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Managerial Accounting

Creating Value in a Dynamic Business Environment


Ninth edition

Ronald W. Hilton
Cornell University

Me
Grain/
Hill

McGraw-Hill
Irwin

Management of Capacity and Capacity


Costs 18
Evolution and Adaptation in Managerial
Accounting 20
M.A.P. The Internet as a Lifeline

1 The Changing Role of Managerial


Accounting in a Dynamic Business
Environment 2
Managerial Accounting: A Business
Partnership with Management 5
Managing Resources, Activities, and
People 5
Decision Making 5
Planning 6
Directing Operational Activities
Controlling 6

How Managerial Accounting Adds Value


to the Organization 6
Objectives of Managerial Accounting
Activity 6
The Balanced Scorecard

22

Cost Management Systems 25


Strategic Cost Management and the Value
Chain 25
The Ethical Climate of Business and the Role
of the Accountant 27
Managerial Accounting as a Career 28
Professional Organizations 28
Professional Certification 29
Professional Ethics 29
Focus on Ethics: IMA Statement of Ethical
Professional Practice 29
Chapter Summary 30
Key Terms 31
Review Questions 31
Exercises 32
Problems 33
Case 35

M.A.P. The Balanced Scorecard

10

Managerial versus Financial


Accounting 11
Managerial Accounting in Different Types of
Organizations 12
Where Are Managerial Accountants Located in
an Organization? 13
Organization Chart 13
Cross-Functional Deployment
Physical Location

16

16

Major Themes in Managerial


Accounting 17
Information and Incentives

17

Behavioral Issues 18
Costs and Benefits

18

Basic Cost Management Concepts


and Accounting for Mass
Customization Operations 36
What Do We Mean by a Cost? 38
Product Costs, Period Costs, and
Expenses 39
Costs on Financial Statements 40
Income Statement 40
Balance Sheet 42

Note: Entries printed in blue denote topics that emphasize


contemporary issues in managerial accounting and cost management.

xxiii

Contents

xxiv

Manufacturing Operations and Manufacturing


Costs 43
M.A.P. Mass Customization 44

Mass-Customization Manufacturing 44
Manufacturing Costs 45
Manufacturing Cost Flows 47
Production Costs in Service Industry Firms
and Nonprofit Organizations 48
Basic Cost Management Concepts: Different
Costs for Different Purposes 50
The Cost Driver Team 50
Variable and Fixed Costs 51
The Cost Management and Control
Team 52

Process-Costing Systems

Summary of Alternative Product-Costing


Systems 86
Accumulating Costs in a Job-Order Costing
System 86
Job-Cost Record

86

Direct-Material Costs
Direct-Labor Costs

Manufacturing-Overhead Costs

Illustration of Job-Order Costing


Purchase of Material

Use of Direct Labor

Review Problems on Cost


Classifications 62
Key Terms 64
Review Questions
Exercises 65
Problems 68
Cases 77

64

90

Summary of Event Sequence in


Job-Order Costing 91

The Outsourcing Action Team 55


Costs and Benefits of Information 59

62

89

M.A.P. Supply Chain Management

Use of Direct Material

Chapter Summary

87
89

M.A.P. Airline Industry: Cost Structure, Cost


Drivers, and a Shifting Business Model 54

Costs in the Service Industry 59


Focus on Ethics: Was WorldCom's Controller
Just Following Orders? 61

86

91

93
93

Use of Indirect Material

93

94

Use of Indirect Labor

94

Incurrence of Manufacturing-Overhead
Costs 94
Application of Manufacturing
Overhead 95
Summary of Overhead Accounting

96

Selling and Administrative Costs

96

Completion of a Production Job

97

Sale of Goods

97

Underapplied and Overapplied


Overhead 97
Schedule of Cost of Goods
Manufactured 99
Schedule of Cost of Goods Sold

99

Posting Journal Entries to the Ledger


Further Aspects of Overhead Application
Actual and Normal Costing

100
100

100

Choosing the Cost Driver for Overhead


Application 103

Product Costing and Cost


Accumulation in a Batch Production
Environment 80
Product and Service Costing 82
Product Costing in Nonmanufacturing
Firms 83
Flow of Costs in Manufacturing Firms 83
Types of Product-Costing Systems 85
Job-Order Costing Systems 85

