CT – Module 06: Cost-Volume-Profit (CVP) Analysis

Module 06: Cost-Volume-Profit (CVP) Analysis
CVP analysis is one of the most important parts of managerial accounting because it helps
management calculate what it has to do to break even on a project, or how costs and profits will
change based on changes in the input. It is important to work through the CVP calculations and
watch the videos to get a firm understanding of the calculation process. Make sure to read all of
the required readings this week and complete the Check Your Understanding activity.

Critical Thinking requirement
Submit as an excel document and show your work with formulas
Fill-in-the-Blank Equations
Fill-in-the-Blank Equations
1. __________ = Difference in Total Cost ÷ Difference in Units Produced
Variable Cost per Unit
2. Contribution Margin = Sales – __________
Variable Costs
3. Contribution Margin Ratio = __________ ÷ Sales
Contribution Margin
4. __________ = Fixed Costs ÷ Unit Contribution Margin
Break-Even Sales (units)
5. Sales (units) = (__________ + Target Profit) ÷ Unit Contribution Margin
Fixed Costs
6. Operating Leverage = Contribution Margin ÷ __________
Operating Income
7. Margin of Safety (percent of current sales) = (Sales – Sales at Break-Even Point) ÷__________
Sales
8. Margin of Safety (SAR) = Sales (SAR) – __________
Break-Even Sales (SAR)
9. The total cost of production for the last four quarters for Moore’s Mowers is as follows. Use
the high-low method to determine the variable cost per unit and the fixed cost.

Quarter 1
Quarter 2
Quarter 3
Quarter 4

Total Cost
51,000 SAR
56,400 SAR
49,200 SAR
53,700 SAR

Units Produced
2,000
2,300
1,900
2,150

Variable Cost = _____________18 SAR per unit

Fixed Cost = ____________ 15,000 SAR
10. During 2023, Caps by Huely sold 50,000 finished products with a contribution margin of
55%. The variable costs totaled 40,500 SAR for the year. Determine the sales, contribution
margin, and unit contribution margin.
Sales = ____________ 90,000 SAR
Sales price per unit = ____________ 1.80 SAR
Variable cost per unit = ____________ (0.81)
Contribution margin per unit= ____________ 0.99 SAR
Contribution margin= ____________ 49,500 SAR
11. If a manufacturing company had a contribution margin of $65,700 for 20Y5 from selling
25,000 products at 6 SAR each, determine the variable cost per unit, contribution margin ratio,
and unit contribution margin. Round unit answers to two decimal places and percentages to the
nearest whole percent.
Sales (SAR) = ____________ $150,000
Contribution margin = ____________ (65,700)
Total variable cost= ____________ $ 84,300
Variable cost per unit= ____________ $3.37
Unit contribution margin= ____________ $2.63
Contribution margin ratio = ____________ 44%
12. Determine the change in operating income for each situation for a company that has an
increase in total sales of $52,000.
a. Unit contribution margin of $4.50 and each product selling for $8.
= ____________$29,250
b. Contribution margin ratio of 24% and each product selling for $10.
= ____________$12,480
c. Unit contribution margin of $6, with total variable costs of $25,000 at $5 per unit.
= ____________$30,000
13. After incurring an operating loss of $(6,000) in 20Y5, the production manager would like to
know the break-even point in sales and units for the company. During 2023, the company sold
6,000 at $3 each. Variable costs for the year totaled $10,800. Determine the sales and units sold
that were needed to break even.
Sales = ____________200,000 SAR
Variable costs = ____________ (80,000)
Contribution margin = ____________120,000 SAR
Fixed costs= ____________ (50,400)
Operating income = ____________ 69,600 SAR
14. A tire manufacturer sells its finished goods for 80 SAR each. The variable cost to
manufacture each product is 20 SAR, while fixed costs equal 20,700 SAR. In 2022, the company
earned operating income of 32,100SAR. In 2023, the CEO would like to increase operating
income by 5%. Determine the sales in dollars and units needed to achieve the CEO’s goal. Round
answers to the nearest whole number.

Target Profit = ____________ 33,705SAR = 32,100SAR × 1.05
Sales (units) = ____________ 907 units = (20,700SAR + 33,705SAR) ÷ $60
Sales (dollars) = ____________ $72,540 = (20,700SAR + 33,705SAR) ÷ 75%, or 907 units × 80SAR
per unit
Submit as an excel document for faculty grading.
*Due to rounding, the two methods will differ by $20 in sales.
15.Prepare a cost-volume-profit chart for a company that has an 80% contribution margin for
goods that it sells for $150 each. The company’s fixed costs total $54,000. Also, determine the
break-even point in units and sales.
Break-Even Point (units) = ____________ 450 units = $54,000 ÷ $120 per unit
Break-Even Point (sales) = ____________ $67,500 = $54,000 ÷ 80%, or 450 units × $150 per
unit
Submit as an excel document with cost-volume-profit chart for faculty grading.

Learning Outcomes
1. Identify cost behaviors and understand costing systems.
2. Recognize variable and fixed costs.
3. Demonstrate cost-volume-profit analysis.
4. Appraise fixed, variable, and mixed costs.
Readings
Required:
• Chapter 6 in Managerial Accounting
• The components of cost volume profit analysis. (n.d.).
AccountingTools.
Recommended:
• Chapter 6 PowerPoint slides in Managerial Accounting

Chapter 6

Cost-Volume-Profit
Analysis

Cost Behavior
(slide 1 of 2)

© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Cost Behavior
(slide 2 of 2)

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Variable Costs
• Variable costs are costs that vary in proportion to
changes in the activity base.

• When the activity base is units produced, direct materials
and direct labor costs are normally classified as variable
costs.

© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Variable Costs and Their Activity Bases

Type of Business

Cost

Activity Base

University

Instructor salaries

Number of classes

Passenger airline

Fuel

Number of miles flown

Manufacturing

Direct materials

Number of units produced

Hospital

Nurse wages

Number of patients

Hotel

Housekeeping wages

Number of guests

Bank

Teller wages

Number of banking transactions

© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Fixed Costs

• Fixed costs are costs that remain the same in total
dollar amount as the activity base changes.

• When the activity base is units produced, many
factory overhead costs such as straight-line
depreciation are classified as fixed costs.

• Fixed costs have the following characteristics:
o Cost per unit decreases as the activity level increases

and increases as the activity level decreases.
o Total cost remains the same regardless of changes in the
activity base.

© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Fixed Costs and Their Activity Bases

Type of Business

Fixed Cost

Activity Base

University

Building (straight-line)
depreciation

Number of students

Passenger airline

Airplane (straight-line)
depreciation

Number of miles flown

Manufacturing

Plant manager salary

Number of units produced

Hospital

Property insurance

Number of patients

Hotel

Property taxes

Number of guests

Bank

Branch manager salary

Number of customer accounts

© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Mixed Costs

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Variable and Fixed Cost Behavior

Effect of Changing Activity Level
Cost

Total Amount

Per-Unit Amount

Variable

Increases and decreases
proportionately with activity level.

Remains the same
regardless of activity level.

Fixed

Remains the same regardless of
activity level.

Increases and decreases
Inversely with activity level.

© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Variable, Fixed, and Mixed Costs

Variable Costs

Fixed Costs

Mixed Costs

Direct materials

Straight-line depreciation

Quality Control
Department salaries

Direct labor

Property taxes

Purchasing Department
salaries

Electricity expense

Production supervisor
salaries

Maintenance expenses

Supplies

Insurance expense

Warehouse expenses

© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Cost-Volume-Profit Relationships
• Cost-volume-profit analysis is the examination of the
relationships among selling prices, sales and production
volume, costs, expenses, and profits.

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Contribution Margin

• Contribution margin is the excess of sales over
variable costs, computed as follows:

• Contribution margin covers fixed costs. Once the
fixed costs are covered, any additional
contribution margin increases operating income.

© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Contribution Margin Ratio
(slide 1 of 2)

• The contribution margin ratio, sometimes
called the profit-volume ratio, indicates the
percentage of each sales dollar available to
cover fixed costs and to provide operating
income.

• The contribution margin ratio is computed as
follows:
Contribution margin ratio =
o

Contribution margin
Sales

The contribution margin for Lambert Inc. is computed as
follows:
Contribution margin ratio =

$400,000
= 40%
$1,000,000

© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Contribution Margin Ratio
(slide 2 of 2)

• The contribution margin ratio is most useful
when the increase or decrease in sales volume
is measured in sales dollars. In this case, the
change in sales dollars multiplied by the
contribution margin ratio equals the change in
operating income, computed as follows:
Change in operating income = Change in sales dollars × Contribution margin ratio
o For example, if Lambert adds $80,000 in sales from

the sale of an additional 4,000 units, its operating
income will increase by $32,000, computed as
follows:
Change in operating income = Change in sales dollars × Contribution margin ratio
Change in operating income = $80,000 × 40% = $32,000
© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Unit Contribution Margin
(slide 1 of 2)

• The unit contribution margin is useful for
analyzing the profit potential of proposed
decisions.

• The unit contribution margin is computed as:
Unit contribution margin = Sales price per unit – Variable cost per unit

o If Lambert Inc.’s unit selling price is $20 and its

variable cost per unit is $12, the unit contribution
margin is computed as follows:
Unit contribution margin = Sales price per unit – Variable cost per unit
Unit contribution margin = $20 – $12 = $8
© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Unit Contribution Margin
(slide 2 of 2)

• The unit contribution margin is most useful when the
increase or decrease in sales volume is measured in
sales units (quantities). In this case, the change in
sales volume (units) multiplied by the unit
contribution margin equals the change in operating
income, computed as follows:
Change in operating income = Change in sales units × Unit contribution margin

o Assume that Lambert’s sales could be increased by

15,000 units, from 50,000 units to 65,000 units. The
increase in Lambert’s operating income is computed
as follows:
Change in operating income = Change in sales units × Unit contribution margin
Change in operating income = 15,000 units × $8 = $120,000
© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Break-Even Point
(slide 1 of 3)

• The break-even point is the level of operations
at which a company’s revenues and expenses
are equal.

• At break-even, a company reports neither an
operating income nor an operating loss.

• The break-even point in sales units is computed
as follows:
Fixed costs
Break – even sales (units) =
Unit contribution margin

© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Break-Even Point
(slide 2 of 3)

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Break-Even Point
(slide 3 of 3)

• The break-even point in sales dollars can be
determined directly as follows:
Break – even sales (dollars) =

Fixed costs
Contribution margin ratio

o The contribution margin ratio can be computed using

the unit contribution margin and unit selling price as
follows:
Unit contribution margin
Contribution Margin Ratio =
Unit selling price

© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Effect of Changes in Fixed Costs

• Fixed costs do not change in total with changes
in the level of activity. However, fixed costs may
change because of other factors such as
advertising campaigns, changes in property tax
rates, or changes in factory supervisors’
salaries.

