Managerial Accounting
Managerial Accounting
Managerial Accounting
CHAPTER 1
Managerial Accounting:
An Overview
Managerial Accounting: Its More
Than Just Crunching Numbers
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Chapter 1
his chapter explains why managerial accounting is important to the future careers of all business students. It begins by answering two
questions: (1) What is managerial accounting? and (2) Why does managerial
accounting matter to your career? It concludes by discussing six topicsethics,
strategic management, enterprise risk management, corporate social responsibility, process management, and leadershipthat define the business context for applying the
quantitative aspects of managerial accounting.
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EXHIBIT 11
Comparison of Financial and
Managerial Accounting
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financial and managerial accounting is that financial accounting serves the needs of those
outside the organization, whereas managerial accounting serves the needs of managers employed inside the organization. Because of this fundamental difference in users,
financial accounting emphasizes the financial consequences of past activities, objectivity and verifiability, precision, and companywide performance, whereas managerial
accounting emphasizes decisions affecting the future, relevance, timeliness, and segment
performance. A segment is a part or activity of an organization about which managers
would like cost, revenue, or profit data. Examples of business segments include product
lines, customer groups (segmented by age, ethnicity, gender, volume of purchases, etc.),
geographic territories, divisions, plants, and departments. Finally, financial accounting
is mandatory for external reports and it needs to comply with rules, such as generally
accepted accounting principles (GAAP) and international financial reporting standards
(IFRS), whereas managerial accounting is not mandatory and it does not need to comply
with externally imposed rules.
As mentioned in Exhibit11, managerial accounting helps managers perform three
vital activitiesplanning, controlling, and decision making. Planning involves establishing goals and specifying how to achieve them. Controlling involves gathering feedback
to ensure that the plan is being properly executed or modified as circumstances change.
Decision making involves selecting a course of action from competing alternatives. Now
lets take a closer look at these three pillars of managerial accounting.
Planning
Assume that you work for Procter & Gamble (P&G) and that you are in charge of
the companys campus recruiting for all undergraduate business majors. In this example,
your planning process would begin by establishing a goal such as: our goal is to recruit
the best and brightest college graduates. The next stage of the planning process would
require specifying how to achieve this goal by answering numerous questions such as:
How many students do we need to hire in total and from each major?
What schools do we plan to include in our recruiting efforts?
Which of our employees will be involved in each schools recruiting activities?
When will we conduct our interviews?
How will we compare students to one another to decide who will be extended job offers?
What salary will we offer our new hires? Will the salaries differ by major?
How much money can we spend on our recruiting efforts?
As you can see, there are many questions that need to be answered as part of the planning process. Plans are often accompanied by a budget. A budget is a detailed plan for
the future that is usually expressed in formal quantitative terms. As the head of recruiting
at P&G, your budget would include two key components. First, you would have to work
with other senior managers inside the company to establish a budgeted amount of total
salaries that can be offered to all new hires. Second, you would have to create a budget
that quantifies how much you intend to spend on your campus recruiting activities.
Controlling
Once you established and started implementing P&Gs recruiting plan, you would transition to the control process. This process would involve gathering, evaluating, and
responding to feedback to ensure that this years recruiting process meets expectations.
It would also include evaluating the feedback in search of ways to run a more effective
recruiting campaign next year. The control process would involve answering questions
such as:
Did we succeed in hiring the planned number of students within each major and at
each school?
Did we lose too many exceptional candidates to competitors?
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Chapter 1
Did each of our employees involved in the recruiting process perform satisfactorily?
Is our method of comparing students to one another working?
Did the on-campus and office interviews run smoothly?
Did we stay within our budget in terms of total salary commitments to new hires?
Did we stay within our budget regarding spending on recruiting activities?
As you can see, there are many questions that need to be answered as part of the control process. When answering these questions your goal would be to go beyond simple
yes or no answers in search of the underlying reasons why performance exceeded or
failed to meet expectations. Part of the control process includes preparing performance
reports. A performance report compares budgeted data to actual data in an effort to
identify and learn from excellent performance and to identify and eliminate sources of
unsatisfactory performance. Performance reports can also be used as one of many inputs
to help evaluate and reward employees.
Although this example focused on P&Gs campus recruiting efforts, we could have
described how planning enables FedEx to deliver packages across the globe overnight,
or how it helped Apple develop and market the iPad. We could have discussed how the
control process helps Pfizer, Eli Lilly, and Abbott Laboratories ensure that their pharmaceutical drugs are produced in conformance with rigorous quality standards, or how
Kroger relies on the control process to keep its grocery shelves stocked. We also could
have looked at planning and control failures such as BPs massive oil spill in the Gulf of
Mexico. In short, all managers (and that probably includes you someday) perform planning and controlling activities.
Decision Making
Perhaps the most basic managerial skill is the ability to make intelligent, data-driven
decisions. Broadly speaking, many of those decisions revolve around the following
three questions. What should we be selling? Who should we be serving? How should we
execute? Exhibit 12 provides examples of decisions pertaining to each of these three
categories.
