Overview managerial accounting chapter 01

Understand the basic concepts underlying Just-In-Time JIT, Total Quality Management TQM, Process Reengineering, and the Theory of Constraints TOC.. Financial and managerial accounting bo

Chapter 1

Managerial Accounting and the Business Environment

Learning Objectives

LO1 Identify the major differences and similarities between financial and managerial

accounting

LO2 Understand the role of management accountants in an organization

LO3 Understand the basic concepts underlying Just-In-Time (JIT), Total Quality

Management (TQM), Process Reengineering, and the Theory of Constraints (TOC) LO4 Understand the importance of upholding ethical standards

New in this Edition

• The discussions of JIT, TQM, and Process Reengineering have been condensed

• Many new In Business focus boxes have been written

is no requirement that management accounting reports conform to GAAP Indeed, it is desirable

to depart from GAAP in some instances

B Organizations. (Exercise 1-1.) A review of the work of managers and the organizations

in which they operate is useful You may want to take a few moments and discuss some organizations that students are familiar with Examples of organizations that students may mention include: sole proprietorships, partnerships, corporations, churches, cities, military units, social clubs, foundations, and families With the various types of organizations listed, focus on two points

1 An organization consists of people who are brought together for some common purpose It

is a group of people working together that is the essence of any organization, not the particular assets used by these people

2 People work together in an organization in order to attain some goals The objectives or goals may be clearly stated, but often they are not The financial objectives for most organizations, even if not articulated, are fairly straightforward In commercial enterprises, the primary goal is ordinarily to maximize profits or to at least earn a “satisfactory profit.”

1 Planning consists of strategic planning and developing more detailed short-term plans

Most of what we refer to below is with reference to the more detailed short-term plans

2 Directing and motivating involves mobilizing people to implement the plan

3 Control is concerned with ensuring that the plan is followed The accounting function plays a major role in the control phase Accountants maintain the databases and prepare the reports that provide feedback to managers The feedback can be used to reward particularly successful employees, but more importantly the feedback can be used to identify potential problems and opportunities that were not anticipated in the plan Based on feedback, it may

be desirable to modify the plan The feedback can be also used to identify parts of the organization that need help and those parts that can provide advice and assistance to others

4 Decision-making is an integral part of the other three management activities

D Need for Information. Accurate and timely accounting information helps management plan effectively and to focus attention on deviations from plans In the planning stage, managers make decisions concerning which alternatives should be selected Financial information is often

a vital component of this decision-making Once the alternatives have been selected, detailed planning is possible These detailed plans are usually stated in the form of budgets The control function of management is aided by performance reports that compare actual performance to the budget This feedback mechanism directs attention to activities where managerial attention is needed

E Comparison of Financial and Managerial Accounting Financial and managerial accounting both rely on the same basic accounting database, although managerial accountants often accumulate and use additional data However, important differences exist between the two disciplines:

1 Financial Accounting:

• Is concerned with reports made to those outside the organization

• Summarizes the financial consequences of past activities

• Emphasizes precision and verifiability

• Summarizes data for the entire organization

• Must follow GAAP since the reports are made to outsiders and are audited

• Is required for publicly-held companies and by lenders

2 Managerial Accounting:

• Is concerned with information for the internal use of management

• Emphasizes the future

• Emphasizes relevance and flexibility of data

• Places more emphasis on non-monetary data and timeliness and less emphasis on precision

• Emphasizes the segments of an organization rather than the organization as a whole

• Is not governed by GAAP

• Is not required by external regulatory bodies or by lenders

F Organizational Structure (Exercise 1-1.) Organizational structure refers to the way in which responsibilities and authority are distributed within an organization

1 Centralization vs decentralization At one extreme is a totally centralized organization in

which the boss makes all decisions The opposite extreme is a totally decentralized organization where decisions are made at the lowest possible level in the organization Centralization tends to be favored in situations where information is centralized and control

is important Decentralization tends to be favored in situations where information is dispersed and centralized control is less important