Departmental Overhead Rates


Two-Stage Cost Allocation

103

104

Project Costing: Job-Order Costing in


Nonmanufacturing Organizations 705
Changing Technology in Manufacturing
Operations 107
EDI and XML

107

Use of Bar Codes

108

M.A.P. Radio Frequency Identification


Systems (RFID) 108

Contents
Focus on Ethics: Did Boeing Exploit
Accounting Rules to Conceal Cost Overruns
and Production Snafus? 709
Chapter Summary 7 70
Review Problem on Job-Order Costing 7 70
Key Terms 772
Review Questions 712
Exercises 772
Problems 718
Cases 730

XXV

Activity-Based Costing and


Management 168
Traditional, Volume-Based Product-Costing
System 7 77
Trouble in Denver 171
Activity-Based Costing System 7 72
ABC Stage One 173
ABC Stage Two 174
Interpreting the ABC Product Costs 178
The Punch Line 179

Process Costing and Hybrid


Product-Costing Systems 134

Why Traditional, Volume-Based Systems


Distort Product Costs 180

Comparison of Job-Order Costing and


Process Costing 736
Flow of Costs 136

M.A.P. Cost Distortion at Rockwell


International 182

Activity-Based Costing: Some Key


Issues 782

Differences Between Job-Order and


Process Costing 138 /
Equivalent Units: A Key Concept
Equivalent Units 138

M.A.P. Cost Distortion at DHL

Cost Drivers

738

Activity-Based Management

142

747
147

Illustration of Customer-Profitability
Analysis 189

Other Cost Drivers for Overhead


Application 147
Subsequent Production Departments
Hybrid Product-Costing Systems 748

786

Two-Dimensional ABC 186


Using ABM to Identify Non-Value-Added
Activities and Costs 186
Customer-Profitability Analysis 789

Weighted-Average Method of Process


Costing 143
Other Issues in Process Costing
Actual versus Normal Costing

183

Collecting ABC Data 184


Activity Dictionary and Bill
of Activities 185

Illustration of Process Costing 740


Basic Data for Illustration 141
M.A.P. New York Wine Industry

183

748

Operation Costing for Batch Manufacturing


Processes 148
Chapter Summary 752
Review Problem on Process Costing 752
Key Terms 754
Review Questions 754
Exercises 754
Problems 757
Cases 765

M.A.P. Customer Profitability Analysis


at Bank One Corp. 191

Activity-Based Costing in the Service


Industry 792
M.A.P. Customer Profitability Analysis
at Best Buy 193

Activity-Based Costing at Delaware Medical


Center 194
Interpreting the Primary Care Unit's ABC
Information 195
Focus on Ethics: Ethical Issues Surrounding
Activity-Based Costing 797

xxvi

Contents
Chapter Summary 798
Review Problems on Cost Drivers and
Product-Cost Distortion 799
Key Terms 200
Appendix to Chapter 5: Just-in-Time Inventory
and Production Management 207
Review Questions 202
Exercises 203
Problems 209
Cases 227

Activity Analysis, Cost Behavior, and


Cost Estimation 232
Cost Behavior Patterns 235
Variable Costs 235
Step-Variable Costs 236
Fixed Costs 237
Step-Fixed Costs 237
Semivariable Cost 239
Curvilinear Cost 240
Using Cost Behavior Patterns to Predict
Costs 241
M.A.P. Is Direct Labor a Variable or a Fixed
Cost? 242

Engineered, Committed, and Discretionary


Costs 243
Cost Behavior in Other Industries 244
Cost Estimation 244
Account-Classification Method 244
Visual-Fit Method 245
High-Low Method 247
Least-Squares Regression Method 248
Multiple Regression 250
Data Collection Problems 250
Engineering Method of Cost Estimation 251
Effect of Learning on Cost Behavior 257
Focus on Ethics: Cisco Systems, Walmart,
Taco Bell, Starbucks, U-Haul, General
Dynamics, and Farmer's Insurance: Is Direct
Labor a Variable Cost? 253

