in context, showing how cost accounting applies to a variety of service and manufacturing companies. Topic Tackler Plus, a multimedia tutorial available at the text Web site or on an optional CD-ROM, gives the students even more real-world flavor with video clips illustrating text concepts at work in actual companies.

Concise
By focusing on key concepts, we have kept Fundamentals of Cost Accounting 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.

I have to say that this is the best cost text I have ever seen by far and I cant stress that enough. . . . The organization of this text in general and the individual chapters is excellent and the clarity of presentation is refreshing.
John Giles North Carolina State University

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ProblemSolving Skills

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our Guide to Y Cost Concepts

5
Chapter Five

Fundamentals of Product and Service Costing

LEARNING OBJECTIVES
After reading this chapter, you should be able to:

L.O.1 Explain the fundamental themes underlying the design of cost systems. L.O.2 Explain how cost allocation is used in a cost management system. L.O.3 Explain how a basic product costing system works.

Working in a group in this executive education class has been really helpful, but maybe not for the reason the instructor thought. About an hour ago, we broke out in groups of three to establish a price for a product. We decided to start by determining the cost of making the product. But the three of us in the group work in very different industries, so when we developed the cost, we all approached it in a different way. We then spent more time talking about the costing systems used in each of our companies than about

coming up with a solution for the case. Now, w to get back to the classroom. I hope the cost w mated makes sense. Selene Theodakis, the production manager Boats, a manufacturer of custom-built pleasure talking during a break at a local college. The othe ple in her group were Cathy Baxter, owner of Bax and Tom Adams, the marketing manager at Thom Sports.

Chapter opener/ opening vignette

Each chapter opens with an engaging, realistic story of how an organization has used cost accounting principles. This sets the stage for the rest of the chapter and encourages students to think of concepts in context.
240

of alternative cost systems for product and service costing. Details and extensions to the basic models described here are presented in the following three chapters. The fundamental approach and the problems that arise from using cost data generated by these basic costing systems can be illustrated by the examples in this chapter. We follow two principles in our discussion: The cost system should be oriented to the needs of the decision makers (that is users of the in

his chapter provides an overview

Chapter 8

Activity-Based Costing

In Action

Activity-Based Costing in a Not for Profit

China. Notice that the first stage separates costs into activities (using number of employees) and then into services using, for one of the activitiespreparing materials, percent of effort.
Source: P. Ip, P. Li, and J. Yau, Application of Activity-Based Costing/(ABC): The Case of a Non-Government Organization, International Journal of Management, v. 20 (3): 282.

Activity-based costing is not just for manufacturing firms or even only for-profit firms. Any organization that wants to better understand the costs of the goods and services it provides can benefit from using it. The following is a cost flow diagram from a proposed activity-based cost system for a not-for-profit (sometimes referred to as a nongovernment organization, or NGO) operating in the Hong Kong Special Administrative Region of

Equipment

Salaries

Other

In Action boxes
These examples, drawn from contemporary journals and the authors own experiences, illustrate how to apply cost accounting methods and tools.

First stage

Number of employees

Conducting courses

Preparing materials

Other

% Effort Second stage

Courses for domestic help

AIDS programs

Other

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job shop, 000 normal cost, 000

underapplied overhead, 000

Review Questions Review Questions

6-1. 6-2. What are characteristics of companies that are likely to use a job cost system? Direct labor-hours and direct labor dollars are the most common allocation b the United States (indeed, throughout the world). Why do you suppose they ar than others?

Analysis and Discussion Questions Critical Analysis and Discussion Questions

o most companies use normal or standard costing? After all, actual costing gives the ost, so the firm could just wait until it knows what the cost will be. control of materials important from a managerial planning perspective? ing about the choice of an overhead allocation base is a waste of time. In the end, overhead is charged to production. Do you agree? Why? w the manager of a construction company (for example, a company that does house ction, remodeling, landscaping, or street or highway construction) about how the ny bids on prospective jobs. Does it use cost information from former jobs that are to prospective ones, for example? Does it have a specialist in cost estimation who es the costs of prospective jobs? Write a report to your instructor summarizing the of your interview. ew the manager of a campus print shop or a print shop in the local area about how mpany bids on prospective jobs. Does it use cost information from former jobs that ilar to prospective ones, for example? Does it have a specialist in cost estimation

End-of-chapter material
The authors have tested the end-of-chapter material over time to ensure quality and consistency with the chapter content.

with McGraw-Hills Homework Manager s

Exercises

Costs to Jobs ansactions occurred in April at Darlington Workshops, a custom manufacturer of ,000 of materials. of supplies from the materials inventory. ,600 of materials. materials purchased in transaction (1). 0 in direct materials to the production department. ct labor costs of $10,000, which were credited to Payroll Payable. cash for utilities, power, equipment maintenance, and other miscellaneous items facturing plant. head on the basis of 125 percent of $10,000 direct labor costs.Problems epreciation on manufacturing property, plant, and equipment of $5,000.

(L.O. 1, 2)

Available with McGraw-Hills Homework Manager

Problems

(L.O. 3) entries to record these transactions. C t t J b

6-25. Estimate Hours Worked from Overhead Data Griffin Corporation estimated that direct labor for the year would be 39,000 hours. G head (all fixed) is applied on the basis of direct labor-hours. The company estimate (L O 1 costs 2) at $156,000. During the year, all overhead costs were exactly as planned ($15 was $5,200 in overapplied overhead. Required How many direct labor-hours were worked during the period? Show computations. 6-26. Assigning CostsMissing Data The following T-accounts represent September activity.
Materials Inventory BB (9/1) 8,000 (a) 9,700 EB (9/30) Finished Goods Inventory Work-In-Process Inven BB (9/1) 4,300 (b) 22,300 180,500 121,000 94,000 17,700

(L.O. 2, 3)

EB (9/30)

Integrative Cases

Integrative Cases
(L. O. 1, 3, 5, 6)

Integrative Cases
These involving cases ask students to apply the different techniques they have learned to a realistic situation.

