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C o s t A c c o u n t i n g

A Managerial Emphasis

15 t h^ E d i t i o n

Charles T. Horngren

Srikant M. Datar

Madhav V. Rajan

The Manager and Management Accounting

C h a p t e r - 1

CHAPTER 1

THE MANAGER AND MANAGEMENT ACCOUNTING

See the front matter of this Solutions Manual for suggestions regarding your choices of assignment material for each chapter.

1-1 Management accounting measures, analyzes, and reports financial and nonfinancial information that helps managers make decisions to fulfill the goals of an organization. It focuses on internal reporting and is not restricted by generally accepted accounting principles (GAAP). Financial accounting focuses on reporting to external parties such as investors, government agencies, and banks. It measures and records business transactions and provides financial statements that are based on generally accepted accounting principles (GAAP). Other differences include (1) management accounting emphasizes the future (not the past), and (2) management accounting influences the behavior of managers and other employees (rather than primarily reporting economic events).

1-2 Financial accounting is constrained by generally accepted accounting principles. Management accounting is not restricted to these principles. The result is that

• management accounting allows managers to charge interest on owners’ capital to help judge a division’s performance, even though such a charge is not allowed under GAAP,
• management accounting can include assets or liabilities (such as “brand names” developed internally) not recognized under GAAP, and
• management accounting can use asset or liability measurement rules (such as present values or resale prices) not permitted under GAAP.

1-3 Management accountants can help to formulate strategy by providing information about the sources of competitive advantage—for example, the cost, productivity, or efficiency advantage of their company relative to competitors or the premium prices a company can charge relative to the costs of adding features that make its products or services distinctive.

1-4 The business functions in the value chain are

• Research and development —generating and experimenting with ideas related to new products, services, or processes.
• Design of products and processes —the detailed planning, engineering, and testing of products and processes.
• Production —procuring, transporting, storing, and assembling resources to produce a product or deliver a service.
• Marketing —promoting and selling products or services to customers or prospective customers.
• Distribution —processing orders and shipping products or services to customers.
• Customer service —providing after-sales service to customers.

1-12 The new controller could reply in one or more of the following ways: (a) Demonstrate to the plant manager how he or she could make better decisions if the plant controller was viewed as a resource rather than a deadweight. In a related way, the plant controller could show how the plant manager’s time and resources could be saved by viewing the new plant controller as a team member. (b) Demonstrate to the plant manager a good knowledge of the technical aspects of the plant. This approach may involve doing background reading. It certainly will involve spending much time on the plant floor speaking to plant personnel. (c) Show the plant manager examples of the new plant controller’s past successes in working with line managers in other plants. Examples could include

• assistance in preparing the budget,
• assistance in analyzing problem situations and evaluating financial and nonfinancial aspects of different alternatives, and
• assistance in submitting capital budget requests. (d) Seek assistance from the corporate controller to highlight to the plant manager the importance of many tasks undertaken by the new plant controller. This approach is a last resort but may be necessary in some cases.

1-13 The controller is the chief management accounting executive. The corporate controller reports to the chief financial officer, a staff function. Companies also have business unit controllers who support business unit managers or regional controllers who support regional managers in major geographic regions.

1-14 The Institute of Management Accountants (IMA) sets standards of ethical conduct for management accountants in the following four areas:

• Competence
• Confidentiality
• Integrity
• Credibility

1-15 Steps to take when established written policies provide insufficient guidance are as follows: (a) Discuss the problem with the immediate superior (except when it appears that the superior is involved). (b) Clarify relevant ethical issues by confidential discussion with an IMA Ethics Counselor or other impartial advisor. (c) Consult your own attorney as to legal obligations and rights concerning the ethical conflicts.

1-16 (15 min.) Value chain and classification of costs, computer company.

Cost Item a.

Value Chain Business Function

b. c. d. e. f.

g. h.

Production Distribution Design of products and processes Research and development Customer service or marketing Design of products and processes (or research and development) Marketing Production

1-17 (15 min.) Value chain and classification of costs, pharmaceutical company.

Cost Item a.

Value Chain Business Function

b. c. d. e. f. g. h.

Marketing Design of products and processes Customer service Research and development Marketing Production Marketing Distribution

1 - 18 (15 min.) Value chain and classification of costs, fast-food restaurant.

Cost Item a.

Value Chain Business Function

b. c. d. e. f. g. h.

