Giáo trình managerial accounting 2nd by balakrishnan

In Chapter 1, we illustrate a four-step framework for decision making, and we distinguish how individuals make decisions from how organizations make decisions.. We end this chapter by

M A N A G E R I A L

A C C O U N T I N G

S e c o n d E d i t i o n

Production Editor: Rocky Buckley

Cover photo: © Greg Epperson/Shutterstock

Copyright © 2012 by John Wiley & Sons, Inc

All rights reserved

No part of this publication may be reproduced, stored in a retrieval system or transmitted in any form

or by any means, electronic, mechanical, photocopying, recording, scanning or otherwise, except

as permitted under Sections 107 or 108 of the 1976 United States Copyright Act, without either the prior written permission of the Publisher, or authorization through payment of the appropriate per-copy fee to the Copyright Clearance Center, Inc., 222 Rosewood Drive, Danvers, MA 01923, website www.copyright.com Requests to the Publisher for permission should be addressed to the Permissions Department, John Wiley & Sons, Inc., 111 River Street, Hoboken, NJ 07030-5774, (201) 748-6011, fax (201) 748-6008, website http://www.wiley.com/go/permissions

To order books or for customer service, please call 1(800)-CALL-WILEY (225-5945)

Printed in the United States of America

ISBN 978-1-118-38538-8

Printed and bound by Walsworth Print Group

10 9 8 7 6 5 4 3 2 1

Ramji Balakrishnan

To my parents, Usha, Vasu and Uma

K Sivaramakrishnan

To my father, my sisters Viji and Parvathi, my wife Devika,

my daughter Vidya, and in loving memory of my mother

Geoffrey B Sprinkle

To Shari, Jason, Jack, and Scott

Dedication

Ramji Balakrishnan is the Harry B Carlson-KPMG Professor of Accounting at the University of Iowa Ramji has a B.Sc in Statistics from the University of Madras

in 1977, an MBA from the Indian Institute of Management, Ahmedabad, in 1979, and a Ph.D from Columbia University in 1986 He is a Certified Management Accountant and is a recipient of the Robert Beyer Bronze Medal A top-rated teacher,

he has taught managerial accounting at the undergraduate, graduate and doctoral levels He joined the University of Iowa in 1986 and has been there since except for

a year at Georgia State University He has published widely in top-tier journals, with several of his papers being recognized as “Outstanding Contributions.” He serves

on several editorial boards and is the Editor of the Journal of Management Accounting Research A sought after speaker, he has delivered workshops in Asia, Europe and

North America He was the President of the Management Accounting Section of the American Accounting Association for 2005-2006

Konduru “Shiva” Sivaramakrishnan is the Henry Gardiner Symonds Professor

in Accounting at the Jesse H Jones Graduate School of Business, Rice University

He received his B Tech in Engineering from the Indian Institute of Technology, Madras in 1977, an MBA from Xavier Institute, Jamshedpur, India, in 1982, and a Ph.D in Accounting and Information Systems from the Kellogg Graduate School

of Management at Northwestern University in 1989 Prior to his current position,

he has held tenured faculty positions at Carnegie Mellon University, Texas A&M University, and the University of Houston Most recently, he held the Peggy Pittman Eminent Scholar Chair at the Mays Business School, Texas A&M University Dr Sivaramakrishnan has significant research and teaching accomplishments His

research has appeared in premier journals such as The Accounting Review, Journal

of Accounting Research, Contemporary Accounting Research, Management Science, Journal

of Management Accounting Research, Accounting Horizons, Journal of Accounting and Economics, and Review of Financial Studies He has won numerous awards for teaching

excellence at both undergraduate and graduate levels.

Geoffrey B Sprinkle Geoffrey B Sprinkle is a Professor of Accounting and Whirlpool Corporation Faculty Fellow at the Kelley School of Business at Indiana University Geoff received his B.S in Accounting and Master of Accountancy degrees from Arizona State University and his Ph.D from The University of Iowa

He earned the Gold Medal in the state of Arizona on the May, 1989 CPA exam and the Elijah Watts Sells award nationally Geoff teaches in the areas of cost and managerial accounting and has received numerous teaching awards His work

has appeared in journals such as The Accounting Review, The American Economic Review, Accounting, Organizations and Society, Behavioral Research in Accounting, Games and Economic Behavior, the Journal of Management Accounting Research, and Issues in Accounting Education.

About the Authors

Compared to existing books on the market, we believe

our book offers several advantages and unique

fea-tures Below, we summarize the key attributes of our

text In the pages following the summary, we provide

a richer discussion of our approach and pedagogy.

• We provide an easy to understand integrated

framework that links topics into a seamless

whole In the early chapters, we introduce two

ideas: More costs and benefits become relevant

as a decision’s horizon expands, and all

deci-sions involve a cycle of planning and control We

implement the first idea by organizing the text

into modules corresponding to short-term and

long-term decisions We then address planning

and control decisions within each horizon We

are pleased to report that our colleagues and

we have received outstanding student feedback

on the tightly integrated nature of our text—

students and instructors report that chapters

follow naturally from one to the next, with

everything “fitting” together.

• Both the overall structure of the book and

indi-vidual chapters emphasize using accounting

information for decision making. Across chapters,

we use the time-based template to emphasize the

links among the various decisions that

manag-ers make, enabling students to see the linkages

among seemingly unrelated decisions Before

each module, we use a part-opener to remind

students about the relations among

organiza-tional decisions, and to place forthcoming topics

in the appropriate context Within each chapter,

we maintain the focus on decision making by

exploring a specific business problem Each chapter also uses the same four-step approach

to solving business problems.

• Both the chapter text and end-of-chapter

materials provide a balanced coverage of

manufacturing and service sectors Examples considered in the chapters include a gym, a caterer, a hospital, a consulting firm, a copy center, and a call center Moreover, every chapter contains numerous exercises and problems relating to service and nonprofit settings We have received rave reviews from instructors and students about both the breadth and depth of our end-of- chapter materials.

• The book is student friendly Our initial

drafts used a conversational tone and day examples to illustrate concepts We then subjected these drafts to several rounds of review by English editors, undergraduate stu- dents, and faculty to increase accessibility and impact In addition to the standard exhibits, we

every-include “Check It!” boxes of mini-worksheets that

students can use to verify and fine-tune their understanding of the material.

• We maintain the integrity of the framework while

allowing instructors the flexibility to modify

cov-erage to best suit their individual needs We help instructors by presenting several sample syllabi that show alternate sequencing of topics (please see Section 5 in this Preface for further details) The primary flexibility lies in whether, after cover- ing basic terminology and cost flows, instructors choose to cover product costing or to plunge directly into short-term decisions.

Executive Summary

Preface

Managerial accounting facilitates planning and

con-trol decisions Planning decisions relate to choices

about acquiring and using resources to deliver

prod-ucts and services to customers (e.g., which prodprod-ucts

and services to offer, their prices, and the resources

needed, such as materials, labor, and equipment)

Control decisions concern how much to delegate,

as well as how to motivate, measure, evaluate, and

reward performance.

