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Accounting Principles: Managerial Accounting A Textbook Equity Open College Textbook originally by Hermanson, Edwards, and Ivancevich Fearless copy, print, remix(tm) www.textbookequity.com www.opencollegetextbooks.org License: CC-BY-NC-SA ISBN-13: 978-1461130239 ISBN-10: 1461130239 About This Publication Simply put, you may copy, print, redistribute, and re-purpose this textbook or parts of this textbook provided that you give attribution (credit) to Textbook Equity, and provided that any derivative work has the same Creative Commons license (CC-BY-NC-SA). That’s it. Textbook Equity, in turn, provides attribution, with thanks, to the Global Text Project, who provided the source textbook. Consistent with it’s strategic mission to provide free and low-cost textbooks, this is Textbook Equity’s derivative work based on “Accounting Principles: A Business Perspective First Global Text Edition, Volume 2 Managerial Accounting”, utilizing the permissions granted by it’s Creative Commons license. Global Text Project nor the original authors endorse or are responsible in any way for this printing or it’s contents. Textbook Provenance (1998 - 2011) 1998 Edition Accounting: A Business Perspective (Irwin/Mcgraw-Hill Series in Principles of Accounting) [Hardcover] Roger H. Hermanson (Author), James Don Edwards (Author), Michael W. Maher (Author) Eighth Edition Hardcover: 944 pages Publisher: Richard D Irwin; Sub edition (April 1998) Language: English ISBN-10: 0075615851 ISBN-13: 978-0075615859 Product Dimensions: 11.1 x 8.7 x 1.8 inches Current Hardbound Price $140.00 (Amazon.com) 2010 Editions (http://globaltext.terry.uga.edu/books/) Global Text Project Conversion to Creative Commons License CC-BY “Accounting Principles: A Business Perspective First Global Text Edition, Volume 1 Financial Accounting”, by Hermanson, Edwards, and Maher, Revision Editor: Donald J. McCubbrey, PhD. PDF Version, 817 pages, Free Download “Accounting Principles: A Business Perspective First Global Text Edition, Volume 2 Managerial Accounting”, by Hermanson, Edwards, and Ivancevich. Revision Editor: Donald J. McCubbrey, PhD. PDF Version Volume 2, 262 pages, Free Download 2 2011 Editions (http://opencollegetextbooks.org) Textbook Equity publishes this soft cover version using a the CC-BY-NC-SA license. They divided Volume 1 into two sections to fit paperback publishing requirements and made other formatting changes. No content changes were made to Global Text’s version. Versions available at the Open College Textbook repository: • PDF Version, Section 1 of Volume 1 (Chapters 1 – 8), 436 pages, Free Download • Textbook Equity Paperback, Principles of Accounting, Volume 1 ,Financial Accounting (Chapters 1 – 8), 436 pages, List Price $24.95 • PDF Version, Financial Accounting (Chapters 9 – 18), Free Download • Textbook Equity Paperback, Principles of Accounting, Volume 1 , Financial Accounting (Chapters 9 – 18), List Price $14.95 • PDF Version, Accounting Principles: Managerial Accounting, Free Download • Textbook Equity Paperback, Accounting Principles: Managerial Accounting, 316 pages, (chapters 19 – 26 of the original volume). List Price $24.95 For original author information and acknowledgments see opencollegetextbooks.org Updated April 27, 2011 3 Contents (Cont' from Vol 1," Financial Accounting") 19 Process: Cost systems...............................................................................................9 19.1 Learning objectives............................................................................................9 19.2 Nature of a process cost system........................................................................9 19.3 Process costing illustration..............................................................................11 19.4 Process costing in service organizations.........................................................22 19.5 Spoilage............................................................................................................22 19.6 Understanding the learning objectives...........................................................23 19.7 Appendix 19A: The FIFO process cost method..............................................25 19.8 FIFO process costing—An illustration...........................................................26 19.9 Appendix 19B: Allocation of joint costs..........................................................30 19.10 Demonstration problem................................................................................32 19.11 Solution to demonstration problem..............................................................32 19.12 Key terms.......................................................................................................33 19.13 Self-test...........................................................................................................34 19.14 Questions.......................................................................................................36 19.15 Exercises.........................................................................................................37 19.16 Problems........................................................................................................38 19.17 Alternate problems........................................................................................40 19.18 Beyond the numbers—Critical thinking........................................................41 19.19 Using the Internet—A view of the real world...............................................43 19.20 Answers to self-test.......................................................................................44 19.21 Comprehensive review problem....................................................................44 20 Using accounting for quality and cost management.............................................47 20.1 Learning objectives..........................................................................................47 20.2 Importance of good accounting information.................................................47 20.3 Quality and the new production environment..............................................48 20.4 Improving quality...........................................................................................48 20.5 Quality and customer satisfaction measures.................................................52 20.6 Just-in-time method.......................................................................................57 20.7 Activity-based costing and management.......................................................62 20.8 Methods used for activity-based costing.......................................................65 20.9 Impact of new production environment on cost drivers...............................71 20.10 Activity-based costing in marketing.............................................................71 20.11 Strategic use of activity-based management.................................................72 