MAS by Cabrera - Chapter 1 MANAGEMENT ACCOUNTING: AN OVERVIEW

MANAGEMENT ACCOUNTING (VOLUME I) - Solutions Manual

CHAPTER 1 MANAGEMENT ACCOUNTING: AN OVERVIEW I.

Questions 1. Use of the word “need” in the quoted passage is pejorative. It implies an unlimited level of demand for information. However, rational managers apply a cost-benefit criterion to information and will only want accounting information if its benefits exceed its costs. Accounting information provides benefits by improving decision making and controlling behavior in organizations. In most organizations, accounting information is very prevalent which implies that its benefits exceed its costs. Hence, successful managers will find it in their self-interest to learn how to use accounting information in these organizations. Clearly, this statement is incurred in those firms where accounting information has very limited usefulness (e.g., if the accounting information is often wrong or is not produced in a timely fashion). In these organizations, managers do not find the accounting information to have benefits in excess of its costs, will not use it, do not need to know how to use it, and definitely do not need it. 2. a. Historical costs are of limited use in making planning decisions in a rapidly changing environment. With changing products, processes and prices, the historical costs are inadequate approximations of the opportunity costs of using resources. Historical costs may, however, be useful for control purposes, as they provide information about the activities of managers and can be used as performance measures to evaluate managers. b. The purpose of accounting systems is to provide information for planning purposes and control. Although historical costs are not generally appropriate for planning purposes, additional measures are costly to make. An accounting system should include additional measures if the benefits of improved decision making are greater than the costs of the additional information. 3. Finance and economics textbooks traditionally state that the goal of a profit organization is to maximize shareholder wealth. Managers are frequently presumed to act in the best interest of the shareholder, although 1-1

Chapter 1 Management Accounting: An Overview

recent finance literature recognizes that appropriate incentives are necessary to align manager interests with shareholder interests. The goal, however, are not very clear as to how this is achieved. Most finance textbooks focus on financing decisions and not on the use of assets and dealing with customers. Marketing’s goal of satisfying customers recognizes that customers are the source of revenues for the organization, and therefore the means through which shareholder value is increased. However, customer satisfaction is only valuable insofar as it creates shareholder wealth. The further goal of marketing is to ensure that customer satisfaction is maximized without compromising the organization’s profitability. 4. Yes. Planning is really much more vital than control; that is, superior control is fruitless if faulty plans are being implemented. However, planning and control are so intertwined that it seems artificial to draw rigid lines of separation between them. 5. Yes. The controller has line authority over the personnel in his own department but is a staff executive with respect to the other departments. 6. Line authority is exerted downward over subordinates. Staff authority is the authority to advise but not command others; it is exercised laterally or upward. Functional authority is the right to command action laterally and downward with regard to a specific function or specialty. 7. Cost accounting is the controller’s primary means of implementing the 7point concept of modern controllership. Cost accounting is intertwined with all seven duties to some extent, but its major focus is on the first three.

8. Bettina Company President

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Management Accounting: An Overview Chapter 1 VP, Production

VP, Finance

VP, Sales

Controller

Treasurer

Assistant Controller

Assistant Treasurer

Special Studies Manager

Cost Accounting Manager

Tax Manager

Internal Audit Manager

Cost Systems Analyst

Budget & Standard Cost Analyst

Performance Analyst

Cost Clerk

Payroll Clerk

Accounts Receivable Clerk

Accounts Payable Clerk

General Accounting Manager

Billing Clerk

System & EDP Manager

General Ledger Bookkeeper

9. Management accountants contribute to strategic decisions by providing information about the sources of competitive advantage and by helping managers identify and build a company’s resources and capabilities. 10. In most organizations, management accountants perform multiple roles: problem solving (comparative analyses for decision making), scorekeeping (accumulating data and reporting reliable results), and attention directing (helping managers properly focus their attention). 11. Three guidelines that help management accountants increase their value to managers are (a) employ a cost-benefit approach, (b) recognize behavioral as well as technical considerations, and (c) identify different costs for different purposes. 12. Management accounting is an integral part of the controller’s function in an organization. In most organizations, the controller reports to the chief financial officer, who is a key member of the top management team. 13. Management accountants have ethical responsibilities that are related to competence, confidentiality, integrity, and objectivity.