Current managerial accounting textbooks generally

group product costing, cost management (ABC/ABM),

short-term decisions, and performance evaluation

prac-tices into four separate modules This grouping allows

students to gain a working knowledge of current

mana-gerial accounting practices However, while each book

may provide solid coverage on one or more important

dimensions, none offers a satisfactory, overarching

theme The average student walks away with a

collec-tion of concepts and techniques but with little idea of

why things work the way they do Armed with only the

“what” and the “how” but not the “why,” students have

no framework that lets them see the principles that drive

practice or helps them adapt to novel or changing

circumstances.

We provide instructors and students with a unifying,

problem-solving framework. We believe that the

frame-work itself must be the key takeaway from any

intro-ductory managerial accounting course By virtue

of its logic and internal consistency, the framework

allows students to:

• Understand the big picture.

• Examine new ideas and concepts and their

relation to existing practice.

• See how accounting information helps manage

a complex entity.

At the core of our framework is the one feature

common to all decisions—every decision involves a

cost-benefit trade-off The decision could be personal

(should I eat out or make dinner?) or organizational

(should we continue using traditional performance

measures or switch to the balanced scorecard?) The

decision could relate to planning (how should we

price this product?) or control (where should we set

the sales quota?) The theme of systematically

mea-suring costs and benefits to make effective decisions

runs throughout our text.

The first outgrowth of this theme, indicated by

the titles of the modules, is our emphasis on a

decision’s horizon Time influences whether a cost

or benefit is relevant for decision The costs of the production plant and equipment are not relevant to many short-term decisions Thus, there is no need to allocate these fixed costs to make effective short-term decisions In the long term, however, a firm can man- age capacity costs by shrinking or expanding its invest- ment in plant and equipment Thus, to make effective long-term decisions, a firm needs to identify varia- tions in resource consumption patterns and create allocation mechanisms that capture the cost impact of these variations Ultimately, when confronted with a decision problem, the successful manager knows what costs and benefits to include in the decision, and how

to measure these costs and benefits.

A second important aspect of our framework is an integrated treatment of planning and control deci- sions Planning and control are two sides of the same coin Diagnostic and feedback measures inform orga- nizations of how well they implemented the plan, thereby providing input for the next plan Similarly, performance evaluation and incentive schemes arise

in response to strategic aspects of the planning cess An integrated treatment highlights these links, permitting students to perceive planning and control decisions as part of the same framework.

pro-PEDAGOGY

Students learn best from simple examples Once students understand the basic issues at an intuitive level, it is easier for them to understand similar issues

in other business contexts We therefore begin each chapter with an example that students can readily comprehend and to which they could relate We then walk students through the issues and use the vignette

as a springboard to more advanced settings.

In addition to linking topics across chapters, we tightly integrate topics within a chapter To this end, each chapter tells a story The opening vignette serves to raise pertinent questions, and the chapter answers these questions In this fashion, the student perceives the concepts as being interrelated and not disjointed.

We note three other important features:

• We made a strategic decision to collaborate

on one chapter at a time; although more consuming, this team-based approach ensures that we choose the best among the many ways

time-of presenting the same material This approach ensures that the book speaks with one voice.

1 Introduction

• We have tried to make the text extremely

acces-sible This allows instructors, after ensuring that

students understand the basics, to devote some

class time to higher-order learning and explore

conceptual and qualitative issues As detailed in

Section 4, the end-of-chapter materials contain

thought questions that instructors can use to ate such discussions.

• We hope to surprise you with both the breadth and depth of our end-of-chapter materials We have devoted substantial efforts to ensuring that the problems and solutions are of the highest quality.

The typical student has limited exposure to business,

even though she may have taken courses in

finan-cial accounting and microeconomics Accordingly,

the key task is both to explain the many kinds of

decisions needed to operate a successful business

and to communicate how managers use cost

infor-mation in these decisions It is not enough to know

prevalent practice It is vital that the student

under-stand whether and why a certain practice has merit

in a given situation This understanding requires

a sound framework In line with the adage about

teaching a man to fish, we believe that the average student will appreciate our framework for decision making.

The focus on using cost data for decision making makes our book well suited for a course that employs

a perspective We believe that such a focus is particularly appropriate for the introductory course It also is consistent with the widespread move to change the curriculum from a technical- accounting perspective to a business- oriented, or process, perspective.

user-2 Audience

Module I: INTRODUCTION

AND FRAMEWORK

Our first module contains three chapters In Chapter

1, we illustrate a four-step framework for decision

making, and we distinguish how individuals make

decisions from how organizations make decisions We

next introduce two important classes of organizational

decisions—planning decisions and control decisions

We then discuss how organizations use managerial

accounting information for both planning and control

We conclude Chapter 1 by examining the role of ethics

in decision making, and discussing how societal and

professional standards shape organizational decisions.

Making a decision requires that we identify what

costs and benefits to measure, and then estimate

them Chapters 2 focuses on the principles that

help us accomplish these two tasks We begin with

two principles, controllability and relevance, that

3 Organization of Content

determine which costs and benefits to measure Using

these principles, we offer an approach for grouping business decisions per their horizon This grouping

of decisions forms the basis for the modular approach that unfolds We next discuss the principles that are fundamental to estimating costs and benefits: variabil- ity and traceability Finally, we extend the principle of variability to develop a hierarchy of costs, which helps

to increase the accuracy of estimated costs.

We conclude this introductory module with a chapter on cost terminology and an overview of how accounting systems record the flow of costs This chapter begins by discussing cost flows in a ser- vice environment such as a health club, where the accounting and cost flows are somewhat intuitive

We next move to cost flows in merchandising firms

to introduce the concept of an inventory account Finally, we consider manufacturing organizations.

CONTROL: MAXIMIZING CONTRIBUTION

We define the short term as a period over which

orga-nizations cannot change capacity costs arising from

long-term commitments related to property, plant,

equipment, and personnel These costs, which we

often term fixed costs, are therefore not relevant for

term decisions Accordingly, the goal for

short-term decisions is to maximize contribution margin,

which is revenue less variable costs.

We begin Module II with a discussion of how to

estimate relevant costs for short-term decisions The

key here is to identify fixed and variable costs,

lead-ing us to discuss techniques such as account

classifi-cation, the high-low method, and regression analysis

We end this chapter by showing how a

contribu-tion margin statement helps managers organize the

resulting information to make effective short-term

decisions

We devote Chapters 5 and 6 to planning decisions

In Chapter 5, we introduce Cost-Volume-Profit (CVP)

analysis, a natural outgrowth of the contribution

mar-gin statement studied in the previous chapter The

CVP relations among costs, volume, and profit provide

a convenient tool for profit planning Following this,

we apply the CVP relation to evaluate decision options

and, in the process, illustrate how managers could use

the CVP relations to evaluate operating risk

While CVP analysis is useful for overall profit

plan-ning, it is not suitable for many localized decision

problems that arise because of the temporary

mis-match between the supply and demand for capacity

resources Specifically, most organizations invest in

capacity resources such as plant, equipment, and

per-sonnel based on expectations of long-term demand

Actual demand rarely equals anticipated demand,

however In some periods, actual demand falls short

of expectations, meaning that managers must find

ways to utilize idle resources gainfully At other times,

actual demand exceeds available capacity,

chang-ing the manager’s problem to one of extractchang-ing the

maximum benefit from available resources In either

instance, organizations cannot fix the mismatch by

changing capacity because they cannot control

capac-ity levels and costs in the short term In Chapter 6,

we discuss two approaches—the incremental and

totals—to frame and solve such decision problems

We illustrate these approaches in several contexts

such as make-or-buy, accepting a special order, and

allocating a scarce resource

Chapter 7 examines operating budgets Budgets

incorporate planning decisions on how and where to

use resources Budgets also serve as the benchmark

for evaluating actual results, a control decision In

this way, budgets bridge the planning and control

the planning and control roles for budgets in our discussion of both the mechanics of budgeting and the budgeting process.