8-38. Cost Allocation and Environmental ProcessesEthical Issues California Circuits Company (3C) manufactures a variety of components. Its Valley plant specializes in two electronic components used in circuit boards. These components serve the same function and perform equally well. The difference in the two products is the raw material. The XL-D chip is the older of the two components and is made with a metal that requires a wash prior to assembly. Originally, the plant released the wastewater directly into a local river. Several years ago, the company was ordered to treat the wastewater before its release, and it installed relatively expensive equipment. While the equipment is fully depreciated, annual operating expenses of $250,000 are still incurred for wastewater treatment. Two years ago, company scientists developed an alloy with all of the properties of the raw materials used in XL-D that generates no wastewater. Some prototype components using the new material were produced and tested and found to be indistinguishable from the old components in every way relating to their fitness for use. The only difference is that the new alloy is more expensive than the old raw material. The company has been test-marketing the newer version of the component, referred to as XL-C, and is currently trying to decide its fate. Manufacturing both components begins in the Production Department and is completed in the Assembly Department. No other products are produced in the plant. The following provides information for the two components:
XL-D Units produced . . . . . . . . . . . . . . . . . . . . . . . Raw material costs per unit . . . . . . . . . . . . . Direct Labor-Hours per unitProduction . . . Direct Labor-Hours per unitAssembly . . . . Direct Labor Rate per hourall labor . . . . . . Machine-Hours per unitproduction . . . . . . Machine-Hours per unitassembly . . . . . . . Testing Hours per unit (all in production) . . . Shipping weight per unit (pounds) . . . . . . . . Wastewater generated per unit (gallons) . . . 100,000 $12 0.1 0.4 $20 1.6 0.4 3.0 1.0 10.0 XL-C 25,000 $14 0.1 0.4 $20 1.6 0.4 3.0 1.6 0.0

Annual overhead costs for the two departments follow:

Production Department Supervision . . . . . . . . . . . . . . . Material handling . . . . . . . . . . . Testing . . . . . . . . . . . . . . . . . . . Wastewater treatment . . . . . . . Depreciation on equipment . . . Shipping . . . . . . . . . . . . . . . . . . Total . . . . . . . . . . . . . . . . . . $ 100,000 93,000 150,000 250,000 400,000 7,000 $1,000,000 Assembly Department $240,000 40,000 0 0 100,000 120,000 $500,000

The company president believes that its foolish to continue producing two essentially equivl t d t At th ti th t i i h tt ih db f t i

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Map through
Maher Lanen Rajan
Chapter 1 Cost Accounting: Information for Decision Making

the chapters

Fundamentals of Cost Accounting is a cost accounting text for decision making. Through real-world examples and detailed illustrations, each chapter provides comprehensive coverage of the basic concepts of cost accounting.
Chapter 5 Fundamentals of Product and Service Costing
This chapter provides an overview of alternative cost systems for product and service costing presented in Chapters 6, 7, and 8. The intuitive approach the chapter takes highlights the basics of product costing systems. The fundamental approach and the problems that arise from using cost data generated by these basic costing systems are illustrated by the examples in the chapter. Two principles are emphasized: the cost system should be oriented to the needs of the decision makers (that is, users of the information) and the cost system should be designed so that its benefits exceed its costs.

The text starts with a detailed overview of cost accounting that describes many of the decisions that require cost accounting information. It also discusses ethical decisions and problems students may face in their careers.

Unlike most first chapters, it provides a good introduction. This is not a chapter Id skip!
Patricia Derrick, Virginia Tech University

Chapter 2 Cost Concepts and Behavior

This chapter discusses how cost accounting systems provide information to help managers make better decisions. Because cost accounting systems are tailored to the needs of individual companies, several terms are used in practice to describe the same or similar cost concepts, depending on the use or the audience.

I see why your book is different. The work to integrate topics in the reading is great. This is a distinct challenge and I can see why it has not been done in this way before.
Thomas Zeller, Loyola UniversityChicago

Good explanation of equivalent units. Really like the way the reader is lead to the need for EQUs. In my experience, students get the concept if they come to see the need for them by themselves through an example. Good discussion of allocation bases. . . . Nice logical flow. Its not rushed (as is often the case in many texts).
Patricia Derrick, Virginia Tech University

Chapter 3 Fundamentals of Cost Analysis for Decision Making

Unlike typical cost accounting texts, this chapter incorporates the discussion of relevant cost and cost analysis into one chapter. Where most texts cover these related concepts in multiple chapters, Fundamentals has grouped the discussion of CVP, decision making, and constraints into one comprehensive chapter at the beginning of the text.

Chapter 6 Job Costing Chapter 7 Process Costing Chapter 8 Activity-Based Costing

Chapters 6, 7, and 8 use detailed flow charts and examples of the various costing systems. Chapter 6 discusses the product costing system, including accounting for the flows of costs through the inventory accounts. It describes a job costing system used in many service and discrete manufacturing settings. Chapter 7 deepens the discussion by describing the development of a process costing system. Operations costing systems are described at the end of the chapter. Chapter 8 describes innovations to the basic costing systems, including activity-based costing (ABC), which has been implemented or considered by manufacturing firms such as General Motors and Chrysler, financial service firms such as Citibank, and even agencies of the U.S. government.

Incorporating relevant cost decisions into the chapter on cost analysisthis is conceptually sound and not usually done in texts.
Margaret OReilly-Allen, Rider University

Chapter 4 Cost Estimation

When managers make decisions, they need to compare the costs (and benefits) among alternative actions by estimating the costs associated with each alternative. This chapter discusses how to estimate the cost data required for decision making and how cost estimates can be an important element in making decisions that add value to the company.

This chapter is written very well on a very, very difficult topic for students.
Jeanne Harrington, Middle Tennessee University

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Chapter 9 Fundamentals of Cost Management

While Chapter 8 discusses the use of activity-based costing to compute the costs of products and services, Chapter 9 considers the use of these methods to manage and control costs. Activity-based management does not focus on the detailed calculation of product costs using activity-based costing already covered in Chapter 8, but explores managements uses of activitybased costing methods to identify ways to assess customer profitability. The chapter also describes the assignment of capacity costs and measuring the cost of quality.

Chapter 13 Business Unit Performance Measurement

Chapter 13 develops and analyzes the performance measures for investment centers or business units. As the chapter develops the performance measures, the discussion centers around three questions:
1) Is the performance measure consistent with the decision authority of the manager? 2) Does the measure reflect the results of the actions that improve the performance of the organization? 3) What actions can the manager take that improve reported performance, but are detrimental to organizational performance?

I think this chapter is a major contribution compared to most old texts.

