Accounting Question

College of Administration and Finance Sciences

Assignment (2)
Deadline: Saturday 23/11/2024 @ 23:59
Course Name: Manegerial Accounting

Student’s Name:

Course Code: ACCT322

Student’s ID Number:

Semester: 1st

CRN:
Academic Year: 1446 H

For Instructor’s Use only
Instructor’s Name:
Students’ Grade:

/15

Level of Marks: High/Middle/Low

Instructions – PLEASE READ THEM CAREFULLY
• The Assignment must be submitted on Blackboard (WORD format only) via
allocated folder.
• Assignments submitted through email will not be accepted.
• Students are advised to make their work clear and well presented, marks may be
reduced for poor presentation. This includes filling your information on the
cover page.
• Students must mention question number clearly in their answer.
• Late submission will NOT be accepted.
• Avoid plagiarism, the work should be in your own words, copying from students
or other resources without proper referencing will result in ZERO marks. No
exceptions.
• All answers must be typed using Times New Roman (size 12, double-spaced)
font. No pictures containing text will be accepted and will be considered plagiarism.
• Submissions without this cover page will NOT be accepted.

College of Administration and Finance Sciences

Assignment Question(s):

(Marks 15)

Q1. ABC Company has equipment and it considers whether to sell it directly at a price of SR
50,000 or to make some modifications costing SR 5,000 to sell it at a price of SR 60,000.
Required: using the differential analysis which alternative do you recommend about the
equipment. (2 marks)

Answer:

Q2. The following data pertain to the Whalen Division of Northern Industries.

The margin at Whalen was exactly the same in Year 2 as it was in Year 1.
Required: Find out the unknown information in the table given. 8 Marks
Hint: The following are the related formulas for your use.

Answer:

College of Administration and Finance Sciences

Q3. The Phelps Company applies overhead costs to products on the basis of standard direct laborhours. The standard cost card shows that 5 direct labor-hours are required per unit of product.
Phelps Company had the following budgeted and actual data for March:

The budgeted direct labor-hours is used as the denominator activity for the month.
Calculate the variable overhead efficiency variance for March. (2 marks)
Answer

Q4. The capital budgeting techniques that best recognize the time value of money are those that
involve discounted cash flows. Explain both discounted and non- discounted methods with
numerical examples. (3 marks)
Answer:

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managers
MANAGERIAL ACCOUNTING for

Second Edition
Eric W. Noreen, Ph.D., CMA
Professor Emeritus
University of Washington

Peter C. Brewer, Ph.D., CPA
Miami University—Oxford, Ohio

Ray H. Garrison, D.B.A., CPA
Professor Emeritus
Brigham Young University

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Dedication
To our families and to our many
colleagues who use this book.

MANAGERIAL ACCOUNTING FOR MANAGERS
Published by McGraw-Hill/Irwin, a business unit of The McGraw-Hill Companies, Inc.,
1221 Avenue of the Americas, New York, NY, 10020. Copyright © 2011, 2008 by The McGraw-Hill
Companies, Inc. All rights reserved. No part of this publication may be reproduced or
distributed in any form or by any means, or stored in a database or retrieval system, without
the prior written consent of The McGraw-Hill Companies, Inc., including, but not limited to, in
any network or other electronic storage or transmission, or broadcast for distance learning.
Some ancillaries, including electronic and print components, may not be available to
customers outside the United States.
This book is printed on acid-free paper.
1 2 3 4 5 6 7 8 9 0 DOW/DOW 1 0 9 8 7 6 5 4 3 2 1 0
ISBN 978-0-07-352713-0
MHID 0-07-352713-0
Vice president and editor-in-chief: Brent Gordon
Editorial director: Stewart Mattson
Publisher: Tim Vertovec
Director of development: Ann Torbert
Development editor: Emily A. Hatteberg
Vice president and director of marketing: Robin J. Zwettler
Marketing manager: Kathleen Klehr
Vice president of editing, design and production: Sesha Bolisetty
Lead project manager: Pat Frederickson
Lead production supervisor: Carol A. Bielski
Senior designer: Mary Kazak Sander
Senior photo research coordinator: Lori Kramer
Photo researcher: Keri Johnson
Media project manager: Jennifer Lohn
Cover designer: Gino Cieslik
Interior design: Gino Cieslik
Cover photo: Integrated Laser Pointer, courtesy of VSON Technology Co., Ltd.
Typeface: 10.5/12 Times Roman
Compositor: Laserwords Private Limited
Printer: R. R. Donnelley
Library of Congress Cataloging-in-Publication Data
Noreen, Eric W.
Managerial accounting for managers / Eric W. Noreen, Peter C. Brewer, Ray H. Garrison.—2nd ed.
p. cm.
Includes index.
ISBN-13: 978-0-07-352713-0 (alk. paper)
ISBN-10: 0-07-352713-0 (alk. paper)
1. Managerial accounting. I. Brewer, Peter C. II. Garrison, Ray H. III. Title.
HF5657.4.N668 2011
658.15’11—dc22
2009037451
www.mhhe.com

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About the
Authors
Eric W. Noreen has held appointments at
institutions in the United States, Europe, and Asia. He is
emeritus professor of accounting at the University of
Washington.
His BA degree is from the University of Washington and his
MBA and PhD degrees are from Stanford University. A Certified
Management Accountant, he was awarded a Certificate of
Distinguished Performance by the Institute of Certified
Management Accountants.
Professor Noreen has served as associate editor of The Accounting Review and the
Journal of Accounting and Economics. He has had numerous articles published in
academic journals including: the Journal of Accounting Research; the Accounting
Review; the Journal of Accounting and Economics; Accounting Horizons; Accounting,
Organizations and Society; Contemporary Accounting Research; the Journal of
Management Accounting Research; and the Review of Accounting Studies.
Professor Noreen has won a number of awards from students for his teaching.

Peter C. Brewer is a professor in the
Department of Accountancy at Miami University, Oxford, Ohio.
He holds a BS degree in accounting from Penn State University,
an MS degree in accounting from the University of Virginia, and
a PhD from the University of Tennessee. He has published
more than 30 articles in a variety of journals including:
Management Accounting Research, the Journal of Information
Systems, Cost Management, Strategic Finance, the Journal of
Accountancy, Issues in Accounting Education, and the Journal
of Business Logistics.

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About the Authors
Professor Brewer is a member of the editorial boards of Issues in Accounting
Education and the Journal of Accounting Education. His article “Putting Strategy
into the Balanced Scorecard” won the 2003 International Federation of Accountants’
Articles of Merit competition and his articles “Using Six Sigma to Improve the
Finance Function” and “Lean Accounting: What’s It All About?” were awarded the
Institute of Management Accountants’ Lybrand Gold and Silver Medals in 2005 and
2006. He has received Miami University’s Richard T. Farmer School of Business
Teaching Excellence Award and has been recognized on two occasions by the Miami
University Associated Student Government for “making a remarkable commitment to
students and their educational development.” He is a leading thinker in undergraduate
management accounting curriculum innovation and is a frequent presenter at various
professional and academic conferences.
Prior to joining the faculty at Miami University, Professor Brewer was employed as
an auditor for Touche Ross in the firm’s Philadelphia office. He also worked as an
internal audit manager for the Board of Pensions of the Presbyterian Church (U.S.A.).
He frequently collaborates with companies such as Harris Corporation, Ghent
Manufacturing, Cintas, Ethicon Endo-Surgery, Schneider Electric, Lenscrafters, and
Fidelity Investments in a consulting or case writing capacity.

Ray H. Garrison is emeritus professor of
accounting at Brigham Young University, Provo, Utah. He
received his BS and MS degrees from Brigham Young University
and his DBA degree from Indiana University.
As a certified public accountant, Professor Garrison has been
involved in management consulting work with both national
and regional accounting firms. He has published articles in The
Accounting Review, Management Accounting, and other
professional journals. Innovation in the classroom has earned
Professor Garrison the Karl G. Maeser Distinguished Teaching Award from Brigham
Young University.

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Focus on the
Future Manager
with Noreen/ Brewer/Garrison
In Managerial Accounting for Managers, the authors have
crafted a streamlined managerial accounting book that is perfect for nonaccounting majors who intend to move into managerial positions. Topics
such as process costing, the statement of cash flows, and financial statement analysis have been dropped to enable instructors to focus their
attention on the bedrocks of managerial accounting—planning,
control, and decision making. Noreen/Brewer/Garrison focuses on the
fundamentals, allowing students to develop the conceptual framework
managers need to succeed.
In its second edition, Managerial Accounting for Managers continues
to adhere to three core standards:

FOCUS. Noreen/Brewer/Garrison pinpoints the key managerial
concepts students will need in their future careers. With no journal
entries or financial accounting topics to worry about, students can focus
on the fundamental principles of managerial accounting.

RELEVANCE. With its insightful Business Focus features
to begin each chapter, current In Business examples throughout the text,
and tried-and-true end-of-chapter material, a student will always see the
real-world applicability of Noreen/Brewer/Garrison.

BALANCE. There is more than one type of business, and so
Noreen/Brewer/Garrison covers a variety of business models, including
nonprofit, retail, service, wholesale, and manufacturing organizations.
Service company examples are highlighted with icons in the margins of
the text.

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Noreen’s Powerful Pedagogy
Managerial Accounting for Managers is full of
pedagogy designed to make studying productive and hassle free.
Opening Vignette
Chapter

10
Standard Costs and
Operating Performance
Measures

Learning Objectives
After studying Chapter 10,
you should be able to:

LO1

Explain how direct materials
standards and direct labor
standards are set.

LO2

Compute the direct materials
price and quantity variances
and explain their significance.

LO3

Compute the direct labor rate
and efficiency variances and
explain their significance.

LO4

Compute the variable
manufacturing overhead rate
and efficiency variances.

LO5

Compute delivery cycle time,
throughput time, and
manufacturing cycle efficiency
(MCE).

LO6

(Appendix 10A) Compute and
interpret the fixed overhead
budget and volume variances.