20.12 Behavioral and implementation issues.........................................................72 20.13 Opportunities to improve activity-based costing in practice.......................73 20.14 Understanding the learning objectives.........................................................73 20.15 Demonstration problem................................................................................74 20.16 Solution to demonstration problem.............................................................75 20.17 Key terms.......................................................................................................76 4 20.18 Self-test..........................................................................................................76 20.19 Questions.......................................................................................................78 20.20 Exercises.......................................................................................................79 20.21 Problems........................................................................................................82 20.22 Alternate problems.......................................................................................85 20.23 Beyond the numbers—Critical thinking.......................................................87 20.24 Using the Internet—A view of the real world..............................................89 20.25 Answers to self-test.......................................................................................89 21 Cost-volume-profit analysis....................................................................................91 21.1 Learning objectives..........................................................................................91 21.2 A manager's perspective..................................................................................91 21.3 Cost behavior patterns....................................................................................92 21.4 Methods for analyzing costs............................................................................96 21.5 Cost-volume-profit (CVP) analysis.................................................................98 21.6 Finding the break-even point........................................................................100 21.7 Cost-volume-profit analysis illustrated........................................................104 21.8 Assumptions made in cost-volume-profit analysis......................................107 21.9 Using computer spreadsheets for CVP analysis...........................................107 21.10 Effect of automation on cost-volume-profit analysis.................................109 21.11 Understanding the learning objectives........................................................110 21.12 Demonstration problem ...............................................................................111 21.13 Solution to demonstration problem ............................................................111 21.14 Key terms*.....................................................................................................112 21.15 Self-test.........................................................................................................113 21.16 Questions......................................................................................................114 21.17 Exercises........................................................................................................115 21.18 Problems.......................................................................................................117 21.19 Alternate problems......................................................................................120 21.20 Beyond the numbers—Critical thinking.....................................................122 21.21 Using the Internet—A view of the real world..............................................124 21.22 Answers to self-test......................................................................................124 22 Short-term decision making: Differential analysis..............................................126 22.1 Learning objectives........................................................................................126 22.2 Contribution margin income statements.....................................................126 22.3 Differential analysis......................................................................................128 22.4 Applications of differential analysis..............................................................131 22.5 Applying differential analysis to quality.......................................................137 22.6 Understanding the learning objectives........................................................138 22.7 Demonstration problem................................................................................140 22.8 Solution to demonstration problem.............................................................140 22.9 Key terms*......................................................................................................141 22.10 Self-test.........................................................................................................141 5 22.11 Questions......................................................................................................142 22.12 Exercises.......................................................................................................143 22.13 Problems......................................................................................................145 22.14 Alternate problems......................................................................................148 22.15 Beyond the numbers—Critical thinking......................................................150 22.16 Using the Internet—A view of the real world.............................................152 22.17 Answers to self-test......................................................................................153 23 Budgeting for planning and control.....................................................................154 23.1 A manager's perspective................................................................................154 23.2 The budget—For planning and control.........................................................155 23.3 The master budget illustrated.......................................................................161 23.4 Budgeting in merchandising companies.......................................................177 23.5 Budgeting in service companies....................................................................178 23.6 Additional concepts related to budgeting.....................................................178 23.7 Understanding the learning objectives.........................................................179 23.8 Demonstration problem...............................................................................180 23.9 