Kathleen Sevigny, Bridgewater State College

This is a relatively new and important topic . . . well done in this chapter.
Margaret OReilly-Allen, Rider University

Chapter 10 Service Department and Joint Cost Allocation

Chapter 10 discusses the allocation of service department costs to production departments. It also considers product costing when multiple products are produced from inputs in fixed proportions. The chapter describes several methods of allocating joint costs and includes multiple examples.

Chapter 14 Transfer Pricing

Chapter 14 explains the basic issues involved with transfer pricing by presenting real-world examples to show the costs of dysfunctional decision making that arise when local managers, making decisions based on local interests, make choices that are suboptimal for the organization as a whole.

Having service department allocations and joint cost allocations in one chapter is very efficient, and facilitates understanding of the material.
Ola Smith, Western Michigan University

The exercises and problems were very interesting as they have a high global and segment reporting content; the examples used were very realistic. They would make the classroom experience very enriching.
Kim Tan, California State University-Stanislaus

Chapter 11 Fundamentals of Management Control Systems

Students explicitly recognize how individuals respond to methods used for performance measurement. Thus, the discussion of the design and use of management control systems uses concepts from human and organizational behavior as well as accounting and economics. This chapter develops basic issues and a coherent framework for assessing management control issues.

Chapter 15 Fundamentals of Variance Analysis

Chapter 15 discusses the control and evaluation activity for profit and cost centers. Comparing actual performance to budgets, students learn how to better understand why targets are not achieved. This helps maintain control by identifying areas for improvement. It also allows firms to assess the performance of managers in different departments.

Chapter 16 Special Topics in Variance Analysis

This chapter discusses additional variances to illustrate some of the ways the basic variance analysis model can be extended and adapted to specific circumstances. The basic principles are the same as those presented in Chapter 15.

Resists temptation to fill with fluff. Presents the material well, grounds it well, but doesnt add the management control system du jour, which quickly dates the book.
Patricia Derrick, Virginia Tech University

Chapter 17 Nonfinancial and Multiple Measures of Performance

This chapter discusses how financial performance measures are commonly used to evaluate employee performance. In recent years, however, more and more companies have begun using nonfinancial measures such as customer satisfaction and product quality measures. This chapter shows innovative ways to evaluate performance beyond the numbers by presenting a framework used to ensure that the performance measures developed are consistent with the rest of the management control system.

Chapter 12 Planning and Budgeting

This chapter focuses on the planning purposes of the budgeting process. It shows how a master budget is developed and how it fits into the overall plan for achieving organizations goals. Before investigating the details of developing a master budget, this chapter discusses how strategic planning can increase competitiveness and affect global operations.

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Technology
Maher Lanen Rajan
OnePass
It can be a challenge remembering all the different access for the many online assets available with Managerial Accounting. To make life easier for your students, McGraw-Hill is pleased to introduce OnePass. With McGraw-Hills OnePass, just one access code gets your students total access to McGraw-Hills Homework Manager, Topic Tackler Plus, NetTutor, and the online version of the textbook. Moreover, the OnePass card fits in your students wallets for safekeeping.

Topic Tackler Plus

This program is a complete tutorial focusing on those areas in the cost accounting course that give students the most trouble. Providing help on two key topics for every single chapter, this program delves into the material via the following: Video clips Audio-narrated PowerPoint slides Interactive quizzes

This icon marks any topic given further coverage in Topic Tackler.

This highly engaging presentation will give your students command of the most fundamental aspects of managerial accounting. Students can access Topic Tackler Plus through the Online Learning Center or an optional CD-ROM.

McGraw-Hills Homework Manager

This Web-based supplement duplicates problems directly from the textbook end-ofchapter material, using algorithms to provide a limitless supply of online self-graded practice for students, or assignments and tests with unique versions of every problem. You now have the power and flexibility youve been waiting for in creating assignments. The enhanced version of McGraw-Hills Homework Manager integrates all of Fundamentals of Cost Accountings online and multimedia assets to allow your students to brush up on a topic before doing their homework. You now have the option to give your students prepopulated hints and feedback. The test bank has been added to Homework Manager so you can create online quizzes and exams and have them autograded and recorded in the same gradebook as your homework assignments. Lastly, the enhanced version provides you with the option of incorporating the complete online version of the textbook, so your students can easily reference the chapter material as they do their homework assignment, even when their textbook is far away. McGraw-Hills Homework Manager is also a useful grading tool. All assignments can be delivered over the Web and are graded automatically, with the results stored in your private grade book. Detailed results let you see at a glance how each student does on an assignment or an individual problemyou can even see how many tries it took them to solve it. Students receive full access to McGraw-Hills Homework Manager when they purchase OnePass, or you can have Homework Manager pass codes shrinkwrapped with the textbook. Students can also purchase access to Homework Manager directly from your course home page. McGraw-Hills Homework Manager is powered by Brownstone.

Online Learning Center (OLC)

www.mhhe.com/maher1e More and more students are studying online. Thats why we offer an Online Learning Center (OLC) that follows Fundamentals of Cost Accounting chapter by chapter. It doesnt require any building or maintenance on your part. Its ready to go the moment you and your students type in the URL. As your students study, they can refer to the OLC Web site for such benefits as: Internet-based activities Self-grading quizzes Links to text references Links to professional resources on the Web and job opportunity information Learning objectives Chapter overviews A secured Instructor Resource Center stores your essential course materials to save you prep time before class. The Instructors Manual, Solutions Manual, and audio-narrated PowerPoints are a couple of clicks away. You will also find useful packaging information and transition notes. OnePass gives students total access to all OLC features, including premium content like the Fundamentals of Cost Accounting online textbook.

NetTutor
Students have other commitments outside of class, making it difficult for them to get help during regular hours. NetTutor is a breakthrough program that connects your students with qualified tutors online, so they can get help at their convenience. Students communicate with tutors through the live tutor center, where students view tutor-created spreadsheets, T-accounts, and instant responses to their questions, or through the Q&A Center, which allows students to submit questions anytime and receive answers within 48 hours. With OnePass, students receive unlimited access to NetTutor for the length of the course.

