Respond to two or more of your colleagues in one or more of the following ways:Provide insights or contrasting observations regarding the variances presented by your colleagues.Comment on a scenario presented and provide additional insight into the method presented and/or propose a different method for making the decision along with your rationale for choosing that method.
WMBA 6050: Accounting for Management Decision Making
Accounting Rate of Return/Return on Investment (ROI)
A company invested $10,000,000 in a project that has a 10-year life and no salvage value. The
expected operating income is $4,000,000 in each of the next ten years, and the tax rate is 40%.
The steps to determine the ROI are as follows:
1. Compute net income
Operating income
Depreciation
Net income before taxes
Taxes (40%)
Net income
$4,000,000
1,000,000
3,000,000
1,200,000
$1,800,000
($10,000,000/10-year life)
($3,000,000 x .40)
2. Compute average net income and average book value of the investment
Calculate the average book value of the investment by taking the beginning book value, adding
the ending book value, and dividing by 2. The ending book value each year is the beginning
book value for the year less the depreciation for the year.
Year
Net
Income
Average
Book Value
of
Investment
1
1,800,000
9,500,000
(10,000,000 + 9,000,000)/2
2
1,800,000
8,500,000
(9,000,000 + 8,000,000)/2
3
1,800,000
7,500,000
(8,000,000 + 7,000,000)/2
4
1,800,000
6,500,000
(7,000,000 + 6,000,000)/2
5
1,800,000
5,500,000
(6,000,000 + 5,000,000)/2
6
1,800,000
4,500,000
(5,000,000 + 4,000,000)/2
7
1,800,000
3,500,000
(4,000,000 + 3,000,000)/2
8
1,800,000
2,500,000
(3,000,000 + 2,000,000)/2
9
1,800,000
1,500,000
(2,000,000 + 1,000,000)/2
10
1,800,000
500,000
Average
1,800,000
5,000,000
(1,000,000 + 0)/2
(An easy way to find the average book value of
The investment is to divide the investment by 2.)
3. Compute ROI
Average annual income from project
Average annual investment in the project
= 1,800,000 = 36%
5,000,000
zim36725_fm_i-xvi.qxd
12/15/09
2:31 PM
Page i
Seventh Edition
Accounting for
Decision Making
and Control
Jerold L. Zimmerman
University of Rochester
To: Conner, Easton, and Jillian
ACCOUNTING FOR DECISION MAKING AND CONTROL, SEVENTH EDITION
Published by McGraw-Hill, a business unit of The McGraw-Hill Companies, Inc., 1221 Avenue of the Americas,
New York, NY 10020. Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved. Previous
editions © 2009, 2006, and 2003. No part of this publication may be reproduced or distributed in any form or by
any means, or stored in a database or retrieval system, without the prior written consent of The McGraw-Hill
Companies, Inc., including, but not limited to, in any network or other electronic storage or transmission, or
broadcast for distance learning.
Some ancillaries, including electronic and print components, may not be available to customers outside the United States.
This book is printed on acid-free paper.
1 2 3 4 5 6 7 8 9 0 DOW/DOW 1 0 9 8 7 6 5 4 3 2 1 0
ISBN
MHID
978-0-07-813672-6
0-07-813672-5
Vice President & Editor-in-Chief: Brent Gordon
Vice President of EDP: Sesha Bolisetty
Editorial Director: Stewart Mattson
Sponsoring Editor: Dick Hercher
Marketing Manager: Sankha Basu
Editorial Coordinator: Rebecca Mann
Project Manager: Erin Melloy
Design Coordinator: Brenda A. Rolwes
Cover Designer: Studio Montage, St. Louis, Missouri
Production Supervisor: Sue Culbertson
Media Project Manager: Balaji Sundararaman
Compositor: MPS Limited, A Macmillan Company
Typeface: 10/12 Times New Roman
Printer: R. R. Donnelley-Willard
All credits appearing on page or at the end of the book are considered to be an extension of the copyright page.
