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Managerial Accounting An Introduction to Concepts, Methods and Uses 10e Michael W. Maher University of California – Davis • Clyde P. Stickney Dartmouth College • Roman L. Weil University of Chicago Managerial Accounting: An Introduction to Concepts, Methods, and Uses, Tenth Edition Michael W. Maher, Clyde P. Stickney, and Roman L. Weil VP/Editorial Director: Jack W. Calhoun Associate Content Project Manager: Joanna Grote Art Director: Linda Helcher Publisher: Rob Dewey Manager, Editorial Media: John Barans Internal Designer: Lisa A. Albonetti Acquisitions Editor: Keith Chasse Senior Technology Project Manager: Sally Nieman Cover Designer: Lisa A. Albonetti Associate Developmental Editor: Mike Guendelsberger Editorial Assistant: Amanda Wolfe Cover Images: Jason Horowitz/The Image Bank/#Getty Images Marketing Communications Manager: Libby Shipp Frontlist Buyer: Doug Wilke Marketing Manager: Kristen Bloomstrom Production House: ICC Macmillan Inc. Printer: West Eagan, MN Marketing Coordinator: Mary Popelar COPYRIGHT # 2008, 2006 Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star logo, and South-Western are trademarks used herein under license. Printed in the United States of America 1 2 3 4 5 10 09 08 07 Student Edition ISBN 13: 978-0-324-63976-6 Student Edition ISBN 10: 0-324-63976-7 ALL RIGHTS RESERVED. No part of this work covered by the copyright hereon may be reproduced or used in any form or by any means— graphic, electronic, or mechanical, including photocopying, recording, taping, Web distribution or information storage and retrieval systems, or in any other manner—without the written permission of the publisher. For permission to use material from this text or product, submit a request online at http://www.thomsonrights.com. Library of Congress Control Number: 2006908740 For more information about our products, contact us at: Thomson Learning Academic Resource Center 1-800-423-0563 Thomson Higher Education 5191 Natorp Boulevard Mason, OH 45040 USA For KATHLEEN, KRISTA, ANDREA For ALLIE, BAILLIE, CHARLIE, CONMAN, GRETA, ISABELLA, AND LILY AND KATHY With Thanks For Our Students Whatever be the detail with which you cram your students, the chance of their meeting in after-life exactly that detail is infinitesimal; and if they do meet it, they will probably have forgotten what you taught them about it. The really useful training yields a comprehension of a few general principles with a thorough grounding in the way they apply to a variety of concrete details. In subsequent practice the students will have forgotten your particular details; but they will remember by an unconscious common sense how to apply principles to immediate circumstances. Alfred North Whitehead The Aims of Education and Other Essays WITH THANKS Preface Our St atement of Principle We remain convinced that our primary job as educators is to teach problem-solving skills as well as the organizational (and social) context in which students will, as managers, conduct economic activities. An increasing number of employers ask that business school graduates seek out ways to add value to organizations, not just work competently on projects that superiors assign to them. Focusing on problem-solving skills and the organizational context of decisions will serve current and future students well in responding to employers’ expectations. Management accounting should not be primarily concerned with making computations. Students should aim to understand the organization’s business issues that created a need for implementing such concepts as activity-based costing and the balanced scorecard. And students should view the success or failure of these methods and concepts in the context of the organization’s operating and business environment. We know many examples in which thoughtful practitioners developed complex activity-based costing, balanced scorecard, and other management accounting methods only to have them fail in implementation. These methods did not fail because of errors in computations; they failed because their developers did not sufficiently understand the problems that the organization needed to solve. Or they failed because these practitioners could not gain agreement on goals and strategies from both top management and the people who would later implement the methods. In other words, understanding business concepts and real incentives for decisions is more valuable than mere proficiency with accounting tools. As educators, and as authors, we aim to help students develop lifelong problem-solving skills and understand the organizational and social context in which the organization’s members make decisions. Students educated in this manner can add value to organizations and society, whether they work in accounting or some other field. The Tenth Edition and the Future of Management Accounting The tenth edition continues to reflect our philosophy in every respect. We emphasize conceptual and analytical thinking over training in procedures. The following three examples demonstrate how we apply that philosophy.  