Chapter 8 focuses on short-term control decisions

We begin by introducing the concept of a variance, which is the deviation between a budgeted and actual result We then present the mechanics of variance analysis, with a focus on using variances to reconcile budgeted and actual profit Finally, we emphasize the link back to planning decisions by discussing how to construct and interpret a profit reconciliation state- ment to determine possible corrective actions.

Module III: PLANNING AND CONTROL OVER THE LONG TERM: MAXIMIZING PROFIT

Over the long term, organizations can control most costs considered fixed in the short term That is, orga- nizations can alter capacity levels over this horizon Thus, the goal for long-term decisions is to maxi- mize profit, which is revenue less variable costs less capacity costs However, it often is difficult to estimate the controllable costs for many long-term decisions that pertain to individual products or customers The difficulty arises because products and customers typically share capacity resources, meaning that orga- nizations cannot trace capacity costs to individual products and customers In the language of Chapter

2, capacity costs are indirect costs Consequently, while performing a detailed account analysis to estimate controllable capacity costs is the economi- cally correct approach, it is not cost effective Thus,

as a practical matter, firms use cost allocations to approximate the change in capacity costs.

We devote Chapter 9 to cost allocations, a tool that firms employ to estimate costs over the long term We begin by describing how a firm might use allocations in a common decision problem—setting prices We note that firms allocate costs not just for decision making but for other reasons as well, including reporting income to external parties such

as shareholders and the IRS, justifying cost-based reimbursements, and influencing behavior within the organization Accordingly, we discuss these uses

of cost allocations and how an allocation’s intended purpose guides the choice of an allocation proce- dure In this way, the chapter provides an integrated discussion of the various demands for cost allocations within an organization.

We focus Chapter 10 on activity-based costing (ABC) and management At its core, ABC is a refined methodology for allocating capacity costs

We examine how ABC can lead to better decisions

by improving estimates of controllable capacity costs

We then discuss the steps associated with designing

product-costing systems and symptoms that might

help organizations decide if they need to update

the current costing system We end by highlighting

some of the costs and benefits of implementing

ABC ABC exploits the linkages among resources,

activities, and products to provide more accurate

measures of product profitability than traditional

allocation systems do Thus, after describing the

mechanics of ABC, we discuss how to use ABC data

to improve profitability by managing products,

customers, and resources Customer Profitability

Analysis allows organizations to identify profitable

and unprofitable customers, and suggests ways to

increase profit by managing customer relationships

We refer to this and other uses of activity-based

cost-ing information to manage profit as activity-based

management, or ABM.

Despite their widespread use, allocations have two

limitations when used to make decisions: (1) They do

not consider the time value of money; and (2) they do

not consider the lumpy nature of capacity resources

These limitations are of particular concern when the

firm is considering a large expenditure on a

long-lived resource For such expenditures, organizations

routinely engage in capital budgeting, the focus of

Chapter 11 As operational budgets do for short-term

decisions, capital budgets provide the link between

long-term planning and control decisions In

par-ticular, capital budgets provide an economic basis for

analyzing expenditures on capacity resources, and

control decisions focus on the effective use of these

resources.

Chapter 12 examines control decisions over the

long term Most organizations delegate decisions over

the use of resources to managers lower in the

orga-nizational hierarchy Decentralization leads to a

con-flict arising from the lack of goal congruence among

different levels in the organization Accordingly, we

begin the chapter by discussing the benefits and

costs associated with decentralizing decision making

We describe common forms of decentralization in

organizations and highlight the critical role of

per-formance evaluation systems in these environments

We discuss the principles that govern performance

measurement in organizations, and apply them to

measure and evaluate the performance of different

responsibility centers

In Chapter 13, we discuss how an organization’s

strategy affects its cost structure and defines the

business and operational constructs that require

measurement We also introduce and present the

balanced scorecard as a means of effectively

inte-grating an organization’s strategy with its control

system We begin with value chain analysis and strategic planning We introduce strategy and, using real-world examples, highlight the critical linkages between the value chain, strategy, and cost struc- ture We next discuss the impact of strategy on key organizational processes In each instance, our aim

is to show why the process configuration follows naturally from the strategic choice and provides a competitive advantage This approach allows us to discuss how to measure whether a process actually is yielding the desired advantage and how to motivate employees to stay focused on strategic objectives We then illustrate how the balanced scorecard can help

in this regard Our discussion underscores how the scorecard categories flow naturally from the organi- zation’s strategy We emphasize the choice among metrics and the importance of linking the metrics both within and across categories We conclude with

a brief discussion of implementation issues.

Module IV: COST ACCOUNTING SYSTEMS

This module explores the mechanics of cost ing systems Chapters 14 and 15, respectively, intro- duce students to two basic cost accounting systems: job and process costing Both of these systems use allocations to value inventory and compute the cost

account-of goods sold in accordance with GAAP As such, these chapters distinguish between cost accounting (computing product costs) and managerial account- ing (providing information for decision making) In the context of job costing, we introduce the notion of

a predetermined overhead rate, and we discuss how

to deal with under- or over-applied overhead In the process-costing chapter, we explain the concept of

an equivalent unit and discuss how to apply process costing to settings with many cost pools and opening inventory

Chapter 16 presents two refinements that could help organizations increase the accuracy of cost systems: dual-rate systems and accounting for interac- tions among departments (service department alloca- tions) We discuss how these refinements arise from the organization’s desire to improve the accuracy in reported product costs Because many might wish to skip or skim these topics, we adopt a modular pre- sentation to give instructors flexibility in the depth

of coverage.

We put the “traditional” cost accounting topics into separate chapters in a stand-alone module This placement provides instructors flexibility in coverage One can cover one or more of these chapters imme- diately after Chapter 3, after Chapter 9, or even skip this material entirely without interrupting the flow of the text.

4 Chapter Template

PART OPENER

Each module begins with a one- to two-page overview

of the module Part openers refer to a template for

organizing business decisions and explain how the

topics in the module fit within the framework The

goal is to provide a “road map” for the module.

Each chapter has the following features:

LEARNING OBJECTIVES

Learning objectives are useful because they prime

students’ thinking and focus their attention on the

big picture both before and after delving into the

details Our goal is to have an average of four to five

learning objectives per chapter Each learning

objec-tive has its own section within the chapter Common

terminology and margin notes alert students to these

linkages between learning objectives and sections

The summary discusses each of the learning

objec-tives and reiterates the key concepts.