B USIN E SS FO CUS

Managing Materials and Labor
Schneider Electric’s Oxford, Ohio,
plant manufactures busways that
transport electricity from its point
of entry into a building to remote
locations throughout the building.
The plant’s managers pay close
attention to direct material costs
because they are more than half
of the plant’s total manufacturing
costs. To help control scrap rates
for direct materials such as
copper, steel, and aluminum, the
accounting department prepares direct materials quantity variances. These variances
compare the standard quantity of direct materials that should have been used to make
a product (according to computations by the plant’s engineers) to the amount of direct
materials that were actually used. Keeping a close eye on these differences helps to
identify and deal with the causes of excessive scrap, such as an inadequately trained
machine operator, poor quality raw material inputs, or a malfunctioning machine.
Because direct labor is also a significant component of the plant’s total manufacturing costs, the management team daily monitors the direct labor efficiency variance.
This variance compares the standard amount of labor time allowed to make a product
to the actual amount of labor time used. When idle workers cause an unfavorable labor
efficiency variance, managers temporarily move workers from departments with slack
to departments with a backlog of work to be done. ■

Each chapter opens with a Business Focus
feature that provides a real-world example
for students, allowing them to see how
the chapter’s information and insights apply
to the world outside the classroom.
Learning Objectives alert students to
what they should expect as they progress
through the chapter.

“Many concepts in accounting are
rather abstract if not given some type
of context to understand them in. The
business focus features help to provide
this context and can lead to discussions
in class if the instructor wishes.”
—Jeffrey Wong, University of Nevada, Reno

Source: Author’s conversation with Doug Taylor, plant controller, Schneider Electric’s Oxford, Ohio, plant.

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IN BUSINESS

In Business Boxes

IS THIS REALLY A JOB?
VBT Bicycling Vacations of Bristol, Vermont, offers deluxe bicycling vacations in the United States,
Canada, Europe, and other locations throughout the world. For example, the company offers a
10-day tour of the Puglia region of Italy—the “heel of the boot.” The tour price includes international
airfare, 10 nights of lodging, most meals, use of a bicycle, and ground transportation. Each tour is
led by at least two local tour leaders, one of whom rides with the guests along the tour route. The
other tour leader drives a “sag wagon” that carries extra water, snacks, and bicycle repair equipment and is available to shuttle guests back to the hotel or up a hill. The sag wagon also transports
guests’ luggage from one hotel to another.
Each specific tour can be considered a job. For example, Giuliano Astore and Debora Trippetti,
two natives of Puglia, led a VBT tour with 17 guests over 10 days in late April. At the end of the tour,
Giuliano submitted a report, a sort of job cost sheet, to VBT headquarters. This report detailed
the on the ground expenses incurred for this specific tour, including fuel and operating costs for the
van, lodging costs for the guests, the costs of meals provided to guests, the costs of snacks, the
cost of hiring additional ground transportation as needed, and the wages of the tour leaders. In
addition to these costs, some costs are paid directly by VBT in Vermont to vendors. The total cost
incurred for the tour is then compared to the total revenue collected from guests to determine the
gross profit for the tour.

These helpful boxed features offer a glimpse
into how real companies use the managerial
accounting concepts discussed within the
chapter. Each chapter contains from three to
fourteen of these current examples.

Sources: Giuliano Astore and Gregg Marston, President, VBT Bicycling Vacations. For more information about
VBT, see www.vbt.com.

“I love these. Again, a connection to real
world that adds credence to the course.”
—Larry N. Bitner, Shippensburg University

Managerial Accounting in
Action Vignettes
These vignettes depict cross-functional
teams working together in real-life
settings, working with the products and
services that students recognize from
their own lives. Students are shown
step-by-step how accounting concepts
are implemented in organizations and
how these concepts are applied to solve
everyday business problems. First, “The
Issue” is introduced through a dialogue;
the student then walks through the
implementation process; finally, “The
Wrap-up” summarizes the big picture.

338

Chapter 9

E X H I B I T 9 – 4 nor27130_ch05_164-205.indd 166
Flexible Budget Based on
Actual Activity

8/31/09 2:20:41 PM

Rick’s Hairstyling
Flexible Budget
For the Month Ended March 31

Actual client-visits (q) …………………………………………..
Revenue ($180.00q) ……………………………………………
Expenses:
Wages and salaries ($65,000 ⫹ $37.00q) ……………
Hairstyling supplies ($1.50q) ……………………………..
Client gratuities ($4.10q) …………………………………..
Electricity ($1,500 ⫹ $0.10q) …………………………….
Rent ($28,500) ………………………………………………..
Liability insurance ($2,800) ………………………………..
Employee health insurance ($21,300) …………………
Miscellaneous ($1,200 ⫹ $0.20q) ………………………
Total expense ……………………………………………………..
Net operating income …………………………………………..

MANAGERIAL
ACCOUNTING IN
ACTION
The Issue

1,100
$198,000
105,700
1,650
4,510
1,610
28,500
2,800
21,300
1,420
167,490
$ 30,510

Victoria: How is the budgeting going?
Rick: Pretty well. I didn’t have any trouble putting together the budget for March. I also
prepared a report comparing the actual results for March to the budget, but that report
isn’t giving me what I really want to know.
Victoria: Because your actual level of activity didn’t match your budgeted activity?
Rick: Right. I know the level of activity shouldn’t affect my fixed costs, but we had
more client-visits than I had expected and that had to affect my other costs.
Victoria: So you want to know whether the higher actual costs are justified by the
higher level of activity you actually had in March?
Rick: Precisely.
Victoria: If you leave your reports and data with me, I can work on it later today, and by
tomorrow I’ll have a report to show you.

How a Flexible Budget Works
A flexible budget approach recognizes that a budget can be adjusted to show what costs
should be for the actual level of activity. To illustrate how flexible budgets work, Victoria
prepared the report in Exhibit 9–4 that shows what the revenues and costs should have
been given the actual level of activity in March. Preparing the report is straightforward.
The cost formula for each cost is used to estimate what the cost should have been for
1,100 client-visits—the actual level of activity for March. For example, using the cost
formula $1,500 ⫹ $0.10q, the cost of electricity in March should have been $1,610
(⫽ $1,500 ⫹ $0.10 ⫻ 1,100).
We can see from the flexible budget that the net operating income in March should have
been $30,510, but recall from Exhibit 9–2 that the net operating income was actually only
$21,230. The results are not as good as we thought. Why? We will answer that question shortly.
To summarize to this point, Rick had budgeted for a profit of $16,800. The actual
profit was quite a bit higher—$21,230. However, given the amount of business the salon
had in March, the profit should have been even higher—$30,510. What are the causes of
these discrepancies? Rick would certainly like to build on the positive factors, while
working to reduce the negative factors. But what are they?

Flexible Budget Variances
To answer Rick’s questions concerning the discrepancies between budgeted and actual costs,
we will need to break down the variances shown in Exhibit 9–3 into two types of variances—
activity variances and revenue and spending variances. We do that in the next two sections.

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“This element is exceptional. The situations truly
reflect real life issues business people would
face—not just “textbook” manufactured examples
that always have black/white answers.”
—Ann E. Selk, University of Wisconsin – Green Bay

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“This text is a clear, succinct
presentation of appropriate
managerial accounting topics for
an introductory course. The
management focus makes the
text more relevant to the
introductory accounting course
in which the majority of students
are non-accounting majors.”

Utilizing the Icons
To reflect our service-based economy,
the text is replete with examples from
service-based businesses. A helpful icon
distinguishes service-related examples in
the text.
Ethics assignments and examples serve
as a reminder that good conduct is vital
in business. Icons call out content that
relates to ethical behavior for students.

—Darlene Coarts, University of
Northern Iowa

“This text is very thorough and has
lots of rich current examples and
applications. It has exceptional
supplements of all types. It is a
very user oriented book and
very appropriate for courses for
non-accounting majors as a
second accounting course.”

Media integrated icons throughout the
text link content back to chapter-specific
quizzes, audio lectures, and visual
presentations; all of which can be
downloaded to an MP3 player. This gives
students access to a portable, electronic
learning option to support their classroom
instruction.

—Dana Carpenter, Madison Area
Technical College

“Clear, concise, covers the most
relevant topics for students in all
concentrations of business and a
great text for students that are
going into Cost Accounting.”

The writing icon denotes problems that
require students to use critical thinking
as well as writing skills to explain their
decisions.

—Shirley Polejewski, University of
St. Thomas

An Excel© icon alerts students that
spreadsheet templates are available for
use with select problems and cases.

“This is a very comprehensive
Managerial Accounting textbook
with an excellent use of
examples within the text.”
—Tammy Metzke, Milwaukee Area
Technical College-West Allis

IFRS

The IFRS icon highlights content that
may be affected by the impending change
to IFRS and possible convergence
between U.S. GAAP and IFRS.

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End-of-Chapter Material
Multiple-choice questions are provided on the text website at www.mhhe.com/noreen2e.

Exercises

EXERCISE 4–1 Preparing a Contribution Format Income Statement [LO1]

www.mhhe.co

Whirly Corporation’s most recent income statement is shown below:

Sales (10,000 units) ………………………
Variable expenses ………………………..

Total

Per Unit

$350,000
200,000

$35.00
20.00

www.mhhe.com/noreen2e

Building on Garrison/Noreen/Brewer’s reputation for
having the best end-of-chapter review and
discussion material of any text on the
market, Noreen’s problem and case material
continues to conform to AACSB, AICPA,
and Bloom’s Taxonomy Categories and
Problems
makes a great starting point for class
discussions and group projects.

Contribution
margin ………………………
150,000
$15.00
PROBLEM 4–19 Basics of CVP Analysis [LO1, LO3, LO4, LO6, LO8]
Fixed
expenses
135 000
Feather
Friends, Inc., distributes a high-quality
wooden birdhouse that sells for $20 per unit. Variable costs

are $8 per unit, and fixed costs total $180,000 per year.
Required:

Answer the following independent questions:
1. What is the product’s CM ratio?
2. Use the CM ratio to determine the break-even point in sales dollars.
3. Due to an increase in demand, the company estimates that sales will increase by $75,000 during the
next year. By how much should net operating income increase (or net loss decrease) assuming that
fixed costs do not change?
4. Assume that the operating results for last year were:

“The end of the chapter problems…
are excellent and are varied enough
so that the student is not performing
the same problem over and over
again.”
—Peter Woodlock, Youngstown State
University

Sales ………………………………………………………………..
Variable expenses ……………………………………………..

$400,000
160,000

Contribution margin ……………………………………………
Fixed expenses ………………………………………………….