Library of Congress Cataloging-in-Publication Data
Zimmerman, Jerold L., 1947Accounting for decision making and control / Jerold L. Zimmerman.—7th ed.
p. cm.
Includes bibliographical references and index.
ISBN-13: 978-0-07-813672-6 (acid-free paper)
ISBN-10: 0-07-813672-5 (acid-free paper) 1. Managerial accounting. I. Title.
HF5657.4.Z55 2010
658.15’11—dc22
2009049120
www.mhhe.com
zim36725_fm_i-xvi.qxd
12/15/09
2:31 PM
Page iii
About the Author
Jerold L. Zimmerman
Jerold Zimmerman is Ronald L. Bittner Professor at the
William E. Simon Graduate School of Business, University of Rochester. He holds an undergraduate degree from
the University of Colorado, Boulder, and a doctorate
from the University of California, Berkeley.
While at Rochester, Dr. Zimmerman has taught a variety of courses spanning accounting, finance, and economics. Accounting courses include nonprofit accounting,
intermediate accounting, accounting theory, and managerial accounting. A deeper appreciation of the challenges of
managing a complex organization was acquired by spending four years as Deputy Dean of the Simon School.
Professor Zimmerman publishes widely in accounting on topics as diverse as cost allocations, Sarbanes-Oxley Act, disclosure, financial accounting theory, capital markets, and
executive compensation. His paper “The Costs and Benefits of Cost Allocations” won the
American Accounting Association’s Competitive Manuscript Contest. He is recognized for
developing Positive Accounting Theory. This work, co-authored with colleague Ross Watts,
at the Massachusetts Institute of Technology, received the American Institute of Certified
Public Accountants’ Notable Contribution to the Accounting Literature Award for “Towards
a Positive Theory of the Determination of Accounting Standards” and “The Demand for
and Supply of Accounting Theories: The Market for Excuses.” Both papers appeared in the
Accounting Review. Professors Watts and Zimmerman are also co-authors of the highly
cited textbook Positive Accounting Theory (Prentice Hall, 1986). More recently, Professors
Watts and Zimmerman received the 2004 American Accounting Association Seminal Contribution to the Literature award. Professor Zimmerman’s textbooks also include: Managerial Economics and Organizational Architecture with Clifford Smith and James Brickley,
5th ed. (McGraw-Hill/Irwin, 2009); and Management Accounting: Analysis and Interpretation with Cheryl McWatters and Dale Morse (Pearson Education Limited UK, 2008). He is
a founding editor of the Journal of Accounting and Economics, published by North-Holland.
This scientific journal is one of the most highly referenced accounting publications.
He and his wife Dodie have two daughters, Daneille and Amy. Jerry has been known
to occasionally engage friends and colleagues in an amicable diversion on the links.
iii
zim36725_fm_i-xvi.qxd
12/15/09
2:31 PM
Page iv
Preface
During their professional careers, managers in all organizations, profit and nonprofit, interact with their accounting systems. Sometimes managers use the accounting system to acquire information for decision making. At other times, the accounting system measures
performance and thereby influences their behavior. The accounting system is both a source
of information for decision making and part of the organization’s control mechanisms—
thus, the title of the book, Accounting for Decision Making and Control.
The purpose of this book is to provide students and managers with an understanding and
appreciation of the strengths and limitations of an organization’s accounting system, thereby
allowing them to be more intelligent users of these systems. This book provides a framework
for thinking about accounting systems and a basis for analyzing proposed changes to these
systems. The text demonstrates that managerial accounting is an integral part of the firm’s
organizational architecture, not just an isolated set of computational topics.
Distinguishing Features
Conceptual
Framework
This book differs from other managerial accounting texts in several ways. The most important
difference is that it offers a conceptual framework for the study of managerial accounting.