Production Distribution Marketing Marketing Marketing Production Design of products and processes (or research and development) Customer service

1-19 (10 min.) Key success factors.

Change in Operations/ Management Accounting Key Success Factor a. b. c. d. e.

Innovation Cost and efficiency and quality Time Time and cost and efficiency Cost and efficiency

1-24 (15 min.) Five-step decision-making process, service firm.

Action a.

Step in Decision-Making Process

b. c. d. e. f.

Make decisions by choosing among alternatives. Identify the problem and uncertainties. Obtain information and/or make predictions about the future. Obtain information and/or make predictions about the future. Make predictions about the future. Obtain information.

1-25 (10–15 min.) Professional ethics and reporting division performance.

1. Mendez’s ethical responsibilities are well summarized in the IMA’s “Standards of Ethical Conduct for Management Accountants” (Exhibit 1-7 of text). Areas of ethical responsibility include the following:
   • Competence
   • Confidentiality
   • Integrity
   • Credibility

The ethical standards related to Mendez’s current dilemma are integrity, competence, and credibility. Using the integrity standard, Mendez should carry out duties ethically and communicate unfavorable as well as favorable information and professional judgments or opinions. Competence demands that Mendez perform her professional duties in accordance with relevant laws, regulations, and technical standards and provide decision support information that is accurate. Credibility requires that Mendez report information fairly and objectively and disclose deficiencies in internal controls in conformance with organizational policy and/or applicable law. Mendez should refuse to book the $200,000 of sales until the goods are shipped. Both financial accounting and management accounting principles maintain that sales are not complete until the title is transferred to the buyer.

2. Mendez should refuse to follow Dalton’s orders. If Dalton persists, the incident should be reported to the corporate controller. Support for line management should be wholehearted, but it should not require unethical conduct.

1-26 (10–15 min.) Professional ethics and reporting division performance.

1. Wilson’s ethical responsibilities are well summarized in the IMA’s “Standards of Ethical Conduct for Management Accountants” (Exhibit 1-7 of text). Areas of ethical responsibility include the following:
   • Competence
   • Confidentiality
   • Integrity
   • Credibility

The ethical standards related to Wilson’s current dilemma are integrity, competence, and credibility. Using the integrity standard, Wilson should carry out duties ethically and communicate unfavorable as well as favorable information and professional judgments or opinions. Competence demands that Wilson perform his professional duties in accordance with relevant laws, regulations, and technical standards and provide decision support information that is accurate. Credibility requires that Wilson report information fairly and objectively and disclose deficiencies in internal controls in conformance with organizational policy and/or applicable law. Wilson should refuse to include the $150,000 of defective inventory. Both financial accounting and management accounting principles maintain that once inventory is determined to be unfit for sale, it must be written off. It may be just a timing issue, but reporting the $150,000 of inventory as an asset would be misleading to the users of the company’s financial statements.

2. Wilson should refuse to follow Leonard’s orders. If Leonard persists, the incident should be reported to the corporate controller of Garman Enterprises. Support for line management should be wholehearted, but it should not require unethical conduct.

1-27 (15 min.) Planning and control decisions, Internet company.

1. Planning decisions a. Decision to raise monthly subscription fee c. Decision to upgrade content of online services (later decision to inform subscribers and upgrade online services is an implementation part of control) e. Decision to decrease monthly subscription fee starting in November. Control decisions b. Decision to inform existing subscribers about the rate of increase—an implementation part of control decisions d. Dismissal of VP of Marketing—performance evaluation and feedback aspect of control decisions
2. Other planning decisions that may be made at PostNews.com: decision to raise or lower advertising fees; decision to charge a fee from on-line retailers when customers click-through from PostNews.com to the retailers’ websites. Other control decisions that may be made at PostNews.com: evaluating how customers like the new format for the weather information, working with an outside vendor to redesign the website, and evaluating whether the waiting time for customers to access the website has been reduced.

1-29 (20 min.) Strategic decisions and management accounting.

1. The strategies the companies are following in each case are a. b. c. d.

Cost leadership strategy Product differentiation strategy Cost leadership strategy Product differentiation strategy

2. Examples of information the management accountant can provide for each strategic decision follow. a.

b.

c.

d.