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Chapter 1 Management Accounting: An Overview

14. By reporting and interpreting relevant data, the controller exerts a force or influence that impels management toward making better-informed decisions. The controller of one company described the job as “a business advisor to…help the team develop strategy and focus the team all the way through recommendations and implementation.” 15. Financial Accounting Audience:

External: authorities

shareholders,

Purpose:

Report on past performance to external parties; basis of contracts with owners and lenders

Timeliness:

Delayed; historical

Restrictions:

Regulated; rules driven by generally accepted accounting principles and government authorities

Type of Information:

Financial measurements only

Nature of Information:

Objective, precise

Scope:

Highly aggregate; report on entire organization

auditable,

creditors,

reliable,

tax

consistent,

Managerial Accounting Audience:

Internal: Workers, managers, executives

Purpose:

Inform internal decisions made by employees and managers; feedback and control on operating performance

Timeliness:

Current, future oriented

Restrictions:

No regulations; systems and information determined by management to meet strategic and operational needs

Type of Information:

Financial, plus operational and physical measurements on processes, technologies, suppliers customers, and competitors

Nature of Information:

More 1-4

subjective

and

judgmental;

valid,

Management Accounting: An Overview Chapter 1

relevant, accurate Scope:

Disaggregate; inform local decisions and actions

16. The competitive environment has changed dramatically. Companies encountered severe competition from overseas companies that offered high-quality products at low prices. Activity-based costing systems are introduced in many manufacturing and service organizations to overcome the inability of traditional cost systems to accurately assign overhead costs. Activity-based management is a viable approach for managers to make decisions based on ABC information. There has been improvement of operational control systems such that information is more current and provided more frequently. The nature of work has changed from controlling to informing. Firms are concerned about continuous improvement, employee empowerment and total quality. Nonfinancial information has become a critical feedback measure. Finally, the focus of many firms is on measuring and managing activities. 17. As measurements are made on operations and, especially, on individuals and groups, the behavior of the individuals and groups are affected. People will react to the measurements being made by focusing on the variables or behavior being measured. In addition, if managers attempt to introduce or redesign cost and performance measurement systems, people familiar with the previous system will resist. Management accountants must understand and anticipate the reactions of individuals to information and measurements. The design and introduction of new measurements and systems must be accompanied with an analysis of the likely reactions to the innovations. II. Exercises Exercise 1 a. b. c. d.

(1) (3) (1) (2)

Problem solving Attention-directing Problem solving Scorekeeping

Exercise 2 a. (4) Marketing b. (3) Production c. (6) Customer service 1-5

Chapter 1 Management Accounting: An Overview

d. (5) Distribution Exercise 3 a. b. c. d. e. f. g. h.

(4) (3) (5) (4) (5) (3) (1) (2)

Marketing Production Distribution Marketing Distribution Production Research and development Design

III. Problems Problem 1 (Problem Solving, Scorekeeping, and Attention Directing) Because the accountant’s duties are often not sharply defined, some of these answers might be challenged: 1. 2. 3. 4. 5. 6. 7. 8.

Scorekeeping Attention directing Scorekeeping Problem solving Attention directing Attention directing Problem solving Scorekeeping (depending on the extent of the report) or attention getting 9. This question is intentionally vague. The give-and-take of the budgetary process usually encompasses all three functions, but it emphasizes scorekeeping the least. The main function is attention directing, but problem solving is also involved. 10. Problem solving Problem 2 (Management Accounting Information System) 1. 2. 3. 4.