This book relies on opportunity cost and organizational architecture as the underlying
framework to organize the analysis. Opportunity cost is the conceptual foundation underlying
decision making. While accounting-based costs are not opportunity costs, in some circumstances accounting costs provide a starting point to estimate opportunity costs. Organizational
architecture provides the conceptual foundation to understand how accounting is employed as
part of the organization’s control mechanism. These two concepts, opportunity costs and
organizational architecture, provide the framework and illustrate the trade-offs created when
accounting systems serve both functions: decision making and control.
Trade-Offs
This text emphasizes that there is no “free lunch”; improving an accounting system’s
decision-making ability often reduces its effectiveness as a control device. Likewise, using
an accounting system as a control mechanism usually comes at the expense of using the
system for decision making. Most texts discuss the importance of deriving different estimates of costs for different purposes. Existing books do a good job illustrating how
accounting costs developed for one purpose, such as inventory valuation, cannot be used
without adjustment for other purposes, such as a make-or-buy decision. However, these
books often leave the impression that one accounting system can be used for multiple
purposes as long as the users make the appropriate adjustments in the data.
What existing texts do not emphasize is the trade-off between designing the accounting system for decision making and designing it for control. For example, activity-based
costing presumably improves the accounting system’s ability for decision making (pricing
and product design), but existing texts do not address what activity-based costing gives up
in terms of control. Accounting for Decision Making and Control emphasizes the trade-offs
managers confront in an organization’s accounting system.
iv
zim36725_fm_i-xvi.qxd
12/15/09
2:31 PM
Page v
Preface
v
Economic
Darwinism
A central theme throughout this book is economic Darwinism, which simply implies that
accounting systems that survive in competitive industries must be yielding benefits that are
at least as large as their costs. While newer accounting innovations such as the balanced
scorecard are described, the text also indicates through a series of company histories that
many elements of today’s modern costing systems can be traced back to much earlier times.
It is useful to understand that today’s managers are struggling with the same accounting issues as their predecessors, because today’s students will also be struggling with the same
problems. These problems continue to exist because they involve making trade-offs, usually between systems for decision making (e.g., product pricing and make-or-buy decisions) versus control (e.g., performance evaluation).
Accounting systems differ across firms and change as firms’ circumstances change.
Today’s students will be making these trade-offs in the future. The current rage in managerial accounting texts is to present the latest, most up-to-date accounting system innovations.
While recent innovations are important to discuss, they should be placed in their proper
perspective. Traditional absorption costing systems have survived the test of time for hundreds of years. Accounting system innovations are new, not necessarily better. We certainly
do not know if they will survive.
Logical Sequence
Another meaningful distinction between this text and other books in the field is that the
chapters in this text build on one another. The first four chapters develop the opportunity
cost and organization theory foundation for the course. The remaining chapters apply the
foundation to analyzing specific topics such as budgets and standard costs. Most of the
controversy in product costing involves apportioning overhead. Before absorption, variable,
and activity-based costing are described, an earlier chapter provides a general analysis of
cost allocation. This analysis is applied in later chapters as the analytic framework for
choosing among the various product costing schemes. Other books emphasize a modular,
flexible approach that allows instructors to devise their own sequence to the material, with
the result that these courses often appear as a series of unrelated, disjointed topics without
any underlying cohesive framework. This book has 14 chapters, compared with the usual
18–25. Instead of dividing a topic such as cost allocation into three small chapters, most
topics are covered in one or at most two unified chapters.
End-of-Chapter
Material
The end-of-chapter problem material is an integral part of any text, and especially important in Accounting for Decision Making and Control. The problems and cases are drawn
from actual company applications described by former students based on their work experience. Many problems require students to develop critical thinking skills and to write short
essays after preparing their numerical analyses. Good problems get students excited about
the material and generate lively class discussions. Some problems do not have a single correct answer. Rather, they contain multiple dimensions demanding a broad managerial perspective. Marketing, finance, and human resource aspects of the situation are frequently
posed. Few problems focus exclusively on computations.