Cost related to training the new cooks Productivity and efficiency advantages relative to competition Sensitivity of target customers to price and quality

Cost of delivery service Premium price that customers would be willing to pay for the service Price of closest competitive product

Cost to develop new software to check in customers Efficiency and cost advantages relative to competition Sensitivity of target customers to change in service

Cost to hire horticultural specialist Premium price that customers would be willing to pay for expert advice Price of closest competitive product

1-30 (15 min.) Management accounting guidelines.

1. Cost-benefit approach
2. Behavioral and technical considerations
3. Different costs for different purposes
4. Cost-benefit approach
5. Behavioral and technical considerations
6. Cost-benefit approach
7. Behavioral and technical considerations
8. Different costs for different purposes
9. Behavioral and technical considerations

1-31 (15 min.) Management accounting guidelines.

1. Cost-benefit approach
2. Behavioral and technical considerations
3. Different costs for different purposes
4. Cost-benefit approach or behavioral and technical considerations, for example, how employees will react to the new technology
5. Behavioral and technical considerations
6. Cost-benefit approach
7. Behavioral and technical considerations or different costs for different purposes. The goal of determining the loss in future business because of poor quality beyond the cost of scrap and waste reported in financial statements is to influence behavior toward improving quality by recognizing its high cost.

1-32 (15 min.) Role of controller, role of chief financial officer.

Activity Controller CFO Managing the company’s long-term investments X Presenting financial statements to the board of directors X Strategic review of different lines of businesses X Budgeting funds for a plant upgrade X Managing accounts receivable X Negotiating fees with auditors X Assessing profitability of various products X Evaluating the costs and benefits of a new product design X

2. As CFO, Jimenez will be interacting much more with the senior management of the company, the board of directors, auditors, and the external financial community. Any experience he can get with these aspects will help him in his new role as CFO. George Jimenez can be better positioned for his new role as CFO by participating in strategy discussions with senior management, by preparing the external investor communications and press releases under the guidance of the current CFO, by attending courses that focus on the interaction and negotiations between the various business functions and outside parties such as auditors and, either formally or on the job, getting training in issues related to investments and corporate finance.

his profession. Taking illegal or unethical action by capitalizing R&D to satisfy the demands of his new supervisor, Ronald Meece, is unacceptable. Although not strictly unethical, I would recommend that Jackson not agree to slow down the R&D efforts on Vyacon or sell off the rights to Martek. Each of these appears to sacrifice the overall economic interests of BrisCor for short- run gain. Jackson should argue against doing this but not resign if Meece insists that these actions be taken. If, however, Meece asks Jackson to capitalize R&D, he should raise this issue with the chair of the audit committee after informing Meece that he is doing so. If the CFO still insists on Jackson capitalizing R&D, he should resign rather than engage in unethical behavior.

1-34 (30–40 min.) Professional ethics and end-of-year actions.

1. The possible motivations for the snack foods division wanting to take end-of-year actions include: (a) Management incentives. Daniel Foods may have a division bonus scheme based on one-year reported division earnings. Efforts to front-end revenue into the current year or transfer costs into the next year can increase this bonus. (b) Promotion opportunities and job security. Top management of Daniel Foods likely will view those division managers who deliver high reported earnings growth rates as being the best prospects for promotion. Division managers who deliver “unwelcome surprises” may be viewed as less capable. (c) Retain division autonomy. If top management of Daniel Foods adopts a “management by exception” approach, divisions that report sharp reductions in their earnings growth rates may attract a sizable increase in top management supervision.
2. The “Standards of Ethical Conduct... ” require management accountants to
   • Perform professional duties in accordance with relevant laws, regulations, and technical standards.
   • Refrain from engaging in any conduct that would prejudice carrying out duties ethically.
   • Communicate information fairly and objectively.

Several of the “end-of-year actions” clearly are in conflict with these requirements and should be viewed as unacceptable by Butler. (b) The fiscal year-end should be closed on midnight of December 31. “Extending” the close falsely reports next year’s sales as this year’s sales. (c) Altering shipping dates is falsification of the accounting reports. (f) Advertisements run in December should be charged to the current year. The advertising agency is facilitating falsification of the accounting records.