The left-hand column of Exhibit 12 suggests that every company must make
decisions related to the products and services that it sells. For example, each year
Procter & Gamble must decide how to allocate its marketing budget across 25 brands
that each generates over $1 billion in sales as well as other brands that have promising growth potential. Mattel must decide what new toys to introduce to the market. Southwest Airlines must decide what ticket prices to establish for each of its
EXHIBIT 12
Examples of Decisions
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thousands of flights per day. General Motors must decide whether to discontinue
certain models of automobiles.
The middle column of Exhibit 12 indicates that all companies must make decisions related to the customers that they serve. For example, Sears must decide how to
allocate its marketing budget between products that tend to appeal to male versus female
customers. FedEx must decide whether to expand its services into new markets across
the globe. Hewlett-Packard must decide what price discounts to offer corporate clients
that purchase large volumes of its products. A bank must decide whether to discontinue
customers that may be unprofitable.
The right-hand column of Exhibit 12 shows that companies also make decisions
related to how they execute. For example, Boeing must decide whether to rely on outside
vendors such as Goodrich, Saab, and Rolls-Royce to manufacture many of the parts
used to make its airplanes. Cintas must decide whether to expand its laundering and
cleaning capacity in a given geographic region by adding square footage to an existing
facility or by constructing an entirely new facility. In an economic downturn, a manufacturer might have to decide whether to eliminate one 8-hour shift at three plants or to close
one plant. Finally, all companies have to decide among competing improvement opportunities. For example, a company may have to decide whether to implement a new software
system, to upgrade a piece of equipment, or to provide extra training to its employees.
This portion of the chapter has explained that the three pillars of managerial accounting are planning, controlling, and decision making. This book helps prepare you to
become an effective manager by explaining how to make intelligent data-driven decisions, how to create financial plans for the future, and how to continually make progress
toward achieving goals by obtaining, evaluating, and responding to feedback.
Business Majors
Exhibit13 provides examples of how planning, controlling, and decision making affect
three majors other than accountingmarketing, supply chain management, and human
resource management.
The left-hand column of Exhibit 13 describes some planning, controlling, and
decision-making applications in the marketing profession. For example, marketing managers make planning decisions related to allocating advertising dollars across various
communication mediums and to staffing new sales territories. From a control standpoint, they may closely track sales data to see if a budgeted price cut is generating an
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Chapter 1
EXHIBIT 13
Relating Managerial Accounting
to Three Business Majors
Supply Chain
Management
Human Resource
Management
How many
salespeople should we
plan to hire to serve a
new territory?
Is our employee
retention rate
exceeding our
goals?
Are we accumulating
too much inventory
during the holiday
shopping season?
Should we transfer
production of a
component part to an
overseas supplier?
Should we hire an
on-site medical staff
to lower our health
care costs?
Should we redesign
our manufacturing
process to lower
inventory levels?
Should we hire
temporary workers
or full-time
employees?
Marketing
Planning
Decision
Making
anticipated increase in unit sales, or they may study inventory levels during the holiday
shopping season so that they can adjust prices as needed to optimize sales. Marketing managers also make many important decisions such as whether to bundle services
together and sell them for one price or to sell each service separately. They may also
decide whether to sell products directly to the customer or to sell to a distributor, who
then sells to the end consumer.
The middle column of Exhibit13 states that supply chain managers have to plan
how many units to produce to satisfy anticipated customer demand. They also need to
budget for operating expenses such as utilities, supplies, and labor costs. In terms of
control, they monitor actual spending relative to the budget, and closely watch operational measures such as the number of defects produced relative to the plan. Supply chain
managers make numerous decisions, such as deciding whether to transfer production of a
component part to an overseas supplier. They also decide whether to invest in redesigning
a manufacturing process to reduce inventory levels.
The right-hand column of Exhibit 13 explains how human resource managers
make a variety of planning decisions, such as budgeting how much to spend on occupational safety training and employee recruitment advertising. They monitor feedback
related to numerous management concerns, such as employee retention rates and the
timely completion of employee performance appraisals. They also help make many
important decisions such as whether to hire on-site medical staff in an effort to lower
health care costs, and whether to hire temporary workers or full-time employees in an
uncertain economy.
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For brevity, Exhibit13 does not include all business majors, such as finance, management information systems, and economics. Can you explain how planning, controlling, and decision-making activities would relate to these majors?
Accounting Majors
Many accounting graduates begin their careers working for public accounting firms that
provide a variety of valuable services for their clients. Some of these graduates will build
successful and fulfilling careers in the public accounting industry; however, most will leave
public accounting at some point to work in other organizations. In fact, the Institute of
Management Accountants (IMA) estimates that more than 80% of professional accountants in the United States work in nonpublic accounting environments (www.imanet.org/
about_ima/our_mission.aspx).
The public accounting profession has a strong financial accounting orientation. Its
most important function is to protect investors and other external parties by assuring
them that companies are reporting historical financial results that comply with applicable
accounting rules. Managerial accountants also have strong financial accounting skills.
For example, they play an important role in helping their organizations design and maintain financial reporting systems that generate reliable financial disclosures. However, the
primary role of managerial accountants is to partner with their co-workers within the
organization to improve performance.