Changes in the Seventh Edition
Based on extensive feedback from instructors using the six editions and from my own
teaching experience, the seventh edition focuses on improving the book’s readability and
accessibility. In particular, the following changes have been made:
• Each chapter has been updated and streamlined based on student and instructor
feedback. More intuitive, easier-to-understand numerical examples have been
added.
zim36725_fm_i-xvi.qxd
vi
12/15/09
2:31 PM
Page vi
Preface
• Additional actual company practices have been integrated into the text.
• Sixteen new problems and cases supplement the existing problems. Users were
uniform in their praise of the problem material. They found it challenged their students
to critically analyze multidimensional issues while still requiring numerical problemsolving skills. Further problems and cases to complement this selection have been
added.
Overview of Content
Chapter 1 presents the book’s conceptual framework by using a simple decision context regarding accepting an incremental order from a current customer. The chapter describes why
firms use a single accounting system and the concept of economic Darwinism, among other
important topics. This chapter is an integral part of the text.
Chapters 2, 4, and 5 present the underlying conceptual framework. The importance of
opportunity costs in decision making, cost–volume–profit analysis, and the difference between accounting costs and opportunity costs are discussed in Chapter 2. Chapter 4 summarizes recent advances in the theory of organizations and Chapter 5 describes the crucial
role of accounting as part of the firm’s organizational architecture. Chapter 3 on capital
budgeting extends opportunity costs to a multiperiod setting. This chapter can be skipped
without affecting the flow of later material. Alternatively, Chapter 3 can be assigned at the
end of the course.
Chapter 6 applies the conceptual framework and illustrates the trade-off managers
must make between decision making and control in a budgeting system. Budgets are a
decision-making tool to coordinate activities within the firm and are a device to control
behavior. This chapter provides an in-depth illustration of how budgets are a significant
part of an organization’s decision-making and control apparatus.
Chapter 7 presents a general analysis of why managers allocate certain costs and the
behavioral implications of these allocations. Cost allocations affect both decision making
and incentives. Thus, there is again the trade-off between decision making and control.
Chapter 8 continues the cost allocation discussion by describing the “death spiral” that can
occur when significant fixed costs exist and excess capacity arises. This leads to an analysis of how to treat capacity costs—a trade-off between underutilization and overinvestment.
Finally, several specific cost allocation methods such as service department costs and joint
costs are described.
Chapter 9 applies the general analysis of overhead allocation in Chapters 7 and 8 to the
specific case of absorption costing in a manufacturing setting. The managerial implications
of traditional absorption costing are provided in Chapters 10 and 11. Chapter 10 analyzes
variable costing, and activity-based costing is the topic of Chapter 11. Variable costing is an
interesting example of economic Darwinism. Proponents of variable costing argue that it
does not distort decision making and therefore should be adopted. Nonetheless it is not
widely practiced, probably because of tax, financial reporting, and control considerations.
Chapter 12 discusses the decision-making and control implications of standard labor
and material costs. Chapter 13 extends the discussion to overhead and marketing variances. Chapter 13 can be omitted without interrupting the flow of later material. Finally,
Chapter 14 synthesizes the course by reviewing the conceptual framework and applying it
to recent organizational innovations, such as Six Sigma, lean production, and the balanced
scorecard. These innovations provide an opportunity to apply the analytic framework underlying the text.
zim36725_fm_i-xvi.qxd
12/15/09
2:31 PM
Page vii
vii
Preface
Overview of Table of Contents
Chapter 1
Introduction
Chapter 4
Organizational Architecture
Chapter 2
The Nature of Costs
Chapter 5
Responsibility Accounting
& Transfer Pricing
Chapter 3*
Opportunity Cost of
Capital and Capital Budgeting
Chapter 6
Budgeting
Chapter 7
Cost Allocation: Theory
Chapter 8
Cost Allocation: Practices
Chapter 9
Absorption Cost Systems
Chapter 10
Criticisms of Absorption Cost Systems: Incentive to Overproduce
Chapter 11
Criticisms of Absorption Cost Systems: Inaccurate Product Costs
Chapter 12
Standard Costs: Direct Labor and Materials
Chapter 13*
Overhead & Marketing Variances
Chapter 14
Management Accounting in a
Changing Environment
*Chapter can be omitted without interrupting the flow of material.
viii
Preface
Using the Text
This book assumes that the student is familiar with introductory financial accounting.