Inputs: b, g, i, m Processes: a, d, f, j Outputs: e, k, n System objectives: c, h, l

Problem 3 (Role of Management Accountants) 1-6

Management Accounting: An Overview Chapter 1

Planning. The management accountant gains an understanding of the impact on the organization of planned transactions (i.e., analyzing strengths and weaknesses) and economic events, both strategic and tactical, and sets obtainable goals for the organization. The development of budgets is an example of planning. Controlling. The management accountant ensures the integrity of financial information, monitors performance against budgets and goals, and provides information internally for decision making. Comparing actual performance against budgeted performance and taking corrective action where necessary is an example of controlling. Internal auditing is another example. Evaluating Performance. The management accountant judges and analyzes the implication of various past and expected events, and then chooses the optimum course of action. The management accountant also translates data and communicates the conclusions. Graphical analysis (such as trend, bar charts, or regression) and reports comparing actual costs with budgeted costs are examples of evaluating performance. Ensuring Accountability of Resources. The management accountant implements a reporting system closely aligned to organizational goals that contribute to the measurement of the effective use of resources and safeguarding of assets. Internal reporting such as comparison of actual to budget is an example of accountability. External Reporting. The management accountant prepares reports in accordance with generally accepted accounting principles and then disseminates this information to shareholders, creditors, and regulatory tax agencies. An annual report or a credit application are examples of external reporting. Problem 4 (Line Versus Staff) Jamie Reyes is staff. She is in a support role – she prepares reports and helps explain and interpret them. Her role is to help the line managers more effectively carry out their responsibilities. Stephen Santos is a line manager. He has direct responsibility for producing a garden hose. Clearly, one of the basic objectives for the existence of a manufacturing firm is to make a product. Thus, Stephen has direct responsibility for a basic objective and therefore holds a line position. 1-7

Chapter 1 Management Accounting: An Overview

Problem 5 (Professional Ethics and End-of-Year Games) Requirement 1 The possible motivations for the snack foods division wanting to play end-ofyear games include: (a) Management incentives. Yummy Foods may have a division bonus scheme based on one-year reported division earnings. Efforts to front-end revenue into the current year or transfer costs into the next year can increase this bonus. (b) Promotion opportunities and job security. Top management of Yummy Foods likely will view those division managers that deliver high reported earnings growth rates as being the best prospects for promotion. Division managers who deliver “unwelcome surprises” may be viewed as less capable. (c) Retain division autonomy. If top management of Yummy Foods adopts a “management by exception” approach, divisions that report sharp reductions in their earnings growth rates may attract a sizable increase in top management supervision. Requirement 2 The “Standards of Ethical Conduct…” require management accountants to: • •

Refrain from either actively or passively subverting the attainment of the organization’s legitimate and ethical objectives, and Communicate unfavorable as well as favorable information and professional judgment or opinions.

Several of the “end-of-year games” clearly are in conflict with these requirements and should be viewed as unacceptable by Tan: (a) The fiscal year-end should be closed on midnight of December 31. “Extending” the close falsely reports next year’s sales as this year’s sales. (b) Altering shipping dates is falsification of the accounting reports. (c) Advertisements run in December should be charged to the current year. The advertising agency is facilitating falsification of the accounting records. The other “end-of-year games” occur in many organizations and may fall into the “gray” to “acceptable” area. However, much depends on the circumstances surrounding each one: (a) If the independent contractor does not do maintenance work in December, there is no transaction regarding maintenance to record. The 1-8

Management Accounting: An Overview Chapter 1

responsibility for ensuring that packaging equipment is well maintained is that of the plant manager. The division controller probably can do little more than observe the absence of a December maintenance charge. (d) In many organizations, sales are heavily concentrated in the final weeks of the fiscal year-end. If the double bonus is approved by the division marketing manager, the division controller can do little more than observe the extra bonus paid in December. (e) If TV spots are reduced in December, the advertising cost in December will be reduced. There is no record falsification here. (g) Much depends on the means of “persuading” carriers to accept the merchandise. For example, if an under-the-table payment is involved, it is clearly unethical. If, however, the carrier receives no extra consideration and willingly agrees to accept the assignment, the transaction appears ethical. Each of the (a), (d), (e) and (g) “end-of-year games” may well disadvantage Yummy Foods in the long run. For example, lack of routine maintenance may lead to subsequent equipment failure. The divisional controller is well advised to raise such issues in meetings with the division president. However, if Yummy Foods has a rigid set of line/staff distinctions, the division president is the one who bears primary responsibility for justifying division actions to senior corporate officers. Requirement 3 If Tan believes that Ryan wants her to engage in unethical behavior, she should first directly raise her concerns with Ryan. If Ryan is unwilling to change his request, Tan should discuss her concerns with the Corporate Controller of Yummy Foods. Tan also may well ask for a transfer from the snack foods division if she perceives Ryan is unwilling to listen to pressure brought by the Corporate Controller, CFO, or even President of Yummy Foods. In the extreme, she may want to resign if the corporate culture of Yummy Foods is to reward division managers who play “end-of-year games” that Tan views as unethical and possibly illegal. Problem 6 James Torres has come up with a scheme that involves a combination of data falsification and smoothing! Not only has he made up the revenue numbers, but also he has had the gall to defer some of them to the next period. Making up such numbers is clearly illegal. Smoothing, in this example is also illegal because the numbers are fictitious. 1-9