Given the 80% figure mentioned above, if you are an accounting major there is a
very high likelihood that your future will involve working for a nonpublic accounting
employer. Your employer will expect you to have strong financial accounting skills, but
more importantly, it will expect you to help improve organizational performance by
applying the planning, controlling, and decision-making skills that are the foundation of
managerial accounting.
A NETWORKING OPPORTUNITY
IN BUSINESS
The Institute of Management Accountants (IMA) is a network of more than 60,000 accounting and
finance professionals from over 120 countries. Every year the IMA hosts a student leadership
conference that attracts 300 students from over 50 colleges and universities. Guest speakers at
past conferences have discussed topics such as leadership, advice for a successful career, how
to market yourself in a difficult economy, and excelling in todays multigenerational workforce. One
student who attended the conference said, I liked that I was able to interact with professionals who
are in fields that could be potential career paths for me. For more information on this worthwhile
networking opportunity, contact the IMA at the phone number and website shown below.
Source: Conversation with Jodi Ryan, the Institute of Management Accountants Director, Education/Corporate
Partnerships. (201) 474-1556 or visit its website at www.imanet.org.
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Chapter 1
EXHIBIT 14
CMA Exam Content
Specifications
IN BUSINESS
Part 1
Part 2
ADD
SUBTRACT
TIMES
ADD
ADD
ADD
$75,807
$28,000
$25,995
$ 700
$13,873
$11,126
$10,193
$75,807
For example, if you make it to top-level management in 10 years, have an advanced degree and a
CMA, your estimated salary would be $135,806 [$75,8071$28,0001(103700)1$13,8731
$11,126].
Source: Lee Schiffel, David L. Schroeder, and Kenneth A. Smith, IMA 2011 Salary Survey, Strategic Finance
June 2012, pp. 2947.
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Chapter Number
Chapter 2
Chapters 3 & 4
Chapter 5
Chapter 6
Chapter 7
Chapter 8
Chapters 9 & 10
Chapter 11
Chapter 12
Chapter 13
Chapter 14
Chapter 15
EXHIBIT 15
Measurement Skills:
AManagers Perspective
An Ethics Perspective
Ethical behavior is the lubricant that keeps the economy running. Without that lubricant,
the economy would operate much less efficientlyless would be available to consumers,
quality would be lower, and prices would be higher. In other words, without fundamental
trust in the integrity of business, the economy would operate much less efficiently. Thus,
for the good of everyoneincluding profit-making companiesit is vitally important
that business be conducted within an ethical framework that builds and sustains trust.
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Chapter 1
EXHIBIT 16
IMA Statement of Ethical Professional Practice
Members of IMA shall behave ethically. A commitment to ethical professional practice includes: overarching principles that express our values, and standards that guide our conduct.
PRINCIPLES
IMAs overarching ethical principles include: Honesty, Fairness, Objectivity, and Responsibility. Members shall act in
accordance with these principles and shall encourage others within their organizations to adhere to them.
STANDARDS
A members failure to comply with the following standards may result in disciplinary action.
I. COMPETENCE
Each member has a responsibility to:
1. Maintain an appropriate level of professional expertise by continually developing knowledge and skills.
2. Perform professional duties in accordance with relevant laws, regulations, and technical standards.
3. Provide decision support information and recommendations that are accurate, clear, concise, and timely.
4. Recognize and communicate professional limitations or other constraints that would preclude responsible judgment or successful performance of an activity.
II. CONFIDENTIALITY
Each member has a responsibility to:
1. Keep information confidential except when disclosure is authorized or legally required.
2. Inform all relevant parties regarding appropriate use of confidential information. Monitor subordinates activities
to ensure compliance.
3. Refrain from using confidential information for unethical or illegal advantage.
III. INTEGRITY
Each member has a responsibility to:
1. Mitigate actual conflicts of interest. Regularly communicate with business associates to avoid apparent conflicts of interest. Advise all parties of any potential conflicts.
2. Refrain from engaging in any conduct that would prejudice carrying out duties ethically.
3. Abstain from engaging in or supporting any activity that might discredit the profession.
IV. CREDIBILITY
Each member has a responsibility to:
1. Communicate information fairly and objectively.
2. Disclose all relevant information that could reasonably be expected to influence an intended users understanding of the reports, analyses, or recommendations.
3. Disclose delays or deficiencies in information, timeliness, processing, or internal controls in conformance with
organization policy and/or applicable law.
RESOLUTION OF ETHICAL CONFLICT
In applying the Standards of Ethical Professional Practice, you may encounter problems identifying unethical
behavior or resolving an ethical conflict. When faced with ethical issues, you should follow your organizations
established policies on the resolution of such conflict. If these policies do not resolve the ethical conflict, you should
consider the following courses of action:
1. Discuss the issue with your immediate supervisor except when it appears that the supervisor is involved. In
that case, present the issue to the next level. If you cannot achieve a satisfactory resolution, submit the issue to
the next management level. If your immediate superior is the chief executive officer or equivalent, the acceptable reviewing authority may be a group such as the audit committee, executive committee, board of directors,
board of trustees, or owners. Contact with levels above the immediate superior should be initiated only with
your superiors knowledge, assuming he or she is not involved. Communication of such problems to authorities
or individuals not employed or engaged by the organization is not considered appropriate, unless you believe
there is a clear violation of the law.