OPENING VIGNETTE

We open each chapter with a simple “story” of a

busi-ness facing a decision problem Vignettes include

a story about a gym dealing with new competition,

a catering business deciding whether to accept an

engagement, and a cabinet-maker expanding his

prod-uct line These vignettes help us link different sections

in the chapter logically A few vignettes continue across

chapters to show linkages among the topics.

BODY OF THE CHAPTER

Each chapter begins with an intuitive discussion of

the issues in the opening vignette Rather than

provid-ing a solution, we focus the discussion on sharpenprovid-ing

the relevant questions and identifying pertinent costs

and benefits Following this discussion, we proceed as

per the list of learning objectives We use numerical

examples, graphs, and additional everyday examples to

make the concepts resonate with students Our goal is

to tell a story rather than present disjointed techniques

As mentioned earlier, one of our main goals is to

provide an integrated framework for using

account-ing information to make effective decisions Two

features help us deliver on this goal

• Apply the Decision Framework! In Chapter 1, we

provide four steps for effective decision making:

(1) Specify the decision problem, including the decision maker’s goals, (2) identify options, (3) measure costs and benefits to determine the value of each option, and (4) make the decision, choosing the option with the highest value At the beginning of each chapter, we summarize the vignette in this sequence, “solving” it by the end

of the chapter This feature serves to underscore our text’s emphasis on introducing every concept

in the context of a specific decision and then generalizing the idea.

• Chapter Connections For every chapter, we have boxes that show how the concept under discussion builds on concepts from prior chapters, and how the current topic is the foundation is the material discussed in later chapters For instance, we link the discussion of CVP analysis (Chapter 5) back to identifying fixed and variable costs (Chapter 4)

We also note that while CVP analysis is useful for profit planning and short-term decisions that per- tain to the firm as a whole, it can be difficult to adapt CVP analysis to more localized short-term decision problems Accordingly, we consider such decisions in Chapter 6

In the spirit of active learning, we induce students

to work along with the text.

• Check-It! These exercises and mini-worksheets ask students to verify some numbers or computa- tions in the text The objective is to confirm that the student is following the material and is not lost There usually are four to six such boxes per chapter (We provide solutions at the end of each chapter to help the student verify that they have mastered the concept.)

Finally, we show application to current business.

• Connecting to Practice: (Description of decision context). We have three to five such “call-out” boxes per chapter Each call-out box discusses

a relevant and recent phenomenon, drawing

from business publications such as the Wall Street Journal, Business Week, or the New York Times

SUMMARY

Our summary section links directly back to our learning objectives The opening paragraph in the

summary section discusses the general theme of the

chapter We then provide a transition to the next

chapter.

RAPID REVIEW

We present this summary of key points at the end of the

chapter There are four to six summary observations

that distill the take-away points for each learning

objective (section) The intent is to cement the

student’s understanding and to provide a ready review

prior to an examination.

REVIEW (SELF-STUDY) PROBLEM

Each chapter has one or two integrated self-study

problems with solutions These problems assist

stu-dents in working through the concepts presented in

the chapter and also ready students for the

end-of-chapter material.

GLOSSARY

Key terms—that is, terms that are novel to the

stu-dent and require definition—are boldfaced and

defined in the chapter We repeat these terms, with

their accompanying definition, in a section

immedi-ately following the summary section

END OF CHAPTER MATERIALS

We hope to surprise you with the quality of the

end-of-chapter materials We note the following points:

• We wrote both the questions and the

solu-tions manual We also developed the materials

concurrently with the text to ensure tight

linkages between chapter content and the

end-of- chapter materials Our extremely detailed

solutions go well beyond providing the

calcula-tions By discussing the application in detail,

the solutions manual serves to reinforce student

understanding.

• We consider examples in both the manufacturing

and the service sectors We also provide a range

of problems that apply the concepts to

not-for-profit entities

• Many questions raise ethical and social issues

These issues arise not as stand-alone topics but as

part of the decision-making process.

• We provide spreadsheet and graphing templates,

where appropriate

We provide two sets of qualitative questions, with

the aim of verifying student preparation and as a

basis for class discussion These are:

• Review Questions. These 10 to 15 questions test definitions and comprehension of key concepts The goal is to verify that the student has read the chapter with some care.

• Discussion Questions. These questions, 10 to 15 per chapter, expand the student’s understanding These questions might ask the student to consider how the analysis would change if an underlying assumption were to change, list additional factors that a manager would consider, and explain how the idea may apply to different settings.

We construct exercises and problems at three levels of difficulty.

• Foundational Exercises. The 15 or so exercises test students’ basic understanding of chapter materials These focused problems apply chapter concepts to the given setting.

• Intermediate Problems. These problems, 10 or so per chapter, typically require both quantitative and qualitative answers These problems often require students to consider (trade off) multiple objectives.

• Advanced Problems. These problems require students to think creatively and to move beyond

a direct application of chapter content We have three to five challenging problems per chapter.

Consistent with the theme of providing a solving framework, we organize many questions (particularly, intermediate and challenging problems) into three parts:

• Application of chapter content. This part asks students to apply a formula or concept discussed

in the chapter

• Sensitivity analysis. Intermediate and advanced level (“challenging”) problems have one or more questions that ask the student to probe the effect of relaxing one of the “simplifying” assump- tions For example, we may ask how estimated cost changes as operations approach capacity limits

• Qualitative and strategic considerations. The final part expands the analysis to include important but hard to quantify factors For example, in this part, we may ask the student

to discuss the quality implications of outsourcing

a component.

Finally, each chapter has one to three mini-cases These cases integrate most of the chapter’s learning objectives and could serve as the basis for group ( collaborative) activity or for a richer discussion of the issues presented in the chapter in a broader organizational context

5 Flexibility in Sequencing Chapters

There are at least three ways to organize the chapters

in this book in the context of a 15-week semester long

course.

A TRADITIONAL ORGANIZATION

Begin with Chapters 1–3 to introduce students to

managerial accounting, cost terminology, and cost

flows Move to Chapters 14 and 15, which cover job

and process costing After covering product costing,

revert to Chapter 4, which covers how to estimate

costs for short-term decisions From here on out,

chapters unfold in a traditional sequence

We anticipate that many instructors following this

sequence will omit Chapter 16 on service department

allocations The instructors also might end the course

with Chapter 12, which covers decentralization,

performance measurement, and transfer pricing.

B DECISION-MAKING FOCUS

We advocate this sequence The only modification

to the chapter sequence that we might make is to reduce the coverage of the chapters on strategic planning and control (Chapter 13) and to skim Chapter 16 We along with some of our colleagues have found that this approach works extremely well for undergraduates and MBA audiences.