• Changes in fixed costs affect the break-even
point as follows:
o

Increases in fixed costs increase the break-even point.

o

Decreases in fixed costs decrease the break-even point.

© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Effect of Change in Fixed Costs
on Break-Even Point

© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Effect of Changes in Unit Variable Costs
• Unit variable costs do not change with changes in the
level of activity. However, unit variable costs may be
affected by other factors such as changes in the cost per
unit of direct materials, changes in the wage rate for
direct labor, or changes in the sales commission paid to
salespeople.

• Changes in unit variable costs affect the break-even
point as follows:
o

Increases in unit variable costs increase the break-even point.

o

Decreases in unit variable costs decrease the break-even point.

© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Effect of Change in Unit Variable
Cost on Break-Even Point

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Effect of Changes in Unit Selling Price

• Changes in the unit selling price affect the
break-even point as follows:
o Increases in the unit selling price decrease the break-

even point.
o Decreases in the unit selling price increase the break-

even point.

© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Effect of Change in Unit Selling Price
on Break-Even Point

© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Effects of Changes in Selling Price and Costs
on Break-Even Point

© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Target Profit

• The sales required to earn a target or desired
amount of profit is determined by modifying the
break-even equation as follows:
Sales (units) =

Fixed costs + Target profit
Unit contribution margin

© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Cost-Volume-Profit (Break-Even) Chart
(slide 1 of 2)

© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Cost-Volume-Profit (Break-Even) Chart
(slide 2 of 2)

• The cost-volume-profit chart is constructed using the following steps:
o

Step 1: Volume in units of sales is indicated along the horizontal axis. The range
of volume shown is the relevant range in which the company expects to operate.
Dollar amounts of total sales and total costs are indicated along the vertical axis.

o

Step 2: A total sales line is plotted by connecting the point at zero on the left
corner of the graph to a second point on the chart. The second point is
determined by multiplying the maximum number of units in the relevant range,
which is found on the far right of the horizontal axis, by the unit sales price. A line
is then drawn through both of these points. This is the total sales line.

o

Step 3: A total cost line is plotted by beginning with total fixed costs on the vertical
axis. A second point is determined by multiplying the maximum number of units in
the relevant range, which is found on the far right of the horizontal axis by the unit
variable costs and adding the total fixed costs. A line is then drawn through both
of these points. This is the total cost line.

o

Step 4: The break-even point is the intersection point of the total sales and total
cost lines. A vertical dotted line drawn downward at the intersection point
indicates the units of sales at the break-even point. A horizontal dotted line drawn
to the left at the intersection point indicates the sales dollars and costs at the
break-even point.
© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Profit-Volume Chart
(slide 1 of 2)

• Another graphic approach to cost-volume-profit
analysis is the profit-volume chart, which plots
only the difference between total sales and total
costs (or profits).
o In this way, the profit-volume chart allows managers to

determine the operating profit (or loss) for various
levels of units sold.

© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Profit-Volume Chart
(slide 2 of 2)

• The profit-volume chart is constructed using the following steps:
o

Step 1: Volume in units of sales is indicated along the horizontal axis.
The range of volume shown is the relevant range in which the company
expects to operate. Dollar amounts indicating operating profits and
losses are shown along the vertical axis.

o

Step 2: A point representing the maximum operating loss is plotted on
the vertical axis at the left. This loss is equal to the total fixed costs at the
zero level of sales.

o

Step 3: A point representing the maximum operating profit within the
relevant range is plotted on the right.

o

Step 4: A diagonal profit line is drawn connecting the maximum
operating loss point with the maximum operating profit point.

o

Step 5: The profit line intersects the horizontal zero operating profit line
at the break-even point in units of sales. The area indicating an operating
profit is identified to the right of the intersection, and the area indicating
an operating loss is identified to the left of the intersection.
© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Assumptions of Cost-Volume-Profit Analysis

• Cost-volume-profit analysis depends on several
assumptions. The primary assumptions are as
follows:
o Total sales and total costs can be represented by straight

lines.
o Within the relevant range of operating activity, the

efficiency of operations does not change.
o Costs can be divided into fixed and variable components.

o The sales mix is constant.
o There is no change in the inventory quantities during the

period.
© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Sales Mix Considerations
(slide 1 of 2)

• Many companies sell more than one product at
different selling prices. In addition, the products
normally have different unit variable costs and,
thus, different unit contribution margins.

• In such cases, break-even analysis can still be
performed by considering the sales mix.
o The sales mix is the relative distribution of sales

among the products sold by a company.

© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Sales Mix Considerations
(slide 2 of 2)

• For break-even analysis, it is useful to think of the
individual products as components of one overall
enterprise product.

• The unit selling price of the overall enterprise
product equals the sum of the unit selling prices of
each product multiplied by its sales mix percentage.

• Likewise, the unit variable cost and unit contribution
margin of the overall enterprise product equal the
sum of the unit variable costs and unit contribution
margins of each product multiplied by its sales mix
percentage.
© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Operating Leverage
(slide 1 of 3)

• A company’s operating leverage is computed as
follows:
Contribution margin
Operating leverage =
Operating income
© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Operating Leverage
(slide 2 of 3)

© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Operating Leverage
(slide 3 of 3)

• Operating leverage can be used to measure the impact
of changes in sales on operating income.

• Using operating leverage, the effect of changes in sales
on operating income is computed as follows:

Percent change in operating income = Percent change  Operating
in sales

leverage

© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Effect of Operating Leverage
on operating income

Operating Leverage

Percentage Impact on Operating
Income from a Change in Sales

High

Large

Low

Small

© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Margin of Safety
(slide 1 of 2)

• The margin of safety indicates the possible
decrease in sales that may occur before an
operating loss results.
o Thus, if the margin of safety is low, even a small

decline in sales revenue may result in an operating
loss.

© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Margin of Safety
(slide 2 of 2)

• The margin of safety may be expressed in the following
ways:
Dollars of sales
o Units of sales
o Percent of current sales
o

▪ The margin of safety expressed as a percent of current sales is
computed as follows:

Sales − Sales at break – even point
Margin of safety =
Sales

© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Cost-Volume-Profit Analysis
for Service Companies

• Cost-volume-profit relationships in a service company
are measured with respect to customers and activities,
rather than units of product.

• Break-even analysis for a service company involves
identifying the correct unit of analysis and the correct
measure of activity for that unit.

• At other units of analysis, the measure of activity may
change.

• The unit of analysis can influence whether costs are
defined as fixed or variable.

© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Managerial

Accounting
Carl S. Warren
Professor Emeritus of Accounting
University of Georgia, Athens

William B. Tayler
Brigham Young University

Australia • Brazil • Mexico • Singapore • United Kingdom • United States

15e

Managerial Accounting, 15e
Carl S. Warren
William B. Tayler

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Intellectual Property Analyst: Reba Frederics

Library of Congress Control Number: 2018954981

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ISBN: 978-1-337-91202-0
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Printed in the United States of America
Print Number: 01
Print Year: 2018

Preface

Roadmap for Success
Warren/Tayler Managerial Accounting, 15e, provides a sound pedagogy for giving s­ tudents a solid
foundation in managerial accounting. Warren/Tayler covers the fundamentals AND ­motivates students to learn by showing how accounting is important to businesses.
Warren/Tayler is successful because it reaches students with a combination of new and tried-andtested pedagogy.
This revision includes a range of new and existing features that help Warren/Tayler provide
­students with the context to see how accounting is valuable to business. These include:
▪▪ New! Make a Decision section
▪▪ New! Pathways Challenge
▪▪ New! Certified Management Accountant (CMA®) Examination Questions
Warren/Tayler also includes a thorough grounding in the fundamentals that any business student
will need to be successful. These key features include:
▪▪ Presentation style designed around the way students learn
▪▪ Updated schema
▪▪ At the start of each chapter, a schema, or roadmap, shows students what they are going to
learn and how it is connected to the larger picture. The schema illustrates how the chapter
content lays the foundation with managerial concepts and principles. Then it moves students
through developing the information and ultimately into evaluating and analyzing information
in order to make decisions.

Chapter

15

Statement
of Cash Flows
Principles
Chapter 1 Introduction to Managerial Accounting

Developing Information
COST SYSTEMS

Chapter 2
Chapter 3
Chapter 4

COST ALLOCATIONS

Chapter 5
Chapter 5

Job Order Costing
Process Costing

Support Departments
Joint Costs

Activity-Based Costing

Decision Making
PLANNING AND EVALUATING TOOLS

Chapter 6
Chapter 7
Chapter 8
Chapter 9
Chapter 10
Chapter 11

Cost-Volume-Profit Analysis
Variable Costing
Budgeting Systems
Standard Costing and Variances
Decentralized Operations

STRATEGIC TOOLS

Chapter 12
Chapter 13
Chapter 13
Chapter 14
Chapter 14

Capital Investment Analysis
Lean Manufacturing
Activity Analysis
The Balanced Scorecard
Corporate Social Responsibility

Differential Analysis

Chapter 15

Financial
accounting

Statement
of Cash Flows

Managerial
accounting

Chapter 16
Financial Statement
Analysis

698

12020_ch15_rev02_698-757.indd 698

8/4/18 11:45 AM

iii

iv

Preface
312

Chapter 7 Variable Costing for Management Analysis

▪▪ Link to the “opening company” of each chapter
examples
how
the byconcepts
The $80,000calls
increaseout
in operating
income underof
Proposal
2 is caused
the allocation of the
fixed manufacturing costs of $400,000 over a greater number of units manufactured. Specifically,
introduced in the chapter are connected to the
opening
company.
This
shows
how
accountan increase in production from 20,000 units to 25,000 units means that the
fixed manufacturing
cost per unit decreases from $20 ($400,000 ÷ 20,000 units) to $16 ($400,000 ÷ 25,000 units). Thus,
ing is used in the real world by real companies.
the cost of goods sold when 25,000 units are manufactured is $4 per unit less, or $80,000 less in
total (20,000 units sold × $4). Since the cost of goods sold is less, operating income is $80,000
more when 25,000 units rather than 20,000 units are manufactured.
Managers should be careful in analyzing operating income under absorption costing when finished goods inventory changes. Increases in operating income may be created by simply increasing finished goods inventory. Thus, managers could misinterpret such increases (or decreases) in
operating income as due to changes in sales volume, prices, or costs.