2 Organization charts Exhibit 1-3 is useful in discussing the structure of an organization

Informal communication links are particularly important

3 Line and staff relationships Exhibit 1-3 is also useful for discussing line and staff

positions A line manager is directly engaged in attaining the organization’s objectives People in staff positions provide support to the line positions Especially important to note here is that the accounting function is a staff position

4 The Chief Financial Officer The controller is the manager in charge of the accounting

department and he/she reports to the Chief Financial Officer (CFO) The CFO is usually a member of the top-management team and should be an active participant in the planning, control, and decision-making processes at the very highest levels in the organization

G The Changing Business Environment. (Exercise 1-2.) Over the last two decades, competition in many industries has become global and the pace of innovation in products and services has accelerated While this has generally been good news for consumers, it has resulted

in wrenching changes in business, including the advent of the internet Many companies now realize that they must continuously improve in order to remain competitive

1 Improvement programs come and go and have almost as many names as there are

consulting firms engaged in marketing continuous improvement programs The boundaries between the various approaches are blurry

2 Historically, Just-In-Time (JIT) was developed first While JIT has its roots in the Rouge River automotive plant built by Henry Ford in the 1920s, it was most fully developed by Toyota in Japan We use the term JIT narrowly to refer to minimum inventory production systems The use of the term JIT to refer to continuous improvement programs in general has fallen out of use

3 In the text, we very briefly describe the major characteristics of three other general

approaches to continuous improvement—Total Quality Management (TQM), Process Reengineering, and the Theory of Constraints (TOC) These approaches are not mutually exclusive They can be used together in concert Indeed, TQM and Process Reengineering may be most effective when they are combined with TOC

4 A key concept in continual improvement is that improvement never ends After every

improvement, a new opportunity for improvement is sought out

5 While not emphasized in the text, you may want to point out that these various

improvement programs are not always successful Advocates of the various programs will invariably claim that failures are due to poor implementation or to lack of support by top management While these two factors undoubtedly account for many of the failures, we suspect that the improvement programs are not as universally appropriate as their proponents claim For example, a TQM program that is focused on improving non-constraint workstations will have difficulty translating operational improvements into additional profits

H Just-In-Time The term JIT means that materials are received just in time to be used in production, manufactured parts are completed just in time to be assembled into products, and products are completed just in time to be shipped to customers As a result, inventories are virtually eliminated in a JIT system

1 JIT uses a “pull” approach to production control

a At the final assembly stage, a signal is sent to the preceding workstation as to the exact amount of parts and materials needed for the next few hours Similar signals are sent back through each preceding workstation All workstations respond to the pull exerted

by the final assembly stage, which in turn responds to customer demands

b In contrast, in a conventional production control system each workstation completes its processing and “pushes” partially completed components forward to the next workstation This is done regardless of whether the next workstation is ready to receive the components or whether anyone actually wants to buy the finished product The result is that work in process tends to build up in front of the workstations that are inherently slower than the others The overriding concern in many conventional facilities is to keep all the workstations busy all of the time Since the capacities at workstations differ, this necessarily results in piles of work in process inventories in front of the workstations with lower capacities

c The pull approach used in JIT reduces inventories since workstations do not produce anything unless it has already been requested by a downstream workstation and ultimately by customers

2 The causes of excessive inventory

a Some inventories are usually maintained to guard against stock-outs These inventories can be cut if the time required to make a product is reduced to the point that current customer demands can be met with current production

b Poor coordination among workstations can lead to excessive inventories

c Large batch sizes lead to excessive inventories

d The desire to “keep everyone busy” often leads to inventory buildups The market may not be able to absorb everything the plant can make Moreover, differing capacities at

workstations will inevitably lead to buildups of work in process inventories in front of the workstations with lower capacities (See the discussion above.)