2. Clarify relevant ethical issues by initiating a confidential discussion with an IMA Ethics Counselor or other
impartial advisor to obtain a better understanding of possible courses of action.
3. Consult your own attorney as to legal obligations and rights concerning the ethical conflict.
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11
IN BUSINESS
When Toyota Motor Corporation failed to meet its profit targets, the company set an aggressive
goal of reducing the cost of its auto parts by 30%. The quality and safety of the companys automobiles eventually suffered mightily resulting in recalls, litigation, incentive campaigns, and marketing
efforts that analysts estimate will cost the company more than $5 billion. The car makers president, Akio Toyoda, blamed his companys massive quality lapses on an excessive focus on profits
and market share. Similarly, Jim Press, Toyotas former top U.S. executive, said the problems were
caused by financially-oriented pirates who didnt have the character to maintain a customer-first
focus.
Sources: Yoshio Takahashi, Toyota Accelerates Its Cost-Cutting Efforts, The Wall Street Journal, December
23, 2009, p. B4; Mariko Sanchanta and Yoshio Takahashi, Toyotas Recall May Top $5 Billion, The Wall Street
Journal, March 10, 2010, p. B2; and Norihiko Shirouzu, Toyoda Rues Excessive Profit Focus, The Wall Street
Journal, March 2, 2010, p. B3.
the economy and all of us would suffer. Consider the following specific examples of
the consequences of not abiding by the standards:
Suppose employees could not be trusted with confidential information. Then top
managers would be reluctant to distribute such information within the company
and, as a result, decisions would be based on incomplete information and operations
would deteriorate.
Suppose employees accepted bribes from suppliers. Then contracts would tend to
go to the suppliers who pay the highest bribes rather than to the most competent
suppliers. Would you like to fly in aircraft whose wings were made by the subcontractor who paid the highest bribe? Would you fly as often? What would happen to
the airline industry if its safety record deteriorated due to shoddy workmanship on
contracted parts and subassemblies?
Suppose the presidents of companies routinely lied in their annual reports and financial statements. If investors could not rely on the basic integrity of a companys
financial statements, they would have little basis for making informed decisions.
Suspecting the worst, rational investors would pay less for securities issued by companies and may not be willing to invest at all. As a consequence, companies would
have less money for productive investmentsleading to slower economic growth,
fewer goods and services, and higher prices.
Not only is ethical behavior the lubricant for our economy, it is the foundation of
managerial accounting. The numbers that managers rely on for planning, control, and
decision making are meaningless unless they have been competently, objectively, and
honestly gathered, analyzed, and reported. As your career unfolds, you will inevitably
face decisions with ethical implications. Before making such decisions, consider performing the following steps. First, define your alternative courses of action. Second,
identify all of the parties that will be affected by your decision. Third, define how each
course of action will favorably or unfavorably impact each affected party. Once you have
a complete understanding of the decision context, seek guidance from external sources
such as the IMA Statement of Ethical Professional Practice, the IMA Ethics Helpline at
(800) 245-1383, or a trusted confidant. Before executing your decision ask yourself one
final questionwould I be comfortable disclosing my chosen course of action on the
front page of The Wall Street Journal?
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Chapter 1
point of a companys strategy should be its target customers. A company can only succeed
if it creates a reason for its target 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 categoriescustomer
intimacy, operational excellence, and product leadership. Companies that adopt a customer intimacy strategy are in essence saying to their customers, You should choose us
because we can customize our products and services to meet your individual needs better than our competitors. Ritz-Carlton, Nordstrom, and Virtuoso (a premium service
travel agency) 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 deliver
products and services faster, more conveniently, and at a lower price than our competitors. Southwest Airlines, Walmart, and Google 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. Apple, Cisco Systems, and W.L. Gore (the creator of GORE-TEX fabrics) are
examples of companies that succeed because of their product leadership.1
The plans managers set forth, the variables they seek to control, and the decisions
they make are all influenced by their companys strategy. For example, Walmart would
not make plans to build ultra-expensive clothing boutiques because these plans would
conflict with the companys strategy of operational excellence and everyday low prices.
Apple would not seek to control its operations by selecting performance measures that
focus solely on cost-cutting because those measures would conflict with its product
leadership customer value proposition. Finally, it is unlikely that Rolex would decide to
implement drastic price reductions for its watches even if a financial analysis indicated
that establishing a lower price might boost short-run profits. Rolex would oppose this
course of action because it would diminish the luxury brand that forms the foundation of
the companys product leadership customer value proposition.
IN BUSINESS
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. 8493.
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A website malfunctioning
A poorly designed incentive compensation system causing employees to make bad decisions
Financial statements inaccurately
reporting the value of inventory
An employee accessing
unauthorized information
13
EXHIBIT 17
Identifying and Controlling
Business Risks
with the law, employee theft, and products harming customers. The right-hand column of
Exhibit17 provides an example of a control that could be implemented to help reduce
each of the risks mentioned in the left-hand column of the exhibit.2 Although these
types of controls cannot completely eliminate risks, they enable companies to proactively manage their risks rather than passively reacting to unfortunate events that have
alreadyoccurred.