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Instructors Resource CD-ROM 0073018384 An all-in-one class resource that allows you to create stimulating custom presentations from your own materials or from the many text-specific materials provided in the CD. The CD includes the following resources: Instructors Manual, Solutions Manual, Computerized Test Bank, and Audio-Narrated PowerPoints. Instructors Resource Manual 0073018406 Each chapter and appendix includes: Chapter Learning Objectives Chapter Outline Comments and observations for each key concept, methods of presentation, and usefulness of specific assignment material. Suggested assignments, demonstration problems, and chapter quizzes organized by learning objectives. Solutions Manual: 0073018392 This comprehensive manual provides solutions to all Discussion Questions, Exercises, Problems, and Integrative Cases. These solutions are also made available on the texts Online Learning Center: www.mhhe.com/maher1e Solutions Transparencies: 0073018422 These are acetates of solutions to all Exercises and Problems found in the Solutions Manual. Online Learning Center (www.mhhe.com/maher1e) All the essential instructor supplements are available here, password protected. The OLC works in tandem with our course delivery portal, PageOut, and the OLC material can also be converted into files for use with Blackboard and WebCT. Test Bank: 0073018414 With an abundance of objective questions and short exercises, this is a valuable resource for instructors who prepare their own quizzes and examinations. Instructor Excel Spreadsheet Templates Solutions to spreadsheet problems found in text endof-chapter material, housed on Instructors Resource CD-ROM and password protected on instructor side of Online Learning Center. PowerPoint Slides This important tool uses audio-narrated PowerPoint slide shows to illustrate the chapters most important concepts, and is available on the Instructors Resource CD-ROM and the Online Learning Center.

Topic Tackler Plus CD-ROM 0073018449 This interactive tutorial software is available as a CD-ROM or through the texts Online Learning Center. It makes accounting visual and helps students learn key concepts for each chapter of the text. Topic Tackler includes: Video clips Audio-narrated PowerPoint Slides Practice quizzes Self-study quizzes Icons in the margin of the book identify items where Topic Tackler Plus reviews are available. McGraw-Hills Homework Manager: 0073103802 This optional online supplement uses an intelligent algorithm to generate an infinite number of problems, based on problem structures from the text. This enables students to practice particular types of problems repeatedly until they have mastered key concepts. Study Guide: 0073018465 For each chapter, students can measure their progress through a wealth of self-test material (with solutions) and a summary of each chapters key points. Excel Spreadsheet Templates An icon denotes selected end-of-chapter material that come with Excel spreadsheet templates for students to use while solving problems. Online Learning Center: 0073018430 www.mhhe.com/maher1e The OLC is full of resources for students, including: Chapter Summaries, Online Quizzing, Key Term Reviews, PowerPoint Presentations, Excel Templates, Links to Net Tutor and Homework Manager, Links to Professional Resources, and Text Updates.

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Print upplements S Instructors Supplements: Student Supplements:

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Acknowledgements
A special thank you
to the following individuals who helped develop and critique the book and ancillary package: Barbi Wiggins, BW Consulting; Kimberly Richardson, George Mason University; Cathy Claiborne, California State University Channel Islands; Chiaho Chang, Montclair University; Robert Gruber, University of WisconsinWhitewater; Michael Haselkorn, Bentley College; Beth Woods, Accuracy Counts; Alice Sineath, Forsyth Tech Community College; and Ilene Persoff, CW Post CampusSchool of Professional Accountancy at Long Island University. We are grateful for the outstanding support of McGraw-Hill/Irwin. In particular, we would like to thank Brent Gordon, Editorial Director; Stewart Mattson, Publisher; Steve Delancey, Senior Sponsoring Editor; Kimberly Hooker, Senior Developmental Editor; Marc Chernoff, Marketing Manager; Mark LaCien, Director of Advertising and Promotions; Daniel Wiencek, Senior Copywriter; Jim Labeots, Project Manager; Adam Rooke, Senior Designer; Gina Hangos, Production Supervisor; Elizabeth Mavetz, Media Producer; Matt Perry, Media Project Manager; Gina DiMartino, Supplement Producer; and Kathy Shive, Photo Research Coordinator. Finally, we wish to thank all the professors who reviewed Fundamentals of Cost Accounting. Their detailed comments, suggestions and words of encouragement were invaluable in creating this book.

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Reviewers
Charles Betts Delaware Technical Community College Timothy B. Biggart University of North Carolina Rodger Brannan University of Minnesota at Duluth Wayne Bremser Villanova University Nat Briscoe Northwestern State University Roberta Cable Pace University Chiaho Chang Montclair State University Kerry Colton Aims Community College William Cready Louisiana State University Patricia Derrick Virginia Polytechnic Institute and State University Robert Elmore Tennessee Tech University John Giles North Carolina State University Penelope Sue Greenberg Widener University Jeannie Harrinigton Middle Tennessee State University Michael Haselkorn Bentley College Daniel A. Hinchliffe Florida Atlantic University M. Zafar Iqbal Cal State Poly University-Pomona Richard Kelsey NOVA Southeastern University Larry N. Killough Virginia Tech Larissa Kyj Rowan University Randall E. LaSalle West Chester University of Pennsylvania John Logsdon Webber International University P. Michael McLain Hampton University Kathleen Metcalf Muscatine Community College Karen Nunez North Carolina State University Margaret O'Reilly-Allen Rider University Tamara Phelan Northern Illinois University Jeanette Ramos-Alexander New Jersey City University Gerald Rosson Lynchburg College Anwar Salimi Cal State Poly University-Pomona Kathleen Sevigny Bridgewater State College Kenneth Sinclair Lehigh University Ola Smith Western Michigan University Cynthia Sneed Jacksonville State University Swaminathan Sridharan Kellogg School of Management Lorraine Stern York College SUNY Verlindsey Stewart J.F. Drake State Technical College Kim Tan California State UniversityStanislaus Debra Warren Chadron State College Anne Warrington Michigan Tech University Thomas Zeller Loyola University at Chicago
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Maher Lanen Rajan

Rowland Atiase University of Texas at Austin

Daniel Law Gonzaya University

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Brief Contents
PART ONE: Introduction and Overview

Chapter One Chapter Two

Cost Accounting: Information for Decision Making Cost Concepts and Behavior 28

PART TWO: Cost Analysis and Estimation

Chapter Three Chapter Four

Fundamentals of Cost Analysis for Decision Making Cost Estimation 106

66

PART THREE: Cost Management Systems

Chapter Five Chapter Six Chapter Seven Chapter Eight Chapter Nine Chapter Ten

Fundamentals of Product and Service Costing Job Costing 162 192 230 268 Process Costing

138

Activity-Based Costing

Fundamentals of Cost Management

Service Department and Joint Cost Allocation

298

PART FOUR: Management Control Systems

Chapter Eleven Chapter Twelve Chapter Thirteen Chapter Fourteen Chapter Fifteen Chapter Sixteen Chapter Seventeen