Chapter 1 Management Accounting: An Overview

Problem 7 Clearly the vice-president will lose his or her job if you turn him or her in. Given that this is a major violation of the code of ethics and a violation patent law, the vice-president could go to jail. Your best course of action is to check your information and if the vice-president is definitely involved, go immediately to the VP’s superior (who is probably a senior VP or the company president). The organization’s attorneys will take over from there.

Problem 8 One option is to do nothing and ignore what you saw, however, this may violate your own code of ethics and your ethical responsibilities under the organization’s code of ethics. Given that you want to do something, it is probably best to start by talking to employees in your organization whose job it is to deal with ethical issues. If no such employees exist or are available, you might start by using a decision model. This model incorporated the following steps: 1. 2. 3. 4. 5. 6. 7.

Determine the Facts – What, Who, Where, How Define the Ethical Issue Identify Major Principles, Rule, Values Specify the Alternatives. Compare Values and Alternatives, See if Clear Decision Assess the Consequences. Make Your Decision.

IV. Cases Case 1 (Financial vs. Managerial Accounting) Requirement (a) Other forward looking information desired in addition to the income statement information are

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Management Accounting: An Overview Chapter 1

1. Disclosure of the components of financial performance, i.e., nature and source of revenues, various activities, transactions, and other relevant events affecting the company. 2. Nature and function of the components of income and expenses Requirement (b) No. GAAP does not allow capitalization of employee training and advertising costs even if management feels that they increase the value of the company’s brand name. The reasons are uncertainty of the future benefits that may be derived therefrom and difficulty and reliability of their measurement.

Requirement (c) Detailed information that managers would likely request are analysis of the significant increases in 1. 2. 3. 4. 5.

Sales Cost of sales Payroll Stock and option based compensation Advertising and promotion.

Requirement (d) Nonmonetary measures: 1. 2. 3. 4. 5.

Change in number and profile of customers Share in the market Who, what and how many are the competitors Product lines offered by the entity vs. Product lines of competitors Sales promotion and advertising activities

Requirement (e) 1. Competitors 2. Employees 3. Prospective creditors Case 2 (You get what you measure!) Requirement (a) Increase in sales to new customers to sales 1-11

Chapter 1 Management Accounting: An Overview

Too much emphasis on this ratio may lead the sales manager to spend more time developing business with new customers and disregard the needs of existing customers. It is therefore possible to lose the business of several key accounts. Requirement (b) Decrease in cost of goods sold to sales This performance measure could create the following problems: 1. Purchasing goods with poor quality at lower cost and selling them for the same price. 2. Indiscriminately increasing selling price to widen the profit margin without regard to competitor’s current prices. 3. If the entity is manufacturing its own goods, managers could try to economize on costs, i.e., buying poorer quality of materials, employing unskilled workers, etc. thereby causing deterioration of the quality of the finished products. In all of the above situations, customer patronage could eventually be adversely affected. Requirement (c) Decrease in selling and administrative expense to sales Cost-cutting is generally advisable for as long as the quality of goods and services are not compromised. Likewise, certain cost-saving measures could demotivate sales people and other employees and could lead to counterproductive activities. Case 3 (The Roles of Managers and Management Accountants) 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11.