Chapter Summary 253


Review Problems on Cost Behavior and
Estimation 254
Key Terms 255
Appendix to Chapter 6: Least-Squares
Regression Using Microsoft Excel 256
Review Questions 258
Exercises 258
Problems 263
Cases 277

Cost-Volume-Profit Analysis

274

Illustration of Cost-Volume-Profit Analysis


Projected Expenses and Revenue
The Break-Even Point

278

Contribution-Margin Approach
Equation Approach

277

279

279

Graphing Cost-Volume-Profit
Relationships 280
Interpreting the CVP Graph

281

Alternative Format for the CVP


Graph 283
Profit-Volume Graph
Target Net Profit

283

284

Contribution-Margin Approach
Equation Approach

284

Graphical Approach

285

Applying CVP Analysis


Safety Margin

284

285

285

Changes in Fixed Expenses

285

Changes in the Unit Contribution


Margin 286
Predicting Profit Given Expected
Volume 287
Interdependent Changes in Key
Variables 288
CVP Information in Published Annual
Reports 289

277

xxvii

Contents
M.A.P. Airlines Keep a Close Eye on BreakEven Load Factors 289

Absorption-Costing Income
Statements 328

CVP Analysis with Multiple Products 290


Assumptions Underlying CVP Analysis 292

Variable-Costing Income
Statements 328

Role of Computerized Planning Models and


Electronic Spreadsheets 292
CVP Relationships and the Income
Statement 293

Reconciling Income under Absorption and


Variable Costing 329

Traditional Income Statement


Contribution Income Statement

Cost- Volume-Profit Analysis 331


Evaluation of Absorption and Variable
Costing 332

293
293

M.A.P. IRS: Unique Product Packaging Is an


Inventoriable Cost 333

Comparison of Traditional and Contribution


Income Statements 294

Throughput Costing

Cost Structure and Operating Leverage 295


Operating Leverage 296

333

Throughput-Costing Income
Statements 334

M.A.P. Operating Leverage Helps Web


Companies Become Profitable 297

Focus on Ethics: Incentive to Overproduce


Inventory 335

Cost Structure and Operating Leverage: A


Cost-Benefit Issue 298

Chapter Summary

335

Review Problem on Absorption and Variable


Costing 336

M.A.P. Cost Structure and Operating


Leverage 299

Key Terms

CVP Analysis, Activity-Based Costing, and


Advanced Manufacturing Systems 299
A Move toward JIT and Flexible
Manufacturing 300
Chapter Summary 302
/

337

Review Questions

338

Exercises 338
Problems
Cases

340

344

Review Problem on Cost-Volume-Profit


Analysis 303
Key Terms 304
Appendix to Chapter 7: Effect of Income
Taxes 304
Review Questions 307
Exercises 308
Problems 370
Cases 327

Profit Planning and Activity-Based


Budgeting 346
Purposes of Budgeting Systems
Types of Budgets

348

349

The Master Budget: A Planning


Tool 350
Sales of Services or Goods

8 Absorption and Variable Costing 324


Product Costs

326

Illustration of Absorption and Variable


Costing 327

Sales Forecasting

350

350

Operational Budgets

351

Budgeted Financial Statements


Nonprofit Organizations 352

352

xxviii

Contents
M.A.P. Activity-Based Budgeting
(ABB) at American Express and AT&T
Paradyne 353

Activity-Based Budgeting

353

Using Activity-Based Budgeting to Prepare the


Master Budget 355
Sales Budget

355

Production Budget

356

Direct-Material Budget
Direct-Labor Budget

10 Standard Costing, Operational


Performance Measures, and the
Balanced Scorecard 404

356
358

Manufacturing-Overhead Budget

359

Selling, General, and Administrative (SG&A)


Expense Budget 360
Cash Receipts Budget

362

Cash Disbursements Budget

Cash Budget: Combining Receipts and


Disbursements 364
Budgeted Schedule of Cost of Goods
Manufactured and Sold 365
366

