Rev.Confirming Pages 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 nor27130_fm_i-xxviii.indd i 10/5/09 2:49:58 PM Rev.Confirming Pages 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 nor27130_fm_i-xxviii.indd ii 10/5/09 2:49:59 PM Rev.Confirming Pages 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. iii nor27130_fm_i-xxviii.indd iii 10/5/09 2:50:00 PM Rev.Confirming Pages 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. iv nor27130_fm_i-xxviii.indd iv 10/5/09 2:50:02 PM Rev.Confirming Pages 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. v nor27130_fm_i-xxviii.indd v 10/5/09 2:50:04 PM Rev.Confirming Pages 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. 367 nor27130_ch10_367-418.indd 367 9/15/09 8:19:34 AM vi nor27130_fm_i-xxviii.indd vi 10/5/09 2:50:05 PM Rev.Confirming Pages 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. nor27130_ch09_334-366.indd 338 9/15/09 10:06:31 AM “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 vii nor27130_fm_i-xxviii.indd vii 10/26/09 4:43:01 PM Rev.Confirming Pages “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. viii nor27130_fm_i-xxviii.indd viii 10/5/09 2:50:28 PM Rev.Confirming Pages 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: Total Sales (10,000 units) ........................... Variable expenses ............................. $350,000 200,000 Per Unit $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. nor27130_ch04_118-163.indd 147 nor27130_ch04_118-163.indd 152 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. nor27130_ch04_118-163.indd 162 8/14/09 8:07:14 PM • Instructor’s Resource Guide • Testbank • Solutions Manual • Workbook/Study Guide ix nor27130_fm_i-xxviii.indd ix 10/26/09 4:43:27 PM This page intentionally left blank Rev.Confirming Pages 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. xi nor27130_fm_i-xxviii.indd xi 10/5/09 2:50:31 PM Rev.Confirming Pages 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 efficient studying, and higher retention of knowledge. 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 anytime and anywhere, making the learning process more accessible and efficient. Connect Accounting offers you the features described below. 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: • • • 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 more efficient than ever. 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 feedback and practice material when they need it, where they need it. When it comes to teaching, your time also is precious. The grading function enables you to: • • • 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 xii nor27130_fm_i-xxviii.indd xii 10/26/09 4:43:29 PM Rev.Confirming Pages 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. xiii nor27130_fm_i-xxviii.indd xiii 10/5/09 2:50:32 PM Rev.Confirming Pages 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 http://tegritycampus.mhhe.com. 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. xiv nor27130_fm_i-xxviii.indd xiv 10/26/09 4:43:29 PM Rev.Confirming Pages 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. 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One of our Technical Support Analysts will be able to assist you in a timely fashion. xv nor27130_fm_i-xxviii.indd xv 10/26/09 4:43:36 PM Rev.Confirming Pages 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. 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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. 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A complete set of slides covers each chapter. xvi nor27130_fm_i-xxviii.indd xvi 10/5/09 2:50:38 PM Rev.Confirming Pages 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. 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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. xvii nor27130_fm_i-xxviii.indd xvii 10/5/09 2:50:38 PM Rev.Confirming Pages 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 xviii nor27130_fm_i-xxviii.indd xviii 10/5/09 2:50:39 PM Rev.Confirming Pages 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 xix nor27130_fm_i-xxviii.indd xix 10/5/09 2:50:39 PM Rev.Confirming Pages Brief Contents Chapter One Managerial Accounting and the Business Environment Chapter Two Managerial Accounting and Cost Concepts Chapter Three Cost Behavior: Analysis and Use Chapter Four Cost-Volume-Profit Relationships Chapter Five Systems Design: Job-Order Costing Chapter Six 1 30 74 118 164 Variable Costing: A Tool for Management 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 234 287 334 Standard Costs and Operating Performance Measures 367 Chapter Eleven Segment Reporting, Decentralization, and the Balanced Scorecard Chapter Twelve Relevant Costs for Decision Making Chapter Thirteen Capital Budgeting Decisions Appendix A Pricing Products and Services Appendix B Profitability Analysis 419 487 534 591 607 Credits 620 Index 621 xx nor27130_fm_i-xxviii.indd xx 10/5/09 2:50:39 PM Rev.Confirming Pages 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 xxi nor27130_fm_i-xxviii.indd xxi 10/5/09 2:50:39 PM Rev.Confirming Pages 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 xxii nor27130_fm_i-xxviii.indd xxii 10/5/09 2:50:41 PM Rev.Confirming Pages 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 Job-Order Costing in Service Companies Summary 183 Review Problem: Job-Order Costing Glossary 185 Questions 186 Exercises 186 Problems 191 Cases 196 Research and Application 198 182 183 184 Appendix 5A: The Predetermined Overhead Rate and Capacity 199 xxiii nor27130_fm_i-xxviii.indd xxiii 10/5/09 2:50:43 PM Rev.Confirming Pages 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 xxiv nor27130_fm_i-xxviii.indd xxiv 10/5/09 2:50:44 PM Rev.Confirming Pages 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 xxv nor27130_fm_i-xxviii.indd xxv 10/5/09 2:50:46 PM Rev.Confirming Pages 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 Manufacturing Cycle