In managerial accounting, companies use controls to reduce the risk that their plans
will not be achieved. For example, if a company plans to build a new manufacturing
facility within a predefined budget and time frame, it will establish and monitor control
measures to ensure that the project is concluded on time and within the budget. Risk
management is also a critically important aspect of decision making. For example, when
a company quantifies the labor cost savings that it can realize by sending jobs overseas, it
should complement its financial analysis with a prudent assessment of the accompanying
2
Besides using controls to reduce risks, companies can also chose other risk responses, such as accepting or avoiding a risk.
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14
Chapter 1
IN BUSINESS
risks. Will the overseas manufacturer use child labor? Will the products quality decline,
thereby leading to more warranty repairs, customer complaints, and lawsuits? Will the
elapsed time from customer order to delivery dramatically increase? Will terminating
domestic employees diminish morale within the company and harm perceptions within
the community? These are the types of risks that managers should incorporate into their
decision-making processes.
Many of the examples in Exhibit 18 were drawn from Terry Leap and Misty L. Loughry, The
Stakeholder-Friendly Firm, Business Horizons, March/April 2004, pp. 2732.
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15
EXHIBIT 18
Examples of Corporate Social
Responsibilities
IN BUSINESS
When Nestl purchased palm oil from an Indonesian supplier to manufacture Kit-Kat candy bars
Greenpeace International used social media to express its disapproval. Greenpeace claimed that
the Indonesian company destroyed rainforest to create its palm oil plantation; therefore, Nestls
actions were contributing to global warming and endangering orangutans. Greenpeace posted
YouTube videos, added comments to Nestls Facebook page, and sent Twitter Tweets to communicate its message to supporters. At one point, the number of fans on Nestls Facebook page
grew to 95,000, most of them being protesters. Nestl terminated its relationship with the supplier, which provided 1.25% of Nestls palm oil needs. A Nestl spokesperson says the difficulty
in responding to social media is to show that we are listening, which we obviously are, while not
getting involved in a shouting match.
Source: Emily Steel, Nestl Takes a Beating on Social-Media Sites, The Wall Street Journal, March 29, 2010, p. B5.
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16
Chapter 1
EXHIBIT 19
Business Functions Making Up
the Value Chain
Research
and
Development
Product
Design
Manufacturing
Marketing
Distribution
Customer
Service
IN BUSINESS
A Leadership Perspective
An organizations employees bring diverse needs, beliefs, and goals to the workplace.
Therefore, an important role for organizational leaders is to unite the behaviors of their
fellow employees around two common themespursuing strategic goals and making
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17
optimal decisions. To fulfill this responsibility, leaders need to understand how intrinsic
motivation, extrinsic incentives, and cognitive bias influence human behavior.
Cognitive Bias Leaders need to be aware that all people (including themselves)
possess cognitive biases, or distorted thought processes, that can adversely affect planning, controlling, and decision making. To illustrate how cognitive bias works, lets consider the scenario of a television infomercial where someone is selling a product with
a proclaimed value of $200 for $19.99 if viewers call within the next 30 minutes. Why
do you think the seller claims that the product has a $200 value? The seller is relying on
a cognitive bias called anchoring bias in an effort to convince viewers that a $180 discount is simply too good to pass up. The anchor is the false assertion that the product
is actually worth $200. If viewers erroneously attach credibility to this contrived piece of
information, their distorted analysis of the situation may cause them to spend $19.99 on
an item whose true economic value is much less than that amount.
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Chapter 1
While cognitive biases cannot be eliminated, effective leaders should take two steps
to reduce their negative impacts. First, they should acknowledge their own susceptibility to cognitive bias. For example, a leaders judgment might be clouded by optimism
bias (being overly optimistic in assessing the likelihood of future outcomes) or selfenhancement bias (overestimating ones strengths and underestimating ones weaknesses
relative to others). Second, they should acknowledge the presence of cognitive bias in
others and introduce techniques to minimize their adverse consequences. For example,
to reduce the risks of confirmation bias (a bias where people pay greater attention to
information that confirms their preconceived notions, while devaluing information that
contradicts them) or groupthink bias (a bias where some group members support a course
of action solely because other group members do), a leader may routinely appoint independent teams of employees to assess the credibility of recommendations set forth by
other individuals and groups.
Summary
This chapter defined managerial accounting and explained why it is relevant to business and
accounting majors. It also discussed six topicsethics, strategic management, enterprise risk
management, corporate social responsibility, process management, and leadershipthat define
the context for applying the quantitative aspects of managerial accounting. The most important
goal of this chapter was to help you understand that managerial accounting matters to your future
career regardless of your major. Accounting is the language of business and youll need to speak it
to communicate effectively with and influence fellow managers.