Adobe Systems Inc.

A

ssume that you have three different options for a summer job.
How would you evaluate these options? Naturally there are
many things to consider, including how much you could earn from
each job.
Determining how much you could earn from each job may
not be as simple as comparing the wage rate per hour. For example, a job as an office clerk at a local company pays $8 per hour. A
job delivering pizza pays $10 per hour (including estimated tips),
although you must use your own transportation. Another job working in a beach resort over 500 miles away from your home pays $8
per hour. All three jobs offer 40 hours per week for the whole summer. If these options were ranked according to their pay per hour,
the pizza delivery job would be the most attractive. However, the
costs associated with each job must also be evaluated. For example, the office job may require that you pay for downtown parking and purchase office clothes. The pizza delivery job will require
you to pay for gas and maintenance for your car. The resort job will
require you to move to the resort city and incur additional living
costs. Only by considering the costs for each job will you be able to
determine which job will provide you with the most income.

Just as you should evaluate the relative income of various
choices, a business also evaluates the income earned from its
choices. Important choices include the products offered and the
geographical regions to be served.
A company will often evaluate the profitability of products
and regions. For example, Adobe Systems Inc. (ADBE),
one of the largest software companies in the world, determines
the income earned from its various product lines, such as Acrobat®,
Photoshop®, Premiere®, and Dreamweaver® software. Adobe uses
this information to establish product line pricing, as well as sales,
support, and development effort. Likewise, Adobe evaluates the
income earned in the geographic regions it serves, such as the
United States, Europe, and Asia. Again, such information aids management in managing revenue and expenses within the regions.
In this chapter, how businesses measure profitability using
absorption costing and variable costing is discussed. After illustrating and comparing these concepts, how businesses use them for
controlling costs, pricing products, planning production, analyzing
market segments, and analyzing contribution margins is described
and illustrated.

Link to
Adobe Systems

Under variable costing, operating income is $200,000, regardless of whether 20,000 units or
25,000 units are manufactured. This is because no fixed manufacturing costs are allocated to the
units manufactured. Instead, all fixed manufacturing costs are treated as a period expense.
To illustrate, Exhibit 8 shows the variable costing income statements for Frand for the
production of 20,000 units, 25,000 units, and 30,000 units. In each case, the operating income
is $200,000.

Chapter 2

Pete Jenkins/AlAmy stock Photo

Exhibit 8
Variable Costing
Income Statements
for Three Production
Levels

52

Job Order Costing

In a recent absorption costing income statement, Adobe Systems reported (in millions) total revenue
of $5,854, cost of revenue of $820, gross profit of $5,034, operating expenses of $3,541, and operating
income of $1,493.

Frand Manufacturing Company
Variable Costing Income Statements

Sales (20,000 units × $75) . . . . . . . . . . . . . . . .
Variable cost of goods sold:
Variable cost of goods manufactured:
(20,000 units × $35) . . . . . . . . . . . . . . .
(25,000 units × $35) . . . . . . . . . . . . . . .
(30,000 units × $35) . . . . . . . . . . . . . . .
Ending inventory:
(0 units × $35) . . . . . . . . . . . . . . . . . . . .
(5,000 units × $35) . . . . . . . . . . . . . . . .
(10,000 units × $35) . . . . . . . . . . . . . . .
Total variable cost of goods sold . . . . . .
Manufacturing margin. . . . . . . . . . . . . . . . . . .
Variable selling and administrative
expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Contribution margin. . . . . . . . . . . . . . . . . . . . .
Fixed costs:
Fixed manufacturing costs . . . . . . . . . . .
Fixed selling and administrative
expenses . . . . . . . . . . . . . . . . . . . . . . . . .
Total fixed costs . . . . . . . . . . . . . . . . . . . . . .
Operating income . . . . . . . . . . . . . . . . . . . . . . .

20,000 Units
Manufactured

25,000 Units
Manufactured

30,000 Units
Manufactured

$1,500,000

$1,500,000

$ 1,500,000

$ (700,000)
$ (875,000)
$(1,050,000)
0
175,000
$ (700,000)
$ 800,000

$ (700,000)
$ 800,000

350,000
$ (700,000)
$ 800,000

(100,000)
$ 700,000

(100,000)
$ 700,000

(100,000)
$ 700,000

no discrepancies, a journal entry is made to record the purchase. The journal
entry$ to
record$ (400,000)
the
$ (400,000)
(400,000)
supplier’s invoice related to Receiving Report No. 196 in Exhibit 4 is as follows:
(100,000)
(100,000)
(100,000)

Link to Adobe Systems . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Pages 305, 309, 312, 316, 319

$ (500,000)
$ 200,000

$ (500,000)
$ 200,000

$ (500,000)
$ 200,000

303

12020_ch07_ptg01_302-351.indd 303

A 5 L 1
1
1

a.

E

Materials
Accounts Payable
Materials purchased during December.

10,500
10,500

7/12/18 12:15 PM

The storeroom releases materials for use in manufacturing when a materials requisition is
received. Examples of materials requisitions are shown in Exhibit 4.
The materials requisitions for each job serve as the basis for recording materials used. For direct
materials, the quantities and amounts from the materials requisitions are posted to job cost sheets. Job
▪▪ To
aid comprehension
and to demonstrate
themake
impact
journal
entriesledger.
include
cost
sheets,
which are also illustrated
in Exhibit 4,
up of
thetransactions,
work in process
subsidiary
the
net
effect
of
the
transaction
on
the
accounting
equation.
Exhibit 4 shows the posting of $2,000 of direct materials to Job 71 and $11,000 of direct
materials to Job 72.2 Job 71 is an order for 20 units of Jazz Series guitars, while Job 72 is an order
for 60 units of American Series guitars.
A summary of the materials requisitions is used as a basis for the journal entry recording the
materials used for the month. For direct materials, this entry increases (debits) Work in Process and
decreases (credits) Materials as follows:
12020_ch07_ptg01_302-351.indd 312

A 5 L
12

1

E

b.

Work in Process
Materials
Materials requisitioned to jobs
($2,000 + $11,000).

13,000
13,000

Many companies use computerized information processes to record the use of materials. In
such cases, storeroom employees electronically record the release of materials, which automatically updates the materials ledger and job cost sheets.

Ethics: Do It!

ETHICS
Phony
Invoice Scams

this information to create a fictitious invoice. The invoice

7/12/18 12:15 PM

Preface

▪▪ Located in each chapter, Why It M
­ atters shows students how accounting is important
to ­businesses with which they are familiar. A Concept Clip icon indicates which Why It
Matters features have an accompanying concept clip video in CNOWv2.
CONCEPT CLIP

476

Chapter 10

Evaluating Decentralized Operations

Why It Matters

CONCEPT CLIP

Coca-Cola Company: Go West Young Man

A

major decision early in the history of Coca-Cola (KO) was to ex314
Chapter 7 Variable Costing
for Management
pand
outside Analysis
of the United States to the rest of the world. As a result,
Coca-Cola
is known today the world over. What is revealing is how
Solution:
a. (1)
this
decision has impacted the revenues and profitability of Coca-Cola across
Absorption Costing Income Statements
(30,000 The
units produced
× $40 variable
its international and
North
following
table shows
Proposal 2: segments.
Proposal
1: American
manufacturing cost per unit) + $600,000
40,000 Units
30,000 Units
the percent of revenues
and percent
of operating
fixed cost income from the internaManufactured Manufactured
Sales (30,000 unitstional
× $100) and North American
$ 3,000,000 geographic
$ 3,000,000 segments.
(40,000 units produced × $40 variable manufacturing
Cost of goods sold:
Cost of goods manufactured
Ending inventory
Total cost of goods sold
Gross profit
Selling and administrative expenses
Operating income

$(1,800,000)
—
$(1,800,000)
$ 1,200,000
(350,000)
$ 850,000

$(2,200,000)
550,000
$(1,650,000)
$ 1,350,000
(350,000)
$ 1,000,000

$(1,200,000)
$ 1,800,000
(210,000)
$ 1,590,000

$(1,200,000)
$ 1,800,000
(210,000)
$ 1,590,000

$ (600,000)
(140,000)
$ (740,000)
$ 850,000

$ (600,000)
(140,000)
$ (740,000)
$ 850,000

different story. More than 65% of Coca- Cola’s profitability comes
from international segments. Given the revenue segmentation,
this suggests that the international profit margins must be higher
than the North American profit margin. Indeed this is the case, as
can be seen in the following table:
Profit Margin
International average
North America

cost per unit) + $600,000 fixed cost

Operating
10,000 units (40,000 produced
– 30,000 sold)
× $55 per unit ($2,200,000 ÷ 40,000 units)
Revenues
Income

48.4%
24.2%

The average profit margin for all the international segments is
two times as large as the North American segment. These results
(2)
reflect the heart of the Coca-Cola marketing strategy. In international markets, Coca-Cola is able to charge relatively higher prices
Proposal 2:
Proposal 1:
due to high demand and less competition as compared to the North
Units 7 Variable
30,000 Units350 40,000
Chapter
Costing
Management
Analysis
30,000
units for
produced
× $40 variable
The first column
showsManufactured
that the international
provide
Manufactured
manufacturing costsegments
per unit
American market.
Sales (30,000 units × $100)
2. units
Chassen
Company,
a cracker and cookie manufacturer, has the following unit costs for the
produced
× $40 variable
over 58% of the$ 3,000,000
revenues,$ 3,000,000
while North40,000
America
provides
almost
Variable cost of goods sold:
month
June:
manufacturing
costofper
unit
Variable cost of goods
$(1,200,000) However,
$(1,600,000)
Variable manufacturing
cost The Coca-Cola
$5.00
Source:
Company, Form 10-K for the Fiscal Year Ended December 31, 2017.
42%manufactured
of the revenues.
the 10,000
operating
income
a
units (40,000 produced
– 30,000 tells
Ending inventory
—
400,000
International segments
North American segment
Variable
Total Costing Income Statements

Total variable cost of goods sold
Manufacturing margin
Variable selling and administrative expenses
Contribution margin
Fixed costs:
Fixed manufacturing costs
Fixed selling and administrative expenses
Total fixed costs
Operating income

