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Page 1: Introduction Chapter One 1 - 3 McGraw-Hill/Irwin Accounting for Decision Making and Control, 5/e © 2006 The McGraw-Hill Companies, Inc., All Rights Reserved
Page 2: Introduction Chapter One 1 - 3 McGraw-Hill/Irwin Accounting for Decision Making and Control, 5/e © 2006 The McGraw-Hill Companies, Inc., All Rights Reserved

Introduction

Chapter One

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McGraw-Hill/IrwinAccounting for Decision Making and Control, 5/e

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Outline of Chapter 1 Introduction

• Managerial Accounting: Decision Making and Control• Design and Use of Cost Systems • Marmots and Grizzly Bears • Management Accountant’s Role in the Organization • Evolution of Management Accounting: A Framework for

Change • Vortec Medical Probe Example • Outline of the Text

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McGraw-Hill/IrwinAccounting for Decision Making and Control, 5/e

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Decision Making - Product Management

Examples• Add new product• Terminate an existing product line• Accept or reject special order

Related Topics• Operations management• Budgeting - capital and operating• Just-in-time (JIT)

Page 5: Introduction Chapter One 1 - 3 McGraw-Hill/Irwin Accounting for Decision Making and Control, 5/e © 2006 The McGraw-Hill Companies, Inc., All Rights Reserved

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Decision Making - Pricing

Examples• Set selling price to achieve desired profits• Set selling price to achieve positive cash flow

Related Topics • Marketing• Microeconomics - Price Theory• Corporate Finance

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McGraw-Hill/IrwinAccounting for Decision Making and Control, 5/e

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Decision Making - Cost Control

Examples• Add new equipment• Change production process• Make internally versus buy externally (outsource)

Related Topics• Process engineering• Management information systems• Activity-based costing (ABC)

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McGraw-Hill/IrwinAccounting for Decision Making and Control, 5/e

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Control - Incentives

Assumptions• Individuals maximize their own self-interest• Owners of firm want to maximize firm value• Maximizing firm profits maximizes firm value

Incentives• Design performance incentives based on internal accounting

measures to motivate employees to take actions that will maximize firm value

Page 8: Introduction Chapter One 1 - 3 McGraw-Hill/Irwin Accounting for Decision Making and Control, 5/e © 2006 The McGraw-Hill Companies, Inc., All Rights Reserved

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Control - Performance Evaluation

Examples• Performance bonuses depend on accounting results• Benchmarking: comparisons to industry leaders

Related Topics• Organizational behavior• Human resources management

Page 9: Introduction Chapter One 1 - 3 McGraw-Hill/Irwin Accounting for Decision Making and Control, 5/e © 2006 The McGraw-Hill Companies, Inc., All Rights Reserved

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McGraw-Hill/IrwinAccounting for Decision Making and Control, 5/e

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Acronyms – Understanding the Practicality and Applicability of these

Concepts Matters

• ABC – Activity-based cost systems• CAM – Computer-aided manufacturing• EDI – Electronic Data Interchange• ERP – Enterprise Resource Planning• JIT – Just-in-time• TQM – Total quality management

Page 10: Introduction Chapter One 1 - 3 McGraw-Hill/Irwin Accounting for Decision Making and Control, 5/e © 2006 The McGraw-Hill Companies, Inc., All Rights Reserved

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McGraw-Hill/IrwinAccounting for Decision Making and Control, 5/e

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Design - Multiple Role of Accounting

Study Figure 1-1.

Main point: Accounting reports are used for multiple purposes.