240,000
180,000

Net operating income …………………………………………

$ 60,000

RESEARCH AND APPLICATION 4-34

[LO3, LO4, LO5, LO6, LO7, LO8, LO9]

The questions in this exercise are based on the Benetton Group, a company headquartered in
Italy and known in the United States primarily for one of its brands of fashion apparel—United
Colors of Benetton. To answer the questions, you will need to download the Benetton Group’s
2004 Annual Report at www.benetton.com/investors. Once at this website, click on the link
toward the top of the page called “Site Map” and then scroll down to the heading called
“Financial Reports” and click on the year 2004. You do not need to print this document to
answer the questions.
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Required:

8/14/09 8:06:59 PM

1. How do the formats of the income statements shown on pages 33 and 50 of Benetton’s
annual report differ from one another (disregard everything beneath the line titled “income
from operations”)? Which expenses shown on page 50 appear to have been reclassified as
variable selling costs on page 33?
2. Why do you think cost of sales is included in the computation of contribution margin on
page 33?
3. Perform two separate computations of Benetton’s break-even point in euros. For the first
computation, use data from 2003. For the second computation, use data from 2004. Why do
the numbers that you computed differ from one another?

8/14/09 8:07:05 PM

Author-Written Supplements
Unlike other managerial accounting texts, Noreen, Brewer, and Garrison
write all of the text’s major supplements, ensuring a perfect fit between
text and supplement. For more information on Managerial Accounting
for Managers’s supplements package, see page xvi.
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• Instructor’s Resource Guide
• Testbank
• Solutions Manual
• Workbook/Study Guide

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New to the
Second Edition
Faculty feedback helps us continue to improve Managerial Accounting for Managers. In response to reviewer
suggestions we have:
• Reordered variances in Chapters 9 and 10. Both chapters have been extensively rewritten to follow a more logical flow.
• Added coverage of corporate social responsibility to Chapter 1 to introduce students to an important and relevant topic in today’s
business world.
• Moved the coverage of balanced scorecard to Chapter 11 where it more naturally belongs.
• Added International Financial Reporting Standards (IFRS) icons throughout the text to highlight topics that may be affected should the
U.S. adopt IFRS in the future.

Specific changes were made in the following chapters:
• In Business boxes updated throughout.
• All end-of-chapter items tagged to Bloom’s Taxonomy categories as well as AACSB and AICPA standards.

Chapter 1

Chapter 6

•
•

•

New material on corporate social responsibility has been added.
Materials dealing with the distinction between financial and
managerial accounting have been moved to Chapter 2.

The chapter has been extensively revised with the overall objective
of making the material more user-friendly. Tables have been
simplified and computing cost of goods sold is streamlined.

Chapter 2

Chapter 9

•

•

The schedule of cost of goods manufactured has been simplified by
eliminating the list of the elements of manufacturing overhead. This
removes a discrepancy that had existed between the coverage of
the schedule of cost of goods manufactured in Chapter 2 and in
Chapter 3.

Chapter 4
•
•

•

The basic equations used in target profit analysis and break-even
analysis have been revised to be more intuitive.
Break-even analysis has been moved to follow target profit analysis
because break-even analysis is just a special caser of target profit
analysis.
Profit graphs are covered in addition to CVP graphs.

Chapter 5
•
•

Portions of the chapter have been rewritten to enhance clarity.
The appendix has been rewritten to highlight its assumptions.

This chapter has been completely rewritten to follow a logical path
leading from budgeting to performance evaluation comparing
budgets to actual results and then on to standard cost analysis.
Flexible budgets are used to prepare performance reports with
activity variances and revenue and spending variances. This chapter
contains some of the material that used to be in Chapter 11.

Chapter 10
•

This chapter now covers all standard cost variances—including
fixed manufacturing overhead variances in an appendix. The
material in this chapter has been extensively rewritten—particularly
the materials dealing with manufacturing overhead.

Chapter 11
•

The balanced scorecard has been moved to this chapter, where it
more naturally belongs.

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Connect Your Students to
Learning and Success
McGraw-Hill Connect TM Accounting
Less Managing. More Teaching. Greater Learning.

accounting

McGraw-Hill Connect Accounting is an online assignment and assessment solution that connects students with
the tools and resources they’ll need to achieve success.
McGraw-Hill Connect Accounting helps prepare students for their future by enabling faster learning, more
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McGraw-Hill Connect Accounting features
Connect Accounting offers a number of powerful tools and features to make managing assignments easier so
faculty can spend more time teaching. With Connect Accounting, students can engage with their coursework
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Simple assignment management
With Connect Accounting, creating assignments is easier than ever, so you can spend more time teaching and
less time managing. The assignment management function enables you to:
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Create and deliver assignments easily with selectable end-of-chapter questions and testbank items.
Streamline lesson planning, student progress reporting, and assignment grading to make classroom management
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Go paperless with the eBook and online submission and grading of student assignments.

Smart grading
When it comes to studying, time is precious. Connect Accounting helps students learn more efficiently by providing
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•
•

Have assignments scored automatically, giving students immediate feedback on their work and side-by-side
comparisons with correct answers.
Access and review each response; manually change grades or leave comments for students to review.
Reinforce classroom concepts with practice tests and instant quizzes.

Instructor library
The Connect Accounting Instructor Library is your repository for additional resources to improve student engagement in and out of class. You can select and use any asset that enhances your lecture. The Connect Accounting
Instructor Library includes:
•
•
•

PowerPoints
Transparency Masters
Instructor’s Resource Guide

•

Assignment Topic Grids

•

Testbank Topic Grids

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Student Study Center
The Connect Accounting Student Study Center is the place for students to access additional resources. The
Student Study Center:
•

Offers students quick access to lectures, practice materials, eBooks, and more.

•

Provides instant practice material and study questions, easily accessible on the go.

•

Gives students access to the Personal Learning Plan described below.

Personal Learning Plan
The Personal Learning Plan (PLP) connects each student to the learning resources needed for success in the course.
For each chapter, students:
•

Take a practice test to initiate the Personal Learning Plan.

•

Immediately upon completing the practice test, see how their performance compares to chapter learning
objectives.

•

Receive a Personal Learning Plan that recommends specific readings from the text, supplemental study material, and practice work that will improve their understanding and mastery of each learning objective.

Diagnostic and adaptive learning of concepts: LearnSmart
Students want to make the best use of their study time. The LearnSmart adaptive self-study technology within
Connect Accounting provides students with a seamless combination of practice, assessment, and remediation for
every concept in the textbook. LearnSmart’s intelligent software adapts to every student response and automatically
delivers concepts that advance the student’s understanding while reducing time devoted to the concepts already
mastered. The result for every student is the fastest path to mastery of the chapter concepts. LearnSmart:
•

Applies an intelligent concept engine to identify the relationships between concepts and to serve new concepts
to each student only when he or she is ready.

•

Adapts automatically to each student, so students spend less time on the topics they understand and practice
more those they have yet to master.

•

Provides continual reinforcement and remediation but gives only as much guidance as students need.

•

Integrates diagnostics as part of the learning experience.

•

Enables you to assess which concepts students have efficiently learned on their own, thus freeing class time
for more applications and discussion.

Student progress tracking
Connect Accounting keeps instructors informed about how each student, section, and class is performing, allowing for more productive use of lecture and office hours. The progress-tracking function enables you to:
•

View scored work immediately and track individual or group performance with assignment and grade reports.

•

Access an instant view of student or class performance relative to learning objectives.

•

Collect data and generate reports required by many accreditation organizations, such as AACSB and AICPA.

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McGraw-Hill Connect™ Plus Accounting
McGraw-Hill reinvents the textbook learning experience for the modern student with Connect Plus Accounting.
A seamless integration of an eBook and Connect Accounting, Connect Plus Accounting provides all of the
Connect Accounting features plus the following:
•

An integrated eBook, allowing for anytime, anywhere access to the textbook.

•

Dynamic links between the problems or questions you assign to your students and the location in the eBook
where that problem or question is covered.

•

A powerful search function to pinpoint and connect key concepts in a snap.

In short, Connect Accounting offers you and your students powerful tools and features that optimize your time
and energies, enabling you to focus on course content, teaching, and student learning. Connect Accounting also
offers a wealth of content resources for both instructors and students. This state-of-the-art, thoroughly tested system supports you in preparing students for the world that awaits.
For more information about Connect, go to www.mcgrawhillconnect.com, or contact your local McGraw-Hill
sales representative.

Tegrity Campus: Lectures 24/7
Tegrity Campus is a service that makes class time available 24/7 by automatically capturing every lecture in a
searchable format for students to review when they study
and complete assignments. With a simple one-click startand-stop process, you capture all computer screens and corresponding audio. Students can replay any part of any
class with easy-to-use browser-based viewing on a PC or Mac.
Educators know that the more students can see, hear, and experience class resources, the better they learn.
In fact, studies prove it. With Tegrity Campus, students quickly recall key moments by using Tegrity Campus’s
unique search feature. This search helps students efficiently find what they need, when they need it, across an
entire semester of class recordings. Help turn all your students’ study time into learning moments immediately
supported by your lecture.
To learn more about Tegrity watch a 2-minute Flash demo at

iPod® Content
Harness the power of one of the most popular technology tools
today—the Apple® iPod®. Our innovative approach allows students
to download audio and video presentations right into their iPod and
take learning materials with them wherever they go.
Students can visit the Online Learning Center at
www.mhhe.com/noreen2e to download our iPod content. For
each chapter of the book they will be able to download narrated
lecture presentations, managerial accounting videos, and even selfquizzes designed for use on various versions of iPods. It makes
review and study time as easy as putting on earphones.

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Online Learning Center (OLC)

www.mhhe.com/noreen2e
More and more students are studying online. That’s why we offer an Online Learning Center (OLC) that follows
Managerial Accounting for Managers chapter by chapter. It doesn’t require any building or maintenance on
your part. It’s ready to go the moment you and your students type in the URL.
As your students study, they can refer to the OLC website for such benefits as:
•
•
•
•
•

Internet-based activities
Self-grading quizzes
Excel spreadsheets
PowerPoint slides
iPod® Content

A secured Instructor Resource Center stores your essential course materials to save you prep time before class.
The Instructor’s Resource Guide, Solutions Manual, Testbank, and PowerPoint slides are now just a couple of clicks away.

CourseSmart
CourseSmart is a new way to find and buy eTextbooks. At CourseSmart you can save
up to 50 percent off the cost of a print textbook, reduce your impact on the environment, and gain access to powerful Web tools for learning. CourseSmart has the
largest selection of eTextbooks available anywhere, offering thousands of the most
commonly adopted textbooks from a wide variety of higher education publishers. CourseSmart eTextbooks are available in one
standard online reader with full text search, notes and highlighting, and e-mail tools for sharing notes between classmates.