(30,000 units sold × $7 variable selling cost per
unit) + $140,000

58.4%
41.6
Variable Costs
100%

65.6%
34.4
100%

sold) × $40 variable cost per unit

Variable marketing cost
Fixed manufacturing cost
Fixed marketing cost

3.50
2.00
4.00

30,000 units sold × $7 variable
selling cost
unitof 100,000 units were manufactured during June, of which 10,000 remain in ending
A per
total

the only finished goods inventory at June 30. Under the absorption costing concept, the
Residualare Income

inventory. Chassen uses the first-in, first-out (FIFO) inventory method, and the 10,000 units

Fixed Costs

value of Chassen’s June 30 finished goods inventory would be:

▪▪ New! Pathways Challenge encourages
students’
interest
in accounting
emphasizes of the return on investment.
Residual income
is useful
in overcoming
some of and
the disadvantages
a. $50,000.
b. $70,000.
Residual income
is
the
excess
of
operating
income
over
aChallenge
minimum acceptable operating income,
the
critical
thinking
aspect
of
accounting.
A
suggested
answer
to
the
Pathways
$85,000.
b. The difference (in a.) is caused by including $150,000 fixed manufacturing costs (10,000 units × $15 fixedc.manufacturing
cost per unit) in the
d. $145,000. 7.
ending inventory, which decreases the cost of goods sold and increases theas
operating
income byin
$150,000.
shown
Exhibit
is provided at the end of the chapter. 3. Mill Corporation had the following unit costs for the recent calendar year:
Check Up Corner

Manufacturing
Nonmanufacturing

Pathways
Challenge
Exhibit
7

Variable

Fixed

$8.00
2.00

$3.00
5.50

Operating Inventory
income for Mill’s sole product totaled 6,000 units on January 1 and 5,200 units on
December 31. When
compared
to variable
income, Mill’s absorption costing income is:
Minimum acceptable
operating
income
ascosting
a
a. $2,400 lower.
Economic Activity
percent ofb.invested
assets
$2,400 higher.
Absorption costing is required by generally accepted accounting principles (GAAP) for reporting to exterc. $6,800 lower.
Residual
nal stakeholders. Thus, auto manufacturers like Ford
Motor income
Company (F) and General Motors

$ XXX

Residual
Income
This is
Accounting!

(XXX)
$ XXX

$6,800 higher.
Company (GM) use absorption costing in preparing their financiald.statements.
Under absorption costing,

fixed manufacturing costs are included in inventory. Thus, the4.
moreBethany
cars the auto
companies
lower
Company
hasmake,
just the
completed
the first month of producing a new product but has
the fixed cost per car and the smaller the cost of goods sold. In the years
preceding
the U.S.
and The product incurred variable manufacturing costs of
not yet
shipped
anyfinancial
of this crisis
product.
economic downturn of 2008, Ford and General Motors produced more
cars than were
to customers.1 costs of $2,000,000, variable marketing costs of $1,000,000,
$5,000,000,
fixedsold
manufacturing

Critical Thinking/Judgment

and fixed marketing costs of $3,000,000.
Under the variable costing concept, the inventory value of the new product would be:

The minimum acceptable operating income is computed by multiplying the company minimum
return on investment by the invested assets. The minimum rate is set by top management, based
d. $11,000,000.
on such factors
as theanswer
cost
ofof chapter.
financing.
Suggested
at end
Marielle Segarra, “Why the Big Three Put Too Many Cars on the
CFO.com (ww2.cfo.com/management-accounting/2012/02/
ToLot,”illustrate,
assume that DataLink Inc. has established 10% as the minimum acceptable return
why-the-big-three-put-too-many-cars-on-the-lot/), February 2, 2012.
Pathways
Challenge
on investment
for divisional
assets. The residual incomes for the three divisions are shown in
Exhibit 8.
This is Accounting!
If Ford and General Motors have high fixed costs and low variable costs,
how would producing more cars
a. $5,000,000.
affect their operating income under absorption costing? under variable
b. costing?
$6,000,000.
If absorption costing allows companies like Ford and General Motors to change their operating income by
c. $8,000,000.
increasing or decreasing production, why does GAAP require absorption costing?

1

Information/Consequences

12020_ch07_ptg01_302-351.indd 314

Exhibit 8

7/12/18 12:15 PM

By producing more cars than were sold, Ford (F) and General Motors (GM) increased their operating income reported under absorption costing. This is because a portion of their fixed manufacturing costs
were included in ending inventory rather than cost of goods sold.

Northern Division

Residual Income—
DataLink, Inc.

12020_ch07_ptg01_302-351.indd 350

Central Division

Southern Division

Underincome
variable costing, producing more cars would not affect operating
income, because all fixed manufacOperating
$ 70,000
$ 84,000
turing costs are included in cost of goods sold regardless of how many cars are produced.

$ 75,000

Minimum acceptable operating income
A reason often given for why GAAP requires absorption costing is that it focuses on operating income “over
as a percent
invested
assets:
the longof
term.
” In other words,
while operating income may vary from year to year, all manufacturing costs
are eventually
reported on the income statement as cost of goods sold
or as a write-down of inventory using
$350,000
× 10%
(35,000)
the lower-of-cost-or-market rule. Thus, over the life of a company, the total amount of operating income will
be the same
regardless of whether absorption or variable costing is used.
$700,000
× 10%
(70,000)
$500,000 × 10%
Suggested Answer
Residual income
$ 35,000
$ 14,000

(50,000)
$ 25,000

7/12/18 12:15 PM

v

Preface

▪▪ To aid learning and problem solving, throughout each chapter the Check Up Corner
exercises provide students with step-by-step guidance on how to solve problems. Problemsolving tips help students avoid common errors.
Chapter 10

Check Up Corner 10-1

Evaluating Decentralized Operations

467

Cost Center Responsibility Measures

Delinco Tech Inc. manufactures corrosion-resistant water pumps and fluid meters. Its Commercial Products
Division is organized as a cost center. The division’s budget for the month ended July 31 is as follows
(in thousands):
Materials
Factory wages
Supervisor salaries
Utilities
Depreciation of plant equipment
Maintenance
Insurance
Property taxes

$140,000
77,000
15,500
8,700
9,000
3,200
750
800
$254,950

During July, actual costs incurred in the Commercial Products Division were as follows:
Materials
Factory wages
Supervisor salaries
Utilities
Depreciation of plant equipment
Maintenance
Insurance
Property taxes

$152,000
77,800
15,500
8,560
9,000
3,025
750
820
$267,455

Prepare a budget performance report for the director of the Commercial Products Division for July.

Solution:
The report shows the budgeted costs and
actual costs along with the differences.

Budget Performance Report
Director, Commercial Products Division
For the Month Ended July 31

Materials ………………………………..
Factory wages ………………………….
Supervisor salaries…………………….
Utilities…………………………………..
Depreciation of plant equipment ….
Maintenance……………………………
Insurance ……………………………….
Property taxes ………………………….

Actual

Budget

$152,000
77,800
15,500
8,560
9,000
3,025
750
820
$267,455

$140,000
77,000
15,500
8,700
9,000
3,200
750
800
$254,950

}

vi

Over
Budget

The report allows cost center
managers to focus on areas
of significant differences.

(Under)
Budget

$12,000
800
$(140)

Each difference is classified as
over budget or under budget.

(175)
20
$12,820

$(315)

Check Up Corner

Preface

▪▪ Analysis for Decision ­Making ­highlights how companies use accounting ­information to make
decisions and evaluate their business. This provides students with context of why accounting
is important 376
to companies.
Chapter 8 Budgeting
Analysis for Decision Making
Objective 6
Describe and
illustrate the use of
staffing budgets for
nonmanufacturing
businesses.

Nonmanufacturing Staffing Budgets
The budgeting illustrated in this chapter is similar to budgeting used for nonmanufacturing
businesses. However, many nonmanufacturing businesses often do not have direct materials
purchases budgets, direct labor cost budgets, or factory overhead cost budgets. Thus, the budgeted income statement is simplified in many nonmanufacturing settings.
A primary budget in nonmanufacturing businesses is the labor, or staffing, budget. This budget, which is highly flexible to service demands, is used to manage staffing levels. For example,
a theme park will have greater staffing in the summer vacation months than in the fall months.
Likewise, a retailer will have greater staffing during the holidays than on typical weekdays.
To illustrate, Concord Hotel operates a hotel in a business district. The hotel has 150 rooms
that average 120 guests per night during the weekdays and 50 guests per night during the weekend. The housekeeping staff is able to clean 10 rooms per employee. The number of housekeepers required for an average weekday and weekend is determined as follows:
Weekday

Weekend

120
÷ 10
12

50
÷ 10
5

Number of guests per day
Rooms per housekeeper
Number of housekeepers per day

If each housekeeper is paid $15 per hour for an eight-hour shift per day, the annual budget
for the staff is as follows:
Weekday
Number of housekeepers per day
Hours per shift
Days per year
Number of hours per year
Rate per hour
Housekeeping staff annual budget

12
8
260*
24,960
×
$15

Weekend

Total

5
8
104**
4,160
× $15

×
×

×
×

$374,400

$62,400

$436,800

* 52 weeks × 5 days
** 52 weeks × 2 days

The budget can be used to plan and manage the staffing of the hotel. For example,
if a wedding were booked for the weekend, the budgeted increase in staffing could be
compared with the increased revenue from the wedding to verify the profit plan.

Make a Decision

Nonmanufacturing Staffing Budgets

Analyze Johnson Stores’ staffing budget for holidays (MAD 8-1)
▪▪ Make a Decision in the end-of-chapter
material gives students a chance to analyze real-world
Analyze Mercy Hospital’s staffing budget (MAD 8-2)
Chapter 6 Cost-Volume-Profit Analysis
297
business decisions.
Analyze Adventure Park’s staffing budget (MAD 8-3)
Analyze Ambassador Suites’ staffing budget (MAD 8-4)

Make a Decision

Make a Decision

Cost-Volume-Profit Analysis for Service Companies
MAD 6-1 Analyze Global Air’s cost-volume-profit relationships

Obj. 6

Global Air is considering a new flight between Atlanta and Los Angeles. The average fare per
seat for the flight is $760. The costs associated with the flight are as follows:

12020_ch08_ptg01_352-409.indd 376

Fixed costs for the flight:
Crew salaries . . . . . . . . . . . . . . . . . . $ 5,000
Operating costs . . . . . . . . . . . . . . . 50,000
Aircraft depreciation . . . . . . . . . . 25,000
Total . . . . . . . . . . . . . . . . . . . . . . . . $80,000
Variable costs per passenger:
Passenger check-in . . . . . . . . . . .
Operating costs . . . . . . . . . . . . . . .
Total . . . . . . . . . . . . . . . . . . . . . . . .