Page 11: Introduction Chapter One 1 - 3 McGraw-Hill/Irwin Accounting for Decision Making and Control, 5/e © 2006 The McGraw-Hill Companies, Inc., All Rights Reserved

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Design - External Reports

Users of external reports• Shareholders, bondholders, and analysts (SEC, FASB)• Taxing authorities (IRS, states, etc.)• Regulatory authorities (GASB, etc.)• Board of directors

Objectives in external reporting• Comparability between firms• Historical accounting • Auditors can verify reports

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Design - Internal Reports

Users of internal reports• Managers at all levels

Objectives of internal reporting• Useful for decision making about future activities• Measure performance that is relevant to the firm• Focus on projects or processes within a firm

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Design - Conflicting Goals

Control• Incentives to motivate behavior changes• Tendency to ignore information not specifically included in

incentive system• Report “good” numbers to satisfy top management

Decision making• Want to avoid distorted information• Estimates useful to plan future activities

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Design - Evolution

Economic Darwinism:

Over the long term systems survive in competitive markets when the benefits exceed or equal the costs of maintaining those systems.

Survival does not imply optimality.

Better systems may exist, but have not yet been discovered.

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Design - Figure 1-2

Study Figure 1-2.

Main Point: In a typical corporation, the corporate controller is responsible for all internal and external accounting reports. There are also controllers in the operating divisions.

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Design - Organizational Structure

Controller• Reports to chief financial officer (CFO)• Administers internal and external accounting• Budget planning• Controls financial data collection and reporting• Growing role as internal consultants or business analysts to the

point of being viewed as business partners

Balance providing information to other managers for decision making against providing monitoring information used to control behavior of lower-level managers.

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Evolution of Management Accounting:A Framework for Change

Business Environment

Business Strategy

Organizational Architecture

•Decision-Right Assignment•Performance Evaluation

•Reward System

Incentives and Actions

Firm Value

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Example - Vortec Special OrderWith no overtime and congestion

Current With Order Incremental Units produced and sold 100,000 102,000 2,000 Total Revenue and Costs Sales ($5.00 regular, $4.00 special) $ 500,000 $508,000 $ 8,000 Cost of sales ($4.50, $4.47) 450,000 455.940 -5,940 Administrative expenses - 27,500 - 27,500 0 Net profit before taxes $ 22,500 $ 24,560 $ 2,060 Incremental revenue (2,000 units x $4.00) $8,000 Total cost @ 102,000 units (102,000 x $4.47) $455,940 Total cost @ 100,000 units (100,000 x $4.50) 450.000 Incremental cost of 2,000 units -5,940 Incremental profit of 2,000 units $2,060

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Example - Vortec Special OrderWith overtime and congestion

Current With Order Incremental

Units produced and sold 100,000 102,000 2,000 Total Revenue and Costs Sales ($5.00 regular, $4.00 special) $ 500,000 $508,000 $ 8,000 Cost of sales ($4.50, $4.08 on additional 2,000) 450,000 458,160 -8,160 Administrative expenses - 27,500 - 27,500 0 Net profit before taxes $ 22,500 $ 22,340 $ - 160 Incremental revenue (2,000 units x $4.00) $8,000 Total cost @ 102,000 units (100,000 x $4.50) plus (2,000 x $4.08) 458,160 Total cost @ 100,000 units (100,000 x $4.50) 450.000 Incremental cost of 2,000 units -8,160 Incremental profit of 2,000 units - 160

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Example - Beware of Average Costs

Average cost per unit at current production volume is usually not an accurate estimate of the cost per unit at other levels of production.

Production costs include:• fixed costs that do not change with volume• variable costs that do change with volume

Costs may increase when production volume is near or above normal operating capacity.

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Example - Consider Opportunity Costs

• Opportunity costs measure what the firm forgoes when it chooses a specific action

• Consider what a firm forgoes by accepting a special order

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Example - Supplement Accounting Data

• Supplement historical cost accounting data with other knowledge

• Could include:- expected customer demands- competitors’ plans- future technology- government regulation

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Example - Accounting Data for Evaluation

When managers have incentives to maximize performance on one particular accounting measure, firm profits are not necessarily maximized.

• Reducing average manufacturing costs per unit does not always maximize profit

• Maximizing total revenue does not always maximize profit

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Outline of Text

See Overview Figure in the preface.

Chapters Theme

2-5 Use of accounting for decision making and control

6-8 Budgeting and cost allocations

9-13 Absorption costing and alternative costing methods

14 Integrative framework