I Key Elements of JIT. In addition to JIT purchasing, successful JIT production control systems usually have the following four key characteristics:

1 Improved plant layout The layout of the plant should be improved to reduce distances

work in process must travel In conventional plant layouts, all of the machines of a similar class are grouped together in one location For example, all of the milling machines are usually in one location and all of the drilling machines in another Consequently, work in process must often move long distances between operations There are a number of problems with this First, moving components around the plant results in unnecessary costs Second, moving introduces delay The components sit around waiting to be moved and then it takes time to actually move them Third, it is difficult to keep track of individual items when the inventory is scattered all over the factory floor

2 Reduced setup time Reduced setup time provides the capability to respond quickly to

customer orders and reduces the need for safety stocks

3 Low defect rates A company should constantly strive to reduce the defects Large numbers of defects require that excess work in process be put into production to ensure that there will be sufficient defect-free output to meet customer orders Therefore, defects should be eliminated as much as possible in a JIT program

4 Flexible workforce Workers should be multi-skilled in a JIT environment, which is often

organized into small “cells” that contain all of the equipment required to carry out many steps in the production process Workers need to be able to use all of the various pieces of equipment in the work cell Also, workers are typically expected to perform maintenance tasks on their own equipment and to do their own quality inspections

K Benefits of JIT. Among the benefits resulting of using JIT are the following:

1 Inventories are reduced In addition to releasing funds tied up in financing inventories

(see below), smaller inventories reduce the risk of potential losses due to obsolescence

2 Space is freed up Areas that were previously devoted to storing inventories are made

available for more productive uses

3 Throughput time is reduced This makes it easier to respond to customer demands and

can be a very significant competitive advantage

4 Defect rates are reduced Operating without large work in process inventories makes it

much easier to quickly identify and correct production problems This latter point cannot be overemphasized Excessive work in process inventories make it very difficult to detect and diagnose problems When a facility operates without significant inventories, it is running

“naked.” Problems become quickly apparent and can be dealt with in a timely manner

L Total Quality Management (TQM) Total Quality Management means different things to different people Nevertheless, most TQM programs seem to share at least two common elements—a focus on the customer and systematic problem-solving using teams made

up largely of front-line workers

1 TQM tools TQM tools include the plan-do-check-act cycle, Pareto analysis, fishbone

charts, storyboards, statistical process control, and benchmarking We defer discussion of all of these tools except benchmarking to operations management courses

2 Benchmarking involves studying the best practices of other organizations to learn how to

do things better and as a means of setting goals For example, a large bakery might study the distribution system of a successful florist to improve its own distribution system

4 TQM empowers employees TQM empowers those who are closest to problems and it

focuses attention on fact-based problem solving rather than on finger pointing For an exceptionally lucid overview of TQM that emphasizes these points, see Wruck and Jensen,

“Science, Specific Knowledge, and Total Quality Management,” Journal of Accounting

and Economics, 18, 1994, pp 247-287

M Process Reengineering. The boundaries between Process Reengineering on the one hand and JIT and TQM on the other hand are fuzzy A successful JIT implementation almost always involves some Process Reengineering—although it may not be called by that name And some TQM advocates would no doubt claim that Process Reengineering is just a special case of TQM

To prevent confusion, we have attempted in the text to draw the sharpest distinction we can between Process Reengineering and the other two methods

1 Process Reengineering involves completely redesigning a business process from the ground

up In this respect, it can be differentiated from TQM, which tends to emphasize small, incremental improvements

2 Process Reengineering begins by flowcharting whatever business process is under

examination Quite often, the flowchart reveals a Rube Goldberg-like process that has been thrown together over time in response to various problems

3 Non-value-added activities in the flowchart are identified These are activities that take

time or consume resources but that do not add any value that the customer is willing to pay for

4 The process is redesigned with a focus on simplification and elimination of

non-value-added activities

5 Unfortunately, Process Reengineering often fails because of behavioral problems

a By simplifying and eliminating non-value-added activities, it should be possible to design a process that gets the job done with fewer resources than before This often means that fewer workers will be required If management lays off the surplus workers

or transfers them to less desirable jobs, morale suffers and further process reengineering efforts will very likely be resisted by employees Management should develop plans for redeploying surplus resources—including people—even before the

