2 MANAGEMENT ACCOUNTING IN A DYNAMIC ENVIRONMENT Whether students pursue a professional career in accounting or in other areas of management, they will interact with accounting systems. In all organizations, managers rely on management accounting systems to provide information in order to deal with changes in their operating environment. This book provides students and managers with an understanding and appreciation of the strengths and limitations of an organization’s accounting system, and enables them to be intelligent and critical users of the system. The text highlights the role of management accounting as an integral part of the organization’s strategy and not merely a set of individual concepts and computations. An analytical framework for organizational change is used throughout the book to underscore how organizations must adapt to create customer and organizational value. This framework provides a way to examine and analyze the organization’s accounting system, and a basis for evaluating proposed changes to the system. With international examples that bring the current business environment to the forefront, problems and cases to promote critical thinking, and online support for students and instructors, Management Accounting in a Dynamic Environment is no mere introductory textbook. It prepares readers to use accounting systems intelligently to achieve organizational success. Cheryl S. McWatters is the Father Edgar Thivierge Chair in Business History and Professor of Accounting at the Telfer School of Management, University of Ottawa, Canada. She is editor of Accounting History Review, associate editor of the Journal of Operations Management and Accounting Perspectives, and on the editorial boards of the Accounting, Auditing & Accountability Journal and the Accounting Historians Journal, among others. An award-winning author and editor, Professor McWatters has published widely in accounting, operations management, and accounting and management history. Jerold L. Zimmerman is Professor Emeritus at the Simon School of Business, University of Rochester, USA. His co-authored research with Professor R.L. Watts, M.I.T., has received the prestigious American Accounting Association Seminal Contribution to the Accounting Literature Award. The Watts and Zimmerman research, which has come to be called ‘positive accounting theory’, seeks to understand the costs and benefits of various accounting procedures. A founding editor of the Journal of Accounting and Economics, one of the most highly cited accounting publications, Professor Zimmerman has published widely in accounting, finance, and managerial economics, including a number of textbooks in both accounting and managerial economics. 3 MANAGEMENT ACCOUNTING IN A DYNAMIC ENVIRONMENT CHERYL S. MCWATTERS AND JEROLD L. ZIMMERMAN 4 First published 2016 by Routledge 711 Third Avenue, New York, NY 10017 and by Routledge 2 Park Square, Milton Park, Abingdon, Oxon, OX14 4RN Routledge is an imprint of the Taylor & Francis Group, an informa business © 2016 Taylor & Francis The right of Cheryl S. McWatters and Jerold L. Zimmerman to be identified as authors of this work has been asserted by them in accordance with sections 77 and 78 of the Copyright, Designs and Patents Act 1988. All rights reserved. No part of this book may be reprinted or reproduced or utilised in any form or by any electronic, mechanical, or other means, now known or hereafter invented, including photocopying and recording, or in any information storage or retrieval system, without permission in writing from the publishers. Trademark notice: Product or corporate names may be trademarks or registered trademarks, and are used only for identification and explanation without intent to infringe. Library of Congress Cataloging-in-Publication Data McWatters, Cheryl S. Management accounting in a dynamic environment/ Cheryl S. McWatters, PhD, CMA, Telfer School of Management, University of Ottawa, Jerrold L. Zimmerman, PhD, University of Rochester. pages cm 1. Managerial accounting. I. Zimmerman, Jerrold L. II. Title. HF5657.4.M393 2015 658.15’11–dc23 2015013569 ISBN: 978–0-415–83901–3 (hbk) ISBN: 978–0-415–83902–0 (pbk) ISBN: 978–0-203–77561–5 (ebk) Typeset in Minion Pro and Futura by Florence Production Ltd, Stoodleigh, Devon, UK Additional materials are available on the companion website at www.routledge.com/cw/mcwatters 5 To John and Dodie 6 CONTENTS Preface How to Use This Book 1 Why Accounting is Important in Organizations Management Accounting in a Dynamic Environment Strategy for Increasing Customer Value Organizations and Decisions The Role of Accounting Trade-Offs in Using Accounting for Multiple Purposes