First and foremost, we are extremely grateful to all of the students who have read earlier versions of this book – the feedback they have provided has been invalu- able Many of our colleagues also went above and beyond the call of duty in pro- viding us with feedback We particularly note, with gratitude, input from Helen Adams (University of Washington), Arthur Francia (University of Houston), Susan Keenan (Indiana University), Laureen Maines (Indiana University), Robert Milbrath (University of Houston), Mark Penno (University of Iowa), Devika Subramanian (Rice University), and Michael Williamson (University

of Texas at Austin) We also owe an intellectual debt to Bala Balachandran (Northwestern University), Joel Demski (University of Florida) and Shyam Sunder (Yale University), who shaped our thinking on the subject of managerial accounting Finally, we greatly appreciate the support and commitment of John Wiley & Sons, Inc We particularly thank Michael McDonald (Editor), Brian Kamins (Content Editor), Rocky Buckley (Production Editor), and Karolina Zarychta Honsa (Marketing Manager) for their efforts on the second edition.

Indiana State University

University of Connecticut, Stamford

California State Polytechnic University, Pomona

Grand Valley State University

Carolyn Strand Norman

Virginia Commonwealth University

College of Eastern Utah

Charles Tony Wain

Babson College

Mary Ann Welden

Wayne State University

Ohio State University

Focus Group Participants

Michigan State University

Joseph San Miguel

Naval Postgraduate School

Notre Dame University

Richard Merryman, Jefferson County Community

College—State University of New York, PowerPoint

and Study Guide author

Patricia Mounce, University of Central Arkansas, Test

Bank author

Debra Cosgrove, University of Nebraska—Lincoln,

Study Guide author

Bernie Weinrich, Lindenwood University

Module I:

I N T R O D U C T I O N A N D F R A M E W O R K

Chapter 1 Accounting: Information for Decision Making 2

Chapter 2 Identifying and Estimating Costs and Benefits 42

Chapter 3 Cost Flows and Cost Terminology 76

M o d u l e I I :

S H O RT- T E R M P L A N N I N G A N D C O N T R O L :

Chapter 4 Techniques for Estimating Fixed and Variable Costs 114

Chapter 5 Cost-Volume-Profit Analysis 160

Chapter 6 Decision Making in the Short Term 208

Chapter 7 Operating Budgets: Bridging Planning and Control 260

Chapter 8 Budgetary Control and Variance Analysis 310

Module III:

PLANNING AND CONTROL OVER THE LONG TERM:

Chapter 9 Cost Allocations: Theory and Applications 360

Chapter 10 Activity-Based Costing and Management 408

Chapter 11 Managing Long-Lived Resources: Capital Budgeting 456

Chapter 12 Performance Evaluation in Decentralized Organizations 500 Chapter 13 Strategic Planning and Control 546

Module IV:

Chapter 14 Job Costing 590

Chapter 15 Process Costing 628

Chapter 16 Support Activity and Dual-Rate Allocations 652

Brief Contents

C h a p t e r 1

Accounting: Information

L E A R N I N G O B J E C T I V E S 3

The Four-Step Framework

for Decision Making 4

Step 1: Specify the Decision Problem,

Including the Decision Maker’s Goals 4

Step 2: Identify Options 5

Step 3: Measure Benefits and Costs to

Determine the Value of Each Option 6

Step 4: Make the Decision 8

Decision Making In Organizations 8

Organizational Goals 9

Aligning Individual Goals With

Organizational Goals 9

The Planning and Control Cycle 11

Accounting and Decision Making 12

A P P E N D I X B : The Institute of Management

Accountants’ (IMA) Code of Ethics 23

Identifying and Estimating

L E A R N I N G O B J E C T I V E S 43Knowing What to Measure 44Relevance 44

Sunk Costs 46Time and Decision Making 47Categorizing Decisions Based on Time 47How to Estimate Costs and Benefits 50Variability 51

Traceability 52Hierarchical Cost Structure 54

Cost Flows and Cost Terminology 76

L E A R N I N G O B J E C T I V E S 77

Product and Period Costs 78

Cost Flows In Service Organizations 79

Cost Flows In Merchandising

Techniques for Estimating

L E A R N I N G O B J E C T I V E S 115

Contribution Margin Statement 116

Organizing Information to Help Make Decisions 116

Using the Contribution Margin Statement 117

Estimating Cost Structure 118

Account Classification Method 120

Evaluation of the Account Classification Method 121

High-Low Method 122

Mechanics of the High-Low Method 123

Evaluation of the High-Low Method 125

Regression Analysis 126

Evaluation of the Regression Method 129

Choosing An Appropriate Method 129

Segmented Contribution

Margin Statements 132

Product-Level Contribution Margin Statement 132

Region- and Customer-Level Contribution Margin

The CVP Relation and Profit Planning 164Breakeven Volume 164

Breakeven Revenues 167 Target Profit 168Using the CVP Relation to Make Short-Term Decisions 170Using the CVP Relation to Evaluate Price Changes 170Using the CVP Relation to

Evaluate Operating Risk 172Margin of Safety 173

Operating Leverage 175Multiproduct CVP Analysis 177Profit Planning With Multiple Products 178 Making Decisions Using CVP Analysis 181CVP Analysis—A Critical Evaluation 183

Characteristics of Short-Term Decisions 210

Fixed Supply of Capacity 210

Demand Changes Frequently 210

Closing the Gap between Demand and Supply 211

Operating Budgets: Bridging

L E A R N I N G O B J E C T I V E S 261

What is a Budget? 262

Why Do Firms Use Budgets? 262

Preparing a Master Budget 266

Budgeted Income Statement 276 Iterative Nature of the Budgeting Process 277Cash Budget 278

Cash Inflows from Operations 279 Cash Outflows from Operations 280 Net Cash Flow from Operations 282 Pulling It All Together 283

Factors Influencing the Budgeting Process 284

Organizational Structure 284 Management Styles 286 Past Performance and the Budgeting Process 288

Budgets as the Basis for Control 312

How to Calculate Variances 314

Breaking Down the Total Profit Variance 315 Flexible Budget 316

Components of the Flexible Budget Variance 319 Input Quantity and Price Variances 321

Interpreting and Using Variances 325

General Rules for Analyzing Variances 326 Making Control Decisions in Response to Variances 328Nonfinancial Controls 329

Nonfinancial Measures and Process Control 330 Nonfinancial Measures and Aligning Goals 332

S U M M A R Y 332

R A P I D R E V I E W 332

A P P E N D I X A : Purchase Price Variance 334

A P P E N D I X B : Market Size and Market Share

Refining the Allocation 367

Pulling It All Together 369

Cost Allocations for Reporting Income 370

Incentives and Cost Allocations 374

Using Allocations to Justify Costs and

Reimbursements 375

Using Cost Allocations to Influence Behavior 377

Controllability and Alternate Demands for Cost

Step 4: Measuring Denominator Volume 416Decision Usefulness of ABC Systems 418

Computing Product Costs 418 Reporting Activity-Based Costing Data 420 Decisions at MKC 422

Implementing Activity Based Costing 423Activity-Based Management 424

Product Planning 424 Customer Planning 424 Resource Planning 427

Roles of Capital Budgets 458

Capital Budgeting and Cost Allocations 458 Capital Budgets and Budgeting 459Elements of Project Cash Flows 460