Process Reengineering is begun and these plans should be communicated to employees

b Reengineering is often guided by consultants or staff specialists who recommend dramatic changes in how jobs are performed Consequently, reengineering is likely to

be resisted by front-line workers Management must work hard to ensure that workers

do not feel threatened by reengineering and that their legitimate concerns are taken into account

N Theory of Constraints (TOC). As with JIT, TQM, and Process Reengineering, we

barely scratch the surface of the Theory of Constraints in the text For additional background, we

recommend THE GOAL: Second Revised Edition, by Goldratt and Cox

1 Every organization has at least one constraint It is easiest to think about this in the context

of a factory whose production cannot keep up with demand In that case, the constraint is inside the factory Ordinarily, the constraint will be the workstation with the lowest rate of output (and smallest capacity)

2 The output of the entire system (in this case, the factory) is determined by the rate of output (i.e., the capacity) of the constraint The non-constraints have excess capacity

3 To increase the output of the system the average rate of output through the constraint must

be increased The constraint should never be starved for work and improvement efforts should be focused on the constraint

4 If improvement efforts are focused on a non-constraint, the end result will be an increase in the amount of excess capacity This will be beneficial only if the excess capacity can be transferred in some way to the constraint or costs can be reduced by eliminating excess capacity However, as noted above, eliminating excess capacity can have a negative impact

on morale if it involves layoffs

5 If improvement efforts are focused on the constraint (as they usually should be), its rate of output may improve to the point that it is no longer the constraint The constraint would then shift elsewhere At that point, improvement efforts should shift to the new constraint

6 The goal in the Theory of Constraints is not to eliminate all constraints; the system always

has a constraint of some sort if the goal is to make more money Nevertheless, constraints determine the performance of the entire system, so they should be intelligently managed

O Professional Ethics. (Exercise 1-4.) Some students tend to equate legal and ethical behavior That is, if an action is legal, they consider it to be ethical We believe it is important to dispel this notion

1 In the text we use a utilitarian approach in arguing for the importance of maintaining ethical standards We argue that ethical standards are necessary for the smooth functioning of an advanced market economy Basically, if you could not trust anyone, you would be unwilling to transact in the marketplace without ironclad guarantees Such guarantees are expensive to write and enforce even when they are feasible See Eric Noreen, “The

economics of ethics: a new perspective on agency theory,” Accounting, Organizations and

Society, vol 13, no 4, 1988 for further development of these ideas

2 One advantage of approaching ethical issues in the managerial accounting course is that the code of ethics promulgated by the Institute of Management Accountants can be used as a framework This code of ethics is more specific than most codes of ethics, which tend to be general platitudes with little substantive content By contrast, the IMA code of ethics is refreshingly specific and strongly worded in some key areas It is also general enough that

it can be used by managers as well as by management accountants

Assignment Materials

Assignment Topic

Level of Difficulty

Suggested Time

Exercise 1-1 The roles of managers and management accountants Basic 10 min Exercise 1-2 The business environment Basic 10 min Exercise 1-3 Ethics in business Basic 15 min Problem 1-4 Preparing an organization chart Basic 30 min Problem 1-5 Ethics and the manager Basic 20 min Problem 1-6 Line and staff positions; organization chart Medium 30 min Problem 1-7 Ethics in business Medium 20 min Problem 1-8 Ethics; just-in-time purchasing Medium 30 min

1 2 3

Chapter 1 Lecture Notes

Helpful Hint: Before beginning the lecture, show students the first segment from the first tape of the McGraw-Hill/Irwin Managerial/Cost Accounting video library This segment introduces students to many of the concepts discussed in chapter 1 The lecture notes reinforce the concepts introduced in the video

Chapter theme: This chapter serves four main purposes

First, it explains the differences and similarities between financial and managerial accounting Second, it describes the role of management accountants in an organization Third, it explains the basic concepts underlying Just-In- Time (JIT), Total Quality Management (TQM), Process Reengineering, and the Theory of Constraints (TOC) Fourth, it discusses the importance of upholding ethical standards