16/07/18 6:34 am

$ 20
100
$120

The airline estimates that the flight will sell 175 seats.
a. Determine the break-even number of passengers per flight.
b. Based on your answer in (a), should the airline add this flight to its schedule?
c. How much profit should each flight produce?
What additional issues might the airline consider in this decision?
d.
MAD 6-2 Analyze Ocean Escape Cruise Lines’ cost-volume-profit relationships

Obj. 6

Ocean Escape Cruise Lines has a boat with a capacity of 1,200 passengers. An eight-day ocean
cruise involves the following costs:
Crew
Fuel
Fixed operating costs

$240,000
60,000
800,000

The variable costs per passenger for the eight-day cruise include the following:
Meals
Variable operating costs

$900
400

The price of the cruise is $2,400 per passenger.
a. Determine the break-even number of passengers for the eight-day cruise.
b. Assume 900 passengers booked the cruise. What would be the profit or loss for the cruise?
c. Assume the cruise was booked to capacity. What would be the profit or loss for the cruise?
If the cruise cannot book enough passengers to break even, how might the cruise
d.
line respond?
MAD 6-3 Analyze Star Stream’s cost-volume-profit relationships

Obj. 6

Star Stream is a subscription-based video streaming service. Subscribers pay $120 per year for the
service. Star Stream licenses and develops content for its subscribers. In addition, Star Stream leases
servers to hold this content. These costs are not variable to the number of subscribers, but must
be incurred regardless of the subscriber base. In addition, Star Stream compensates telecommunication companies for bandwidth so that Star Stream customers receive fast streaming services.

vii

viii

Preface

▪▪ At the end of each chapter, Let’s Review is a new chapter summary and self-assessment feature
that is designed to help busy students prepare for an exam. It includes a summary of each
learning objective’s key points, key terms, multiple-choice questions, exercises, and a sample
problem that students may use to practice.
▪▪ Sample multiple-choice questions allow students to practice with the type of assessments they
are likely to see on an exam.
▪▪ Short exercises and a longer problem allow students to apply their knowledge.
▪▪ Answers provided at the end of the Let’s Review section let students check their knowledge
immediately.
▪▪ Take It Further in the end-of-chapter activities allows instructors to assign other special activities related to ethics, communication, and teamwork.
▪▪ NEW! Certified Management Accountant (CMA®) Examination Questions help students
­prepare for the CMA exam so they can earn CMA certification.

CengageNOWv2
CengageNOWv2 is a powerful course management and online homework resource that provides
control and customization to optimize the student learning experience. Included are many proven
resources, such as algorithmic activities, a test bank, course management tools, reporting and
assessment options, and much more.

NEW! Excel Online
Cengage and Microsoft have partnered in CNOWv2 to provide students with a uniform, authentic
Excel experience. It provides instant feedback, built-in video tips, and easily accessible spreadsheet
work. These features allow you to spend more time teaching college accounting applications and
less time troubleshooting Excel.
These new algorithmic activities offer pre-populated data directly in Microsoft Excel Online. Each
student receives his or her own version of the problem to perform the necessary data calculations
in Excel Online. Their work is constantly saved in Cengage cloud storage as a part of homework
assignments in CNOWv2. It’s easily retrievable so students can review their answers without cumbersome file management and numerous downloads/uploads.

Motivation: Set Expectations and Prepare Students
for the Course
CengageNOWv2 helps motivate students and get them ready to learn by reshaping their misconceptions about the introductory accounting course and providing a powerful tool to engage students.

CengageNOWv2 Start-Up Center
Students are often surprised by the amount of time they need to spend outside of class working
through homework assignments in order to succeed. The CengageNOWv2 Start-Up Center will help
students identify what they need to do and where they need to focus in order to be successful
with a variety of new resources.
▪▪ What Is Accounting? Module ensures students understand course expectations and how to be
successful in the introductory accounting course. This module consists of two assignable videos: Introduction to Accounting and Success Strategies. The Student Advice Videos offer advice
from real students about what it takes to do well in the course.
▪▪ Math Review Module, designed to help students get up to speed with necessary math skills,
includes math review assignments and Show Me How math review videos to ensure that students have an understanding of basic math skills.
▪▪ How to Use CengageNOWv2 Module focuses on learning accounting, not on a particular software system. Quickly familiarize your students with CengageNOWv2 and direct them to all of
its built-in student resources.

Preface

Motivation: Prepare Them for Class
With all the outside obligations accounting students have, finding time to read the textbook before
class can be a struggle. Point students to the key concepts they need to know before they attend
class.
▪▪ Video: Tell Me More. Short Tell Me More lecture activities explain the core concepts of the
chapter through an engaging auditory and visual presentation. Available either on a standalone basis or as an assignment, they are ideal for all class formats—flipped model, online,
hybrid, or face-to-face.

Provide Help Right When Students Need It
The best way to learn accounting is through practice, but students often get stuck when attempting homework assignments on their own.
▪▪ Video: Show Me How. Created for the most frequently assigned end-of-chapter items,
Show Me How problem demonstration videos provide a step-by-step model of a similar problem. Embedded tips help students avoid common mistakes and pitfalls.

SHOW ME HOW

ix

x

Preface

Help Students Go Beyond Memorization to True
Understanding
Students often struggle to understand how concepts relate to one another. For most students, an
introductory accounting course is their first exposure to both business transactions and the accounting system. While these concepts are already difficult to master individually, their combination
and interdependency in the introductory accounting course often pose a challenge for students.
▪▪ Mastery Problems. Mastery Problems enable you to assign problems and activities designed to
test students’ comprehension and mastery of difficult concepts.

MindTap eReader
The MindTap eReader for Warren/Tayler’s Managerial Accounting is the most robust digital
reading experience available. Hallmark features include:
▪▪ Fully optimized for the iPad.
▪▪ Note taking, highlighting, and more.
▪▪ Embedded digital media.
▪▪ The MindTap eReader also features ReadSpeaker®, an online text-to-speech application that
vocalizes, or “speech-enables,” online educational content. This feature is ideally suited for
both instructors and learners who would like to listen to content instead of (or in addition
to) reading it.

Cengage Unlimited
Cengage Unlimited is a first of-its-kind digital subscription designed specifically to lower costs.
Students get total access to everything Cengage has to offer on demand—in one place. That’s
20,000 eBooks, 2,300 digital learning products, and dozens of study tools across 70 disciplines and
over 675 courses. Currently available in select markets. Details at www.cengage.com/unlimited.

New to This Edition
In all chapters, the following improvements have been made:
▪▪ Chapter schemas revised throughout.
▪▪ Link to page references added at the beginning of the
chapter allow students to easily locate the ties to the
opening company throughout the chapter.
▪▪ New learning objective for Analysis for Decision Making.
▪▪ Stock ticker symbol has been inserted for all real-world
(publicly listed) companies. This helps students to use
financial websites to locate real company data.
▪▪ New Pathways Challenge feature added, consistent with
the work of the Pathways Commission. This feature
emphasizes the critical thinking aspect of accounting. A
Suggested Answer to the Pathways Challenge is provided
at the end of the chapter.
▪▪ New Make a Decision section at the end of the Analysis
for Decision Making directs students and instructors to
the real-world company end-of-chapter materials related
to Analysis for Decision Making. Also, the continuing company analysis is identified and referenced in this Make a
Decision section.

▪▪ New items have been added to the Take It Further section
at the end of the chapter.
▪▪ New Certified Management Accountant (CMA®) Examination Questions help students prepare for the CMA exam
so they can earn CMA certification.

Chapter 1
▪▪ “Managerial Accounting in the Organization” section significantly revised to discuss horizonal and vertical business units; McAfee, Inc., is used as an illustration.
▪▪ New Why It Matters features the IMA and CMA.
▪▪ New Why It Matters features vertical and horizontal
­functions for service companies.
▪▪ Discussion of sustainability and accounting moved to new
Chapter 14.

Chapter 2
▪▪ Discussion of sustainability and accounting moved to new
Chapter 14.
▪▪ Added one new Analysis for Decision Making item.

Preface

Chapter 3
▪▪ Why It Matters feature (Sustainable Papermaking) moved
to Chapter 14.
▪▪ Lean manufacturing discussion with related homework
items moved to Chapter 13.
▪▪ Added one new Analysis for Decision Making item.

xi

▪▪ Added four new revenue variance exercises.
▪▪ Added one new Analysis for Decision Making item.

Chapter 10
▪▪ Balanced scorecard discussion moved to new Chapter 14.
▪▪ Added one new Analysis for Decision Making item.

Chapter 4

Chapter 11

▪▪ Added Learning Objective 7: Describe and illustrate the use
of activity-based costing information in decision making.

▪▪ Total cost and variable cost concepts for product pricing
were moved to an end-of-chapter appendix.
▪▪ Added one new Make a Decision item.

Chapter 5—NEW Chapter
▪▪ Learning Objectives:
▪▪ Describe support departments and support department
costs.
▪▪ Describe the allocation of support department costs
using a single plantwide rate, multiple department
rates, and activity-based costing.
▪▪ Allocate support department costs to production
departments using the direct method, sequential
method, and reciprocal services method.
▪▪ Describe joint products and joint costs.
▪▪ Allocate joint costs using the physical units, weighted
average, market value at split-off, and net realizable
value methods.
▪▪ Describe and illustrate the use of support department
and joint cost allocations to evaluate the performance
of production managers.

Chapter 6
▪▪ Added one new Analysis for Decision Making item.

Chapter 7
▪▪ Contribution margin analysis deleted from chapter.
▪▪ Revenue variance added as an appendix to Chapter 9.

Chapter 8
▪▪ Added one new Analysis for Decision Making item.

Chapter 9
▪▪ Added new appendix on revenue variances.
▪▪ Nonfinancial performance measures (previously Learning
Objective 6) moved to new Chapter 14.

Chapter 12
▪▪ Analysis for Decision Making on capital investment for
sustainability has been moved to new Chapter 14.
▪▪ Added new Analysis for Decision Making entitled “Uncertainty: Sensitivity and Expected Value Analyses.”
▪▪ Added six new Make a Decision items.

Chapter 13
▪▪ Added Objective 4: Describe and illustrate the use of lean
principles and activity analysis in a service or administrative setting.