Accounting for Decision Making and Control can be used in advanced undergraduate, graduate, or executive programs. It is being used widely outside the United States. While the
book relies on opportunity costs and organizational economics, much of the discussion is
at an intuitive level. To focus on the managerial implications of the material, journal entries
are deliberately de-emphasized.
The text is concise, which allows the instructor to supplement the course with additional
outside readings or heavy problem assignments. The text has been used in a 10-week quarter course with few outside readings and two to three hours of homework assignments for
every class period. MBA students find this challenging and rewarding. They report a better
understanding of how to use accounting numbers, are more comfortable at preparing financial analyses, and are better able to take a set of facts and communicate a cogent analysis.
Alternatively, the text can support a semester-length course. Executive MBA students praise
the text’s real-world applicability, readability, and the relevance of the problem material.
Some of the more challenging material is presented in appendixes following the chapters. Chapter 2’s appendix describes the pricing decision. Chapter 6’s appendix contains a
comprehensive master budget. The reciprocal method for allocating service department
costs is described in the appendix to Chapter 8. The appendixes to Chapter 9 describe
process costing and demand shifts, fixed costs, and pricing. Appendixes can be deleted
without affecting future chapter discussions.
Supplements
Online Learning Center (OLC): www.mhhe.com/zimerman7e.
The Instructor Edition of Accounting for Decision Making and Control, 7e, OLC is password protected and a convenient place for instructors to access course supplements. Resources for professors include chapter-by-chapter teaching strategies, suggested problem
assignments, recommended outside cases, lecture notes, sample syllabi, chapter PowerPoint
presentations, and complete solutions to all problems and case material within the text.
The Student Edition of Accounting for Decision Making and Control, 7e, OLC
contains review material to help students study, including PowerPoint presentations and
multiple-choice quizzes.
Tegrity Campus: Lectures 24/7
Tegrity Campus is a service that makes
class time available 24/7 by automatically capturing lectures in a searchable format for students to review when they study and complete assignments. With a simple one-click startand-stop process, you capture all computer screens and corresponding audio. Students can
replay any part of any class with easy-to-use browser-based viewing. With Tegrity Campus,
students quickly recall key moments by using Tegrity Campus’s unique search feature.
To learn more about Tegrity, watch a two-minute Flash demo at http://tegritycampus
.mhhe.com.
Acknowledgments
William Vatter and George Benston motivated my interest in managerial accounting. The
genesis for this book and its approach reflect the oral tradition of my colleagues, past and
present, at the University of Rochester. William Meckling and Michael Jensen stimulated
my thinking and provided much of the theoretical structure underlying the book, as anyone
familiar with their work will attest. My long and productive collaboration with Ross Watts
sharpened my analytical skills and further refined the approach. He also furnished most of
the intellectual capital for Chapter 3, including the problem material. Ray Ball has been a
zim36725_fm_i-xvi.qxd
12/15/09
2:31 PM
Page ix
ix
Preface
constant source of ideas. Clifford Smith and James Brickley continue to enhance my economic education. Three colleagues, Andrew Christie, Dan Gode, and Scott Keating, supplied particularly insightful comments that enriched the analysis at critical junctions.
Valuable comments from Anil Arya, Ron Dye, Andy Leone, K. Ramesh, Shyam Sunder,
and Joseph Weintrop are gratefully acknowledged.
This project benefited greatly from the honest and intelligent feedback of numerous
instructors. I wish to thank Mahendra Gupta, Susan Hamlen, Badr Ismail, Charles Kile,
Leslie Kren, Don May, William Mister, Mohamed Onsi, Ram Ramanan, Stephen Ryan,
Michael Sandretto, Richard Sansing, Deniz Saral, Gary Schneider, Joe Weber, and William
Yancey. This book also benefited from two other projects with which I have been involved.
