CHAPTER ONE Introduction

McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. 1-3 Accounting for Decision Making and Control Fourth Edition Jerold L. Zimmerman Ronald L. Bittner Professor William E. Simon Graduate School of Business Administration University of Rochester Published by Irwin/McGraw-Hill 2003

McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. 1-4 Outline of Chapter 1 Introduction  Managerial Accounting: Decision Making and Control  Design and Use of Cost Systems  Marmots and Grizzly Bears  Management Accountant’s Role in the Organization  Evolution of Management Accounting: A Framework for Change  Vortec Medical Probe Example  Outline of the Text

McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. 1-5 Decision Making - Product Management Examples  Add new product  Terminate an existing product line  Accept or reject special order Related Topics  Operations management  Budgeting - capital and operating  Just-in-time (JIT)

McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. 1-6 Decision Making - Pricing Examples  Set selling price to achieve desired profits  Set selling price to achieve positive cash flow Related Topics  Marketing  Microeconomics - Price Theory  Corporate Finance

McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. 1-7 Decision Making - Cost Control Examples  Add new equipment  Change production process  Make internally versus buy externally (outsource) Related Topics  Process engineering  Management information systems  Activity-based costing (ABC)

McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. 1-8 Control - Incentives Assumptions  Individuals maximize their own self-interest  Owners of firm want to maximize firm value  Maximizing firm profits maximizes firm value Incentives  Design performance incentives based on internal accounting measures to motivate employees to take actions that will maximize firm value

McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. 1-9 Control - Performance Evaluation Examples  Performance bonuses depend on accounting results  Benchmarking: comparisons to industry leaders Related Topics  Organizational behavior  Human resources management

McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved Design - Multiple Role of Accounting Study Figure 1-1. Main point: Accounting reports are used for multiple purposes.

McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved Design - External Reports Users of external reports  Shareholders, bondholders, and analysts (SEC, FASB)  Taxing authorities (IRS, states, etc.)  Regulatory authorities (GASB, etc.)  Board of directors Objectives in external reporting  Comparability between firms  Historical accounting  Auditors can verify reports

McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved Design - Internal Reports Users of internal reports  Managers at all levels Objectives of internal reporting  Useful for decision making about future activities  Measure performance that is relevant to the firm  Focus on projects or processes within a firm

McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved Design - Conflicting Goals Control  Incentives to motivate behavior changes  Tendency to ignore information not specifically included in incentive system  Report “good” numbers to satisfy top management Decision making  Want to avoid distorted information  Estimates useful to plan future activities

McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved Design - Evolution Economic Darwinism: Over the long term systems survive in competitive markets when the benefits exceed or equal the costs of maintaining those systems. Survival does not imply optimality. Better systems may exist, but have not yet been discovered.

McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved Design - Figure 1-2 Study Figure 1-2. Main Point: In a typical corporation, the corporate controller is responsible for all internal and external accounting reports. There are also controllers in the operating divisions.

McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved Design - Organizational Structure Controller  Reports to chief financial officer (CFO)  Administers internal and external accounting  Budget planning  Controls financial data collection and reporting  Growing role as internal consultants or business analysts to the point of being viewed as business partners Balance providing information to other managers for decision making against providing monitoring information used to control behavior of lower-level managers.

McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved Evolution of Management Accounting: A Framework for Change Business Environment Business Strategy Organizational Architecture Decision-Right Assignment Performance Evaluation Reward System Incentives and Actions Firm Value

McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved Example - Vortec Special Order With no overtime and congestion Current With Order Incremental Units produced and sold 100, ,000 2,000 Total Revenue and Costs Sales ($5.00 regular, $4.00 special) $ 500,000 $508,000 $ 8,000 Cost of sales ($4.50, $4.47)450, ,940 Administrative expenses - 27, ,500 0 Net profit before taxes $ 22,500 $ 24,560 $ 2,060 Incremental revenue (2,000 units x $4.00)$8,000 Total 102,000 units (102,000 x $4.47) $455,940 Total 100,000 units (100,000 x $4.50) Incremental cost of 2,000 units -5,940 Incremental profit of 2,000 units$2,060

McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved Example - Vortec Special Order With overtime and congestion Current With Order Incremental Units produced and sold 100, ,000 2,000 Total Revenue and Costs Sales ($5.00 regular, $4.00 special) $ 500,000 $508,000 $ 8,000 Cost of sales ($4.50, $4.08 on additional 2,000)450, ,160 -8,160 Administrative expenses - 27, ,500 0 Net profit before taxes $ 22,500 $ 22,340 $ Incremental revenue (2,000 units x $4.00)$8,000 Total 102,000 units (100,000 x $4.50) plus (2,000 x $4.08) $458,160 Total 100,000 units (100,000 x $4.50) Incremental cost of 2,000 units -8,160 Incremental profit of 2,000 units $ - 160

McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved Example - Beware of Average Costs Average cost per unit at current production volume is usually not an accurate estimate of the cost per unit at other levels of production. Production costs include:  fixed costs that do not change with volume  variable costs that do change with volume Costs may increase when production volume is near or above normal operating capacity.

McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved Example - Consider Opportunity Costs  Opportunity costs measure what the firm forgoes when it chooses a specific action  Consider what a firm forgoes by accepting a special order

McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved Example - Supplement Accounting Data  Supplement historical cost accounting data with other knowledge  Could include: –expected customer demands –competitors’ plans –future technology –government regulation

McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved Example - Accounting Data for Evaluation When managers have incentives to maximize performance on one particular accounting measure, firm profits are not necessarily maximized.  Reducing average manufacturing costs per unit does not always maximize profit  Maximizing total revenue does not always maximize profit

McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved Outline of Text See Overview Figure in the preface. Chapters Theme 2-5 Use of accounting for decision making and control 6-8 Budgeting and cost allocations 9-13 Absorption costing and alternative costing methods 14 Integrative framework