371

Participation in Setting Standards

373
374

Behavioral Impact of Budgets 375

Perfection versus Practical Standards: A


Behavioral Issue 408
Use of Standards by Service
Organizations 409
409
410
410

Standard Costs Given Actual Output

M.A.P. Parker Hannifin Corporation's Brass


Products Division 415

Multiple Types of Direct Material or Direct


Labor 415
Allowing for Spoilage or Defects
Significance of Cost Variances

Participative Budgeting

Behavioral Impact of Standard


Costing 479

376

Focus on Ethics: Is Padding the Budget


Unethical? 376
377

Review Problem on Preparing Master Budget


Schedules 377
Review Questions
Exercises 380
Problems

384

Cases 398

380

411

Analysis of Cost Variances 411

Budgetary Slack: Padding the


Budget 375

Key Terms 379

408

Direct-Labor Variances 413

M.A.P. Budget Administration at Cornell


University 373

Chapter Summary

407

Direct-Material Variances 411

372

International Aspects of Budgeting

407

407

Direct-Labor Standards

Assumptions and Predictions Underlying the


Master Budget 369

Budgeting Product Life-Cycle Costs

Setting Standards

Direct-Material Standards

Budgeted Balance Sheet 368

Budget Administration

Management by Exception

Cost Variance Analysis

Budgeted Statement of Cash


Flows 367

Financial Planning Models

406

Methods for Setting Standards

363

Budgeted Income Statement

Managing Costs

A Statistical Approach

415

476

418

Controllability of Variances

479

Interaction among Variances 420


Standard Costs and Product Costing

427

Evaluation of Standard Costing


Systems 422
Advantages of Standard Costing

422

Criticisms of Standard Costing in Today's


Manufacturing Environment 422
M.A.P. Cost of Ownership

424

xxix

Contents
Operational Performance Measures in Today's
Manufacturing Environment 424
Gain-Sharing Plans 427
The Balanced Scorecard 427
Lead and Lag Measures: The Key to the
Balanced Scorecard 430
Linking the Balanced Scorecard to
Organizational Strategy 431
M.A.P. Linking the Balanced Scorecard to
Organizational Strategy 432

Focus on Ethics: Sacrificing Quality to Cut


Standard Costs 434
Chapter Summary 434
Review Problems on Standard Costing and
Operational Performance Measures 435
Key Terms 437
Appendix to Chapter 10: Use of Standard
Costs for Product Costing 438
Review Questions 440
Exercises 440
>
Problems 443
Cases 454

11 Flexible Budgeting and the


Management of Overhead and Support
Activity Costs 458
Overhead Budgets

460

Flexible Budgets 461


Advantages of Flexible Budgets 461
The Activity Measure 462
Flexible Overhead Budget Illustrated 463
Formula Flexible Budget 463
Overhead Application in a Standard-Costing
System 465
Choice of Activity Measure 466
Criteria for Choosing the Activity
Measure 466
Cost Management Using Overhead Cost
Variances 467
Variable Overhead 468
Fixed Overhead 471

Overhead Cost Performance Report

473

M.A.P. Cost Management Systems in


Germany 474

Activity-Based Flexible Budget 474


Flexible Budgeting in the Service
Industry 476
Focus on Ethics: Misstated Standards Affect
Accuracy of Reports 478
Chapter Summary 479
Review Problem on Overhead Variances 480
Key Terms 487
Appendix A to Chapter 11: Standard Costs
and Product Costing 487
Appendix B to Chapter 11: Sales
Variances 483
Review Questions
Exercises 485
Problems 488
Cases 500

484

12 Responsibility Accounting, Quality


Control, and Environmental Cost
Management 504
Responsibility Centers

506

Illustration of Responsibility
Accounting 507
Performance Reports

570

Budgets, Variance Analysis, and


Responsibility Accounting 512
Cost Allocation 512
Cost Allocation Bases 512
Allocation Bases Based on Budgets
Activity-Based Responsibility
Accounting 514
Behavioral Effects of Responsibility
Accounting 574
Information versus Blame 514
Controllability 514
Motivating Desired Behavior 515