Glossary
Budget A detailed plan for the future that is usually expressed in formal quantitative terms. (p. 3)
Business process A series of steps that are followed in order to carry out some task in a
business. (p. 15)
Controlling The process of gathering feedback to ensure that a plan is being properly executed or
modified as circumstances change. (p. 3)
Corporate social responsibility A concept whereby organizations consider the needs of all stakeholders when making decisions. (p. 14)
Decision making Selecting a course of action from competing alternatives. (p. 3)
Enterprise risk management A process used by a company to identify its risks and develop
responses to them that enable it to be reasonably assured of meeting its goals. (p. 12)
Financial accounting The phase of accounting that is concerned with reporting historical financial information to external parties, such as stockholders, creditors, and regulators. (p. 2)
Lean Production A management approach that organizes resources such as people and machines
around the flow of business processes and that only produces units in response to customer
orders. (p. 16)
Managerial accounting The phase of accounting that is concerned with providing information to
managers for use within the organization. (p. 2)
Performance report A report that compares budgeted data to actual data to highlight instances of
excellent and unsatisfactory performance. (p. 4)
Planning The process of establishing goals and specifying how to achieve them. (p. 3)
Segment A part or activity of an organization about which managers would like cost, revenue, or
profit data. (p. 3)
Strategy A companys game plan for attracting customers by distinguishing itself from competitors. (p. 11)
Value chain The major business functions that add value to a companys products and services,
such as research and development, product design, manufacturing, marketing, distribution,
and customer service. (p. 15)
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19
Questions
11
12
13
14
15
16
17
18
19
110
111
112
113
114
115
Exercises
For this chapter, LearnSmart and Interactive Presentations are available with
McGraw-Hills Connect Accounting.
EXERCISE 11 Planning and Control
Many companies use budgets for three purposes. First, they use them to plan how to deploy resources to
best serve customers. Second, they use them to establish challenging goals, or stretch targets, to motivate
employees to strive for exceptional results. Third, they use them to evaluate and reward employees.
Assume that you are a sales manager working with your boss to create a sales budget for next
year. Once the sales budget is established, it will influence how other departments within the company plan to deploy their resources. For example, the manufacturing manager will plan to produce
enough units to meet budgeted unit sales. The sales budget will also be instrumental in determining
your pay raise, potential for promotion, and bonus. If actual sales exceed the sales budget, it bodes
well for your career. If actual sales are less than budgeted sales, it will diminish your financial
compensation and potential for promotion.
Required:
1.
2.
3.
4.
5.
6.
Do you think it would be appropriate for your boss to establish the sales budget without any
input from you? Why?
Do you think the company would be comfortable with allowing you to establish the sales
budget without any input from your boss? Why?
Assume the company uses its sales budget for only one purposeplanning to deploy resources
in a manner that best serves customers. What thoughts would influence your estimate of future
sales as well as your bosss estimate of future sales?
Assume the company uses its sales budget for only one purposemotivating employees to
strive for exceptional results. What thoughts would influence your estimate of future sales as
well as your bosss estimate of future sales?
Assume the company uses its sales budget for only one purposeto determine your pay raise,
potential for promotion, and bonus. What thoughts would influence your estimate of future
sales as well as your bosss estimate of future sales?
Assume the sales budget is used for all three purposes described in questions 35. Describe any
conflicts or complications that might arise when using the sales budget for these three purposes.
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Chapter 1
EXERCISE 12 Controlling
Assume that you work for an airline unloading luggage from airplanes. Your boss has said that,
on average, each airplane contains 100 pieces of luggage. Furthermore, your boss has stated that
you should be able to unload 100 pieces of luggage from an airplane in 10 minutes. Today an airplane arrived with 150 pieces of luggage and you unloaded all of it in 13 minutes. After finishing
with the 150 pieces of luggage, your boss yelled at you for exceeding the 10 minute allowance for
unloading luggage from an airplane.
Required:
How would you feel about being yelled at for taking 13 minutes to unload 150 pieces of luggage?
How does this scenario relate to the larger issue of how companies design control systems?
EXERCISE 13 Decision Making
Exhibit 12 (see page 4) includes 12 questions related to 12 types of decisions that companies
often face. In the chapter, these 12 decisions were discussed within the context of for-profit companies; however, they are also readily applicable to nonprofit organizations. To illustrate this point,
assume that you are a senior leader, such as a president, provost, or dean, in a university setting.
Required:
For each of the 12 decisions in Exhibit12, provide an example of how that type of decision might
be applicable to a university setting.
EXERCISE 14 Ethics and the Manager
Richmond, Inc., operates a chain of 44 department stores. Two years ago, the board of directors of
Richmond approved a large-scale remodeling of its stores to attract a more upscale clientele.
Before finalizing these plans, two stores were remodeled as a test. Linda Perlman, assistant
controller, was asked to oversee the financial reporting for these test stores, and she and other
management personnel were offered bonuses based on the sales growth and profitability of these
stores. While completing the financial reports, Perlman discovered a sizable inventory of outdated
goods that should have been discounted for sale or returned to the manufacturer. She discussed the
situation with her management colleagues; the consensus was to ignore reporting this inventory as
obsolete because reporting it would diminish the financial results and their bonuses.
Required:
1.
2.
According to the IMAs Statement of Ethical Professional Practice, would it be ethical for
Perlman not to report the inventory as obsolete?
Would it be easy for Perlman to take the ethical action in this situation?
(CMA, adapted)
EXERCISE 15 Strategy
For each company, categorize its strategy as being focused on customer intimacy, operational
excellence, or product leadership. If you wish to improve your understanding of each companys
customer value proposition before completing the exercise, review its most recent annual report.