Writing Managerial Economics and Organizational Architecture (McGraw-Hill/Irwin,
2009) with James Brickley and Clifford Smith and Management Accounting: Analysis and
Interpretation (Pearson Education, Limited (UK), 2008) with Cheryl McWatters and Dale
Morse helped me to better understand how to present certain topics.
To the numerous students who endured the development process, I owe an enormous
debt of gratitude. I hope they learned as much from the material as I learned teaching them.
Some were even kind enough to provide critiques and suggestions, in particular Jan Dick
Eijkelboom. Others supplied, either directly or indirectly, the problem material in the text.
The able research assistance of P. K. Madappa, Eamon Molloy, Jodi Parker, Steve Sanders,
Richard Sloan, and especially Gary Hurst, contributed amply to the manuscript and problem material. Janice Willett and Barbara Schnathorst did a superb job of editing the manuscript and problem material.
The very useful comments and suggestions from the following reviewers are greatly
appreciated:
Urton Anderson
Howard M. Armitage
Vidya Awasthi
Kashi Balachandran
Da-Hsien Bao
Ron Barden
Howard G. Berline
Margaret Boldt
David Borst
Eric Bostwick
Marvin L. Bouillon
Wayne Bremser
David Bukovinsky
Linda Campbell
William M. Cready
James M. Emig
Gary Fane
Anita Feller
Tahirih Foroughi
Ivar Fris
Jackson F. Gillespie
Irving Gleim
Jon Glover
Gus Gordon
Sylwia Gornik-Tomaszewski
Susan Haka
Bert Horwitz
Steven Huddart
Robert Hurt
Douglas A. Johnson
Lawrence A. Klein
Thomas Krissek
A. Ronald Kucic
Daniel Law
Chi-Wen Jevons Lee
Suzanne Lowensohn
James R. Martin
Alan H. McNamee
Marilyn Okleshen
Shailandra Pandit
Sam Phillips
Frank Probst
Kamala Raghavan
Ram Ramanan
William Rau
Jane Reimers
Thomas Ross
Harold P. Roth
P. N. Saksena
Donald Samaleson
Michael J. Sandretto
Arnold Schneider
Henry Schwarzbach
Elizabeth J. Serapin
Norman Shultz
James C. Stallman
William Thomas Stevens
Monte R. Swain
Clark Wheatley
Lourdes F. White
Paul F. Williams
Robert W. Williamson
Jeffrey A. Yost
S. Mark Young
zim36725_fm_i-xvi.qxd
x
12/15/09
2:31 PM
Page x
Preface
Kathy Jones, my very able assistant, had the difficult and often impossible task of
managing and editing the manuscript and instructor manual. She did a superb job. To my
wife Dodie and daughters Daneille and Amy, thank you for setting the right priorities and
for giving me the encouragement and environment to be productive. Finally, I wish to thank
my parents for all their support.
Jerold L. Zimmerman
University of Rochester
zim36725_fm_i-xvi.qxd
12/15/09
2:31 PM
Page xi
Brief Contents
1
Introduction 1
2
The Nature of Costs 22
3
Opportunity Cost of Capital and Capital Budgeting 89
4
Organizational Architecture 135
5
Responsibility Accounting and Transfer Pricing 170
6
Budgeting 229
7
Cost Allocation: Theory 302
8
Cost Allocation: Practices 347
9
Absorption Cost Systems 409
10
Criticisms of Absorption Cost Systems: Incentive to Overproduce 468
11
Criticisms of Absorption Cost Systems: Inaccurate Product Costs 501
12
Standard Costs: Direct Labor and Materials 554
13
Overhead and Marketing Variances 592
14
Management Accounting in a Changing Environment 627
Solutions to Concept Questions
Glossary 684
Index 693
674
xi
zim36725_fm_i-xvi.qxd
12/16/09
8:30 PM
Page xii
Contents
1
Introduction 1
A.