512

Contents

XXX

Segmented Reporting 575


Segments versus Segment Managers 516
Key Features of Segmented
Reporting 517
Customer-Profitability Analysis and ActivityBased Costing 517
Total Quality Management

578

Changing Views of Optimal Product


Quality 520
M.A.P. Six Sigma for Quality Management
and Cost Reduction 522

523

Environmental Cost Management

524

Classifying Environmental Costs 524


Managing Private Environmental
Costs 525
Environmental Cost Strategies

527

Tie-In to the Responsibility-Accounting


System 527
Focus on Ethics: Short-Sighted View of Cost
Cutting 527
Chapter Summary

528

Review Problem on Responsibility


Accounting 529
Key Terms 530
Review Questions

Return on Investment 550


Residual Income 552
Economic Value Added 555
M.A.P. Pay for Performance Based on
EVA 556

Measuring Income and Invested


Capital 557

Measuring and Reporting Quality


Costs 518

ISO 9000 Standards

Measuring Performance in Investment


Centers 550

537

Exercises 537
Problems 534
Cases 542

Invested Capital 557


Measuring Investment-Center
Income 560
Inflation: Historical-Cost versus CurrentValue Accounting 561
Other Issues in Segment Performance
Evaluation 567
Alternatives to ROI, Residual Income, and
Economic Value Added (EVA) 561
Importance of Nonfinancial
Information 562
Measuring Performance in Nonprofit
Organizations 562
Transfer Pricing 563
Goal Congruence

563

General Transfer-Pricing Rule 564


Transfers Based on the External Market
Price 567
Negotiated Transfer Prices 568
Cost-Based Transfer Prices 569
Standard versus Actual Costs 570
Undermining Divisional Autonomy 570
An International Perspective 570
M.A.P. Transfer Pricing and Tax Issues 571

Transfer Pricing in the Service


Industry 572
Behavioral Issues: Risk Aversion and
Incentives 572

13 Investment Centers and Transfer


Pricing 546
Delegation of Decision Making 548
Obtaining Goal Congruence: A Behavioral
Challenge 549
Adaptation of Management Control
Systems 549

Goal Congruence and Internal Control


Systems 573
Chapter Summary 574
Review Problems on Investment Centers
and Transfer Pricing 574
Key Terms 576
Review Questions
Exercises 576
Problems 579
Cases 585

576

xxxi

Contents

Focus on Ethics: Effects of Decision to Close a


Department and Outsource 67 7
Chapter Summary 678
Review Problem on Relevant Costs

678

Key Terms 679


Appendix to Chapter 14: Linear
Programming 620

14 Decision Making: Relevant Costs


and Benefits 590

Review Questions

The Managerial Accountant's Role in Decision


Making 592

Exercises

623

Problems

626

622

Cases 639

Steps in the Decision-Making Process 593


Quantitative versus Qualitative Analysis 593
Obtaining Information: Relevance, Accuracy,
and Timeliness 594
Relevant Information 595
Unique versus Repetitive Decisions

595

Importance of Identifying Relevant Costs


and Benefits 596 9
Identifying Relevant Costs and Benefits 596
Sunk Costs 596
Irrelevant Future Costs and Benefits
Opportunity Costs
Summary 600

599

599
,

Analysis of Special Decisions

600

Accept or Reject a Special Offer 600

Major Influences on Pricing Decisions


Customer Demand 645
Actions of Competitors 645
Costs 645

644

Political, Legal, and Image-Related


Issues 646

Outsource a Product or Service 602


M.A.P. Outsourcing

15 Target Costing and Cost Analysis for


Pricing Decisions 642

Economic Profit-Maximizing Pricing

603

646

Add or Drop a Service, Product, or


Department 605

Total Revenue, Demand, and Marginal


Revenue Curves 646

M.A.P. Adding a Service

Total Cost and Marginal Cost Curves 648


Profit-Maximizing Price and Quantity 648
Price Elasticity 651

607

Special Decisions in Manufacturing


Firms 607
Joint Products: Sell or Process Further 607
Decisions Involving Limited Resources 609
Uncertainty 611
Activity-Based Costing and Today's Advanced
Manufacturing Environment 672
Conventional Outsourcing (Make-or-Buy)
Analysis 613
Activity-Based Costing Analysis of the
Outsourcing Decision 614
Other Issues in Decision Making 675
Incentives for Decision Makers 615
Short-Run versus Long-Run Decisions
Pitfalls to Avoid 616