McGraw-Hill Customer Care Contact Information
At McGraw-Hill, we understand that getting the most from new technology can be challenging. That’s why our
services don’t stop after you purchase our products. You can e-mail our Product Specialists 24 hours a day to get
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website. For Customer Support, call 800-331-5094, e-mail [email protected], or visit
www.mhhe.com/support. One of our Technical Support Analysts will be able to assist you in a timely fashion.

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Instructor Supplements
Assurance of Learning Ready
Many educational institutions today are focused on the notion of
assurance of learning, an important element of some accreditation
standards. Managerial Accounting for Managers, 2e, is designed
specifically to support your assurance of learning initiatives with a
simple, yet powerful, solution.
Each testbank question for Managerial Accounting for
Managers, 2e, maps to a specific chapter learning outcome/objective
listed in the text. You can use our testbank software, EZ Test, to
easily query for learning outcomes/objectives that directly relate to
the learning objectives for your course. You can then use the
reporting features of EZ Test to aggregate student results in similar
fashion, making the collection and presentation of assurance of
learning data simple and easy.

AACSB Statement
McGraw-Hill Companies is a proud corporate member of AACSB
International. Recognizing the importance and value of AACSB
accreditation, we have sought to recognize the curricula guidelines
detailed in AACSB standards for business accreditation by connecting
selected questions in Managerial Accounting for Managers, 2e,
to the general knowledge and skill guidelines found in the AACSB
standards. The statements contained in Managerial Accounting
for Managers, 2e, are provided only as a guide for the users of this
text. The AACSB leaves content coverage and assessment clearly
within the realm and control of individual schools, the mission of the
school, and the faculty. The AACSB does also charge schools with
the obligation of doing assessment against their own content and
learning goals. While Managerial Accounting for Managers, 2e,
and its teaching package make no claim of any specific AACSB
qualification or evaluation, we have, within Managerial Accounting
for Managers, 2e, labeled selected questions according to the six
general knowledge and skills areas. The labels or tags within
Managerial Accounting for Managers, 2e, are as indicated. There
are, of course, many more within the testbank, the text, and the
teaching package which might be used as a “standard” for your course.
However, the labeled questions are suggested for your consideration.

the same test. Use this testbank to make different versions of the
same test, change the answer order, edit and add questions, and
conduct online testing. Technical support for this software is
available.

Instructor CD-ROM
MHID 0077268563
ISBN-13 9780077268565
Allowing instructors to create a customized multimedia presentation,
this all-in-one resource incorporates the testbank, PowerPoint
Slides, Instructor’s Resource Guide and the Solutions Manual.

Instructor’s Resource Guide
Available on the Instructor CD and the password-protected
Instructor OLC.
Extensive chapter-by-chapter lecture notes help with classroom
presentations and contain useful suggestions for presenting key
concepts and ideas. The lecture notes dovetail exactly with the
PowerPoint Slides, making lesson planning even easier.

Testbank
Available on the Instructor CD and the password-protected
Instructor OLC.
Over 2,000 questions are organized by chapter and include true/false,
multiple-choice, and problems. The testbank includes worked out
solutions and all items have been tied to AACSB-AICPA standards.

Microsoft Excel® Template Solutions
Available on the Instructor CD and the password-protected
Instructor OLC.
Prepared by Jack Terry of ComSource Associates, Inc., these Excel
templates offer solutions to the student version.

Check Figures

EZ Test

These provide key answers for selected problems and cases should
you want to make them available for your students. They are available
on the student side of the text’s website.

Available on the Instructor CD and the password-protected Instructor
OLC.

PowerPoint® Slides
Available on the Instructor CD and the OLC.

McGraw-Hill’s EZ Test is a flexible electronic testing program. The
program allows instructors to create tests from book-specific items.
It accommodates a wide range of question types, plus instructors
may add their own questions and sort questions by format. EZ Test
can also scramble questions and answers for multiple versions of

Prepared by Jon Booker and Charles Caldwell of Tennessee
Technological University, and Susan Galbreath of Lipscomb
University, these slides offer a great visual complement for your
lectures. A complete set of slides covers each chapter.

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Student Supplements
McGraw-Hill Connect TM Accounting

Workbook/Study Guide

McGraw-Hill Connect Accounting is an online assignment and
assessment solution that connects students with the tools and
resources they’ll need to achieve success. McGraw-Hill Connect
Accounting helps prepare students for their future by enabling
faster learning, more efficient studying, and higher retention of
knowledge. See page xii for details.

MHID: 007726858X
ISBN-13: 9780077268589
This study aid provides suggestions for studying chapter material,
summarizes essential points in each chapter, and tests your knowledge
using self-test questions and exercises.

iPod Content
Available on the OLC.
The online learning center contains course-related videos, chapterspecific quizzes, and audio and visual lecture presentations that tie
directly to the text. Icons in the margins of the book direct you to
the assets available on the website that can offer you additional help
in understanding difficult topics.

Excel® Templates
Available on the OLC.

PowerPoint® Slides
Available on the OLC.
Separate from the instructor PowerPoint slides, this short and
manageable supplement focuses on the most important topics in the
chapter and is perfect as a refresher for right before a big test or as
a reference during homework or study time.

Online Learning Center (OLC)
When it comes to getting the most out of your textbook, the Online
Learning Center is the place to start. The OLC follows Managerial
Accounting for Managers chapter by chapter, offering all kinds of
supplementary help for you as you read. Before you even start reading
Chapter 1, go to this address and bookmark it:
www.mhhe.com/noreen2e
Remember, your Online Learning Center was created specifically to
accompany Managerial Accounting for Managers—so don’t let this
great resource pass you by!

Prepared by Jack Terry of ComSource Associates, Inc., this
spreadsheet-based software uses Excel to solve selected problems
and cases in the text. These selected problems and cases are
identified in the margin of the text with an appropriate icon.

Practice Set
MHID: 0073396192
ISBN-13: 9780073396194
Available via Primus Online
Authored by Janice L. Cobb of Texas Christian University, Doing
the Job of the Managerial Accountant is a real-world application
for the introductory Managerial Accounting student. The case is
based on an actual growing, entrepreneurial manufacturing company
that is complex enough to demonstrate the decisions management
must make, yet simple enough that a sophomore student can easily
understand the entire operations of the company. The case requires
the student to do tasks they would perform working as the managerial accountant for the company. The required tasks are directly
related to the concepts learned in all managerial accounting classes.
The practice set can be used by the professor as a teaching tool for
class lectures, as additional homework assignments, or as a semester project.

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Acknowledgments
Suggestions have been received from many of our colleagues throughout the world. Each of those who have
offered comments and suggestions has our thanks.
The efforts of many people are needed to develop and improve a text. Among these people are the reviewers and
consultants who point out areas of concern, cite areas of strength, and make recommendations for change. In this
regard, the following professors provided feedback that was enormously helpful in preparing the second edition
of Managerial Accounting for Managers:
Second Edition Reviewers:
Linda Abernathy, Kirkwood Community College
James Andrews, Central New Mexico Community College
Kashi R. Balachandran, New York University
Larry N. Bitner, Shippensburg University
Jorja Bradford, Alabama State University
Rusty Calk, New Mexico State University
Dana Carpenter, Madison Area Technical College
Robert Clarke, Brigham Youg University-Idaho
Darlene Coarts, University of Northern Iowa
Elizabeth Connors, University of Massachusetts-Boston
David L. Doyon, Southern New Hampshire University
J. Marie Gibson, University of Nevada Reno
Richard O. Hanson, Southern New Hampshire University
Iris Jenkel, St. Norbert College
Cynthia Khanlarian, University of North Carolina-Greensboro
Leon Korte, The University of South Dakota
Chuo-Hsuan Lee, SUNY-Plattsburgh
Natasha Librizzi, Milwaukee Area Technical College
William R. Link, University of Missouri-St. Louis
Mary Loretta Manktelow, James Madison University
Tammy Metzke, Milwaukee Area Technical College-West Allis
Tim Mills, Eastern Illinois University
Mark E. Motluck, Anderson University
Gerald M. Myers, Pacific Lutheran University
Joseph M. Nicassio, Westmoreland County Community College
Shirley Polejewski, University of St. Thomas
Luther L. Ross, Sr., Central Piedmont Community College
Ann E. Selk, University of Wisconsin-Green Bay
Vic Stanton, University of California-Berkeley
Samantha Ternes, Kirkwood Community College
Kiran Verma, University of Massachusetts-Boston
Jeffrey Wong, University of Nevada, Reno
Peter Woodlock, Youngstown State University
Ronald Zhao, Monmouth University

Previous Edition Reviewers:
Frank Aquilino, Montclair State University
Kashi R. Balachandran, New York University
Surasakdi Bhamornsiri, University of North Carolina-Charlotte

Janet Butler, Texas State University-San Marcos
Rusty Calk, New Mexico State University
Cathy Claiborne, Texas Southern Univiversity
Nancy Coulmas, Bloomsburg University of Pennsylvania
Jean Crawford, Alabama State University
Andrea Drake, University of Cincinnati-Cincinnati
Jan Duffy, Iowa State University
Cindy Easterwood, Virginia Tech
Janice Fergusson, University of South Carolina
Ananda Ganguly, Clairmont College
Olen Greer, Missouri State University
Ken Harmon, Kennesaw State University
Kathy Ho, Niagara University
Maggie Houston, Wright State University
Tom Hrubec, Franklin University
Robyn Jarnagin, Montana State University
Randy Johnston, Michigan State University
Nancy Jones, California State University
Carl Keller, Indiana Purdue University/Fort Wayne
James Kinard, Ohio State University-Columbus
Kathy Long, University of Tennessee at Chattanooga
Patti Lopez, Valencia Comm College East
Jim Lukawitz, University of Memphis
Anna Lusher, Slippery Rock University
Laurie Mcwhorter, Mississippi State University
James Meddaugh, Ohio University
Alfonso R. Oddo, Niagara University
Tamara Phelan, Northern Illinois University
Les Price, Pierce College
Kamala Raghavan, Robert Morris University
Raul Ramos, Lorain County Community College
John Reisch, East Carolina University
Michelle Reisch, East Carolina University
Pamela Rouse, Butler University
Amy Santos, Manatee Community College
Ellen Sweatt, Georgia Perimeter College
Rick Tabor, Auburn University
Diane Tanner, University of North Florida
Chuck Thompson, University of Massachusetts
Marjorie E. Yuschak, Rutgers Business School

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We are grateful for the outstanding support from McGraw-Hill. In particular, we would like to
thank Stewart Mattson, Editorial Director; Tim Vertovec, Publisher; Emily Hatteberg, Developmental Editor;
Kathleen Klehr., Marketing Manager; Pat Frederickson, Lead Project Manager; Carol Bielski, Production
Supervisor; Mary Sander, Senior Designer; Jennifer Lohn, Media Project Manager; and Lori Kramer, Photo
Research Coordinator.
Finally, we would like to thank Beth Woods for working so hard to ensure an error-free second edition. The
authors also wish to thank Linda and Michael Bamber for inspiring the creation of the 10-K Research and
Application exercises that are included in the end-of-chapter materials throughout the book.
We are grateful to the Institute of Certified Management Accountants for permission to use questions and/
or unofficial answers from past Certificate in Management Accounting (CMA) examinations. Likewise, we
thank the American Institute of Certified Public Accountants, the Society of Management Accountants of
Canada, and the Chartered Institute of Management Accountants (United Kingdom) for permission to use
(or to adapt) selected problems from their examinations. These problems bear the notations CPA, SMA,
and CIMA respectively.