Fundamentals of Management Control Systems Planning and Budgeting Transfer Pricing 428 458 502 362 400 Business Unit Performance Measurement Fundamentals of Variance Analysis Special Topics in Variance Analysis

337

Nonfinancial and Multiple Measures of Performance Evaluation

532

Appendix: Capital Investment Decisions: An Overview 552

Glossary 563 Photo Credits 569 Index 571

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CHAPTER ONE Cost Accounting: Information for Decision Making 2 VALUE CREATION IN ORGANIZATIONS Value Chain 3 Supply Chain 4 3 Benchmarking and Continuous Improvement 13 Activity-Based Costing and Management 13 Enterprise Resource Planning 14 Six Sigma 14 Performance Measurement 14 Creating Value in the Organization 14 KEY FINANCIAL PLAYERS IN THE ORGANIZATION 15 CHOICES: ETHICAL ISSUES FOR ACCOUNTANTS 16 What Makes Ethics So Important? 16 In Action: Channel Surfing 16 What Should You Do If You Discover Unethical Conduct? 17 Sarbanes-Oxley Act of 2002 and Ethics 17 COST ACCOUNTING AND OTHER BUSINESS DISCIPLINES 18
Summary 18 Key Terms 19 Appendix 1A: Institute of Management Accountants Code of Ethics 19 Review Questions 21 Critical Analysis and Discussion Questions 21 Exercises 22 Problems 23 Solutions to Self-Study Questions 26

ROLE OF INFORMATION IN THE ORGANIZATION 4 The Managers Job Is to Make Decisions 4 Decision Making Requires Information 4 Managers Are Not Owners 5 Using Cost Information to Increase Value 5 In Action: Palliative Care Unit 5 Finding and Eliminating Activities That Dont Add Value 5 Strategic Cost Analysis 6 COST DATA FOR MANAGERIAL DECISIONS 6 Costs for Decision Making 6 Costs for Control and Evaluation 7 Different Data for Different Decisions ACCOUNTING SYSTEMS 10 Financial Accounting 10 Cost Accounting 10 Cost Accounting and GAAP 11 Customers of Cost Accounting 11 Ethical Issues and Cost Accounting 12 TRENDS IN COST ACCOUNTING 12 Cost Accounting in High-Tech Production Settings 12 Just-in-Time Methods 13 Lean Production 13 Emphasis on Quality 13

CHAPTER TWO Cost Concepts and Behavior WHAT IS A COST? 29 Cost versus Expenses 30 PRESENTATION OF COSTS IN FINANCIAL STATEMENTS 30 Service Organizations 31 Retail and Wholesale Companies 31
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Manufacturing Companies 33 Direct and Indirect Product Manufacturing (Product) Costs 33 Prime Costs and Conversion Costs 34 Nonmanufacturing (Period) Costs 34 In Action: Indirect Costs in Banking 35 COST ALLOCATION 35 Direct versus Indirect Costs 36

DETAILS OF MANUFACTURING COST FLOWS 37 HOW COSTS FLOW THROUGH THE STATEMENTS 38 Income Statements 38 Cost of Goods Sold 38 Direct Materials 39 Work in Process 39 Finished Goods Inventory 40 Cost of Goods Sold Statement 40 COST BEHAVIOR 41 Fixed versus Variable Costs 41

Graphic Presentation 71 Profit-Volume Model 72 Use of CVP to Analyze the Effect of Different Cost Structures 73 In Action: Effect of Cost Structure on Operating and Investing Decisions 74 Margin of Safety 75 CVP Analysis with Spreadsheets 75 Extensions of the CVP Model 76 Income Taxes 76 Multiproduct CVP Analysis 76 DIFFERENTIAL ANALYSIS 77 Differential Costs versus Total Costs 78 Differential Analysis and Pricing Decisions 79 Short-Run versus Long-Run Pricing Decisions 79 Short-Run Pricing Decisions: Special Orders 80 Long-Run Pricing Decisions 81 Long-Run versus Short-Run Pricing: Is There a Difference? 82 Cost Analysis for Pricing 82 In Action: Take Back Laws in Europe 83 USE OF DIFFERENTIAL ANALYSIS FOR PRODUCTION DECISIONS 83 Make-It or Buy-It Decisions 83 Make-or-Buy Decisions Involving Differential Fixed Costs 83 Opportunity Costs of Making 86 Decision to Add or Drop a Product Line or Close a Business Unit? 87 Product Choice Decisions 88
Summary 90 Key Terms 91 Appendix: Theory of Constraints 91 Review Questions 92 Critical Analysis and Discussion Questions Exercises 93 Problems 98 Solutions to Self-Study Questions 103

COMPONENTS OF PRODUCT COSTS 43 Unit Fixed Costs Can Be Misleading for Decision Making 44 HOW TO MAKE COST INFORMATION MORE USEFUL FOR MANAGERS 48 Gross Margin versus Contribution Margin Income Statements 48 Developing Financial Statements for Decision Making 48
Summary 50 Key Terms 51 Review Questions 51 Critical Analysis and Discussion Questions Exercises 52 Problems 59 Solutions to Self-Study Questions 63

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CHAPTER THREE Fundamentals of Cost Analysis for Decision Making 66 COST-VOLUME-PROFIT ANALYSIS Profit Equation 67 CVP Example 69 67

CHAPTER FOUR Cost Estimation 106 107 107

WHY ESTIMATE COSTS?