Limitations of the Profit-Maximizing


Model 651
Costs and Benefits of Information

Cost-Pius Pricing 652


Absorption-Cost Pricing Formulas 653
Variable-Cost Pricing Formulas 654
Determining the Markup 654
M.A.P. Price Competition and Cost
Management 656

616

651

Role of Accounting Product Costs in


Pricing 652

Cost-Pius Pricing: Summary and


Evaluation 656

Contents

xxxii

Strategic Pricing of New Products


Target Costing

657

657

M.A.P. Pricing on the Internet by


"e-Tailers" 658

A Strategic Profit and Cost Management


Process 658
Activity-Based Costing and Target
Costing 660
Product-Cost Distortion and Pricing:
The Role of Activity-Based Costing 660
Value Engineering and Target Costing 661
Time and Material Pricing 662
Competitive Bidding 664
Effect of Antitrust Laws on Pricing 666
Chapter Summary 667
Review Problem on Cost-Pius Pricing 668
Key Terms 669
Review Questions 670
Exercises 670
Problems 673
Cases 680

16 Capital Expenditure Decisions

684

Modified Accelerated Cost Recovery


System (MACRS) 701
Gains and Losses on Disposal 703
Investment in Working Capital 704
Extended Illustration of Income-Tax Effects
in Capital Budgeting 705
M.A.P. Capital Budgeting at Pharmaceutical
Firms 708

Ranking Investment Projects 709


Section 3: Alternative Methods for Making
Investment Decisions 770
Payback Method 711
Accounting-Rate-of-Return Method 712
Estimating Cash Flows: The Role of ActivityBased Costing 775
Justification of Investments in Advanced
Manufacturing Systems 775
Focus on Ethics: Dysfunctional Focus on Early
Cash Flows 776
Chapter Summary 778
Review Problems on Capital Expenditure
Decisions 779
Key Terms 720
Appendix A to Chapter 16: Future Value and
Present Value Tables 720
Appendix B to Chapter 16: Impact of
Inflation 722
Review Questions 725
Exercises 725
Problems 728
Cases 735

Section 1: Discounted-Cash-Flow Analysis 687


Net-Present-Value Method

688

Internal-Rate-of-Return Method

688

Comparing the NPV and IRR Methods

691

Assumptions Underlying Discounted-CashFlow Analysis 691


Choosing the Hurdle Rate 692
Depreciable Assets 693
Comparing Two Investment Projects 693
Managerial Accountant's Role 696
Postaudit

Section 1: Service Department Cost


Allocation 740

696

Real Option Analysis

697

Section 2: Income Taxes and Capital


Budgeting 697
After-Tax Cash Flows

697

Accelerated Depreciation

17 Allocation of Support Activity Costs


and Joint Costs 738

700

Direct Method 743


Step-Down Method 743
Reciprocal-Services Method 744
Fixed versus Variable Costs 745

Contents
M.A.P. Cost Management in the Health Care
Industry 747

Dual Cost Allocation 74 7


Allocate Budgeted Costs 748
Today's Advanced Manufacturing
Environment 749
The Rise of Activity-Based Costing 750
Section 2: Joint Product Cost Allocation 750
Allocating Joint Costs 751
M.A.P. Joint Cost Allocation in the Petroleum
Industry 752

Chapter Summary

753

Review Problem on Service Department Cost


Allocation 754
Key Terms 755
Appendix to Chapter 17: Reciprocal-Services
Method 755
Review Questions 757
Exercises

757

Problems

759

Cases 764

xxxiii

Appendix I: The Sarbanes-Oxley Act,


Internal Controls, and Management
Accounting 766
Appendix II: Compound Interest
and the Concept of Present
Value 772
Appendix III: Inventory
Management 780
References for "In Their Own
Words" 786
Glossary 789
Photo Credits

800

Index of Companies and


Organizations 801
Index of Subjects

803

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