Eric W. C. Noreen • Peter Brewer • Ray H. Garrison

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Brief Contents

Chapter One

Managerial Accounting and the Business Environment

Chapter Two

Managerial Accounting and Cost Concepts

Chapter Three

Cost Behavior: Analysis and Use

74

Chapter Four

Cost-Volume-Profit Relationships

118

Chapter Five

Systems Design: Job-Order Costing

164

Chapter Six

Variable Costing: A Tool for Management

1

30

206

Chapter Seven

Activity-Based Costing: A Tool to Aid Decision Making

Chapter Eight

Profit Planning

Chapter Nine

Flexible Budgets and Performance Analysis

Chapter Ten

Standard Costs and Operating Performance Measures

234

287
334
367

Chapter Eleven

Segment Reporting, Decentralization, and the Balanced Scorecard

Chapter Twelve

Relevant Costs for Decision Making

Chapter Thirteen

Capital Budgeting Decisions

534

Appendix A

Pricing Products and Services

591

Appendix B

Profitability Analysis

419

487

607

Credits 620
Index 621

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Contents

Chapter

1

Chapter

2

Managerial Accounting and the
Business Environment 1

Managerial Accounting and
Cost Concepts 30

Globalization 2
Strategy 4
Organizational Structure
Decentralization 5

The Work of Management and the Need for Managerial
Accounting Information 31
Planning 31

5

Directing and Motivating
Controlling

The Functional View of Organizations 5
Process Management 7
Lean Production 8
The Lean Thinking Model 8
The Theory of Constraints (TOC)
Six Sigma

The Planning and Control Cycle

Relevance of Data
14

34

Less Emphasis on Precision

35

Generally Accepted Accounting Principles
(GAAP) 35

17

Managerial Accounting—Not Mandatory

18

Enterprise Risk Management 19
Identifying and Controlling Business Risks

19

Corporate Social Responsibility 21
The Certified Management Accountant (CMA)

22

35

General Cost Classifications 36
Manufacturing Costs 36
Direct Materials 36
Direct Labor 37
Manufacturing Overhead 37
Nonmanufacturing Costs 38
Product Costs versus Period Costs
Product Costs 38
Period Costs

29

33

Segments of an Organization 35

14

Codes of Conduct on the International Level

Summary 23
Glossary 24
Questions 25
Exercises 25
Problems 26
Research and Application

33

Comparison of Financial and Managerial
Accounting 33
Emphasis on the Future 34

10

The Importance of Ethics in Business 12
Code of Conduct for Management Accountants

Corporate Governance 17
The Sarbanes-Oxley Act of 2002

32

The End Results of Managers’ Activities

11

Company Codes of Conduct

32

38

39

Prime Cost and Conversion Cost

39

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Cost Classifications on Financial Statements
The Balance Sheet 41
The Income Statement

Fixed Costs

41

Types of Fixed Costs 81
Committed Fixed Costs 81
Discretionary Fixed Costs 82
The Trend toward Fixed Costs 82
Is Labor a Variable or a Fixed Cost? 83
Fixed Costs and the Relevant Range 84

42

Schedule of Cost of Goods Manufactured

44

Product Cost Flows 45
Inventoriable Costs 46
An Example of Cost Flows

46

Mixed Costs

Cost Classifications for Predicting Cost Behavior
Variable Cost 48
Fixed Cost

46

49

Cost Classifications for Assigning Costs to Cost
Objects 51
Direct Cost 51
Indirect Cost

51

Cost Classifications for Decision Making
Differential Cost and Revenue 52
Opportunity Cost
Sunk Cost

52

53

54

Summary 54
Review Problem 1: Cost Terms 55
Review Problem 2: Schedule of Cost of Goods
Manufactured and Income Statement 56
Glossary 57
Questions 58
Exercises 59
Problems 64
Cases 71
Research and Application 73

Chapter

80

3

Cost Behavior: Analysis
and Use 74
Types of Cost Behavior Patterns 75
Variable Costs 75
The Activity Base 76
Extent of Variable Costs 76
True Variable versus Step-Variable Costs 77
True Variable Costs 77
Step-Variable Costs 77
The Linearity Assumption and the Relevant Range 79

85

The Analysis of Mixed Costs 86
Diagnosing Cost Behavior with a
Scattergraph Plot 88
The High-Low Method

90

The Least-Squares Regression Method
Multiple Regression Analysis

94

96

The Contribution Format Income Statement
Why a New Income Statement Format? 96
The Contribution Approach

96

96

Summary 97
Review Problem 1: Cost Behavior 98
Review Problem 2: High-Low Method 99
Glossary 100
Questions 100
Exercises 101
Problems 104
Cases 109
Research and Application 110
Appendix 3A: Least-Squares Regression
Computations 111

Chapter

4

Cost-Volume-Profit
Relationships 118

The Basics of Cost-Volume-Profit (CVP)
Analysis 119
Contribution Margin 120
CVP Relationships in Equation Form

122

CVP Relationships in Graphic Form 123
Preparing the CVP Graph 123
Contribution Margin Ratio (CM Ratio) 125

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Some Applications of CVP Concepts 127
Change in Fixed Cost and Sales Volume 127
Change in Variable Costs and Sales Volume 128
Change in Fixed Cost, Sales Price, and Sales
Volume 129
Change in Variable Cost, Fixed Cost, and Sales
Volume 130
Change in Selling Price 131
Target Profit and Break-Even Analysis 131
Target Profit Analysis 131
The Equation Method 131
The Formula Method 131
Target Profit Analysis in Terms of Sales Dollars
Break-Even Analysis 133
Break-Even in Unit Sales 133
Break-Even in Sales Dollars 134
The Margin of Safety 135
CVP Considerations in Choosing a Cost Structure
Cost Structure and Profit Stability 136
Operating Leverage

138

Assumptions of CVP Analysis

Chapter

141

143

Summary 143
Review Problem: CVP Relationships
Glossary 146
Questions 147
Exercises 147
Problems 152
Cases 160
Research and Application 162

144

5

Systems Design: Job-Order
Costing 164
Process and Job-Order Costing
Process Costing 165
Job-Order Costing

165

165

Job Cost Sheet

168

Measuring Direct Labor Cost

169

Applying of Manufacturing Overhead 170
Using the Predetermined Overhead Rate
The Need for a Predetermined Rate 171

171

Choice of an Allocation Base for
Overhead Cost 172
Computation of Unit Costs

173

Summary of Document Flows

173

132
An Extended Example of Job-Order
Costing 175
Direct and Indirect Materials 175
Labor Cost
136

176

Manufacturing Overhead Cost

176

Applying Manufacturing Overhead

177

Underapplied or Overapplied Overhead 178
Disposition of Underapplied or Overapplied
Overhead 179

Structuring Sales Commissions 140
Sales Mix 140
The Definition of Sales Mix 140
Sales Mix and Break-Even Analysis

Job-Order Costing—An Overview 166
Measuring Direct Materials Cost 167

Prepare an Income Statement 180
Cost of Goods Sold 180
The Direct Method of Determining Cost of
Goods Sold 180
The Indirect Method of Determining Cost of
Goods Sold 180
Income Statement 182
Multiple Predetermined Overhead Rates

182

Job-Order Costing in Service Companies

183

Summary 183
Review Problem: Job-Order Costing
Glossary 185
Questions 186
Exercises 186
Problems 191
Cases 196
Research and Application 198

184

Appendix 5A: The Predetermined Overhead
Rate and Capacity 199
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Chapter

Manufacturing Costs and Activity-Based
Costing 236

6

Cost Pools, Allocation Bases, and Activity-Based
Costing 236

Variable Costing: A Tool for
Management 206
Overview of Absorption and Variable Costing
Absorption Costing 207
Variable Costing

207

207

Selling and Administrative Expenses 207
Summary of Differences 207
Absorption Costing Income Statement 209

The Mechanics of Activity-Based Costing 243
Step 2: Assign Overhead Costs to Activity
Cost Pools 243

Variable Costing Contribution Format Income
Statement 210

Step 3: Calculate Activity Rates

Reconciliation of Variable Costing with Absorption
Costing Income 211
Choosing a Costing Method 214
The Impact on the Manager 214
CVP Analysis and Absorption Costing
Decision Making

Step 5: Prepare Management Reports

247

250

215

The Differences between ABC and Traditional
Product Costs 254

Variable Costing and the Theory of Constraints

217

217

Summary 218
Review Problem: Contrasting Variable and Absorption
Costing 218
Glossary 220
Questions 220
Exercises 221
Problems 225
Cases 231

Chapter

Step 4: Assign Overhead Costs to Cost Objects

215

Advantages of Variable Costing and the Contribution
Approach 216
Impact of Lean Production

246

Comparison of Traditional and ABC
Product Costs 253
Product Margins Computed Using the Traditional
Cost System 253

215

External Reporting and Income Taxes

Designing an Activity-Based Costing (ABC)
System 239
Steps for Implementing Activity-Based
Costing 241
Step 1: Define Activities, Activity Cost Pools, and
Activity Measures 241

7

Activity-Based Costing: A Tool
to Aid Decision Making 234
Activity-Based Costing: An Overview 235
How Costs Are Treated under Activity-Based
Costing 236
Nonmanufacturing Costs and Activity-Based
Costing 236