Initial Outlay 461

Estimated Life and Salvage Value 461

Timing and Amounts of Operating Cash Inflows 462

Cost of Capital 463

Methods for Evaluating Project Profitability 464

Discounted Cash Flow Techniques in Capital

Budgeting 464

Net Present Value 464

Internal Rate of Return 468

Comparing NPV and IRR 469

Other Evaluation Criteria for Capital

Budgeting 469

Payback Method 469

Modified Payback 471

Accounting Rate of Return 472

Popularity of Discounted Cash Flow Techniques 472

Taxes and Capital Budgeting 473

Depreciation Tax Shield 474

Salvage Value and Taxes 475

Allocating Capital Among Projects 476

Nonfinancial Costs and Benefits 477

Flexibility and Real Options 478

Decentralization of Decision Making 502

Benefits and Costs of Decentralization 503

Evaluating Cost and Profit Centers 507

Performance Evaluation in Profit Centers 508

Performance Measurement in Investment Centers 510

Return on Investment 510 Residual Income 514 Economic Value Added 515 Measuring Long-Term Performance 517Transfer Pricing 518

Demand for Transfer Prices 518 Conflict in Setting Transfer Prices 519 Practice Patterns 520

International Transfer Pricing 521

Building a Value Chain 553 Management Accounting and the Value Chain 554Strategic Cost Planning 556

Life-Cycle Analysis 556 Target Costing 558Implementing Strategy 560

Critical Success Factors 560Monitoring Strategy Implementation 565

Components of a Balanced Scorecard 566

Predetermined Overhead Rates 601

Determining Cost of Goods Manufactured 602

Determining Cost of Goods Sold 603

End-of-Period Adjustments for

Overhead 605

Calculating the Amount in the Control

Accounts 606

Correct Rates at Year-End 606

Write Off to Cost of Goods Sold 607

Prorate among Inventory Accounts and COGS 607

Comparing the Methods 608

Mechanics of Process Costing 630

Process Costing with Many Cost Pools

and Beginning Inventory 632

Process Costing with Many Pools 632

Considering Beginning Inventory 635

Standard Process Costing 636

Line and Support Activities 654

Methods for Allocating Support Activity Costs 656

Direct Method 657 Step-Down Method 659 Reciprocal Method 661 Integration with Predetermined Overhead Rates 663Dual-Rate Allocations 664

M A N A G E R I A L

A C C O U N T I N G

S e c o n d E d i t i o n

TO M A N D LY N D A OW N A N D OP E R AT E

Hercules Health Club Hercules maintains a

top-notch reputation because of Tom and

Lynda’s attention to detail The club is neat

and clean, and offers the small conveniences

and personalized services that many people

appreciate As a result, Hercules is a profitable

business even though it does not provide the

latest in physical training equipment.

Well, as it often happens in business, when

the going gets good, competition moves in

Tempted by the market potential, a national

health-club chain, Apex Health & Fitness,

recently opened a branch in the community

Compared to Hercules, Apex’s larger facility

provides a wider choice of equipment, a bigger

swimming pool, and more classes in aerobics,

karate, strength training, and yoga.

Tom and Lynda did not expect Apex to

affect their business significantly, as many

of Hercules’ members have been loyal to

the club for years Imagine Tom and Lynda’s

surprise when they lost nearly 10 percent of

their members to Apex within the first three

months! Concerned by this development, they ask you to recommend options for regaining the lost membership and improving profits.

Accounting:

Information for Decision Making

A P P LY I N G T H E

D E C I S I O N F R A M E WO R K

What Is the Problem?

Tom and Lynda’s primary goal is

to restore Hercules’ profits to the level earned before Apex arrived

to cut costs without bringing down the quality of services offered? Can offering new programs, such

as yoga, control the tide of tions? Should Tom and Lynda invest money to renovate the spa and steam rooms to help differen-tiate Hercules from Apex?

defec-What Are the Costs and Benefits?

Each of these options triggers many costs and generates many benefits

Make the Decision!

You can only make an effective sion after systematically considering all of the costs and benefits of the various options in the context of Tom and Lynda’s goals

deci-As you can see in the Apply the Decision Framework

box on the opposing page, there are many possible strategies for you to consider With all these ques- tions and options available, how should you sort through them to determine Hercules’ best course of action? You know other businesses routinely face similar decisions How do they manage?

In this book, we provide you with a foundation

in managerial accounting—a branch of accounting that helps you make business decisions We begin

in this chapter by describing a four-step framework that you could use to systematically structure and analyze any personal or business decision Next,

we explain how decision making in organizations differs from the decisions that we, as individuals, make in our daily lives We then introduce you to two important kinds of organizational decisions— planning decisions and control decisions—and

we discuss how organizations use managerial accounting information to make these decisions

After studying this chapter, you will be able to:

1 Describe the four-step framework for making

decisions.

2 Explain how decision making in organizations

differs from decision making by individuals.

3 Understand how planning and control decisions

relate to each other.

4 Differentiate between financial accounting and

managerial accounting.

5 Discuss the role of ethics in decision making.

L E A R N I N G O B J E C T I V E S

Tom and Lynda are proud owners of a popular gym They are wondering how best to

respond to emerging competition.

We end the chapter by examining how ethics, as well as societal and professional standards, influence decisions.

We make decisions all the time Do I have enough time for breakfast this morning before rushing off to school or work? What should I wear today? Should I major in accounting, finance, management, or marketing? Which car should I buy? Where should I live next year? When making decisions, most of us follow a process: we think about what we want out of the decision, identify available options, evaluate

each one, and then select the option that best meets our goals A decision,

there-fore, is simply choosing one option from a set of options to achieve a goal.

As such, we can describe decision making as consisting of the following four steps:

Step 1: Specify the decision problem, including the decision maker’s goals Step 2: Identify options.

Step 3: Measure benefits (advantages) and costs (disadvantages) to determine the

value (benefits reaped less costs incurred) of each option.

Step 4: Make the decision, choosing the option with the highest value.

This four-step process, the Decision Framework, applies equally to all decisions, whether

personal or business-related Only the context differs As the book unfolds, you will see the general applicability of this framework For now, let us look closer at each step.

STEP 1: SPECIFY THE DECISION PROBLEM, INCLUDING THE DECISION MAKER’S GOALS

Decisions help us accomplish goals We all have goals, or objectives, that we strive to

achieve Tom and Lynda’s primary goal is to restore Hercules’ profits to the level earned before Apex arrived on the scene Thus, their decisions should help them achieve this objective Because of the intertwining of their personal lives and the club, however, Tom and Lynda’s personal goals might influence their decisions For exam- ple, reducing the membership fee carries the risk of permanently lowering income if the lower fee does not lead to an increase in membership An unwillingness to bear this risk may steer Tom and Lynda away from this option Similarly, Tom and Lynda may not be willing to put in an extra 15 hours per week even if doing so increases profits by $1,000 a month Ultimately, Tom and Lynda’s decisions also will depend on the relative importance they attach to other factors such as risk and leisure.