Management Accountants in Organizations Ethics and Management Accounting Summary Key Terms Analysis and Interpretation Problems Extended Analysis and Interpretation Problems Notes 2 Cost Behavior and Activity Costs Making Planning Decisions The Benefit and Cost of Information Activity Costs and the Rate of Output Approximations of Activity Costs Estimating Activity Costs through the Identification of Variable and Fixed Costs Summary Key Terms Appendix: Using Regression to Estimate Fixed and Variable Costs Numerical Exercises Numerical Problems Analysis and Interpretation Problems Extended Analysis and Interpretation Problem Notes 3 Measuring and Analyzing Product Costs Activities and Product Costs Estimating Product Costs for Planning Decisions Direct Product Costs Indirect Product Costs Indirect Costs Traced Using a Cost Driver Activity-Based Costing Indirect Product Costs Traced Using a Single Cost Driver Summary Key Terms Appendix: Product Costs and Financial Reporting Numerical Exercises Numerical Problems Analysis and Interpretation Problems 7 Extended Analysis and Interpretation Problem Notes 4 Managing Activities Strategic Decisions Activity-Based Management and the Value Chain Cost Reduction Supply Chain Management and Costs Customer Relations and Profitability Pricing and Customer Value Summary Key Terms Numerical Exercises Numerical Problems Analysis and Interpretation Problems Extended Analysis and Interpretation Problem Notes 5 Managing Organizations Framework for Organizational Change Revisited Control within an Organization Knowledge and Decision Making within an Organization Motivation of Individuals to Support an Organization’s Goals Summary Key Terms Analysis and Interpretation Problems Extended Analysis and Interpretation Problems Notes 6 Decentralized Organizations The Controllability Principle Responsibility Centers Accounting-Based Performance Measures Transfer Pricing Globalization and Transfer Pricing Summary Key Terms Numerical Exercises Numerical Problems Analysis and Interpretation Problems Extended Analysis and Interpretation Problems Notes 7 Budgeting Purpose of Budgeting Conflict Between Planning and Control How Budgeting Helps Resolve Organizational Problems Comprehensive Master Budget Illustration 8 Summary Key Terms Appendix: Monthly Cash-Flow Estimates and Spreadsheets Numerical Exercises Numerical Problems Analysis and Interpretation Problems Extended Analysis and Interpretation Problems Notes 8 Cost Allocations Allocating Indirect Costs Reasons for Allocating Indirect Costs Basic Steps of Cost Allocation Segment Reporting Summary Key Terms Appendix: Allocating Costs of Service Departments with Interactions Numerical Exercises Numerical Problems Analysis and Interpretation Problems Extended Analysis and Interpretation Problems Notes 9 Absorption Costing Systems Product Costing Procedures in Organizations Job-Order Costing Cost Flows through the Accounts Allocating Overhead to Jobs Activity-Based Costing (ABC) and Multiple Allocation Bases Multi-Stage Allocation Processes Process Costing Summary Key Terms Appendix: Cost of Goods Manufactured, Cost of Goods Sold, and Alternative Cost Flow Methods for Inventory Numerical Exercises Numerical Problems Analysis and Interpretation Problems Extended Analysis and Interpretation Problems Notes 10 Variable Costing and Capacity Costs Criticisms of Absorption Cost Systems Variable Costing Capacity Costs Summary Key Terms 9 Appendix: Joint Costs Numerical Exercises Numerical Problems Analysis and Interpretation Problems Extended Analysis and Interpretation Problems Notes 11 Standard Costs and Variance Analysis Standard Costs Direct Labor and Direct Materials Variances Incentive Effects of Direct Labor and Materials Variances Standard Overhead Costs and Variances Variance Investigation Costs and Benefits of Using Standard Costing Systems Summary Key Terms Appendix: Overhead Variances Numerical Exercises Numerical Problems Analysis and Interpretation Problems Extended Analysis and Interpretation Problems Notes 12 Short-Term Decisions and Constraints Short-Term Planning Decisions Cost-Volume-Profit Analysis Pricing Decisions in the Short Term Product-Mix Decisions Product-Mix Decisions with Constraints Theory of Constraints Summary Key Terms Appendix: Additional Aspects of CVP Analysis Numerical Exercises Numerical Problems Analysis and Interpretation Problems Extended Analysis and Interpretation Problems Notes 13 Investment Decisions Long-Term Investment Decisions Investment Criteria Ignoring the Opportunity Cost of Capital The Net Present Value of Cash Flows Internal Rate of Return Capital-Budgeting Methods Used in Practice Summary Key Terms 10