Targeting Process Improvements 257
Activity-Based Costing and External Reports 259
The Limitations of Activity-Based Costing 259
Summary 260
Review Problem: Activity-Based Costing
Glossary 262
Questions 263
Exercises 263
Problems 271
Research and Application 275
Appendix 7A: ABC Action Analysis

Chapter
Profit Planning

261

275

8
287

The Basic Framework of Budgeting
Advantages of Budgeting 288
Responsibility Accounting

288

Choosing a Budget Period

289

288

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The Self-Imposed Budget

Human Factors in Budgeting
The Budget Committee

Performance Reports in Nonprofit Organizations 343

290

Performance Reports in Cost Centers

291

292

The Master Budget: An Overview
Preparing the Master Budget
The Sales Budget 296
The Production Budget

Flexible Budgets with Multiple Cost Drivers
Some Common Errors 346

293

Inventory Purchases—Merchandising
Company 298
The Direct Labor Budget

299

301

The Manufacturing Overhead Budget

302

The Ending Finished Goods Inventory Budget

303

The Selling and Administrative Expense Budget
The Cash Budget

Chapter

The Budgeted Balance Sheet

308

Standard Costs—Management by Exception
Who Uses Standard Costs? 370

311

Setting Standard Costs 370
Ideal versus Practical Standards
Setting Direct Labor Standards

373

Setting Variable Manufacturing Overhead
Standards 374

335

Deficiencies of the Static Planning Budget

335

338

Using Standard Costs—Direct Labor Variances
Labor Rate Variance—A Closer Look 381
Labor Efficiency Variance—A Closer Look

338

Revenue and Spending Variances

374

Using Standard Costs—Direct Materials
Variances 375
Materials Price Variance—A Closer Look 378
Isolation of Variances 378
Responsibility for the Variance 378
Materials Quantity Variance—A Closer Look 379

334

Flexible Budgets 335
Characteristics of a Flexible Budget

Flexible Budget Variances
Activity Variances 339

372

A General Model for Variance Analysis
Price and Quantity Variances 374

How a Flexible Budget Works

369

371

Setting Direct Materials Standards

9

Flexible Budgets and
Performance Analysis

10

Standard Costs and Operating
Performance Measures 367

309

Summary 311
Review Problem: Budget Schedules
Glossary 313
Questions 313
Exercises 314
Problems 318
Cases 330
Research and Application 332

Chapter

303

304

The Budgeted Income Statement

344

Summary 347
Review Problem: Variance Analysis Using a
Flexible Budget 348
Glossary 349
Questions 350
Exercises 350
Problems 358
Cases 363

294

296

The Direct Materials Budget

344

340

A Performance Report Combining Activity and Revenue
and Spending Variances 341

380

381

Using Standard Costs—Variable Manufacturing
Overhead Variances 382
Manufacturing Overhead Variances—A Closer
Look 383
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Variance Analysis and Management by Exception 385
International Uses of Standard Costs 386
Evaluation of Controls Based on Standard Costs 387
Advantages of Standard Costs 387
Potential Problems with the Use of Standard Costs
Operating Performance Measures
Delivery Cycle Time 388

388

Throughput (Manufacturing Cycle) Time

388

Manufacturing Cycle Efficiency (MCE)

389

Summary 390
Review Problem: Standard Costs
Glossary 393
Questions 393
Exercises 394
Problems 397
Cases 404

387

391

Segmented Financial Information in
External Reports 431
Hindrances to Proper Cost Assignment
Omission of Costs 431

431

Net Operating Income and Operating
Assets Defined 434
Understanding ROI

434

Criticisms of ROI

436

Residual Income 437
Motivation and Residual Income

438

Divisional Comparison and Residual Income

Segment Reporting,
Decentralization, and the
Balanced Scorecard 419

439

Balanced Scorecard 440
Common Characteristics of Balanced Scorecards

Decentralization in Organizations 420
Advantages and Disadvantages of Decentralization

420

Responsibility Accounting 421
Cost, Profit, and Investment Centers 421
Cost Center 421
Profit Center 421
Investment Center 422
An Organizational View of Responsibility Centers 422
Decentralization and Segment Reporting 423
Building a Segmented Income Statement 424
Sales and Contribution Margin

430

Evaluating Investment Center Performance—Return on
Investment 433
The Return on Investment (ROI) Formula 434

11

Levels of Segmented Statements

Segment Margin

429

Inappropriate Methods for Assigning Traceable Costs
among Segments 432
Failure to Trace Costs Directly 432
Inappropriate Allocation Base 432
Arbitrarily Dividing Common Costs among
Segments 432

Appendix 10A: Predetermined Overhead Rates and
Overhead Analysis in a Standard Costing System 406

Chapter

Traceable Costs Can Become Common Costs

425
427

Traceable and Common Fixed Costs 427
Identifying Traceable Fixed Costs 428
Activity-Based Costing 428

441

A Company’s Strategy and the Balanced
Scorecard 443
Tying Compensation to the Balanced Scorecard
Advantages of Timely and Graphic Feedback

445
445

Summary 446
Review Problem 1: Segmented Statements 446
Review Problem 2: Return on Investment (ROI)
and Residual Income 448
Glossary 448
Questions 449
Exercises 449
Problems 456
Cases 463
Research and Applications 466
Appendix 11A: Transfer Pricing 467
Appendix 11B: Service Department Charges

479

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Chapter

12

Chapter

13

Relevant Costs for Decision
Making 487

Capital Budgeting
Decisions 534

Cost Concepts for Decision Making 488
Identifying Relevant Costs and Benefits 488

Capital Budgeting—Planning Investments 535
Typical Capital Budgeting Decisions 535

Different Costs for Different Purposes

489

The Time Value of Money

An Example of Identifying Relevant Costs
and Benefits 490

Discounted Cash Flows—The Net Present
Value Method 536
The Net Present Value Method Illustrated 536

Reconciling the Total and Differential
Approaches 492

Emphasis on Cash Flows 538
Typical Cash Outflows 538
Typical Cash Inflows 538
Recovery of the Original Investment

Why Isolate Relevant Costs? 493
Adding and Dropping Product Lines and Other
Segments 494
An Illustration of Cost Analysis 495
A Comparative Format

497

Beware of Allocated Fixed Costs

497

The Make or Buy Decision 498
Strategic Aspects of the Make or Buy Decision
An Example of Make or Buy

499

499

506

Summary 510
Review Problem: Relevant Costs
Glossary 511
Questions 511
Exercises 512
Problems 519
Cases 527

510

540

Discounted Cash Flows—The Internal Rate
of Return Method 542
The Internal Rate of Return Method
Illustrated 542
Salvage Value and Other Cash Flows
Using the Internal Rate of Return

543

543

The Cost of Capital as a Screening Tool

The Incremental-Cost Approach

508

Activity-Based Costing and Relevant Costs

Choosing a Discount Rate

Expanding the Net Present Value Method
The Total-Cost Approach 544

Joint Product Costs and the Contribution
Approach 506
The Pitfalls of Allocation 506
Sell or Process Further Decisions

539

543

Comparison of the Net Present Value and Internal
Rate of Return Methods 543

504

The Problem of Multiple Constraints

Simplifying Assumptions

538

An Extended Example of the Net Present
Value Method 541

Opportunity Cost 500
Special Orders 501
Utilization of a Constrained Resource 502
Contribution Margin per Unit of the Constrained
Resource 503
Managing Constraints

535

509

Least-Cost Decisions

546

Uncertain Cash Flows
An Example 548

548

Real Options

544

545

549

Preference Decisions—The Ranking of Investment
Projects 549
Internal Rate of Return Method 550
Net Present Value Method

550
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Other Approaches to Capital Budgeting
Decisions 551
The Payback Method 551

The Absorption Costing Approach to Cost-Plus
Pricing 596
Setting a Target Selling Price Using the Absorption
Costing Approach 596

Evaluation of the Payback Method

552

An Extended Example of Payback

553

Determining the Markup Percentage

Payback and Uneven Cash Flows

554

Problems with the Absorption Costing Approach

The Simple Rate of Return Method

554

Criticisms of the Simple Rate of Return
Postaudit of Investment Projects

556

An Example of Target Costing

556

Appendix

Appendix 13A: The Concept of Present Value 575
Appendix 13B: Present Value Tables 581
Appendix 13C: Income Taxes in Capital Budgeting
Decisions 583

Pricing Products and
Services 591

A

Introduction 592
The Economists’ Approach to Pricing
Elasticity of Demand 592
The Profit-Maximizing Price

593

598

599

600

Summary 600
Glossary 601
Questions 601
Exercises 601
Problems 602

Summary 557
Review Problem: Comparison of Capital
Budgeting Methods 558
Glossary 559
Questions 560
Exercises 560
Problems 564
Cases 573

Appendix

Target Costing 599
Reasons for Using Target Costing

597

592

Profitability Analysis

B
607

Introduction 608
Absolute Profitability 608
Relative Profitability 608
Volume Trade-Off Decisions 611
Managerial Implications 613
Summary 614
Glossary 614
Questions 615
Exercises 615
Problems 616
Cases 619
Credits 620
Index 621

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Chapter

1
Managerial Accounting
and the Business
Environment

BU SIN E S S F O CU S

Management Accounting: It’s More Than Just
Crunching Numbers
“Creating value through values”
is the credo of today’s management accountant. It means that
management accountants should
maintain an unwavering commitment to ethical values while using
their knowledge and skills to influence decisions that create value
for organizational stakeholders.
These skills include managing
risks and implementing strategy
through planning, budgeting and
forecasting, and decision support. Management accountants are strategic business
partners who understand the financial and operational sides of the business. They not
only report and analyze financial measures, but also nonfinancial measures of process
performance and corporate social performance. Think of these responsibilities as profits (financial statements), process (customer focus and satisfaction), people (employee
learning and satisfaction), and planet (environmental stewardship). ■

Learning Objectives
After studying Chapter 1,
you should be able to:

LO1

Understand the role of
management accountants in an
organization.

LO2

Understand the basic concepts
underlying Lean Production, the
Theory of Constraints (TOC),
and Six Sigma.

LO3

Understand the importance of
upholding ethical standards.

Source: Conversation with Jeff Thomson, president and CEO of the Institute of Management Accountants.