Managerial accounting, Financial accounting Planning Directing and motivating Feedback Decentralization Line Staff Controller Budgets Performance report Chief Financial Officer 1-12

Management Accounting: An Overview Chapter 1

12. Precision; Nonmonetary data Case 4 (Ethics in Business) If cashiers routinely short-changed customers whenever the opportunity presented itself, most of us would be careful to count our change before leaving the counter. Imagine what effect this would have on the line at your favorite fast-food restaurant. How would you like to wait in line while each and every customer laboriously counts out his or her change? Additionally, if you can’t trust the cashiers to give honest change, can you trust the cooks to take the time to follow health precautions such as washing their hands? If you can’t trust anyone at the restaurant would you even want to eat out? Generally, when we buy goods and services in the free market, we assume we are buying from people who have a certain level of ethical standards. If we could not trust people to maintain those standards, we would be reluctant to buy. The net result of widespread dishonesty would be a shrunken economy with a lower growth rate and fewer goods and services for sale at a lower overall level of quality. Case 5 (Ethics and the Manager) Requirement 1 Failure to report the obsolete nature of the inventory would violate the Standards of Ethical Conduct as follows: Competence • •

Perform duties in accordance with relevant technical standards. Prepare complete reports using reliable information.

By failing to write down the value of the obsolete inventory, Perez would not be preparing a complete report using reliable information. In addition, generally accepted accounting principles (GAAP) require the write-down of obsolete inventory. Integrity • • • •

Avoid conflicts of interest. Refrain from activities that prejudice the ability to perform duties ethically. Refrain from subverting the legitimate goals of the organization. Refrain from discrediting the profession. 1-13

Chapter 1 Management Accounting: An Overview

Members of the management team, of which Perez is a part, are responsible for both operations and recording the results of operations. Since the team will benefit from a bonus, increasing earnings by ignoring the obsolete inventory is clearly a conflict of interest. Perez would also be concealing unfavorable information and subverting the goals of the organization. Furthermore, such behavior is a discredit to the profession. Objectivity • •

Communicate information fairly and objectively. Disclose all relevant information.

Hiding the obsolete inventory impairs the objectivity and relevance of financial statements. Requirement 2 As discussed above, the ethical course of action would be for Perez to insist on writing down the obsolete inventory. This would not, however, be an easy thing to do. Apart from adversely affecting her own compensation, the ethical action may anger her colleagues and make her very unpopular. Taking the ethical action would require considerable courage and self-assurance. Case 6 (Preparing an Organization Chart) Requirement 1 See the organization chart on page 17. Requirement 2 Line positions would include the university president, academic vice-president, the deans of the four colleges, and the dean of the law school. In addition, the department heads (as well as the faculty) would be in line positions. The reason is that their positions are directly related to the basic purpose of the university, which is education. (Line positions are shaded on the organization chart.) All other positions on the organization chart are staff positions. The reason is that these positions are indirectly related to the educational process, and exist only to provide service or support to the line positions. Requirement 3 All positions would have need for accounting information of some type. For 1-14

Management Accounting: An Overview Chapter 1

example, the manager of central purchasing would need to know the level of current inventories and budgeted allowances in various areas before doing any purchasing; the vice president for admissions and records would need to know the status of scholarship funds as students are admitted to the university; the dean of the business college would need to know his/her budget allowances in various areas, as well as information on cost per student credit hour; and so forth. Case 7 (Ethics in Business) Requirement 1 No, Santos did not act in an ethical manner. In complying with the president’s instructions to omit liabilities from the company’s financial statements he was in direct violation of the IMA’s Standards of Ethical Conduct for Management Accountants. He violated both the “Integrity” and “Objectivity” guidelines on this code of ethical conduct. The fact that the president ordered the omission of the liabilities is immaterial. Requirement 2 No, Santos’ actions can’t be justified. In dealing with similar situations, the Securities and Exchange Commission (SEC) has consistently ruled that “… corporate officers…cannot escape culpability by asserting that they acted as ‘good soldiers’ and cannot rely upon the fact that the violative conduct may have been condoned or ordered by their corporate superiors.” (Quoted from: Gerald H. Lander, Michael T. Cronin, and Alan Reinstein, “In Defense of the Management Accountant,” Management Accounting, May, 1990, p. 55) Thus, Santos not only acted unethically, but he could be held legally liable if insolvency occurs and litigation is brought against the company by creditors or others. It is important that students understand this point early in the course, since it is widely assumed that “good soldiers” are justified by the fact that they are just following orders. In the case at hand, Santos should have resigned rather than become a party to the fraudulent misrepresentation of the company’s financial statements.