Chapter 14—NEW chapter
▪▪ Learning objectives:
▪▪ Describe the concept of a performance measurement
system.
▪▪ Describe and illustrate the basic elements of a balanced scorecard.
▪▪ Describe and illustrate the balance scorecard, including
the use and impact of strategy maps, measure maps,
strategic learning, scorecard cascading, and cognitive
biases.
▪▪ Describe corporate social responsibility (CSR), including methods of measuring and encouraging social
responsibility using the balanced scorecard.
▪▪ Use capital investment analysis to evaluate CSR projects.

Acknowledgements
The many enhancements to this edition of Managerial Accounting are the direct result of reviews, surveys, and focus groups
with instructors at institutions across the country. We would like to take this opportunity to thank those who have helped
us better understand the challenge of the financial accounting course and provided valuable feedback on our content and
digital assets.
John Alpers, Tennessee Wesleyan
Anne Marie Anderson, Raritan Valley
Community College
Maureen Baker, Long Beach City
College
Cindy Bolt, The Citadel
Julie Bonner, Central Washington
University
Charles Boster, Salisbury University
Jerold K. Braun, Daytona State College
Shauna Butler, St. Thomas Aquinas
College
Kirk Canzano, Long Beach City College
Dixon Cooper, Ouachita Baptist
University
Bryan Corsnitz, Long Beach City
College
Pat Creech, Northeastern Oklahoma
A&M
Daniel De La Rosa, Fullerton College
Heather Demshock, Lycoming College

xii

Scott Dotson, Tennessee Wesleyan
University
Hong Duong, Salisbury University
James Emig, Villanova University
Dave Fitzgerald, Jackson College
Kenneth Flug, St. Thomas Aquinas
College
Thomas Heikkinen, Jackson College
Susanne Holloway, Salisbury University
Daniel Kim, Midlands Technical
College
Angela Kirkendall, South Puget Sound
Community College
Satoshi Kojima, East Los Angeles
College
Tara Maciel, San Diego Mesa College
Annette Maddox, Georgia Highlands
College
LuAnn Bean Mangold, Florida Institute
of Technology
Allison McLeod, University of North Texas

Rodney Michael
Shawn Miller, Lone Star College
Dr. April Poe, University of the
Incarnate Word
Francisco Rangel, Riverside City
College
Benjamin Reyes, Long Beach City
College
Lauran B. Schmid, The University of
Texas Rio Grande Valley
Meghna Singhvi, Loyola Marymount
University
Margie Snow, Norco College
Michael Stoots, UCLA extension
Patricia Tupaj, Quinsigamond
Community College
Randi Watts, Baker College
Cammy Wayne, Harper College
Melissa Youngman, National Technical
Institute for the Deaf, RIT

About the Authors

Carl S. Warren
©Terry R. Spray InHisImage Studios

Dr. Carl S. Warren is Professor Emeritus of Accounting at the University of Georgia, Athens. Dr.
Warren has taught classes at the University of Georgia, University of Iowa, Michigan State University, and University of Chicago. He has focused his teaching efforts on principles of accounting
and auditing. Dr. Warren received his Ph.D. from Michigan State University and his BBA and MA
from the University of Iowa. During his career, Dr. Warren published numerous articles in professional journals, including The Accounting Review, Journal of Accounting Research, Journal of
Accountancy, The CPA Journal, and Auditing: A Journal of Practice and Theory. Dr. Warren has
served on numerous committees of the American Accounting Association, the American Institute of
Certified Public Accountants, and the Institute of Internal Auditors. He has consulted with numerous companies and public accounting firms. His outside interests include handball, golfing, skiing,
backpacking, motorcycling, and fly-fishing. He also enjoys interacting with his five grandchildren,
Bella and Mila (twins), Jeremy, and Brooke and Robbie (twins).

William B. Tayler

© Emory University

Dr. William B. Tayler is the Robert J. Smith Professor of Accountancy in the Marriott School of
Business at Brigham Young University (BYU). Dr. Tayler is an internationally renowned, awardwinning accounting researcher and instructor. He has presented his research as an invited speaker
at universities and conferences across the globe. Dr. Tayler earned his Ph.D. and master’s degree at
Cornell University. He teaches in BYU’s Executive MBA Program and in BYU’s School of Accountancy, one of the top ranked accounting programs in the world. Dr. Tayler has also taught at
Cornell University and Emory University and has received multiple teaching awards. Dr. Tayler is
a Certified Management Accountant and consultant specializing in cost accounting, performance
measurement, the assignment of decision rights, and incentive compensation. His work has been
published in top journals, including Accounting Horizons, Accounting, Organizations and Society, The Accounting Review, Contemporary Accounting Research, IMA Educational Case Journal,
Journal of Accounting Research, Journal of Behavioral Finance, Journal of Finance, Review of
Financial Studies, and Strategic Finance. Dr. Tayler serves on the editorial boards of The Accounting Review, Management Accounting Research, and Accounting, Organizations and Society. He is
also director of the Institute of Management Accountants Research Foundation.

xiii

Brief Contents
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16

Introduction to Managerial Accounting. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

2

Job Order Costing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

46

Process Cost Systems . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

94

Activity-Based Costing. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

150

Support Department and Joint Cost Allocation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

204

Cost-Volume-Profit Analysis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

248

Variable Costing for M
­ anagement Analysis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

302

Budgeting . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

352

Evaluating Variances from Standard Costs. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

410

Evaluating Decentralized Operations. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

460

Differential Analysis and Product Pricing. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

510

Capital Investment Analysis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

564

Lean Manufacturing and Activity Analysis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

612

The Balanced Scorecard and Corporate Social Responsibility. . . . . . . . . . . . . . . . . . . . . . . . . .

654

Statement of Cash Flows. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

698

Financial Statement Analysis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

758

Appendix A Interest Tables. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

A-1

Nike Inc., Form 10-K for the Fiscal Year Ended May 31, 2017 Selected Excerpts. . . .

B-1

Glossary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

G-1

Index. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

I-1

Appendix B

xiv

Contents

1

Introduction to Managerial
Accounting 2

Managerial Accounting 4
Differences Between Managerial and Financial Accounting 5
Managerial Accounting in the Organization 6
The Management Process 8
Uses of Managerial Accounting Information 9

Manufacturing Operations 11
Nature of Manufacturing 11
Direct and Indirect Costs 11
Manufacturing Costs 12

Financial Statements for a Manufacturing Business 17
Balance Sheet 17
Income Statement 18

Analysis for Decision Making 21
Utilization Rates 21

Make a Decision 41
Take It Further 43
Certified Management Accountant (CMA®)
Examination Questions (Adapted) 45

Take It Further 89
Certified Management Accountant (CMA®)
Examination Questions (Adapted) 92
Pathways Challenge 59, 93

3

Process Cost Systems 94

Process Manufacturers 96
Comparing Job Order and Process Cost Systems 97
Cost Flows for a Process Manufacturer 98

Cost of Production Report 101
Step 1: Determine the Units to Be Assigned Costs 102
Step 2: Compute Equivalent Units of Production 102
Step 3: Determine the Cost per Equivalent Unit 106
Step 4: Allocate Costs to Units Transferred
Out and Partially Completed Units 107
Preparing the Cost of Production Report 109

Journal Entries for a Process Cost System 112
Using the Cost of Production Report 116

Pathways Challenge 13, 45

Analysis for Decision Making 116

2

Appendix Weighted Average Method 118

Job Order Costing 46

Cost Accounting Systems Overview 48
Job Order Cost Systems 48
Process Cost Systems 48

Job Order Cost Systems for Manufacturing
Businesses 49
Materials 50
Factory Labor 52
Factory Overhead 54
Work in Process 60
Finished Goods 61
Sales and Cost of Goods Sold 61
Period Costs 62
Summary of Cost Flows for Legend Guitars 62

Job Order Cost Systems for Service Businesses 64
Types of Service Businesses 64
Flow of Costs in a Service Job Order Cost System 64

Analysis for Decision Making 66
Analyzing Job Costs 66

Make a Decision 86

Analyzing Process Costs 116
Determining Costs Using the Weighted
Average Method 118
The Cost of Production Report 120

Make a Decision 142
Take It Further 145
Certified Management Accountant (CMA®)
Examination Questions (Adapted) 147
Pathways Challenge 112, 149

4

Activity-Based Costing 150

Product Costing Allocation Methods 152
Single Plantwide Factory
Overhead Rate Method 153
Multiple Production Department Factory
Overhead Rate Method 155
Department Overhead Rates and Allocation 156
Distortion of Product Costs 157

xv

xvi

Contents

Activity-Based Costing Method 160
Activity Rates 162
Allocating Costs 163
Distortion in Product Costs 165
Dangers of Product Cost Distortion 165

Activity-Based Costing for
Selling and Administrative Expenses 167
Activity-Based Costing in Service
Businesses 168
Analysis for Decision Making 173
Using ABC Product Cost Information to Reduce Costs 173

Make a Decision 199
Take It Further 201
Certified Management Accountant (CMA®)
Examination Questions (Adapted) 202

6

Cost-Volume-Profit
Analysis 248

Cost Behavior 250
Variable Costs 251
Fixed Costs 252
Mixed Costs 254
Summary of Cost Behavior Concepts 256

Cost-Volume-Profit Relationships 258
Contribution Margin 258
Contribution Margin Ratio 258
Unit Contribution Margin 259

Mathematical Approach to Cost-Volume-Profit
Analysis 261
Break-Even Point 261
Target Profit 265

Pathways Challenge 171, 203

Graphic Approach to Cost-Volume-Profit Analysis 266

5

Special Cost-Volume-Profit Relationships 272

 Support Department and Joint
Cost Allocation 204

Support Departments 206
Support Department Cost Allocation 207
Single Plantwide Rate 208
Multiple Production Department Rates 208
Activity-Based Costing 209

Allocating Support Department Costs
to Production Departments 210
Direct Method 211
The Sequential Method 213
The Reciprocal Services Method 217
Comparison of Support Department Cost
Allocation Methods 221

Joint Costs 222
Joint Cost Allocation 222
The Physical Units Method 222
The Weighted Average Method 223
The Market Value at Split-Off Method 223
The Net Realizable Value Method 224
Comparison of Joint Cost Allocation Methods 225
By-Products 227

Analysis for Decision Making 227
Using Support Department and Joint Cost
Allocations for Performance Evaluation 227

Make a Decision 243
Take It Further 245
Certified Management Accountant (CMA®)
Examination Questions (Adapted) 246
Pathways Challenge 221, 247

Cost-Volume-Profit (Break-Even) Chart 266
Profit-Volume Chart 268
Use of Spreadsheets in Cost-Volume-Profit Analysis 269
Assumptions of Cost-Volume-Profit Analysis 270
Sales Mix Considerations 272
Operating Leverage 274
Margin of Safety 275