1

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2

Chapter 1

T

hroughout this book you will study how management accounting
functions within organizations. However, before embarking on the study of
management accounting, you need to develop an appreciation for the larger
business environment within which it operates. This chapter is divided into
nine sections: (1) globalization, (2) strategy, (3) organizational structure, (4) process management, (5) the importance of ethics in business, (6) corporate governance, (7) enterprise
risk management, (8) corporate social responsibility, and (9) the Certified Management
Accountant (CMA). Other business classes provide greater detail on many of these topics.
Nonetheless, a broad discussion of these topics is useful for placing management accounting in its proper context.

Globalization
The world has become much more intertwined over the last 20 years. Reductions in
tariffs, quotas, and other barriers to free trade; improvements in global transportation
systems; explosive expansion in Internet usage; and increasing sophistication in international markets have created a truly global marketplace. Exhibit 1–1 illustrates this
tremendous growth in international trade from the standpoint of the United States and
some of its key trading partners. Panel A of the exhibit shows the dollar value of
imports (stated in billions of dollars) into the United States from six countries; Panel
B shows the dollar value of exports from the United States to those same six countries. As you can see, the increase in import and export activity from 1995 to 2007
was huge. In particular, trade with China expanded enormously as did trade with
Mexico and Canada, which participate in the North American Free Trade Agreement
(NAFTA).
In a global marketplace, a company that has been very successful in its local market
may suddenly find itself facing competition from halfway around the globe. For example, in the 1980s American automobile manufacturers began losing market share to
Japanese competitors who offered American consumers higher quality cars at lower
prices. For consumers, heightened international competition promises a greater variety
of goods and services, at higher quality and lower prices. However, heightened international competition threatens companies that may have been quite profitable in their own
local markets.
Although globalization leads to greater competition, it also means greater access to
new markets, customers, and workers. For example, the emerging markets of China,
India, Russia, and Brazil contain more than 2.5 billion potential customers and workers.1 Many companies such as FedEx, McDonald’s, and Nike are actively seeking to
grow their sales by investing in emerging markets. In addition, the movement of jobs
from the United States and Western Europe to other parts of the world has been notable
in recent years. For example, one study estimates that by the end of the decade more
than 825,000 financial services and high-tech jobs will transfer from Western Europe to
less expensive labor markets such as India, China, Africa, Eastern Europe, and Latin
America.2
The Internet fuels globalization by providing companies with greater access to geographically dispersed customers, employees, and suppliers. While the number of Internet
users continues to grow, as of 2008, more than 78% of the world’s population was still
not connected to the Internet. This suggests that the Internet’s impact on global business
has yet to fully develop.
1
2

nor27130_ch01_001-029.indd 2

The Economist: Pocket World in Figures 2004, Profile Books Ltd., London, U.K.
“Job Exports: Europe’s Turn,” BusinessWeek, April 19, 2004, p. 50.

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Managerial Accounting and the Business Environment

Panel A: Imports to the United States (billions of dollars)

EXHIBIT 1–1
United States Global Trade
Activity (in billions of U.S.
dollars)

$400

Imports to the US (billions)

$350
$300
$250

3

Canada
China
Germany
Japan
Mexico
United Kingdom

$200
$150
$100
$50
$0

1995

2000

2005

2007

Panel B: Exports from the United States (billions of dollars)

Exports from the US (billions)

$300
$250
$200

Canada
China
Germany
Japan
Mexico
United Kingdom

$150
$100
$50
$0

1995

2000

2005 2007

Source: U.S. Census Bureau, Foreign Trade Division, Data Dissemination Branch,
Washington, D.C. 20233. www.census.gov/foreign-trade/balance.

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4

Chapter 1

IN BUSINESS
THE IMPLICATIONS OF GLOBALIZATION
International competition goes hand-in-hand with globalization. China’s entrance into the global marketplace has highlighted this stark reality for many U.S. companies. For example, from 2000 to 2003,
China’s wooden bedroom furniture exports to the United States increased by more than 233% to a
total of $1.2 billion. During this same time, the number of workers employed by U.S. furniture manufacturers dropped by about a third, or a total of 35,000 workers.
However, globalization means more than international competition. It brings opportunities for
companies to enter new markets. FedEx has pushed hard to be an important player in the emerging
Asian cargo market. FedEx makes 622 weekly flights to and from Asian markets, including service
to 224 Chinese cities. FedEx currently has 39% of the U.S.–China express market and it plans to
pursue continuous growth in that region of the world.
Sources: Ted Fishman, “How China Will Change Your Business,” Inc. magazine, March 2005, pp. 70–84;
Matthew Boyle, “Why FedEx is Flying High,” Fortune, November 1, 2004, pp. 145–150.

Strategy
Even more than in the past, companies that now face global competition must have a
viable strategy for succeeding in the marketplace. A strategy is a “game plan” that
enables a company to attract customers by distinguishing itself from competitors. The
focal point of a company’s strategy should be its target customers. A company can only
succeed if it creates a reason for customers to choose it over a competitor. These reasons,
or what are more formally called customer value propositions, are the essence of
strategy.
Customer value propositions tend to fall into three broad categories—customer intimacy, operational excellence, and product leadership. Companies that adopt a customer
intimacy strategy are in essence saying to their target customers, “You should choose us
because we understand and respond to your individual needs better than our competitors.” Ritz-Carlton, Nordstrom, and Starbucks rely primarily on a customer intimacy
value proposition for their success. Companies that pursue the second customer value
proposition, called operational excellence, are saying to their target customers, “You
should choose us because we can deliver products and services faster, more conveniently,
and at a lower price than our competitors.” Southwest Airlines, Wal-Mart, and The
Vanguard Group are examples of companies that succeed first and foremost because of
their operational excellence. Companies pursuing the third customer value proposition,
called product leadership, are saying to their target customers, “You should choose us
because we offer higher quality products than our competitors.” BMW, Cisco Systems,
and W.L. Gore (the creator of GORE-TEX® fabrics) are examples of companies that
succeed because of their product leadership. Although one company may offer its customers a combination of these three customer value propositions, one usually outweighs
the others in terms of importance.3
Next we turn our attention to how businesses create organizational structures to help
accomplish their strategic goals.

3

These three customer value propositions were defined by Michael Treacy and Fred Wiersema in
“Customer Intimacy and Other Value Disciplines,” Harvard Business Review, Volume 71 Issue 1,
pp. 84–93.

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Managerial Accounting and the Business Environment

5

IN BUSINESS
OPERATIONAL EXCELLENCE COMES TO THE DIAMOND BUSINESS
An average engagement ring purchased from Blue Nile, an Internet diamond retailer, costs $5,200
compared to $9,500 if purchased from Tiffany & Co., a bricks-and-mortar retailer. Why is there such
a difference? There are three reasons. First, Blue Nile allows wholesalers to sell directly to customers using its website. In the brick-and-mortar scenario, diamonds change hands as many as seven
times before being sold to a customer—passing through various cutters, wholesalers, brokers, and
retailers, each of whom demands a profit. Second, Blue Nile carries very little inventory and incurs
negligible overhead. Diamonds are shipped directly from wholesalers after they have been purchased by a customer—no retail outlets are necessary. Bricks-and-mortar retailers tie up large
amounts of money paying for the inventory and employees on their showroom floors. Third, Blue
Nile generates a high volume of transactions by selling to customers anywhere in the world; therefore, it can accept a lower profit margin per transaction than local retailers, who complete fewer
transactions with customers within a limited geographic radius.
Perhaps you are wondering why customers are willing to trust an Internet retailer when buying an
expensive item such as a diamond. The answer is that all of the diamonds sold through Blue Nile’s
website are independently certified by the Gemological Institute of America in four categories—carat
count, type of cut, color, and clarity. In essence, Blue Nile has turned diamonds into a commodity and is
using an operational excellence customer value proposition to generate annual sales of $154 million.
Source: Victoria Murphy, “Romance Killer,” Forbes, November 29, 2004, pp. 97–101.

Organizational Structure
Our discussion of organizational structure is divided into two parts. First, we highlight
the fact that presidents of all but the smallest companies cannot execute their strategies
alone. They must seek the help of their employees by empowering them to make decisions—they must decentralize. Next, we describe the most common formal decentralized
organizational structure in use today—the functional structure.

LEARNING OBJECTIVE 1

Understand the role of
management accountants in an
organization.

Decentralization
Decentralization is the delegation of decision-making authority throughout an organization by giving managers the authority to make decisions relating to their area of responsibility. Some organizations are more decentralized than others. For example, consider
Good Vibrations, an international retailer of music CDs with shops in major cities scattered across the Pacific Rim. Because of Good Vibrations’ geographic dispersion and the
peculiarities of local markets, the company is highly decentralized.
Good Vibrations’ president (often synonymous with the term chief executive officer, or
CEO) sets the broad strategy for the company and makes major strategic decisions such as
opening stores in new markets; however, much of the remaining decision-making authority
is delegated to managers at various levels throughout the organization. Each of the company’s numerous retail stores has a store manager as well as a separate manager for each music
category such as international rock and classical/jazz. In addition, the company has support
departments such as a central Purchasing Department and a Personnel Department.

The Functional View of Organizations
Exhibit 1–2 shows Good Vibrations’ organizational structure in the form of an organization
chart. The purpose of an organization chart is to show how responsibility is divided among
managers and to show formal lines of reporting and communication, or chain of command.
Each box depicts an area of management responsibility, and the lines between the boxes
show the lines of formal authority between managers. The chart tells us, for example, that

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6

Chapter 1

EXHIBIT 1–2

Organization Chart, Good Vibrations, Inc.