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Case 6 Requirement 1 President

Vice President , Auxiliary Services

Manager, Central Purchasing

Vice

Vice President , Adm issions & Records

Manager, University Press

Dean, Business

(Departments)

Academic Vice President

Manager, University Bookstore

Dean, Humanities

(Departments)

President , Financial Services (Cont roller)

Manager, Computer Services

Manager, Accounting & Finance

Dean, Engineering & Quantitative

Dean, Fine Arts

(Departments) 1-16

Vice President, Physical Plant

(Departments)

Manager, Grounds & Custodial Services

Dean, Law School

Manager, Plant & Maintenance

Chapter 1 Management Accounting: An Overview

Case 8 (Ethics in Business) Requirement 1 Andres Romero has an ethical responsibility to take some action in the matter of PhilChem, Inc. and the dumping of toxic wastes. The Standards of Ethical Conduct for Management Accountants specifies that management accountants should not condone the commission of acts by their organization that violate the standards of ethical conduct. The specific standards that apply are as follows. • •

•

•

Competence. Management accountants have a responsibility to perform their professional duties in accordance with relevant laws and regulations. Confidentiality. Management accountants must refrain from disclosing confidential information unless legally obligated to do so. However, Andres Romero may have a legal responsibility to take some action. Integrity. Management accountants have a responsibility to: - refrain from either actively or passively subverting the attainment of the organization’s legitimate and ethical objectives. - communicate favorable as well as unfavorable information and professional judgments or opinions. Objectivity. Management accountants must fully disclose all relevant information that could reasonably be expected to influence an intended user’s understanding of the reports, comments, and recommendations.

Requirement 2 The Standards of Ethical Conduct for Management Accountants indicates that the first alternative being considered by Andres Romero, seeking the advice of his boss, is appropriate. To resolve an ethical conflict, the first step is to discuss the problem with the immediate superior, unless it appears that this individual is involved in the conflict. In this case, it does not appear that Romero’s boss is involved. Communication of confidential information to anyone outside the company is inappropriate unless there is a legal obligation to do so, in which case Romero should contact the proper authorities. Contacting a member of the Board of Directors would be an inappropriate action at this time. Romero should report the conflict to successively higher levels within the organization and turn only to the Board of Directors if the 1-17

Chapter 1 Management Accounting: An Overview

problem is not resolved at lower levels. Requirement 3 Andres Romero should follow the established policies of the organization bearing on the resolution of such conflict. If these policies do not resolve the ethical conflict, Romero should report the problem to successively higher levels of management up to the Board of Directors until it is satisfactorily resolved. There is no requirement for Romero to inform his immediate superior of this action because the superior is involved in the conflict. If the conflict is not resolved after exhausting all courses of internal review, Romero may have no other recourse than to resign from the organization and submit an informative memorandum to an appropriate member of the organization. (CMA Unofficial Solution, adapted) V. Multiple Choice Questions 1. 2. 3. 4. 5. 6. 7. 8. 9. 10.

D D D B D A B D D A

11. 12. 13. 14. 15. 16. 17. 18. 19. 20.

D D D A A A D A D D

21. 22. 23. 24. 25. 26. 27. 28. 29. 30.

B B A A B C B D B C

31. 32. 33. 34. 35. 36. 37. 38. 39. 40.

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D C D B D B C B A A

41. 42. 43. 44. 45. 46. 47. 48. 49. 50.

A C D B C B A B C D

51. 52. 53. 54. 55. 56. 57. 58. 59. 60.

B B A C D C C C A B