Analysis for Decision Making 277
Cost-Volume-Profit Analysis for Service Companies 277

Make a Decision 297
Take It Further 298
Certified Management Accountant (CMA®)
Examination Questions (Adapted) 300
Pathways Challenge 256, 301

7

 Variable Costing for
­Management Analysis 302

Operating Income: Absorption and Variable Costing 304
Absorption Costing 304
Variable Costing 305
Effects of Inventory 307

Analyzing Operating Income Using
Absorption and ­Variable Costing 310
Using Absorption and Variable Costing 315
Controlling Costs 315
Pricing Products 315
Planning Production 316
Analyzing Market Segments 316

Analyzing Market Segments 316
Sales Territory Profitability Analysis 318
Product Profitability Analysis 319
Salesperson Profitability Analysis 319

Contents

Variable Costing for Service Businesses 321
Reporting Income 321
Analyzing Segments 322

Analysis for Decision Making 324
Segment Analysis and EBITDA 324

Make a Decision 346
Take It Further 348
Certified Management Accountant (CMA®)
Examination Questions (Adapted) 349
Pathways Challenge 314, 350

8

Budgeting 352

Nature and Objectives of Budgeting 354
Objectives of Budgeting 354
Human Behavior and Budgeting 355

Budgeting Systems 356
Static Budget 357
Flexible Budget 358

Master Budget 360
Operating Budgets 361
Sales Budget 361
Production Budget 362
Direct Materials Purchases Budget 363
Direct Labor Cost Budget 364
Factory Overhead Cost Budget 366
Cost of Goods Sold Budget 366
Selling and Administrative Expenses Budget 368
Budgeted Income Statement 369

Financial Budgets 370
Cash Budget 370
Capital Expenditures Budget 375
Budgeted Balance Sheet 375

Analysis for Decision Making 376
Nonmanufacturing Staffing Budgets 376

Make a Decision 404
Take It Further 405
Certified Management Accountant (CMA®)
Examination Questions (Adapted) 407
Pathways Challenge 370, 408

9

 Evaluating Variances
from Standard Costs 410

Standards 412
Setting Standards 412
Types of Standards 413

Reviewing and Revising Standards 413
Criticisms of Standard Costs 413

Budgetary Performance Evaluation 414
Budget Performance Report 414
Manufacturing Cost Variances 415

Direct Materials and
Direct Labor Variances 416
Direct Materials Variances 416
Direct Labor Variances 419

Factory Overhead Variances 422
The Factory Overhead Flexible Budget 423
Variable Factory Overhead Controllable Variance 424
Fixed Factory Overhead Volume Variance 424
Reporting Factory Overhead Variances 426
Factory Overhead Account 427

Recording and Reporting Variances
from Standards 430
Analysis for Decision Making 432
Service Staffing Variances 432

Appendix Revenue Variances 433
Comprehensive Problem 5 453
Make a Decision 455
Take It Further 456
Certified Management Accountant (CMA®)
Examination Questions (Adapted) 458
Pathways Challenge 418, 459

10

 Evaluating Decentralized
Operations 460

Centralized and Decentralized Operations 462
Advantages of Decentralization 462
Disadvantages of Decentralization 463
Responsibility Accounting 464

Responsibility Accounting for Cost Centers 464
Responsibility Accounting for Profit Centers 468
Support Department Allocations 468
Profit Center Reporting 470

Responsibility Accounting
for Investment Centers 472
Return on Investment 472
Residual Income 476

Transfer Pricing 479
Market Price Approach 480
Negotiated Price Approach 480
Cost Price Approach 483

Analysis for Decision Making 483
Franchise Operations 483

Make a Decision 504

xvii

xviii

Contents

Take It Further 506
Certified Management Accountant (CMA®)
Examination Questions (Adapted) 508
Pathways Challenge 463, 509

11

 Differential Analysis and
Product Pricing 510

Differential Analysis 512
Lease or Sell 514
Discontinue a Segment or Product 515
Make or Buy 516
Replace Equipment 518
Process or Sell 519
Accept Business at a Special Price 519

Setting Normal Product Selling Prices 522
Cost-Plus Methods 523
Product Cost Method 523
Illustration 524
Target Costing Method 525

Production Bottlenecks 527
Managing Bottlenecks 528
Pricing Bottleneck Products 528

Analysis for Decision Making 529
Yield Pricing in Service Businesses 529

Appendix Total and Variable Cost Methods to Setting
Normal Price 530
Total Cost Method 530
Variable Cost Method 533

Make a Decision 557
Take It Further 559
Certified Management Accountant (CMA®)
Examination Questions (Adapted) 561
Pathways Challenge 517, 562

Factors That Complicate Capital
Investment Analysis 579
Income Tax 579
Unequal Proposal Lives 579
Lease Versus Capital Investment 581
Uncertainty 581
Changes in Price Levels 582
Qualitative Considerations 583

Capital Rationing 583
Analysis for Decision Making 584
Uncertainty: Sensitivity and Expected
Value Analyses 584

Make a Decision 605
Take It Further 607
Certified Management Accountant (CMA®)
Examination Questions (Adapted) 609
Pathways Challenge 575, 610

13

 Lean Manufacturing and
Activity Analysis 612

Lean Principles 614
Reducing Inventory 615
Reducing Lead Times 615
Reducing Setup Time 617
Emphasizing Product-Oriented Layout 620
Emphasizing Employee Involvement 620
Emphasizing Pull Manufacturing 620
Emphasizing Zero Defects 621
Emphasizing Supply Chain
Management 621

Lean Accounting 623
Fewer Transactions 623
Combined Accounts 623
Nonfinancial Performance Measures 625
Direct Tracing of Overhead 625

12

Activity Analysis 626

Nature of Capital Investment Analysis 566

Analysis for Decision Making 632

 Capital Investment
Analysis 564

Methods Not Using Present Values 567
Average Rate of Return Method 567
Cash Payback Method 568

Methods Using Present Values 570
Present Value Concepts 571
Net Present Value Method and Index 573
Internal Rate of Return Method 576

Costs of Quality 626
Quality Activity Analysis 627
Value-Added Activity Analysis 629
Process Activity Analysis 630
Lean Performance for Nonmanufacturing 632

Make a Decision 649
Take It Further 651
Certified Management Accountant (CMA®)
Examination Questions (Adapted) 652
Pathways Challenge 619, 653

14

 The Balanced Scorecard
and Corporate Social
Responsibility 654

Performance Measurement Systems 656
The Balanced Scorecard 657
Performance Perspectives 657
Strategic Objectives 659
Performance Metrics 659
Strategic Initiatives 660
Performance Targets 661

Using the Balanced Scorecard 661
Strategy Maps 661
Measure Maps 663
Strategic Learning 665
Scorecard Cascading 667
Cognitive Biases 667

Corporate Social Responsibility 670
CSR Reporting 671
Corporate Social Responsibility and the Balanced Scorecard 672
Encouraging Corporate Social Responsibility 674

Analysis for Decision Making 674
Capital Investment in CSR 674

Contents

Cash Flows from Financing
Activities 712
Bonds Payable 712
Common Stock 712
Dividends and Dividends Payable 713
Preparing the Statement of Cash Flows 714

Analysis for Decision Making 716
Free Cash Flow 716

Appendix 1 Spreadsheet (Work Sheet)
for Statement of Cash Flows—The Indirect
Method 717
Analyzing Accounts 718
Retained Earnings 719
Other Accounts 719
Preparing the Statement of Cash Flows 720

Appendix 2 Preparing the Statement of Cash
Flows—The Direct Method 720
Cash Received from Customers 721
Cash Payments for Merchandise 721
Cash Payments for Operating Expenses 722
Gain on Sale of Land 722
Interest Expense 723
Cash Payments for Income Taxes 723
Reporting Cash Flows from Operating
Activities—Direct Method 723

Make a Decision 692

Make a Decision 752

Take It Further 693

Take It Further 755

Certified Management Accountant (CMA®)
Examination Questions (Adapted) 695

Pathways Challenge 714, 756

Pathways Challenge 669, 696

16

15

 Statement of Cash
Flows 698

Reporting Cash Flows 700
Cash Flows from Operating Activities 701
Cash Flows from Investing Activities 703
Cash Flows from Financing Activities 703
Noncash Investing and Financing
Activities 704
Format of the Statement of Cash
Flows 704
No Cash Flow per Share 705

Cash Flows from Operating
Activities—The Indirect Method 705
Net Income 707
Adjustments to Net Income 707

Cash Flows from Investing Activities 710
Land 710
Building and Accumulated
Depreciation—Building 711

 Financial Statement
Analysis 758

Analyzing and Interpreting Financial Statements 760
The Value of Financial Statement Information 760
Techniques for Analyzing Financial Statements 761

Analytical Methods 761
Horizontal Analysis 761
Vertical Analysis 763
Common-Sized Statements 765

Analyzing Liquidity 766
Current Position Analysis 767
Accounts Receivable Analysis 768
Inventory Analysis 769

Analyzing Solvency 772
Ratio of Fixed Assets to Long-Term Liabilities 772
Ratio of Liabilities to Stockholders’ Equity 772
Times Interest Earned 773

Analyzing Profitability 774
Asset Turnover 775
Return on Total Assets 775
Return on Stockholders’ Equity 776

xix

xx

Contents

Return on Common Stockholders’ Equity 777
Earnings per Share on Common Stock 778
Price-Earnings Ratio 779
Dividends per Share 780
Dividend Yield 780
Summary of Analytical Measures 782

Corporate Annual Reports 783
Management Discussion and Analysis 783
Report on Internal Control 784
Report on Fairness of the Financial Statements 784

Appendix 1 Unusual Items on the Income Statement 785
Unusual Items Affecting the Current Period’s
Income Statement 785
Unusual Items Affecting the Prior Period’s
Income Statement 786

Appendix 2 Fair Value and Comprehensive Income 786
Fair Value 787
Comprehensive Income 787

Make a Decision 815
Take It Further 816
Pathways Challenge 779, 818
Appendix A: Interest Tables A-1
Appendix B: Nike Inc., Form 10-K for the Fiscal Year
Ended May 31, 2017 Selected Excerpts B-1
Glossary G-1
Index I-1

Managerial

Accounting

15e

Chapter

1

Introduction to
Managerial Accounting
Chapter 1

Principles
Introduction to Managerial Accounting

Developing Information
COST SYSTEMS

COST ALLOCATIONS

Chapter 2   Job Order Costing
Chapter 3   Process Costing
Chapter 4   Activity-Based Costing