To obtain electronic access to this information, perform an Internet search on each companys
name followed by the words annual report.
Company
1.
2.
3.
4.
5.
6.
Deere . . . . . . . . . . . . . . . . . . . . .
FedEx . . . . . . . . . . . . . . . . . . . . .
State Farm Insurance . . . . . . . . .
BMW . . . . . . . . . . . . . . . . . . . . .
Amazon.com . . . . . . . . . . . . . . .
Charles Schwab . . . . . . . . . . . . .
Strategy
?
?
?
?
?
?
For each industry, identify one important risk faced by the companies that compete within that industry. Also, describe one control that companies could use to reduce the risk that you have identified.
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Industry
1.
2.
3.
4.
5.
6.
7.
Type of Risk
21
Control to
Reduce the Risk
Consumers and attorney generals in more than 40 states accused a prominent nationwide chain of
auto repair shops of misleading customers and selling them unnecessary parts and services, from
brake jobs to front-end alignments. Lynn Sharpe Paine reported the situation as follows in Managing for Organizational Integrity, Harvard Business Review, Volume 72 Issue 3:
In the face of declining revenues, shrinking market share, and an increasingly competitive
market ... management attempted to spur performance of its auto centers.... The automotive service advisers were given product-specific sales quotassell so many springs, shock
absorbers, alignments, or brake jobs per shiftand paid a commission based on sales....
[F]ailure to meet quotas could lead to a transfer or a reduction in work hours. Some employees spoke of the pressure, pressure, pressure to bring in sales.
This pressure-cooker atmosphere created conditions under which employees felt that the
only way to satisfy top management was by selling products and services to customers that
they didnt really need.
Suppose all automotive repair businesses routinely followed the practice of attempting to sell
customers unnecessary parts and services.
Required:
1.
2.
How would this behavior affect customers? How might customers attempt to protect themselves against this behavior?
How would this behavior probably affect profits and employment in the automotive service
industry?
In the 1970s, one million college-bound students were surveyed and asked to compare themselves
to their peers. Some of the key findings of the survey were as follows:
a. 70% of the students rated themselves as above average in leadership ability, while only 2%
rated themselves as below average in this regard.
b. With respect to athletic skills, 60% of the students rated their skills as above the median and
only 6% of students rated themselves as below the median.
c. 60% of the students rated themselves in the top 10% in terms of their ability to get along with
others, while 25% of the students felt that they were in the top 1% in terms of this interpersonal skill.
Required:
What type of cognitive bias reveals itself in the data mentioned above? How might this cognitive
bias adversely influence a managers planning, controlling, and decision-making activities? What
steps could managers take to reduce the possibility that this cognitive bias would adversely influence their actions?
Source: Dan Lovallo and Daniel Kahneman, Delusions of Success: How Optimism Undermines
Executives Decisions, Harvard Business Review, July 2003, pp. 5663.
EXERCISE 19 Ethics and Decision Making
Assume that you are the chairman of the Department of Accountancy at Mountain State University.
One of the accounting professors in your department, Dr. Candler, has been consistently and uniformly regarded by students as an awful teacher for more than 10 years. Other accounting professors within your department have observed Dr. Candlers classroom teaching and they concur that
his teaching skills are very poor. However, Dr. Candler was granted tenure 12 years ago, thereby
ensuring him life-long job security at Mountain State University.
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Chapter 1
Much to your surprise, today you received a phone from an accounting professor at Oregon
Coastal University. During this phone call you are informed that Oregon Coastal University is on
the verge of making a job offer to Dr. Candler. However, before extending the job offer, the faculty
at Oregon Coastal wants your input regarding Dr. Candlers teaching effectiveness while at Mountain State University.
Required:
How would you respond to the professor from Oregon Coastal University? What would you say
about Dr. Candlers teaching ability? Would you describe your answer to this inquiry as being ethical? Why?
EXERCISE 110 Corporate Social Responsbility
In his book Capitalism and Freedom, economist Milton Friedman wrote on page 133: There is
one and only one social responsibility of businessto use its resources and engage in activities
designed to increase its profits so long as it ... engages in open and free competition, without
deception or fraud.
Required:
In a Harvard Business Review article titled Why Incentive Plans Cannot Work, (Volume 71, Issue5)
author Alfie Kohn wrote: Research suggests that, by and large, rewards succeed at securing one
thing only: temporary compliance. When it comes to producing lasting change in attitudes and
behavior, however, rewards, like punishment, are strikingly ineffective. Once the rewards run out,
people revert to their old behaviors.... Incentives, a version of what psychologists call extrinsic
motivators, do not alter the attitudes that underlie our behaviors. They do not create an enduring commitment to any value or action. Rather, incentives merelyand temporarilychange what we do.
Required:
1.
2.
3.
During World War II, the U.S. military was studying its combat-tested fighter planes to determine
the parts of the plane that were most vulnerable to enemy fire. The purpose of the study was to
identify the most vulnerable sections of each plane and then take steps to reinforce those sections
to improve pilot safety and airplane durability. The data gathered by the U.S. military showed that
certain sections of its combat-tested fighter planes were consistently hit more often with enemy
fire than other sections of the plane.
Required:
1.