More than three-fourths of the book focuses on managerial decision making (Chapters 1, 4–12). This is not a baby cost accounting book. We want our students to focus on business problem solving and the business context in which they use accounting information.  We devote an entire chapter (Chapter 12) to incentive issues that go beyond the conventional profit and investment center material because students should be aware that these issues drive management decision making to a large degree. This chapter includes extensive discussion of problems with incentive systems that lead to fraudulent financial reporting.  We provide answers to even-numbered exercises in addition to the usual self-study problems so students get immediate feedback on each chapter’s basic ideas. By enabling students to get immediate feedback on each chapter’s basic ideas, we provide opportunity for instructors to explore the big concepts and to integrate ideas from different chapters. iv Preface T HEMES OF THE R EVIS ION We wrote this book for students who expect to become managers, whether in marketing, finance, IT, or some other area. Previous editions have taught readers how to use accounting information to add value to their organizations and have emphasized concepts over procedures. The tenth edition continues these themes and improves on their application, as the list of chapter changes makes clear. We have increased our discussion of ethical issues, including the Sarbanes-Oxley Act, and management’s use of internal controls to prevent fraud. We have added discussions of strategic cost management issues in Chapters 1 and 4, as noted below. T HE ORGANIZ ATION AND US E OF T HIS B OOK We divide the book into three major parts to allow maximum flexibility for instructors’ teaching preferences. Part One, ‘‘Overview and Basic Concepts’’ (Chapters 1–3) Part Two, ‘‘Managerial Decision Making’’ (Chapters 4–8) Part Three, ‘‘Motivating Managers to Make Good Decisions’’ (9–13) Part One covers fundamental concepts, including activity-based management, and provides an overview of managerial accounting. After Part One, instructors may cover Parts Two and Three in whichever order they prefer. Chapter 1 introduces managerial accounting and ties it to strategic cost analysis, the value chain, and ethical issues. Chapter 2 presents traditional job and process product costing. Chapter 3 covers activity-based costing and management. Part Two discusses concepts and methods useful for managerial decision making. Chapter 4 covers strategic management of costs, quality, and time. Chapter 5 discusses cost behavior and methods of estimating cost driver rates. Chapter 6 discusses financial modeling, with cost volume profit treated as a simple example. Chapter 7 discusses differential cost and revenue analysis. Chapter 8 discusses long-run decision making involving capital budgeting. Part Three concentrates on managerial planning and performance evaluation. Chapter 9 provides an overview of planning and control and discusses development of budgets as tools for planning and control. Chapter 10 discusses profit and cost center performance evaluation, including profit variance analysis, cost variance analysis, variance investigation, and the use of nonfinancial performance measures. Chapter 11 focuses on performance evaluation in investment centers, including transfer pricing and EVA1. Chapter 12 discusses incentive issues, including use of the balanced scorecard, internal controls, and ethical problems related to incentive systems, such as financial fraud. Chapter 13 discusses cost allocation, which is self-contained and can be taught anywhere in chapter sequence. The Appendix discusses compound interest calculations used in discounted cash flow analysis. It provides concepts of the time value of money useful to management accountants. The Glossary defines comprehensively the concepts and terms used by managers and management accountants. It is one of the most comprehensive and informative glossaries that students might ever find. Major Fe atures of the