B.
C.
D.
E.
F.
G.
H.
2
Managerial Accounting: Decision Making and Control 2
Design and Use of Cost Systems 4
Marmots and Grizzly Bears 8
Management Accountant’s Role in the Organization 10
Evolution of Management Accounting: A Framework for Change 13
Vortec Medical Probe Example 15
Outline of the Text 18
Summary 19
The Nature of Costs 22
A. Opportunity Costs 23
1. Characteristics of Opportunity Costs 24
2. Examples of Decisions Based on Opportunity Costs 24
B. Cost Variation 28
1. Fixed, Marginal, and Average Costs 28
2. Linear Approximations 31
3. Other Cost Behavior Patterns 32
4. Activity Measures 33
C. Cost–Volume–Profit Analysis 34
1. Copier Example 34
2. Calculating Break-Even and Target Profits 36
3. Limitations of Cost–Volume–Profit Analysis 40
4. Multiple Products 40
5. Operating Leverage 42
D. Opportunity Costs versus Accounting Costs 45
1. Period versus Product Costs 46
2. Direct Costs, Overhead Costs, and Opportunity Costs 46
E. Cost Estimation 50
1. Account Classification 50
2. Motion and Time Studies 50
F. Summary 50
Appendix: Costs and the Pricing Decision 51
3
Opportunity Cost of Capital and Capital Budgeting 89
A. Opportunity Cost of Capital 90
B. Interest Rate Fundamentals 93
1. Future Values 93
2. Present Values 94
xii
zim36725_fm_i-xvi.qxd
12/15/09
2:31 PM
Page xiii
xiii
Contents
C.
D.
E.
F.
4
3. Present Value of a Cash Flow Stream 95
4. Perpetuities 96
5. Annuities 97
6. Multiple Cash Flows per Year 98
Capital Budgeting: The Basics 100
1. Decision to Acquire an MBA 100
2. Decision to Open a Video Rental Store 101
3. Essential Points about Capital Budgeting 102
Capital Budgeting: Some Complexities 104
1. Risk 104
2. Inflation 105
3. Taxes and Depreciation Tax Shields 107
Alternative Investment Criteria 109
1. Payback 109
2. Accounting Rate of Return 109
3. Internal Rate of Return (IRR) 111
4. Methods Used in Practice 114
Summary 115
Organizational Architecture 135
A. Basic Building Blocks 136
1. Self-Interested Behavior, Team Production,
and Agency Costs 136
2. Decision Rights and Rights Systems 142
3. Role of Knowledge and Decision Making 142
4. Markets versus Firms 143
5. Influence Costs 145
B. Organizational Architecture 146
1. Three-Legged Stool 147
2. Decision Management versus Decision Control 150
C. Accounting’s Role in the Organization’s Architecture 152
D. Example of Accounting’s Role: Executive
Compensation Contracts 155
E. Summary 157
5
Responsibility Accounting and Transfer Pricing 170
A. Responsibility Accounting 171
1. Cost Centers 171
2. Profit Centers 174
3. Investment Centers 175
4. Economic Value Added (EVA®) 180
5. Controllability Principle 183
B. Transfer Pricing 185
1. International Taxation 185
2. Economics of Transfer Pricing 187
3. Common Transfer Pricing Methods 191
4. Reorganization: The Solution If All Else Fails 197
5. Recap 197
C. Summary 199
zim36725_fm_i-xvi.qxd
xiv
12/15/09
2:31 PM
Page xiv
Contents
6
Budgeting 229
A. Generic Budgeting Systems 231
1. Country Club 231
2. Private University 236
3. Large Corporation 238
B. Trade-Off between Decision Management
and Decision Control 241
1. Communicating Specialized Knowledge versus
Performance Evaluation 242
2. Budget Ratcheting 242
3. Participative Budgeting 245
4. New Approaches to Budgeting 246
5. Managing the Trade-Off 249
C. Resolving Organizational Problems 249