Solution to demonstration problem.............................................................181 23.10 Key terms*....................................................................................................181 23.11 Self-test.........................................................................................................182 23.12 Questions.....................................................................................................183 23.13 Exercises......................................................................................................184 23.14 Problems......................................................................................................185 23.15 Alternate problems......................................................................................188 23.16 Beyond the numbers—Critical thinking......................................................191 23.17 Using the Internet—A view of the real world..............................................192 23.18 Comprehensive problems............................................................................193 23.19 Answers to self-test......................................................................................196 24 Control through standard costs...........................................................................198 24.1 Learning objectives........................................................................................198 24.2 Uses of standard costs...................................................................................198 24.3 Nature of standard costs...............................................................................198 24.4 Advantages and disadvantages of using standard costs..............................201 24.5 Computing variances....................................................................................203 24.6 Goods completed and sold............................................................................216 24.7 Investigating variances from standard.........................................................216 24.8 Disposing of variances from standard..........................................................217 24.9 Nonfinancial performance measures...........................................................219 24.10 Activity-based costing, standards, and variances.......................................219 24.11 Understanding the learning objectives.......................................................220 24.12 Demonstration problem..............................................................................222 24.13 Solution to demonstration problem...........................................................222 24.14 Key terms.....................................................................................................223 6 24.15 Self-test........................................................................................................224 24.16 Questions.....................................................................................................226 24.17 Exercises.......................................................................................................227 24.18 Problems.....................................................................................................228 24.19 Alternate problems.....................................................................................229 24.20 Beyond the numbers—Critical thinking....................................................230 24.21 Using the Internet—A view of the real world.............................................232 24.22 Answers to self-test.....................................................................................232 25 Responsibility accounting: Segmental analysis...................................................234 25.1 Learning objectives........................................................................................234 25.2 Responsibility accounting.............................................................................234 25.3 Responsibility reports...................................................................................236 25.4 Responsibility reports—An illustration.......................................................238 25.5 Responsibility centers...................................................................................240 25.6 Transfer prices..............................................................................................243 25.7 Use of segmental analysis.............................................................................243 25.8 Concepts used in segmental analysis...........................................................244 25.9 Investment center analysis...........................................................................248 25.10 Economic value added and residual income..............................................253 25.11 Segmental reporting in external financial statements................................255 25.12 Understanding the learning objectives.......................................................255 25.13 Appendix: Allocation of service department costs.....................................256 25.14 Demonstration problem..............................................................................258 25.15 Solution to demonstration problem...........................................................259 25.16 Key terms*...................................................................................................259 25.17 Self-test........................................................................................................260 25.18 Questions.....................................................................................................262 25.19 Exercises......................................................................................................263 25.20 Problems.....................................................................................................265 25.21 Alternate problems......................................................................................269 25.22 Beyond the numbers—Critical thinking.....................................................271 25.23 Using the Internet—A view of the real world.............................................273 25.24 Answers to self-test.....................................................................................274 26 Capital budgeting:Long-range planning..............................................................276 26.1 Learning objectives........................................................................................276 26.2 Capital budgeting defined.............................................................................277 26.3 Project selection: A general view..................................................................278 26.4 Project selection: Payback period................................................................282 26.5 Project selection: Unadjusted rate of return...............................................284 26.6 Project selection: Net present value method...............................................286 26.7 Profitability index..........................................................................................287 26.8 Project selection: The time-adjusted rate of return (or internal rate of 7 return)....................................................................................................................289 26.9 Investments in working capital....................................................................292 26.10 The postaudit..............................................................................................293 26.11 Investing in high technology projects.........................................................293 26.12 Capital budgeting in not-for-profit organizations.....................................294 26.13 Epilogue.......................................................................................................294 26.14 Understanding the learning objectives......................................................294 26.15 Demonstration problem..............................................................................295 26.16 Solution to demonstration problem...........................................................296 26.17 Key terms*...................................................................................................297 26.18 Self-test........................................................................................................298 26.19 Questions.....................................................................................................299 26.20 Exercises.....................................................................................................300 26.21 Problems......................................................................................................302 26.22 Alternate problems.....................................................................................305 26.23 Beyond the numbers—Critical thinking.....................................................307 26.24 Using the Internet—A view of the real world............................................309 26.25 Answers to self-test.....................................................................................310 8 19 Process: Cost systems 19.1 Learning objectives After studying this chapter, you should be able to: • Describe the types of operations that require a process cost system. • Distinguish between process and job costing systems. • Discuss the concept of equivalent units in a process cost system. • Compute equivalent units of production and unit costs under the average cost procedure. • Prepare a production cost report for a process cost system and discuss its relationship to the Work in Process Inventory account. • Distinguish between normal and abnormal spoilage. • Compute equivalent units of production and unit costs under the first-in first-out (FIFO) system (Appendix 19-A). • Discuss how joint costs are allocated to joint products (Appendix 19-B). This chapter continues the discussion of cost accumulation systems. In Chapter 18, we explained and illustrated job costing. The job cost system (job costing) accumulates costs incurred to produce a product according to individual jobs. For example, construction companies use job costing to keep track of the costs of each construction job. This chapter discusses another cost accumulation system, process costing. The chapter begins with a discussion of the nature of a process cost system. We review the similarities and differences between job costing and process costing. We also present an extended illustration of process costing that includes a discussion of equivalent units of production and the production cost report. In the chapter appendixes, we discuss and illustrate FIFO process costing and the allocation of joint product costs. 19.2 Nature of a process cost system Many businesses produce large quantities of a single product or similar products. Pepsi-Cola makes soft drinks, Exxon Mobil produces oil, and Kellogg Company produces breakfast cereals on a continuous basis over long periods. For these kinds of products, companies do not have separate jobs. Instead, production is an ongoing process. A process cost system (process costing) accumulates costs incurred to produce a product according to the processes or departments a product goes through on its way to completion. 9 Companies making paint, gasoline, steel, rubber, plastic, and similar products using process costing. In these types of operations, accountants must accumulate costs for each process or department involved in making the product. Accountants compute the cost per unit by first accumulating costs for the entire period (usually a month) for each process or department. Second, they divide the accumulated costs by the number of units produced (tons, pounds, gallons, or feet) in that process or department. In "A broader perspective: Producing cans of Coca-Cola", we describe production in bottling and canning plants that use a process cost system. Job costing and process costing have important similarities: • Both job and process cost systems have the same goal: to determine the cost of products. • Both job and process cost systems have the same cost flows. Accountants record production in separate accounts for materials inventory, labor, and overhead. Then, they transfer the costs to a Work in Process Inventory account. • Both job and process cost systems use predetermined overhead rates (defined in Chapter 18) to apply overhead. Job costing and process costing systems also have their significant differences: • Types of products produced. Companies that use job costing work on many different jobs with different production requirements during each period. Companies that use process costing produce a single product, either on a continuous basis or for long periods. All the products that the company produces under process costing are the same. • Cost accumulation procedures. Job costing accumulates costs by individual jobs. Process costing accumulates costs by process or department. • Work in Process Inventory accounts. Job cost systems have one Work in Process Inventory account for each job. Process cost systems have a Work in Process Inventory account for each department or process. Exhibit 1 shows the cost flows in a process cost system that processes the products in a specified sequential order. That is, the production and processing of products begin in Department A. From Department A, products go to Department B. Department B inputs direct materials and further processes the products. Then Department B transfers the products to Finished Goods Inventory. For illustration purposes, we assume that all the process cost systems in this chapter are sequential. There are many production flow combinations; Exhibit 2 presents three possible production flow combinations. 10