Tenth Edition E NHANCES C RITIC AL T HINKING S KILL S Users of previous editions have found this book to be strong in requiring critical thinking. A critical-thinking approach views accounting as a process of reporting information for people v vi Preface to use, as opposed to a view of accounting as a set of rules or procedures to follow. We hope to prepare the next generation of managers and managerial accountants to think through specific situations for themselves using the concepts explored in this book. To enhance instructors’ ability to get students into a critical-thinking mode, we include in each chapter a section of assignment materials called Critical Analysis and Discussion Questions. We have found these questions particularly useful for in-class assignments for groups of students who discuss the issues and report the results of their discussion. These questions make good take-home group or individual writing assignments. C ONCEP TUAL A P P ROACH This edition, like those before it, emphasizes concepts over procedures. We believe students in M.B.A. managerial accounting classes should understand the fundamental concepts and see the ‘‘big picture,’’ leaving more detailed procedures to cost accounting classes and onthe-job training. Although a minority of students taking managerial accounting classes will become accountants, all will use managerial accounting concepts during their careers. We intend to give them a solid grounding in those concepts in this book. E THIC AL AND C ONTROL I S SUES In previous editions, we integrated discussion of ethical issues throughout the chapters. In addition, Chapter 12 (‘‘Incentive Issues’’) had an extensive discussion of financial fraud and ethical issues related to incentive plans. In this edition, we discuss ethical issues and cover the Sarbanes-Oxley Act in Chapter 1, which also has new, provocative assignment items. Chapter 4 (‘‘Strategic Management of Costs, Quality, and Time’’) has new material linking ethical decisions to creating quality products and the effects of good or bad reputation on the company. In Chapter 12, we have added a discussion of internal controls from a management perspective and added new assignment material. VARIE T Y OF E ND - OF - CHAP TER A S S IGNMENT M ATERIAL S Accounting instructors know the value of interesting and accurate assignment materials. We have written exercises and problems to reflect the new material. We have extensively classtested the assignment material and worked every question, exercise, problem, and case many times in preparing this edition. The variety and quantity of end-of-chapter assignment materials make the book suitable for various approaches to the M.B.A. managerial course. To help the instructor assign homework and select items for class presentation, we have divided the assignment materials into five categories: Review Questions, Critical Analysis and Discussion Questions, Exercises, Problems, and Cases.  Review Questions are straightforward questions about key concepts in the chapter.  Critical Analysis and Discussion Questions are thought-provoking questions about the challenging issues that managers and accountants face. These questions are particularly good for written essays and class discussions.  Exercises reinforce key concepts in the chapter, often referring the student to a particular illustration. Exercises typically deal with a single topic and are particularly useful for classroom demonstration. To enhance the self-learning dimension of the book, we include fully worked-out solutions at the end of the chapter to the even-numbered exercises. (For convenience, we also place these solutions in the Solutions Manual.)  Problems challenge the student to apply and interpret the material in the chapter, many with thought-provoking discussion or essay questions. We have added more critical-thinking requirements to problems, and we have added numerous problems, particularly in Chapters 7 (‘‘Differential Cost Analysis for Decision Making’’) and 12 (‘‘Incentive Issues’’). Preface  Cases encourage students to apply concepts from multiple chapters and their other courses to deal with complex managerial issues. These are particularly good for advanced students and graduate students with some previous background in managerial accounting. S ELF -S TUDY P ROBLEMS WITH F ULL S OLUTIONS Better and more motivated students take every opportunity to test their understanding. Students who find managerial accounting at the M.B.A. level to be more challenging need additional resources for self-help. We have designed this book