1. Short-Run versus Long-Run Budgets 250
2. Line-Item Budgets 252
3. Budget Lapsing 253
4. Static versus Flexible Budgets 253
5. Incremental versus Zero-Based Budgets 257
D. Summary 258
Appendix: Comprehensive Master Budget Illustration 259
7
Cost Allocation: Theory 302
A. Pervasiveness of Cost Allocations 304
1. Manufacturing Organizations 305
2. Hospitals 306
3. Universities 306
B. Reasons to Allocate Costs 308
1. External Reporting/Taxes 308
2. Cost-Based Reimbursement 309
3. Decision Making and Control 311
C. Incentive/Organizational Reasons for
Cost Allocations 312
1. Cost Allocations Are a Tax System 312
2. Taxing an Externality 313
3. Insulating versus Noninsulating Cost Allocations 319
D. Summary 322
8
Cost Allocation: Practices 347
A. Death Spiral 348
B. Allocating Capacity Costs: Depreciation 353
C. Allocating Service Department Costs 353
1. Direct Allocation Method 355
2. Step-Down Allocation Method 357
3. Service Department Costs and Transfer Pricing of Direct
and Step-Down Methods 359
4. Reciprocal Allocation Method 362
5. Recap 364
zim36725_fm_i-xvi.qxd
12/15/09
2:31 PM
Page xv
Contents
xv
D. Joint Costs 364
1. Chickens 366
2. Net Realizable Value 367
3. Decision Making and Control 371
E. Segment Reporting and Joint Benefits 372
F. Summary 373
Appendix: Reciprocal Method for Allocating Service Department Costs 374
9
Absorption Cost Systems 409
A. Job Order Costing 411
B. Cost Flows through the T-Accounts 413
C. Allocating Overhead to Jobs 416
1. Overhead Rates 416
2. Over/Underabsorbed Overhead 417
3. Flexible Budgets to Estimate Overhead 420
4. Expected versus Normal Volume 423
D. Permanent versus Temporary Volume Changes 427
E. Plantwide versus Multiple Overhead Rates 428
F. Process Costing: The Extent of Averaging 432
G. Summary 433
Appendix A: Process Costing 433
Appendix B: Demand Shifts, Fixed Costs, and Pricing 439
10
Criticisms of Absorption Cost Systems: Incentive to Overproduce 468
A. Incentive to Overproduce 470
1. Example 470
2. Reducing the Overproduction Incentive 472
B. Variable (Direct) Costing 474
1. Background 474
2. Illustration of Variable Costing 474
3. Overproduction Incentive under Variable
Costing 477
C. Problems with Variable Costing 478
1. Classifying Fixed Costs as Variable Costs 478
2. Ignores Opportunity Cost of Capacity 480
D. Beware of Unit Costs 481
E. Summary 483
11
Criticisms of Absorption Cost Systems: Inaccurate Product Costs 501
A. Inaccurate Product Costs 502
B. Activity-Based Costing 506
1. Choosing Cost Drivers 507
2. Absorption versus Activity-Based Costing: An Example 513
C. Analyzing Activity-Based Costing 517
1. Reasons for Implementing Activity-Based Costing 517
2. Benefits and Costs of Activity-Based Costing 519
3. ABC Measures Costs, Not Benefits 521
D. Acceptance of Activity-Based Costing 523
E. Summary 527
zim36725_fm_i-xvi.qxd
xvi
12/15/09
2:31 PM
Page xvi
Contents
12
Standard Costs: Direct Labor and Materials 554
A. Standard Costs 555
1. Reasons for Standard Costing 556
2. Setting and Revising Standards 557
3. Target Costing 561
B. Direct Labor and Materials Variances 562
1. Direct Labor Variances 563
2. Direct Materials Variances 567
3. Risk Reduction and Standard Costs 571
C. Incentive Effects of Direct Labor and Materials Variances 571
1. Build Inventories 572
2. Externalities 572
3