2.
Would you recommend reinforcing the sections of the plane that were hit most often by enemy
fire, or would you reinforce the sections that were hit less frequently by enemy fire? Why?
Do you think cognitive bias had the potential to influence the U.S. militarys decision-making
process with respect to reinforcing its fighter planes?
Source: Jerker Denrell, Selection Bias and the Perils of Benchmarking, Harvard Business
Review, Volume 83, Issue 4, pp. 114119.
EXERCISE 113 Ethics and Decision Making
Assume that you just completed a December weekend vacation to a casino within the United
States. During your trip you won $10,000 gambling. When the casino exchanged your chips for
cash they did not record any personal information, such as your drivers license number or social
security number. Four months later while preparing your tax returns for the prior year, you stop to
contemplate the fact that the Internal Revenue Service requires taxpayers to report all gambling
winnings on Form 1040.
Required:
Would you report your gambling winnings to the Internal Revenue Service so that you could pay
federal income taxes on those winnings? Do you believe that your actions are ethical? Why?
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This definition of corporate governance was adapted from the 2004 report titled OECD Principles of
Corporate Governance published by the Organization for Economic Co-Operation and Development.
2
A summary of the Sarbanes-Oxley Act of 2002 can be obtained at www.soxlaw.com.
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Chapter 1
responsibility to establish and maintain adequate internal controls and it must contain
an assessment by management of the effectiveness of its internal control structure. The
internal control report is accompanied by an opinion from the companys audit firm
as to whether management has maintained effective internal control over its financial
reporting process.
Finally, the Act establishes severe penalties of as many as 20 years in prison for
altering or destroying any documents that may eventually be used in an official proceeding and as many as 10 years in prison for managers who retaliate against a so-called
whistle-blower who goes outside the chain of command to report misconduct. Collectively, these six aspects of the Sarbanes-Oxley Act of 2002 were intended to help reduce
the incidence of fraudulent financial reporting.
Companies also use internal controls to achieve efficient and effective operations and to ensure compliance with applicable laws and regulations.
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Type of Control
Classification
Description
Authorizations
Preventive
Reconciliations
Detective
Segregation of
duties
Preventive
Physical
safeguards
Preventive
Performance
reviews
Detective
Maintaining
records
Detective
Information
systems
security
Preventive/Detective
25
EXHIBIT 1A1
Types of Internal Controls
forFinancial Reporting
by employees in supervisory positions to ensure that actual results are reasonable when
compared to relevant benchmarks. If actual results unexpectedly deviate from expectations, then it triggers further analysis to determine the root cause of the deviation. Companies maintain records to provide evidence that supports each transaction. For example,
companies use serially numbered checks so that they can readily track all of their cash
disbursements. Finally, companies use passwords (a preventive control) and access logs
(a detective control) to restrict electronic data access as appropriate.
It is important to understand that internal controls cannot guarantee that objectives
will be achieved. For example, a person can regularly exercise and eat healthy foods, but
this does not guarantee that they will live to a certain age. Similarly, an effective internal control system can provide reasonable assurance that financial statement disclosures
are reliable, but it cannot offer guarantees because even a well-designed internal control
system can break down. Furthermore, two or more employees may collude to circumvent
the control system. Finally, a companys senior leaders may manipulate financial results
by intentionally overriding prescribed policies and procedures. This reality highlights the
importance of having senior leaders (including the chief executive officer, the chief financial officer, and the audit committee of the board of directors) who value the importance
of effective internal controls and are committed to creating an ethical tone at the top of
the organization.
Glossary
Corporate governance The system by which a company is directed and controlled. (p. 23)
Detective control A control that detects undesirable events that have already occurred. (p. 24)
Internal control A process designed to provide reasonable assurance that objectives are being
achieved. (p. 24)
Preventive control A control that deters undesirable events from occurring. (p. 24)
Sarbanes-Oxley Act of 2002 A law intended to protect the interests of those who invest in publicly traded companies by improving the reliability and accuracy of corporate financial reports
and discloures. (p. 23)
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Chapter 1
Questions
1A1 Imagine that you are the head coach of a college sports team. One of your most important objectives is to win as many games as possible. Describe some controls that you
would implement to help achieve the objective of winning as many games as possible.
1A2 Perhaps your most important post-graduation objective is to get a job. Describe some
control activities that you would pursue to help achieve this objective.
1A3 Describe some controls that parents use to keep their homes safe for themselves and
their children.
1A4 Many retail companies experience customer and employee theft (or what is referred to as
shrinkage) that equals 1%2% of their total sales. For a company such as Walmart, this
seemingly small percentage of total sales translates to billions of dollars. What types of
internal controls might Walmart use to reduce its shrinkage?
1A5 If you were a restaurant owner, what internal controls would you implement to help
maintain control of your cash?
1A6 As a form of internal control, what documents would you review prior to paying an
invoice received from a supplier?
1A7 What internal controls would you implement to help maintain control of your credit
sales and accounts receivable?
1A8 Why do companies take a physical count of their inventory on hand at least once per year?
1A9 Why do companies use sequential prenumbering for documents such as checks, sales
invoices, and purchase orders?
1A10 How can an annual budget function as a form of internal control?
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