When determining their goals, individuals frequently differ in the factors they consider and the importance they attach to these factors For example, one musician may wish to become a pop diva, while another may wish to play only for personal enjoyment Some students attach primary importance to their grade point average (GPA), while others accept lower grades for greater involvement in extracurricular activities As you might expect, these differences in goals often lead individuals to make different choices, even when confronted with the same options Given an

CHAPTER CONNECTIONS

In Chapters 2–4 , we apply the four-step decision framework to Hercules’ problem.

LEARNING OBJECTIVE 1

Describe the four step

framework for making

decisions.

The Four-Step Framework for Decision Making

hour of free time, one person may prefer to watch television while another might

exercise While at the food court in the mall, one person might choose pizza and

another might choose tacos.

As you can see, these examples illustrate the importance of clearly identifying goals

before making decisions Understanding the factors that influence the decision

mak-er’s goals and their relative importance is the first step in making effective decisions.

STEP 2: IDENTIFY OPTIONS

The second step is to identify options Some decisions involve a small number of

options For example, consider a contestant’s decision on the popular TV game

show, Let’s Make a Deal! In this show, one of three doors hides a valuable prize such

as a car, while the other two doors conceal less desirable items The contestant first

chooses one of the three doors Let’s assume the contestant picks Door 1 At this

point, the game-show host opens one of the other doors (say Door 2) to reveal a less

desired prize The contestant can now switch between the door initially chosen

(Door 1) and the remaining door (Door 3) The host then opens the final door

chosen to reveal the contestant’s prize.

In this game, the contestant has two decisions: the initial choice and the follow-up

choice For both decisions, the contestant has a clear set of options; the first decision

has three options (see Exhibit 1.1), and the second decision has two options.

In contrast, many decisions have a large number of options Think about

decid-ing where to go on vacation Identifydecid-ing all potential destinations is practically

impossible In such cases, we narrow the options to a manageable number in any

number of ways, such as by placing a budget limit of $1,000 or by only considering

locations within a 6-hour drive.

Business decisions frequently have numerous options Tom and Lynda’s options

include reducing the membership fee, offering new programs such as yoga, and

renovating the spa and steam rooms For most businesses, identifying the set of

options is one of the more important tasks of management Managers frequently

distinguish themselves by their ability to identify the most promising options

Throughout the book, we help you sharpen these skills by considering many different types of

business decisions, each with numerous options.

Exhibit 1.1 The Three Doors on Let’s Make a Deal! Represent a Clear Set of

Options for the Decision Maker

STEP 3: MEASURE BENEFITS (ADVANTAGES) AND COSTS (DISADVANTAGES) TO DETERMINE THE VALUE (BENEFITS REAPED LESS COSTS INCURRED) OF EACH OPTION

Every option presents a unique trade-off between benefits and costs Suppose you seek to increase profit by increasing a product’s sales You have identified two options to accom- plish this goal: a price cut or an advertising campaign A price cut will increase sales, but each unit sold will bring in less money An advertising campaign also will increase sales, but it costs money to execute Which of these two options should you choose? Naturally,

you will choose the option that maximizes value, which in this case is the increase in profit.

The value of an option is a measure of how much the option contributes to the

decision maker’s goals It equals the benefits from choosing the option less the ciated costs Suppose Megan, a college student, can make $50 running experiments for her biology professor this Saturday If she has nothing else planned for the day, Megan might as well run the experiments and make $50, and therefore $50 is the value of this option to Megan

asso-In a business context, firms routinely have to choose among different options to increase their profits In such contexts, it is convenient to define the value of an option as

the extent to which the profit would increase by choosing that option relative to not doing

anything For example, suppose a company expects to make a profit of $400,000 selling its product at the current price in the coming year However, the manager of the com- pany feels that reducing the price somewhat can increase sales volume to a point where the company will able to make a profit of $460,000 The value of this option (to lower

prices and boost demand) is the incremental profit of $60,000 that the company expects to

make relative to the option of doing nothing and keeping prices at current levels.

Businesses typically measure value in terms of money, or profit But value need not always

be a monetary amount We could measure value in terms of leisure time, convenience,

or the feeling of satisfaction that we get from working on a charitable cause As such, the value of the same option might differ among decision makers Returning to Megan’s decision regarding whether to run the biology experiments that Saturday, she may really wish to take much needed rest rather than make $50 Doing so means that she attaches greater value to leisure than to making $50.

Opportunity Cost

Suppose you need to travel from Orlando, Florida, to Atlanta, Georgia, for the ding of a family friend You need to choose between flying and driving As Exhibit 1.2 shows, these two options differ in terms of their costs and time required Their value to your decision will rely on your goals for the trip, such as maximizing your time in Atlanta or minimizing your traveling costs.

wed-Whenever we make a decision and choose an option, we give something up For example, if you decide to drive from Orlando to Atlanta for a wedding, you will lose the time saved by flying If you fly, you will spend money that you would have saved

by driving Opportunity cost is the value of what you give up by making your decision.

In the Atlanta wedding example, you had only two choices, making it easy to measure value and opportunity lost Now consider an example with many options Returning to Megan’s decision, suppose she has two other options that Saturday— working as an usher at her school’s football game and earning $75, and working at the library and making $60 Considering only money, what is Megan’s opportunity cost for running the experiments? Is it determined by the “library” option of $60 or

by the “football game” option of $75? By preferring to run the experiments over the library option, Megan loses $60 in earnings By choosing to run the experiments

over the football game option, Megan loses $75 in earnings Thus, $75 is the most

she stands to lose by running the experiments The opportunity cost of any option

is the value to the decision maker of the next best option Moreover, as with running

the experiments, the opportunity cost to Megan from choosing to work at the library

is also $75 Finally, the opportunity cost of the “football game” option is $60 as the

“library” option is, from a monetary standpoint, Megan’s next best option.

Suppose Tom and Lynda consider offering either yoga or karate classes at Hercules

In this case, they have three options—offering a yoga class, a karate class, or neither class

(the status quo of doing nothing) The value of offering the yoga class is the added profit

from the yoga class relative to doing nothing Likewise, the value of the karate class is the

change in profit compared to doing nothing If both classes are profitable, then

the opportunity cost of offering the yoga class is the profit from the karate class Similarly,

the opportunity cost of offering the karate class is the profit from the yoga class.

Effective decision makers ensure that the value of the chosen decision option

exceeds its opportunity cost This comparison makes sure that they are putting their

resources to the best possible use and are maximizing value In essence, the

con-cepts of value and opportunity cost emphasize that every decision involves trading

off what we get with what we give up.

Recall that we defined value of an option as the contribution to a decision

mak-er’s goals relative to doing nothing A second definition of value, one which we do

not emphasize in this book, is that it is the net benefit a decision maker derives from

an option relative to the next best option Using this second definition, Megan’s value

Solution at end of chapter.