BASIC COST BEHAVIOR PATTERNS

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WHAT METHODS ARE USED TO ESTIMATE COST BEHAVIOR? 107 Engineering Method 108 Account Analysis Method 108 Statistical Cost Estimation 110 In Action: Using Regression to Evaluate Cost Behavior 116 Multiple Regression 116 Practical Implementation Problems 117 In Action: Learning Curves 118 HOW IS AN ESTIMATION METHOD CHOSEN? 120 Data Problems 120 Effect of Different Methods on Cost Estimates 121
Summary 122 Key Terms 123 Appendix 4A: Using Microsoft Excel to Estimate Regression Coefficients 123 Review Questions 127 Critical Analysis and Discussion Questions 128 Exercises 128 Problems 132 Solutions to Self-Study Questions 137

COSTING IN A MULTIPLE PRODUCT, DISCRETE PROCESS INDUSTRY 144 Predetermined Overhead Rates 146 Product Costing of Multiple Products 146 Choice of the Allocation Base for Predetermined Overhead Rate 147 Choice among Possible Allocation Bases 148 MULTIPLE ALLOCATION BASES AND TWOSTAGE SYSTEMS 149 Choice of Allocation Bases 150 DIFFERENT COMPANIES, DIFFERENT PRODUCTION, AND COSTING SYSTEMS Operations Costing: An Illustration 152
Summary 153 Key Terms 154 Review Questions 154 Critical Analysis and Discussion Questions Exercises 155 Problems 158 Integrative Case 158 Solutions to Self-Study Questions 159

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CHAPTER SIX Job Costing 162 163

CHAPTER FIVE Fundamentals of Product and Service Costing 138 COST MANAGEMENT SYSTEMS 139 Reasons to Calculate Product or Service Costs 139 In Action: Importance of Distinguishing between Production Costs and Overhead Costs 140 Cost Allocation and Product Costing 140 Cost Flow Diagram 140 FUNDAMENTAL THEMES UNDERLYING THE DESIGN OF COST SYSTEMS FOR MANAGERIAL PURPOSES 141 COSTING IN A SINGLE PRODUCT, CONTINUOUS PROCESS INDUSTRY 142 Basic Cost Flow Model 142 Costing with No Work-in-Process Inventories 142 Costing with Ending Work-in-Process Inventories 142

DEFINING IS A JOB?

USING ACCOUNTING RECORDS IN A JOB SHOP 163 COMPUTING THE COST OF A JOB 164 Production Process at InShape 164 Record of Costs at InShape 165 How Manufacturing Overhead Costs Are Recorded at InShape 168 In Action: Effect of Overhead Rates on Production Decisions 168 Over- and Underapplied Overhead 171 Multiple Allocation Bases: The Two-Stage Approach 173 Summary of Steps in a Job Costing System 173 USING JOB COSTING IN SERVICE ORGANIZATIONS 173 ETHICAL ISSUES AND JOB COSTING 175 Misstating Stage of Completion 176 Charging Costs to the Wrong Jobs 176 Misrepresenting the Cost of Jobs 176

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MANAGING PROJECTS 176 In Action: Determination of Costs of Large Projects and Ethical Implications 178
Summary 178 Key Terms 178 Review Questions 178 Critical Analysis and Discussion Questions Exercises 179 Problems 182 Integrative Case 191 Solutions to Self-Study Questions 191

Step 5: Assign Product Cost: FIFO 204 How This Looks in T-Accounts 205 DETERMINING WHICH IS BETTER: FIFO OR WEIGHTED AVERAGE? 205 COMPUTING PRODUCT COSTS: SUMMARY OF THE STEPS 206 USING COSTS TRANSFERRED IN FROM PRIOR DEPARTMENTS 208 Who Is Responsible for Costs Transferred in from Prior Departments? 208 CHOOSING BETWEEN JOB AND PROCESS COSTING 208

179

CHAPTER SEVEN Process Costing 192 194

DETERMINING EQUIVALENT UNITS

USING PRODUCT COSTING IN A PROCESS INDUSTRY 194 Step 1: Measure the Physical Flow of Resources 195 Step 2: Compute the Equivalent Units of Production 196 Step 3: Identify the Products Costs for which to Account 196 Time Out! We Need to Make an Assumption about Costs and the Work-in-Process Inventory 197 Step 4: Compute Costs per Equivalent Unit: Weighted Average 198 Step 5: Assign Product Cost to Batches of Work: Weighted-Average Process Costing 198 REPORTING THIS INFORMATION TO MANAGERS: THE PRODUCTION COST REPORT 199 Sections 1 and 2: Managing the Physical Flow of Units 200 Sections 3, 4, and 5: Managing Costs 200 ASSIGNING COSTS USING FIRST-IN, FIRSTOUT (FIFO) PROCESS COSTING 200 Step 1: Measure the Physical Flow of Resources 201 Step 2: Compute the Equivalent Units of Production 201 Step 3: Identify the Costs for Which to Account 203 Step 4: Compute Costs per Equivalent Unit: FIFO 203

OPERATION COSTING 209 Product Costing in Operations 209 Operation Costing Illustration 210 COMPARING JOB, PROCESS, AND OPERATION COSTING 212
Summary 213 Key Terms 214 Review Questions 214 Critical Analysis and Discussion Questions Exercises 215 Problems 220 Solutions to Self-Study Questions 226

214

CHAPTER EIGHT Activity-Based Costing 230

REPORTED PRODUCT COSTS AND DECISION MAKING 231 Dropping a Product 231 The Death Spiral 233 TWO-STAGE COST ALLOCATION 234 Two-Stage Cost Allocation and the Choice of Cost Drivers 235 Plantwide versus Department-Specific Rates 238 Choice of Cost Allocation Methods: A Cost-Benefit Decision 238 ACTIVITY-BASED COSTING 239 In Action: Activity-Based Costing in a Not for Profit 240 Developing Activity-Based Costs 240 COST HIERARCHIES 242

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ACTIVITY-BASED COSTING ILLUSTRATED 243 Step 1: Identify the Activities 243 Step 2: Identify the Cost Drivers 243 Step 3: Compute the Cost Driver Rates 244 Step 4: Assign Costs Using Activity-Based Costing 244 Unit Costs Compared 246 COST FLOWS THROUGH ACCOUNTS 246

MANAGING THE COST OF CAPACITY 277 Using and Supplying Resources 278 Computing the Cost of Unused Capacity 279 Assigning the Cost of Unused Capacity 281 Seasonal Demand and the Cost of Unused Capacity 281 MANAGING THE COST OF QUALITY 283 How Can Traditional Managerial Accounting Systems Limit the Impact of Total Quality Management 283 What Is Quality? 284 The Cost of Quality 284 Trade-Offs, Quality Control and Failure Costs 286 In Action: Cost Elements included n Reported Quality Costs 287
Summary 288 Key Terms 289 Review Questions 289 Critical Analysis and Discussion Questions Exercises 290 Problems 294 Integrative Case 296 Solutions to Self-Study Questions 296

CHOICE OF ACTIVITY BASES IN MODERN PRODUCTION SETTINGS 248 In Action: Evidence on the Benefits of ActivityBased Costing 249 ACTIVITY-BASED COSTING IN ADMINISTRATION 249 WHO USES ABC? 250