Board of
Directors
President

Purchasing
Department

Personnel
Department

Vice President
Operations

Chief Financial
Officer

Treasurer
Manager
Hong Kong Store

Manager
Intn’l Rock

Controller

Manager
Tokyo Store

Manager
Classical/Jazz

Manager
Intn’l Rock

Manager
CantoPop

Manager
Classical/Jazz
Manager
Karaoke

Other Stores

the store managers are responsible to the operations vice president. In turn, the operations
vice president is responsible to the company president, who in turn is responsible to the
board of directors. Following the lines of authority and communication on the organization
chart, we can see that the manager of the Hong Kong store would ordinarily report to the
operations vice president rather than directly to the president of the company.
An organization chart also depicts line and staff positions in an organization. A person in a line position is directly involved in achieving the basic objectives of the organization. A person in a staff position, by contrast, is only indirectly involved in achieving
those basic objectives. Staff positions provide assistance to line positions or other parts of
the organization, but they do not have direct authority over line positions. Refer again to
the organization chart in Exhibit 1–2. Because the basic objective of Good Vibrations is
to sell recorded music at a profit, those managers whose areas of responsibility are directly
related to selling music occupy line positions. These positions, which are shown in a
darker color in the exhibit, include the managers of the various music departments in
each store, the store managers, the operations vice president, the president, and the board
of directors.
By contrast, the managers of the central Purchasing Department and the Personnel
Department occupy staff positions, because their departments support other departments
rather than carry out the company’s basic missions. The chief financial officer is a member of the top management team who also occupies a staff position. The chief financial
officer (CFO) is responsible for providing timely and relevant data to support planning
and control activities and for preparing financial statements for external users. In the
United States, a manager known as the controller often runs the accounting department
and reports directly to the CFO. More than ever, the accountants who work under the

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Managerial Accounting and the Business Environment

7

CFO are focusing their efforts on supporting the needs of co-workers in line positions as
one report concluded:
Growing numbers of management accountants spend the bulk of their time as internal consultants or business analysts within their companies. Technological advances
have liberated them from the mechanical aspects of accounting. They spend less time
preparing standardized reports and more time analyzing and interpreting information. Many have moved from the isolation of accounting departments to be physically positioned in the operating departments with which they work. Management
accountants work on cross-functional teams, have extensive face-to-face communications with people throughout their organizations, and are actively involved in decision making. . . . They are trusted advisors.4

IN BUSINESS
WHAT DOES IT TAKE?
A controller at McDonald’s describes the characteristics needed by its most successful management accountants as follows:
[I]t’s a given that you know your accounting cold. You’re expected to know the tax implications
of proposed courses of action. You need to understand cost flows and information flows. You
have to be very comfortable with technology and be an expert in the company’s business and
accounting software. You have to be a generalist. You need a working knowledge of what people do in marketing, engineering, human resources, and other departments. You need to understand how the processes, departments, and functions work together to run the business. You’ll
be expected to contribute ideas at planning meetings, so you have to see the big picture, keep
a focus on the bottom line, and think strategically.
Source: Gary Siegel, James E. Sorensen, and Sandra B. Richtermeyer, “Becoming a Business Partner: Part 2,”
Strategic Finance, October 2003, pp. 37–41. Used with permission from the Institute of Management Accountants (IMA), Montvale, N.J., USA, www.imanet.org.

Process Management
As global competition intensifies, companies are realizing that they must complement the
functional view of their operations with a cross-functional orientation that seeks to
improve the business processes that deliver customer value. A business process is a
series of steps that are followed in order to carry out some task in a business. It is quite
common for the linked set of steps comprising a business process to span departmental
boundaries. The term value chain is often used when we look at how the functional
departments of an organization interact with one another to form business processes. A
value chain, as shown in Exhibit 1–3, consists of the major business functions that
add value to a company’s products and services. The customer’s needs are most effectively
met by coordinating the business processes that span these functions.
EXHIBIT 1–3

LEARNING OBJECTIVE 2

Understand the basic concepts
underlying Lean Production, the
Theory of Constraints (TOC),
and Six Sigma.

Business Functions Making Up the Value Chain

Research
and
Development

Product
Design

Manufacturing

Marketing

Distribution

Customer
Service

4

Gary Siegel Organization, Counting More, Counting Less: Transformations in the Management
Accounting Profession, The 1999 Practice Analysis of Management Accounting, Institute of Management
Accountants, Montvale, NJ, August 1999, p. 3.

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8

Chapter 1

This section discusses three different approaches to managing and improving business processes—Lean Production, the Theory of Constraints (TOC), and Six Sigma.
Although each is unique in certain respects, they all share the common theme of focusing
on managing and improving business processes.

Lean Production
Traditionally, managers in manufacturing companies have sought to maximize production so as to spread the costs of investments in equipment and other assets over as many
units as possible. In addition, managers have traditionally felt that an important part of
their jobs was to keep everyone busy on the theory that idleness wastes money. These
traditional views, often aided and abetted by traditional management accounting practices, resulted in a number of practices that have come under criticism in recent years.
In a traditional manufacturing company, work is pushed through the system in order
to produce as much as possible and to keep everyone busy—even if products cannot be
immediately sold. This almost inevitably results in large inventories of raw materials,
work in process, and finished goods. Raw materials are the materials that are used to
make a product. Work in process inventories consist of units of product that are only
partially complete and will require further work before they are ready for sale to a customer. Finished goods inventories consist of units of product that have been completed
but have not yet been sold to customers.
The push process in traditional manufacturing starts by accumulating large amounts
of raw material inventories from suppliers so that operations can proceed smoothly even
if unanticipated disruptions occur. Next, enough materials are released to workstations to
keep everyone busy. When a workstation completes its tasks, the partially completed
goods (i.e., work in process) are “pushed” forward to the next workstation regardless of
whether that workstation is ready to receive them. The result is that partially completed
goods stack up, waiting for the next workstation to become available. They may not be
completed for days, weeks, or even months. Additionally, when the units are finally completed, customers may or may not want them. If finished goods are produced faster than
the market will absorb, the result is bloated finished goods inventories.
Although some may argue that maintaining large amounts of inventory has its benefits, it clearly has its costs. In addition to tying up money, maintaining inventories encourages inefficient and sloppy work, results in too many defects, and dramatically increases
the amount of time required to complete a product. For example, when partially completed goods are stored for long periods of time before being processed by the next workstation, defects introduced by the preceding workstation go unnoticed. If a machine is out
of calibration or incorrect procedures are being followed, many defective units will be
produced before the problem is discovered. And when the defects are finally discovered,
it may be very difficult to track down the source of the problem. In addition, units may be
obsolete or out of fashion by the time they are finally completed.
Large inventories of partially completed goods create many other problems that are
best discussed in more advanced courses. These problems are not obvious—if they were,
companies would have long ago reduced their inventories. Managers at Toyota are credited with the insight that large inventories often create many more problems than they
solve. Toyota pioneered what is known today as Lean Production.

The Lean Thinking Model The lean thinking model is a five-step management

approach that organizes resources such as people and machines around the flow of business processes and that pulls units through these processes in response to customer orders.
The result is lower inventories, fewer defects, less wasted effort, and quicker customer
response times. Exhibit 1–4 (page 9) depicts the five stages of the lean thinking model.
The first step is to identify the value to customers in specific products and services.
The second step is to identify the business process that delivers this value to customers.5
5

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The Lean Production literature uses the term value stream rather than business process.

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Managerial Accounting and the Business Environment

EXHIBIT 1–4

9

The Lean Thinking Model

Step 1:
Identify value in
specific
products/services

Step 2:
Identify the
business process
that delivers
value

Step 3:
Organize work
arrangements
around the flow
of the business
process

Step 4:
Create a pull
system that
responds to
customer orders

Step 5:
Continuously
pursue perfection
in the business
process

Source: This exhibit is adapted from James P. Womack and Daniel T. Jones, Lean Thinking: Banish Waste and
Create Wealth in Your Corporation, Revised and Updated, 2003, Simon & Schuster, New York, NY.

As discussed earlier, the linked set of steps comprising a business process typically span
the departmental boundaries that are specified in an organization chart. The third step is
to organize work arrangements around the flow of the business process. This is often
accomplished by creating what is known as a manufacturing cell. The cellular approach
takes employees and equipment from departments that were previously separated from
one another and places them side-by-side in a work space called a cell. The equipment
within the cell is aligned in a sequential manner that follows the steps of the business
process. Each employee is trained to perform all the steps within his or her own manufacturing cell.
The fourth step in the lean thinking model is to create a pull system where production
is not initiated until a customer has ordered a product. Inventories are reduced to a minimum by purchasing raw materials and producing units only as needed to meet customer
demand. Under ideal conditions, a company operating a pull system would purchase only
enough materials each day to meet that day’s needs. Moreover, the company would have no
goods still in process at the end of the day, and all goods completed during the day would
be shipped immediately to customers. As this sequence suggests, work takes place “just-intime” in the sense that raw materials are received by each manufacturing cell just in time to
go into production, manufactured parts are completed just in time to be assembled into
products, and products are completed just in time to be shipped to customers. This facet of
the lean thinking model is often called just-in-time production, or JIT for short.
The change from push to pull production is more profound than it may appear.
Among other things, producing only in response to a customer order means that workers
will be idle whenever demand falls below the company’s production capacity. This can be
an extremely difficult cultural change for an organization. It challenges the core beliefs of
many managers and raises anxieties in workers who have become accustomed to being
kept busy all of the time.
The fifth step of the lean thinking model is to continuously pursue perfection in the
business process. In a traditional company, parts and materials are inspected for defects
when they are received from suppliers, and assembled units are inspected as they progress along the production line. In a Lean Production system, the company’s suppliers are
responsible for the quality of incoming parts and materials. And instead of using quality
inspectors, the company’s production workers are directly responsible for spotting defective units. A worker who discovers a defect immediately stops the flow of production.
Supervisors and other workers go to the cell to determine the cause of the problem and
correct it before any further defective units are produced. This procedure ensures that
problems are quickly identified and corrected.
The lean thinking model can also be used to improve the business processes that link
companies together. The term supply chain management is commonly used to refer to
the coordination of business processes across companies to better serve end consumers.
For example Procter & Gamble and Costco coordinate their business processes to ensure
that Procter & Gamble’s products, such as Bounty, Tide, and Crest, are on Costco’s

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Confirming Pages

10

Chapter 1

IN BUSINESS
LEAN SUPPLY CHAIN MANAGEMENT
Tesco, a grocery retailer in Britain, used lean thinking to improve its replenishment process for cola
products. Tesco and Britvic (its cola supplier) traced the cola delivery process from “the checkout
counter of the grocery store through Tesco’s regional distribution center (RDC), Britvic’s RDC, the
warehouse at the Britvic bottling plant, the filling lines for cola destined for Tesco, and the warehouse of Britvic’s can supplier.” Each step of the process revealed enormous waste. Tesco implemented numerous changes such as electronically linking its point-of-sale data from its grocery
stores to its RDC. This change let customers pace the replenishment process and it helped increase
store delivery frequency to every few hours around the clock. Britvic also began delivering cola to
Tesco’s RDC in wheeled dollies that could be rolled directly into delivery trucks and then to point-ofsale locations in grocery stores.
These changes reduced the total product “touches” from 150 to 50, thereby cutting labor
costs. The elapsed time from the supplier’s filling line to the customer’s cola purchase dropped
from 20 days to 5 days. The number of i…
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