Suppose Tom and Lynda believe that offering yoga will increase Hercules’ profits

by $2,500, while offering karate will decrease Hercules’ profits by $500 Compute

the value and the opportunity cost of Tom and Lynda’s three options

Check It! Exercise #1

Exhibit 1.2 Decision Makers Might Evaluate

the Costs and Benefits of the Same Two Options (e.g., Flying versus Driving) Differently If Their Goals Differ

for running experiments is –$25, the inflow of $50 less the opportunity cost of $75

It is $15 for the football option, the inflow of $75 less the opportunity cost of $60

We note that either definition of value leads to the same ranking of options in any decision setting Our intuitive definition of value is appealing because it captures the change in profit/cash flows as per accounting conventions

STEP 4: MAKE THE DECISION (CHOOSING THE OPTION WITH THE HIGHEST VALUE)

The best choice is the option with the highest value to the decision maker This also is the only

option whose value exceeds its opportunity cost If your goal is to maximize time with family and friends, flying from Orlando to Atlanta is your best option Similarly,

if Megan’s goal is to make the most money that Saturday, then working as an usher

at the football game is her best option.

Throughout the book, we use these four steps to frame and describe decisions

To underscore the process, we use a box titled Applying the Decision Framework to show

how it applies to the decision at hand For example, you can use the framework to guide your decision regarding whether to drive or fly from Orlando to Atlanta.

A P P LY I N G T H E D E C I S I O N F R A M E WO R K

What Is the Problem?

You need to travel from Orlando to Atlanta for a wedding, where you want to spend as much time as possible with family and friends

What Are the Options?

The two options are to drive or to fly

What Are the Costs and Benefits?

Driving is cheaper but results in less time with family and friends Flying costs more but requires less travel time

Make the Decision!

After considering all of the costs and benefits, you decide to fly so that you can maximize your time in Atlanta

CHAPTER CONNECTIONS

In Chapter 2 , we discuss the concepts associated with identifying and measuring costs and benefits to determine value and opportunity cost.

Decision Making in Organizations

The four-step decision-making framework applies equally well to both individual and

organizational decisions However, there are two important differences First, unlike individuals whose goals might have several factors, organizations tend to have focused goals For example, maximizing profit is the dominant goal of commercial organizations As such, these organizations primarily evaluate decisions by their impact on the bottom line.

Thus far, we have examined how the four-step framework applies to individual decision making In the next section, we discuss how the framework applies to deci- sion making in organizations.

Second, because an organization is a collection of individuals, we need to think

about how individual goals relate to organizational goals Organizations don’t make

decisions; the people that comprise the organization do Individual goals might

dif-fer from organizational goals, leading to actions that are not in the firm’s best

inter-ests To see this, consider a sports team The team’s goal is to win the game However,

seeking individual recognition, some players might take actions that put them in the

best light even if doing so is not in the team’s best interests The lack of alignment in

goals is even more of an issue when organizational goals are unclear For an example,

think back to your last team project Some members may have wanted to work hard

and receive a high grade, while others may have simply wanted to pass the class.

ORGANIZATIONAL GOALS

An organization is a group of individuals engaged in a collectively beneficial mission

Organizations form for many reasons Nonprofit organizations and charities such as the

Red Cross and Habitat for Humanity seek to help individuals in need and improve

peo-ple’s lives Professional organizations, such as the American Bar Association , serve the

public and the legal profession by promoting justice, education, and professional integrity.

A for-profit business usually specifies organizational goals according to

owner-ship For a family-owned venture such as Hercules, the goal is to increase family

wealth, which means maximizing Hercules’ profit The goal for a publicly held

busi-ness such as General Motors or IBM , collectively owned by shareholders, is to

maxi-mize shareholder value—that is, to maximaxi-mize the returns (stream of profits or,

equivalently, stream of cash flows) to shareholders investing in the company.

ALIGNING INDIVIDUAL GOALS

WITH ORGANIZATIONAL GOALS

As we mentioned earlier, organizational goals rarely coincide with the goals of all

indi-vidual participants Hercules’ employees care more about their own compensation, job

security, and well-being than about how much money Tom and Lynda make These

employees want the gym to do well financially primarily because it ensures their

contin-ued employment and not because of its profit potential for Tom and Lynda Similarly,

professional managers, who run large firms such as General Electric , also are employees

with their own goals While companies hire managers to act in the best interests of

share-holders, these individuals wish to maximize their own compensation and happiness.

Corporate mission statements often specify elements of an organization’s strategy for

achieving its goals and core values Amazon’s mission “is to be the earth’s most

cus-tomer centric company; to build a place where people can come to find and discover

anything they might want to buy online.” Starbucks’ mission is “to inspire and nurture

the human spirit – one person, one cup, and one neighborhood at a time.” Likewise,

Southwest Airlines’ mission is “dedication to the highest quality of Customer Service

delivered with a sense of warmth, friendliness, individual pride, and Company Spirit.”

C OMMENTARY : While corporate mission statements often do not make explicit

ref-erence to maximizing profit, such statements are a means to an end For example, a

focus on pleasing customers is simply good business and leads to increased profits

Connecting to Practice

ing framework? In Step 1 of the decision process, a firm’s owners would like to frame decision problems in terms of maximizing profit However, owners do not make all of the decisions in an organization They delegate many decisions to employees But, as you know, employees come to the organization with their own goals Thus, these employ-

ees will look at the same decision in terms of maximizing their own goals and might

attach lower importance to the firm’s profit As a result, the decisions that best attain individual goals may not necessarily maximize profit, the organization’s goal.

What can owners do to align individual and organizational goals? To influence employees to achieve organizational goals, firms use the following methods:

• Policies and procedures to define acceptable behavior Tom and Lynda keep

detailed attendance records to discourage employees from claiming payment for time not worked Bank of America requires tellers to balance their drawers at the end of their shifts, and UPS expects its drivers to follow safe driving practices.

• Monitoring to enforce policies and procedures Tom and Lynda routinely walk

around the gym to make sure that their employees are doing their jobs and providing helpful and courteous service Pilots at Delta are subject to random drug and alcohol tests at the end of every flight, and McDonald’s uses a mystery shopper program to ensure quality and consistency among its restaurants.

• Incentive schemes and performance evaluation to motivate employees to consider

organizational goals Tom and Lynda solicit feedback from class patrons and link instructor bonuses to satisfaction ratings Realtors at Century 21 earn commissions based on their sales, and the United States Marine Corps requires its soldiers to go through annual performance evaluations.

As these examples illustrate, firms promote goal congruence by tailoring policies and procedures, monitoring, incentives, and performance evaluation to fit their specific needs In Chapters 8 , 12 , and 13 we discuss extensively the choice of specific systems to increase goal congruence.

In essence, the key difference between individual and business decisions relates to Step 1 of the four-step framework—that is, organizations need to ensure that the goals of individual employees mesh with the focused goals of the organization To accomplish their goals, then, organizations need to not only

statement touted four key values: “respect, integrity, communication, and excellence,”

and noted that all business dealings would be conducted in an environment that

was “open and fair.” As became eminently clear, Enron’s employees were not ing the company’s mission statement

follow-C OMMENTARY : Such debacles can occur when there is a mismatch between an organization’s stated goals and its actual monitoring, performance evaluation, and incentives As some would say, “you get what you measure.”

Connecting to Practice