Summary 251 Key Terms 252 Review Questions 252 Critical Analysis and Discussion Questions Exercises 252 Problems 257 Integrative Cases 263 Solutions to Self-Study Questions 266

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CHAPTER TEN 268 Service Department and Joint Cost Allocation 298 SERVICE DEPARTMENT COST ALLOCATION 299 METHODS OF ALLOCATING SERVICE DEPARTMENT COSTS 301 Allocation Bases 301 Direct Method 301 Step Method 305 In Action: Step Method at Stanford University 307 Reciprocal Method 307 Comparison of the Direct, Step, and Reciprocal Methods 310 ALLOCATION OF JOINT COSTS Joint Costing Defined 311 311

CHAPTER NINE Fundamentals of Cost Management

USING ACTIVITY-BASED COST MANAGEMENT TO ADD VALUE 269 Using Activity-Based Cost Information to Improve Processes 271 Using Cost Hierarchies 271 MANAGING THE COST OF CUSTOMERS AND SUPPLIERS 272 Using Activity-Based Costing to Determine the Cost of Customers and Suppliers 273 Determining Why the Cost of Customers Matters 275 Using Cost of Customer Information to Manage Costs 275 In Action: Customer, Not Product, Profitability 276 Determining the Cost of Suppliers 276 Capturing the Cost Savings 277

REASONS FOR ALLOCATING JOINT COSTS 311

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JOINT COST ALLOCATION METHODS Net Realizable Value Method 312 Physical Quantities Method 315 Evaluation of Joint Cost Methods 315

312

DECIDING WHETHER TO SELL GOODS NOW OR PROCESS THEM FURTHER 316 In Action: Different Demands for Different Parts 316 WHAT TO DO WITH BY-PRODUCTS 316
Summary 318 Key Terms 319 Appendix 10A: Calculation of the Reciprocal Method Using Computer Spreadsheets 319 Review Questions 321 Critical Analysis and Discussion Questions 321 Exercises 322 Problems 326 Integrative Case 332 Solutions to Self-Study Questions 333

Revenue Centers 342 Profit Centers 342 Investment Centers 343 Responsibility Centers and Organization Structure 343 MEASURING PERFORMANCE 344 Two Basic Questions 344 In Action: Teacher Pay and Student Performance 345 Cost Centers 345 Revenue Centers 345 Profit Centers 345 Investment Centers 346 EVALUATING PERFORMANCE 346 Relative Performance versus Absolute Performance Standards 346 Evaluating Managers Performance versus Economic Performance of the Responsibility Center 347 Relative Performance Evaluations in Organizations 347 COMPENSATION SYSTEMS 348 In Action: Beware of the Kink 348 Illustration: Corporate Cost Allocation 349 Incentive Problems with Allocated Costs 349 Effective Corporate Cost Allocation 350 DO PERFORMANCE EVALUATION SYSTEMS CREATE INCENTIVES TO COMMIT FRAUD? 351
Summary 352 Key Terms 353 Review Questions 353 Critical Analysis and Discussion Questions Exercises 354 Problems 355 Integrative Case 357 Solutions to Self-Study Questions 360

CHAPTER ELEVEN Fundamentals of Management Control Systems 336 WHY A MANAGEMENT CONTROL SYSTEM? 337 Alignment of Managerial and Organizational Interests 337 Evolution of the Control Problem: An Example 337 DECENTRALIZED ORGANIZATIONS 338 Why Decentralize the Organization? 338 Advantages of Decentralization 339 Disadvantages of Decentralization 339 FRAMEWORK FOR EVALUATING MANAGEMENT CONTROL SYSTEMS 340 Organizational Environment and Strategy 340 Results of the Management Control System 340 Elements of a Management Control System 340 Balancing the Elements 341 DELEGATED DECISION AUTHORITY: RESPONSIBILITY ACCOUNTING 342 Cost Centers 342 Discretionary Cost Centers 342

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CHAPTER TWELVE Planning and Budgeting 362

HOW STRATEGIC PLANNING INCREASES COMPETITIVENESS 363 OVERALL PLAN 364

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Organization Goals 364 Strategic Long-Range Profit Plan 364 Master Budget (Tactical Short-Range Profit Plan): Tying the Strategic Plan to the Operating Plan 364 HUMAN ELEMENT IN BUDGETING 365 Value of Employee Participation 366 DEVELOPING THE MASTER BUDGET 366 WHERE TO START? 366 Sales Forecasting 366 COMPREHENSIVE ILLUSTRATION 368 Forecasting Production 368 Forecasting Production Costs 369 Direct Labor 371 Overhead 371 Completing the Budgeted Cost of Goods Sold 372 Revising the Initial Budget 373 MARKETING AND ADMINISTRATIVE BUDGET 373 PULLING IT TOGETHER INTO THE INCOME STATEMENT 374 KEY RELATIONSHIPS: THE SALES CYCLE 375

Summary 384 Key Terms 385 Review Questions 385 Critical Analysis and Discussion Questions Exercises 385 Problems 390 Integrative Case 395 Solutions to Self-Study Questions 396

385

CHAPTER THIRTEEN Business Unit Performance Measurement 400 In Action: What Determination whether Firms Use Divisional Measures for Measuring Divisional Performance 401 ACCOUNTING INCOME 402 Computing Divisional Income 402 Advantages and Disadvantages of Divisional Income 402 Some Simple Financial Ratios 403 RETURN ON INVESTMENT 404 Performance Measures for Control: A Short Detour 405 Limitations of ROI 405 RESIDUAL INCOME MEASURES 408 Limitations of Residual Income 409 ECONOMIC VALUE ADDED (EVA) 410 Limitations of EVA 411 In Action: Does Using Residual Income as a Performance Measure Affect Managers Decisions? 412 MEASURING THE INVESTMENT BASE 412 Gross Book Value versus Net Book Value 412 Historical Cost versus Current Cost 413 Beginning, Ending, or Average Balance 415 OTHER ISSUES IN DIVISIONAL PERFORMANCE MEASUREMENT
Summary 416 Key Terms 416 Review Questions 416 Critical Analysis and Discussion Questions Exercises 417 Problems 420 Integrative Case 423 Solutions to Self-Study Questions 426