Chapter 5   Support Departments
Chapter 5   Joint Costs

Decision Making
PLANNING AND EVALUATING TOOLS

Chapter 6  Cost-Volume-Profit Analysis
Chapter 7   Variable Costing
Chapter 8   Budgeting Systems
Chapter 9  Standard Costing and Variances
Chapter 10 Decentralized Operations
Chapter 11 Differential Analysis

2

STRATEGIC TOOLS

Chapter 12
Chapter 13
Chapter 13
Chapter 14
Chapter 14

Capital Investment Analysis
Lean Manufacturing
Activity Analysis
The Balanced Scorecard
Corporate Social Responsibility

Gibson Guitars

G

ibson guitars have been used by musical legends over the
years, including B.B. King, Chet Atkins, Brian Wilson (Beach
Boys), Jimmy Page (Led Zeppelin), Jackson Browne, John Fogerty,
Jose F­ eliciano, Miranda Lambert, Sheryl Crow, and ­Wynonna Judd.
For example, Sheryl Crow has used her 1964 Gibson Country Western guitar in all of her recordings.
Known for its quality, Gibson Guitars ­celebrated its 120th
anniversary in 2014. Staying in business for over 120 years requires
a thorough understanding of how to manufacture high-quality
­guitars.1 In addition, it requires knowledge of how to account for
the costs of making guitars. For example, Gibson needs cost information to answer the following questions:

This chapter introduces managerial accounting concepts that are
useful in addressing these questions. This chapter begins by ­describing
managerial accounting and its relationship to financial accounting.
Following this overview, the management process is described along
with the role of managerial accounting. Finally, characteristics of managerial accounting reports, managerial ­accounting terms, and uses of
managerial accounting information are described and illustrated.
Sources: Chris Kornelis, The
Wall Street Journal, “How Sheryl Crow Finally Broke Her Starbucks Habit,”
May 24, 2017.

Fabio Pagani/Shutterstock.com

▪ What should be the selling price of its guitars?
▪ How many guitars does it have to sell in a year to cover its
costs and earn a profit?

▪ How many employees should the company have working on
each stage of the manufacturing process?
▪ How would purchasing automated equipment affect the costs
of its guitars?

Link to Gibson Guitars . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Pages 4, 5, 6, 7, 9, 11, 16

In May 2016, Gibson Guitars filed for bankruptcy. Gibson blamed its financial woes on the debt it had incurred by acquiring companies that produced headphones, turntables,
and speakers. After satisfying its creditors and reorganizing, Gibson plans to focus its future operations on its core competency—the manufacture of guitars.

1

3

4

Chapter 1 Introduction to Managerial Accounting

What’s Covered
Introduction to Managerial Accounting
Role of Managerial Accounting
▪▪ Differences with Financial Accounting (Obj. 1)
▪▪ Management Organization (Obj. 1)
▪▪ Management Process (Obj. 1)
▪▪ Uses of Managerial Accounting
Information (Obj. 1)

Manufacturing Operations
▪▪ Nature of Manufacturing (Obj. 2)
▪▪ Direct and Indirect Costs (Obj. 2)
▪▪ Manufacturing Costs (Obj. 2)

Manufacturing Financial
Statements
▪▪ Balance Sheet (Obj. 3)
▪▪ Income Statement (Obj. 3)

Learning Objectives
Obj. 1 Describe managerial accounting, including its
differences with financial accounting, its place in
the organization, and its uses.
Obj. 2 Describe and illustrate the nature of manufacturing
operations, including different types and classifications
of costs.

Obj. 3 Describe and illustrate financial statements for a
manufacturing business, including the balance sheet,
statement of cost of goods manufactured, and income
statement.

Analysis for Decision Making
Obj. 4 Describe and illustrate utilization rates in evaluating performance for service companies.

Objective 1
Describe managerial
accounting, including
its differences with
financial accounting, its
place in the organization, and its uses.

Managerial Accounting
Managers make numerous decisions during the day-to-day operations of a business and in planning
for the future. Managerial accounting provides much of the information used for these decisions.
Some examples of managerial accounting information along with the chapter in which it is
described and illustrated follow:
▪▪ Classifying manufacturing and other costs and reporting them in the financial statements
(Chapter 1)
▪▪ Determining the cost of manufacturing a product or providing a service (Chapters 2, 3, 4,
and 5)
▪▪ Evaluating the impact of cost allocation and activity-based costing (Chapters 4, 5)
▪▪ Estimating the behavior of costs for various levels of activity and assessing cost-volume-profit
relationships (Chapter 6)
▪▪ Evaluating operating performance using cost behavior relationships (Chapter 7)
▪▪ Planning for the future by preparing budgets (Chapter 8)
▪▪ Evaluating manufacturing costs by comparing actual with expected results (Chapter 9)
▪▪ Evaluating decentralized operations by comparing actual and budgeted costs as well as computing various measures of profitability (Chapter 10)
▪▪ Evaluating special decision-making situations by comparing differential revenues and costs,
pricing products, and managing bottlenecks (Chapter 11)
▪▪ Evaluating alternative proposals for long-term investments in fixed assets (Chapter 12)
▪▪ Planning operations using principles of lean manufacturing and activity analysis (Chapter 13)
▪▪ Evaluating company performance using the balanced scorecard and corporate responsibility
metrics (Chapter 14)

Link to
Gibson Guitars

Orville Gibson started producing guitars in 1894 in Kalamazoo, Michigan. He produced guitars and mandolins
based upon the arch-top design of violins.

Chapter 1

Introduction to Managerial Accounting

Differences Between Managerial and Financial Accounting
Accounting information is often classified into two types: financial and managerial. E
­ xhibit 1 shows
the relationship between financial accounting and managerial accounting.
Exhibit 1
Financial Accounting
and Managerial
Accounting

Managerial
Accounting
Reports

Financial
Statements
Statement of
Cash Flows
Balance Sheet

Production
Report

Statement of
Stockholders’ Equity

Activity
Analysis

Income
Statement

Budget
Report

Financial Statements

Managerial Accounting Reports

Users of Information

External users and company management

Management

Nature of Information

Objective

Objective and subjective

Guidelines for Preparation

Prepared according to GAAP

Prepared according to management needs

Timeliness of Reporting

Prepared at fixed intervals

Prepared at fixed intervals and on an ­as-needed basis

Focus of Reporting

Company as a whole

Company as a whole or segment

Financial accounting information is reported at fixed intervals (monthly, quarterly, yearly)
in general-purpose financial statements. These financial statements—the income statement, statement of stockholders’ equity, balance sheet, and statement of cash flows—are prepared according
to generally accepted accounting principles (GAAP). These statements are used by external users
such as the following:
▪▪ Shareholders
▪▪ Creditors
▪▪ Government agencies
▪▪ The general public

Gibson Mandolin-Guitar Mfg. Co., Ltd. was formed in 1902 in Kalamazoo, M
­ ichigan, with the
support of five investors.

Managers of a company also use general-purpose financial statements. For example, in planning future operations, managers often begin by evaluating the current income statement and
statement of cash flows.
Managerial accounting information is designed to meet the specific needs of a company’s
management. This information includes the following:
▪▪ Historical data, which provide objective measures of past operations
▪▪ Estimated data, which provide subjective estimates about future decisions
Management uses both types of information in directing daily operations, planning future operations, and developing business strategies.
Unlike the financial statements prepared in financial accounting, managerial accounting reports
do not always have to be:
▪▪ Prepared according to generally accepted accounting principles (GAAP). This is because GAAP
may not always be relevant to the specific decision-making needs of management.

Link to
Gibson Guitars

5

6

Chapter 1 Introduction to Managerial Accounting

▪▪ Prepared at fixed intervals (monthly, quarterly, yearly). Although some management reports are
prepared at fixed intervals, most reports are prepared as management needs the information.
▪▪ Prepared for the business as a whole. Most management reports are prepared for products,
projects, sales territories, or other segments of the company.

Link to
Gibson Guitars

Chicago Musical Instrument Company purchased Gibson in 1944.

Managerial Accounting in the Organization
While no two company structures are identical, most large companies are organized in terms of “verticals” and “horizontals.” Verticals are sometimes referred to as business units, because they are often
structured as separate businesses within the parent company. These verticals normally develop products that are sold directly to customers. Verticals prepare their own income statements, also referred to
as profit and loss (P&L) statements, which report their ongoing performance and profitability.
Horizontals are departments within the company that are not responsible for developing products. The role of horizontals is to provide services to the various verticals and other horizontals.
As such, horizontals do not report profit and loss (P&L) statements. Marketing, human resources,
information technology, legal, facilities, accounting, and finance are normally horizontal departments within a company.
At McAfee, Inc. (MFE), a cyber security provider, the Chief Financial Office functions as a
horizontal department that serves McAfee’s two main verticals: the Consumer Business Unit and the
Enterprise Business Unit. Rather than hire and train separate accounting and finance departments
within each vertical, it is more efficient to centralize this function as a horizontal department.
To illustrate, a partial organizational chart of McAfee’s Chief Executive Office and Chief Financial Office are shown in Exhibit 2.
Exhibit 2

Partial Organization Chart for McAfee
Chief Executive Officer (CEO)
Chief Executive Office

Exec.
Vice President
Consumer
Business Unit

Exec.
Vice President
Enterprise
Business Unit

Exec.
Vice President
Sales &
Marketing

Exec.
Vice President
(Chief Financial
Officer)
Chief Financial
Office

Sr.
Vice President
(Chief Tech.
Officer)
Chief Technology
Office

Verticals

Sr.
Vice President
General Counsel

Sr.
Vice President
Human
Resources

Horizontals

Exec. Vice President
(Chief Financial Officer)
Chief Financial Office

VP, Finance
Consumer

VP, Finance
Enterprise

Supports Verticals

VP, Finance
Sales &
Marketing

VP, Finance
Consolidations

Supports Horizontals

VP, Accounting
(Chief Acct.
Officer)
Chief Accounting
Office

Supports Corporate

Chapter 1

Introduction to Managerial Accounting

7

As shown in Exhibit 2, the chief financial officer (CFO) is an executive vice president, who,
along with leadership of the other verticals and horizontals, reports directly to the chief executive
officer (CEO). Each of the two verticals (Consumer Business Unit and Enterprise Business Unit)
has a “VP of Finance” that reports to the CFO. In addition, the Sales & Marketing and Consolidations horizontals have their own “VP of Finance” that reports to the CFO.2 The “VP of Accounting”
is called the chief …
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