to make it easy for students to learn the basic concepts on their own, thereby making more class time available for discussion. Like most other managerial accounting textbooks, this one includes Self-Study Problems placed at key points in each chapter. (Their answers appear at the end of the chapter.) In addition, the worked-out solutions to half of the exercises in each chapter give students ample opportunity to test their knowledge of the basic concepts. Ideally, they will come to class with a solid understanding of the basic ideas, and instructors can devote class time to provocative discussion. M ANAGERIAL A P PLIC ATIONS Students are more motivated to learn the material if they see its application to real-world problems, particularly ones they believe they will face. This book contains Managerial Applications that are similar to sidebars in news magazines. These allow the student to explore company practices that illustrate concepts discussed in the text without disrupting the flow of study. See the table of contents for a list of Managerial Applications. Supplements Accompanying the Text INS TRUC TOR’ S M ANUAL The Instructor’s Manual (by P. N. Saksena, Indiana University, South Bend) includes chapter overviews, learning objectives, lecture notes with teaching suggestions, and suggestions for group discussion, all focusing on the needs of M.B.A. instructors. The Instructor’s Manual is available on the Instructor’s Resource CD. T ES T B ANK The Test Bank includes a mix of questions and problems tuned to the lasting needs of M.B.A. instructors. The Test Bank is available in ExamView format on the Instructor’s Resource CD. S OLUTIONS M ANUAL The Solutions Manual (by the text authors) contains responses to questions and solutions to all exercises, problems, and cases. The Solutions Manual is available on the Instructor’s Resource CD. INS TRUC TOR’ S R ESOURCE CD WITH E X AMV IE W R This CD contains the Solutions Manual, Instructor’s Manual, Test Bank files in Word, ExamView1, and PowerPoint slides. vii viii Preface L EC TURES IN P OWER P OINT Accompanying the tenth edition are PowerPoint slides (by Gail Wright, Professor Emeritus, Bryant University), available by download to students and instructors for use in preparing and displaying material for lectures. The PowerPoint slides may be found on the product Web site and on the Instructor’s Resource CD. P RODUC T S UP PORT W EB S ITE Instructors and students may turn to www.thomsonedu.com/accounting/maher for resources geared to the M.B.A. managerial course such as PowerPoint lectures, instructor supplements, and quizzes. ACKNOWLED GMENTS We are grateful to a number of people for their comments, criticisms, and suggestions, among them Peter Ben Ezra (George Washington University), P. N. Saksena (Indiana University, South Bend), Felix Amenkhienan (Radford University), Frank LaMarra (Wayne State University), Dan Law (Gonzaga University), James Bierstaker (University of Massachusetts-Boston), Laurie McWhorter (University of North Carolina-Charlotte), Jay Holmen (University of Wisconsin-Eau Claire), and Myung-Ho Yoon (Northeastern Illinois University). We wish to thank Acquisitions Editor Keith Chasse, Developmental Editor Michael Guendelsberger, Marketing Manager Kristen Bloomstrom Hurd, Content Project Manager Joanna Grote, Art Director Linda Helcher, Marketing Coordinator Mary Popelar, Editorial Assistant Amanda Wolfe, Project Manager Santosh Vasudevan with ICC Macmillan Inc., and Executive MarComm Manager Brian Chaffee, among others, for their efforts. We especially appreciate their patience and dedication to publishing excellence. M. W. M. C. P. S. R. L. W. Brief Contents Preface iv Part One Overview and Basic Concepts 1 Chapter 1 Fundamental Concepts 3 Chapter 2 Measuring Product Costs 33 Chapter 3 Activity-Based Management 77 Part Two Managerial Decision Making 113 Chapter 4 Strategic Management of Costs, Quality, and Time 115 Chapter 5 Cost Drivers and Cost Behavior 141 Chapter 6 Financial Modeling for Short-Term Decision Making 183 Chapter 7 Differential Cost Analysis for Operating Decisions Chapter 8 Capital Expenditure Decisions 273 Part Three Chapter 9 219 Motivating Managers to Make Good Decisions 301 Profit Planning and Budgeting 303 Chapter 10 Profit and Cost Center Performance Evaluation 349 Chapter 11 Investment Center Performance Evaluation Chapter 12 Incentive Issues 429 Chapter 13 Allocating Costs to Responsibility Centers 461 393 Appendix: Compound Interest Examples and Applications 491 Compound Interest and Annuity Tables 506 Glossary Index 509 603 ix