Efficiency (MCE) Summary 390 Review Problem: Standard Costs Glossary 393 Questions 393 Exercises 394 Problems 397 Cases 404 387 Traceable Costs Can Become Common Costs Segment Margin Segmented Financial Information in External Reports 431 Hindrances to Proper Cost Assignment Omission of Costs 431 389 391 11 Net Operating Income and Operating Assets Defined 434 Understanding ROI 434 436 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 431 Evaluating Investment Center Performance—Return on Investment 433 The Return on Investment (ROI) Formula 434 Criticisms of ROI Levels of Segmented Statements 430 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 432 388 Appendix 10A: Predetermined Overhead Rates and Overhead Analysis in a Standard Costing System 406 Chapter 429 425 427 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 xxvi nor27130_fm_i-xxviii.indd xxvi 10/5/09 2:50:48 PM Rev.Confirming Pages 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 xxvii nor27130_fm_i-xxviii.indd xxvii 10/5/09 2:50:49 PM Rev.Confirming Pages Other Approaches to Capital Budgeting Decisions 551 The Payback Method 551 Evaluation of the Payback Method 552 An Extended Example of Payback 553 Payback and Uneven Cash Flows Determining the Markup Percentage 554 Criticisms of the Simple Rate of Return 556 Summary Glossary Questions Exercises Problems A Introduction 592 The Economists’ Approach to Pricing Elasticity of Demand 592 The Profit-Maximizing Price 593 592 598 599 600 600 601 601 601 602 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 Target Costing 599 Reasons for Using Target Costing An Example of Target Costing 556 Summary 557 Review Problem: Comparison of Capital Budgeting Methods 558 Glossary 559 Questions 560 Exercises 560 Problems 564 Cases 573 Appendix 597 Problems with the Absorption Costing Approach 554 The Simple Rate of Return Method Postaudit of Investment Projects The Absorption Costing Approach to Cost-Plus Pricing 596 Setting a Target Selling Price Using the Absorption Costing Approach 596 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 xxviii nor27130_fm_i-xxviii.indd xxviii 10/5/09 2:50:50 PM Confirming Pages 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 nor27130_ch01_001-029.indd 1 8/14/09 4:42:48 PM Confirming Pages 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. 8/14/09 4:43:15 PM Confirming Pages 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. nor27130_ch01_001-029.indd 3 8/14/09 4:43:16 PM Confirming Pages 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. nor27130_ch01_001-029.indd 4 8/14/09 4:43:16 PM Confirming Pages 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 nor27130_ch01_001-029.indd 5 8/14/09 4:43:17 PM Confirming Pages 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 nor27130_ch01_001-029.indd 6 8/14/09 4:43:19 PM Confirming Pages 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. nor27130_ch01_001-029.indd 7 8/14/09 4:43:19 PM Confirming Pages 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 nor27130_ch01_001-029.indd 8 The Lean Production literature uses the term value stream rather than business process. 8/14/09 4:43:20 PM Confirming Pages 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 nor27130_ch01_001-029.indd 9 8/14/09 4:43:20 PM 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 inventory stocking locations declined from five to two, and the supplier’s distribution center was eliminated. Source: Ghostwriter, “Teaching the Big Box New Tricks,” Fortune, November 14, 2005, pp. 208B–208F. shelves when customers want them. Both Procter & Gamble and Costco realize that their mutual success depends on working together to ensure Procter & Gamble’s products are available to Costco’s customers. The Theory of Constraints (TOC) A constraint is anything that prevents you from getting more of what you want. Every individual and every organization faces at least one constraint, so it is not difficult to find examples of constraints. You may not have enough time to study thoroughly for every subject and to go out with your friends on the weekend, so time is your constraint. United Airlines has only a limited number of loading gates available at its busy Chicago O’Hare hub, so its constraint is loading gates. Vail Resorts has only a limited amount of land to develop as homesites and commercial lots at its ski areas, so its constraint is land. The Theory of Constraints (TOC) is based on the insight that effectively managing the constraint is a key to success. As an example, long waiting periods for surgery are a chronic problem in the National Health Service (NHS), the government-funded provider of health care in the United Kingdom. The diagram in Exhibit 1–5 illustrates a simplified version of the steps followed by a surgery patient. The number of patients who can be processed through each step in a day is indicated in the exhibit. For example, appointments for outpatient visits can be made for as many as 100 referrals from general practitioners in a day. EXHIBIT 1–5 Processing Surgery Patients at an NHS Facility (simplified)* General practitioner referral Appointment made Outpatient visit Add to surgery waiting list Surgery Follow-up visit Discharge 100 patients per day 100 patients per day 50 patients per day 150 patients per day 15 patients per day 60 patients per day 140 patients per day *This diagram originally appeared in the February 1999 issue of the U.K. magazine Health Management. nor27130_ch01_001-029.indd 10 8/14/09 4:43:20 PM Confirming Pages Managerial Accounting and the Business Environment 11 The constraint, or bottleneck, in the system is determined by the step that has the smallest capacity—in this case surgery. The total number of patients processed through the entire system cannot exceed 15 per day—the maximum number of patients who can be treated in surgery. No matter how hard managers, doct...
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