USING CASH FLOW BUDGETS TO ESTIMATE CASH NEEDS 376 Multiperiod Cash Flows 377 In Action: The Curse of Growth 378 PLANNING FOR THE ASSETS AND LIABILITIES ON THE BUDGETED BALANCE SHEETS 379 BIG PICTURE: HOW IT ALL FITS TOGETHER 379 BUDGETING IN RETAIL AND WHOLESALE ORGANIZATIONS 379 BUDGETING IN SERVICE ORGANIZATIONS 381 In Action: Budget is the Law of Government ETHICAL PROBLEMS IN BUDGETING BUDGETING UNDER UNCERTAINTY 382 383

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CHAPTER FOURTEEN Transfer Pricing 428

WHAT IS TRANSFER PRICING AND WHY IS IT IMPORTANT? 429 DETERMINING THE OPTIMAL TRANSFER PRICE 430 The Setting 430 Determining Whether a Transfer Price Is Optimal 430 Case 1: A Perfect Intermediate Market 432 In Action: Transfer Pricing in State-Owned Enterprises 434 Case 2: No Intermediate Market 434 OPTIMAL TRANSFER PRICE: A GENERAL PRINCIPLE 435 Other Market Conditions 436 APPLYING THE GENERAL PRINCIPLE 436

Exercises 447 Problems 449 Integrative Cases 454 Solutions to Self-Study Questions

456

CHAPTER FIFTEEN Fundamentals of Variance Analysis 458

USING BUDGETS FOR PERFORMANCE EVALUATION 459 PROFIT VARIANCE 460 Why Are Actual and Budgeted Results Different? 461 FLEXIBLE BUDGETING 461

COMPARING BUDGETS AND RESULTS 463 Sales Activity Variance 463 In Action: Using the Sales Activity Variance to Explain Results 464 PROFIT VARIANCE ANALYSIS AS A KEY TOOL FOR MANAGERS 464 Sales Price Variance 466 Variable Production Cost Variances 466 Fixed Production Cost Variance 466 Marketing and Administrative Variances 466 PERFORMANCE MEASUREMENT AND CONTROL IN A COST CENTER 466 Variable Production Costs 467 VARIABLE COST VARIANCE ANALYSIS 468 General Model 468 Direct Materials 469 Direct Labor 471 Variable Production Overhead 472 Variable Cost Variances Summarized in Graphic Form 474 FIXED COST VARIANCES 475 Fixed Cost Variances with Variable Costing 475 Absorption Costing: The Production Volume Variance 476 SUMMARY OF OVERHEAD VARIANCES Key Points 478 In Action: Does Standard Costing lead to Waste? 479 478

HOW TO HELP MANAGERS ACHIEVE THEIR GOALS WHILE ACHIEVING THE ORGANIZATIONS GOALS 437 TOP-MANAGEMENT INTERVENTION IN TRANSFER PRICING 438 CENTRALLY ESTABLISHED TRANSFER PRICE POLICIES 438 Establishing a Market Price Policy 438 Establishing a Cost-Basis Policy 439 Alternative Cost Measures 440 Remedying Motivational Problems of Transfer Pricing Policies 441 NEGOTIATING THE TRANSFER PRICE IMPERFECT MARKETS 442 441

GLOBAL PRACTICES 442 In Action: Management Control and Tax Consideration in Transfer Pricing 443 MULTINATIONAL TRANSFER PRICING SEGMENT REPORTING 444 443

Summary 445 Key Terms 446 Review Questions 446 Critical Analysis and Discussion Questions

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Summary 479 Key Terms 480 Appendix A Recording Costs in a Standard Cost System Review Questions 483 Critical Analysis and Discussion Questions 484 Exercises 484 Problems 490 Integrative Case 496 Solutions to Self-Study Questions 499

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Review Questions 519 Critical Analysis and Discussion Questions Exercises 519 Problems 522 Integrative Case 526 Solutions to Self-Study Questions 528

519

CHAPTER SEVENTEEN Nonfinancial and Multiple Measures of Performance 532 502 BEYOND THE ACCOUNTING NUMBERS ORGANIZATIONAL ENVIRONMENT AND BUSINESS STRATEGY 534 RESPONSIBILITIES ACCORDING TO LEVEL OF ORGANIZATION 534 BUSINESS MODEL 535 533

CHAPTER SIXTEEN Additional Topics in Variance Analysis

PROFIT VARIANCE ANALYSIS WHEN UNITS PRODUCED DO NOT EQUAL UNITS SOLD 503 In Action: Financial Analysis and Variance Analysis 505 Reconciling Variable Costing Budgets and FullAbsorption Income Statements 505 MATERIALS PURCHASES DO NOT EQUAL MATERIALS USED 506 MARKET SHARE VARIANCE AND INDUSTRY VOLUME VARIANCE 508 SALES ACTIVITY VARIANCES WITH MULTIPLE PRODUCTS 509 Evaluating Product Mix 509 Evaluating Sales Mix and Sales Quantity 510 In Action: Sales Mix and financial Reporting 511 PRODUCTION MIX AND YIELD VARIANCES 512 Mix and Yield Variances in Manufacturing

MULTIPLE MEASURES OR A SINGLE MEASURE OF PERFORMANCE? 536 Balanced Scorecard 536 In Action: Using Balanced Scorecard Information to Evaluate Multiple Divisions 539 Continuous Improvement and Benchmarking 539 In Action: Sources and uses of Benchmarking Data 541 PERFORMANCE MEASUREMENT FOR CONTROL 542 SOME COMMON NONFINANCIAL PERFORMANCE MEASURES 542 Customer Satisfaction Performance Measures 542 Functional Performance Measures 543 Nonfinancial Performance and Activity-Based Management 544 Objective and Subjective Performance Measures 544 EMPLOYEE INVOLVEMENT 545
Summary 546 Key Terms 547 Review Questions 547 Critical Analysis and Discussion Questions Exercises 548 Problems 549 Solutions to Self-Study Questions 551

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VARIANCE ANALYSIS IN NONMANUFACTURING SETTINGS 515 Using the Profit Variance Analysis in Service and Merchandise Organizations 515 Efficiency Measures 515 Mix and Yield Variances in Service Organizations 516 KEEPING AN EYE ON VARIANCES AND STANDARDS 516 How Many Variances to Calculate 516 When to Investigate Variances 517 Updating Standards 518
Summary 518 Key Terms 518

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APPENDIX Capital Investment Decisions: An Overview 552 GLOSSARY 563 PHOTO CREDITS 569 INDEX 571

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Fundamentals of Cost Accounting