I The work of management and the need for managerial

accounting information

A Managers carry out three main activities – planning,

directing and motivating, and controlling

i Planning

1 The first step in planning is to identify alternatives and then to select from among

the alternatives the one that does the best

job of furthering the organization’s objectives

2

1

3

3 4 5

2 Once alternatives have been identified, the plans of management are often expressed

formally in budgets

a Budgets are usually prepared under the

direction of the controller, who is the

manager in charge of the accounting department

b Typically, budgets are prepared

annually

ii Directing and motivating

1 In addition to planning for the future,

managers must oversee day-to-day

activities to keep the organization

functioning smoothly

2 Managerial accounting data, such as daily

sales reports, are often used in this type of

day-to-day decision making

iii Controlling

1 In carrying out the control function,

managers seek to ensure that the plan is

being followed Feedback, which signals

whether operations are on track, is the key to effective control

a A performance report compares

budgeted to actual results It suggests

where operations are not proceeding as planned and where some parts of the organization may require additional attention

3

4

5

6 7

iv The planning and control cycle

1 The work of management, which is known

as the planning and control cycle, can be depicted as shown

II Comparison of financial and managerial accounting

A Seven key differences

i Users

1 Financial accounting reports are prepared

for external parties, whereas managerial accounting reports are prepared for internal

users

ii Emphasis on the future

1 Financial accounting summarizes past

transactions Managerial accounting has a

strong future orientation

iii Relevance of data

1 Financial accounting data are expected to be

objective and verifiable Managerial

accountants focus on providing relevant

data even if it is not completely objective or

verifiable

“In Business Insights”

Management accounting systems should be flexible enough to provide whatever data are relevant for a particular decision

6

7

7

“Why Do You Ask?” (page 8)

• Caterpillar has long been on the forefront of

management accounting practice When asked by

a manager for the cost of something, accountants

at Caterpillar have been trained to ask “What are you going to use the cost for?”

• One management accountant at Caterpillar

explains: “We want to make sure the information

is formatted and the right elements are included

Do you need a variable cost, do you need a fully burdened cost, do you need overhead applied, are you just talking about discretionary cost? The cost that they really need depends on the decision they are making.”

iv Less emphasis on precision

1 Financial accounting focuses on precision

when reporting to external parties

Managerial accounting aids decision makers

by providing good estimates as soon as

possible rather than waiting for precise data later

v Segments of an organization

1 Financial accounting is concerned with

reporting for the company as a whole

Managerial accounting focuses more on the

segments of the company Examples of

segments include:

a Product lines, sales territories, divisions, departments, etc

7

7 8 9

vi Generally Accepted Accounting Principles

(GAAP)

1 Financial accounting conforms to GAAP Managerial accounting is not bound by

GAAP

vii Managerial accounting – not mandatory

1 Financial accounting is mandatory because

various outside parties require periodic financial statements Managerial accounting

is not mandatory

III Organizational structure

A Decentralization

i Decentralization is the delegation of

decision-making authority throughout an

organization by providing managers with the authority to make decisions relating to their area of responsibility

ii An organizational chart shows how

responsibility is divided among managers and

it shows formal lines of reporting and communication

B Line and staff relationships

i An organization chart also depicts line and

staff positions in an organization

7

8

9

9 10

1 A person in a line position is directly

involved in achieving the basic objectives of the organization

2 A person in a staff position is indirectly

involved in achieving those basic objectives Staff positions support line positions, but they do not have direct authority over line positions

C The Chief Financial Officer

i The Chief Financial Officer (CFO) is the

member of the top management team who is responsible for providing timely and relevant

data to support planning and control

activities and for preparing financial statements for external users

1 The controller reports to the CFO

“In Business Insights”

CFOs and their subordinates in most organizations contribute in numerous ways beyond just preparing financial statements For example:

“Beyond the Numbers” (page 11)

• Judy C Lewent is the CFO of Merck, a major

pharmaceutical company She is in charge of 750 people

• Merck’s chairman, CEO, and president Raymond

Gilmartin says this about Lewent “Many CFOs take as their prime directive the timely, accurate delivery of detailed financial data and analysis to top management While the importance of these services cannot be overestimated, with Judy they

9

10

11 12

are simply one of the many ways she contributes

to the business.”

• Gilmartin went on to say that Lewent helps “make

decisions about which developmental-product projects to fund and how to structure our product franchises, acquisition possibilities, and licensing arrangements.”

“What Does It Take?” (page 12)

• A controller at McDonald’s claims that its most

successful management accountants must possess numerous skills

• For example, they need to be experts in the

company’s business and accounting software They need to have a working knowledge of what people do in marketing, engineering, human resources, and other departments They also need

to understand how the processes, departments, and functions work together to run the business

IV The changing business environment

A We are going to discuss six changes in the business

environment, namely Just-In-Time production, Total Quality Management, Process Reengineering, the Theory of Constraints, international competition, and e- commerce

B Just-In-Time (JIT)

i When companies use the JIT production and

inventory control system, they purchase

materials and produce units only as needed

to meet actual customer demand The

11

12

12 13

receipt of a customer order triggers the steps

as shown

1 When applied in a manufacturing setting,

JIT systems seek to minimize raw

materials, work in process, and finished goods inventories

ii Other improvements required to support JIT

and inventory reduction include:

1 Reduce the number of suppliers to a

reliable few who can make frequent deliveries of defect-free goods in small lot sizes

2 Improve the plant layout by creating a

focused factory or manufacturing cell

a An improved plant layout can

dramatically reduced throughput time

(also known as cycle time), which is the time required to make a product

“In Business Insights”

Numerous companies have adopted cellular manufacturing to cut costs and boost productivity For example:

“Canon Goes Cellular” (page 14)

• Canon has completely revamped its production

processes in its photocopier plants, ripping out the conveyor belts and heavy equipment that used

to be the core of its assembly lines

• Instead, Canon has adopted cell production with

small teams of about six workers concentrating on building a single type of copying machine

12

13

13 14

• Instead of being bolted to the floor, the production

equipment is lighter and modular, and can be easily moved into new configurations

• As a result, assembly costs have been cut in half

and productivity has been boosted by 20%

3 Reduce setup time to make smaller batch

sizes economical

4 Eliminate defects to ensure a smooth flow

of production and timely customer shipments

5 Develop a flexible workforce that is

capable of operating all of the equipment in

a manufacturing cell

iii Benefits of a JIT system

1 Funds tied up in inventory can be used

elsewhere

2 Areas previously used to store inventories

can be used for productive purposes

3 Throughput time is reduced enabling more

rapid response to customers

4 Defect rates are reduced resulting in less waste and greater customer satisfaction

“In Business Insights”

While JIT offers many benefits, it can cause some problems as well For example:

“The Downside of JIT” (page 15)

• Toyota is a strong proponent of JIT; however, it

found out the hard way that unexpected disruptions in supply can bring the production line to a halt

13

14

15 16

• One Saturday, a fire at Aisin Seiki Company’s

plant in Aichi Prefecture stopped the delivery of all brake parts to Toyota

• By Tuesday, Toyota had to close down all of its

Japanese assembly lines By the time the supply of brake parts had been restored, Toyota had lost an estimated $15 billion in sales

C Total quality management (TQM)

i TQM improves productivity by encouraging

the use of science in decision-making and discouraging counter-productive defensive

behavior There are two main characteristics

of TQM:

1 A focus on serving customers

2 The use of systematic problem solving

using teams made up of front-line workers

a One problem solving tool commonly

used is called benchmarking, which

involves studying and learning from organizations that are among the best

in world at a particular task

D Process reengineering

i In Process Reengineering, a business process

is diagrammed in detail, questioned, and then

completely redesigned to eliminate all value-added activities

1 A business process is any series of steps

that are followed to carry out some task in a business

15

16

17 18