The other “end-of-year actions” occur in many organizations and fall into the “gray” to “acceptable” area. However, much depends on the circumstances surrounding each one, such as the following: (a) If the independent contractor does not do maintenance work in December, there is no transaction regarding maintenance to record. The responsibility for ensuring that packaging equipment is well maintained is that of the plant manager. The division

controller probably can do little more than observe the absence of a December maintenance charge. (d) In many organizations, sales are heavily concentrated in the final weeks of the fiscal year-end. If the double bonus is approved by the division marketing manager, the division controller can do little more than observe the extra bonus paid in December. (e) If TV spots are reduced in December, the advertising cost in December will be reduced. There is no record falsification here. (g) Much depends on the means of “persuading” carriers to accept the merchandise. For example, if an under-the-table payment is involved, or if carriers are pressured to accept merchandise, it is clearly unethical. If, however, the carrier receives no extra consideration and willingly agrees to accept the assignment because it sees potential sales opportunities in December, the transaction appears ethical.

Each of the (a), (d), (e), and (g) “end-of-year actions” may well disadvantage Daniel Foods in the long run. For example, lack of routine maintenance may lead to subsequent equipment failure. The divisional controller is well advised to raise such issues in meetings with the division president. However, if Daniel Foods has a rigid set of line/staff distinctions, the division president is the one who bears primary responsibility for justifying division actions to senior corporate officers.

3. If Butler believes that Ray wants her to engage in unethical behavior, she should first directly raise her concerns with Ray. If Ray is unwilling to change his request, Butler should discuss her concerns with the Corporate Controller of Daniel Foods. She could also initiate a confidential discussion with an IMA Ethics Counselor, other impartial adviser, or her own attorney. Butler also may well ask for a transfer from the snack foods division if she perceives Ray is unwilling to listen to pressure brought by the Corporate Controller, CFO, or even President of Daniel Foods. In the extreme, she may want to resign if the corporate culture of Daniel Foods is to reward division managers who take “end-of-year actions” that Butler views as unethical and possibly illegal. It was precisely actions along the lines of (b), (c), and (f) that caused Betty Vinson, an accountant at WorldCom, to be indicted for falsifying WorldCom’s books and misleading investors.

1-35 (30 min.) Professional ethics and end-of-year actions.

1. The possible motivations for Controller Rhett Gable to modify the division’s year-end earnings are (i) Job security and promotion. The company’s CFO will likely reward him for meeting the company’s performance expectations. Alternately, the Gable may be penalized, perhaps even by losing his job if the performance expectations are not met. (ii) Management incentives. Gable’s bonus may be based on the division’s ability to meet certain profit targets. If the House and Home division has already met its profit target for the year, the Controller may personally benefit if new printing equipment is sold off and replaced with the discarded equipment that no longer meets current safety standards, or if operating income is manipulated by questionable revenue and/or expense recognition.

competitors do. If, however, the company changes to straight-line depreciation with the sole purpose of reducing expenses to meet its profit goals, such behavior would be unacceptable. The Standards of Ethical Behavior require management accountants to communicate information fairly and objectively and to carry out duties ethically.

3. Gable should directly raise his concerns first with the CFO, especially if the pressure from the CFO is so great that the only course of action on the part of the controller is to otherwise behave unethically. If the CFO refuses to change his direction, then the controller should raise these issues with the CEO, and next to the Audit Committee and the Board of Directors, after informing the CFO that he is doing so. The Controller could also initiate a confidential discussion with an IMA Ethics Counselor, other impartial adviser, or his/her own attorney. In the extreme, the Controller may want to resign if the corporate culture of Macon Publishing is to reward executives who take year-end actions that the Controller views as unethical and possibly illegal. It was precisely actions along the lines of (c), (d) and (e) that caused Betty Vinson, an accountant at WorldCom, to be indicted for falsifying WorldCom’s books and misleading investors.

1-36 (40 min.) Ethical challenges, global company.

1. The overarching principles of the IMA Statement of Ethical Professional Practice are Honesty, Fairness, Objectivity, and Responsibility. The statement’s corresponding “Standards for Ethical Conduct…” require management accountants to
   • Perform professional duties in accordance with relevant laws, regulations, and technical standards.
   • Refrain from engaging in any conduct that would prejudice carrying out duties ethically.
   • Communicate information fairly and objectively.
   • Disclose all relevant information that could reasonably be expected to influence an intended user’s understanding of the reports, analyses, or recommendations.

Several of the suggestions made by Chang’s staff are clearly in conflict with the statement’s principles and required standards and should be viewed as unacceptable.

c. Pressure current customers to take early delivery of goods before the end of the year so that more revenue can be reported on this year’s financial statements. This tactic, commonly known as channel stuffing, merely results in shifting future period revenues into the current period. The overstatement of revenue in the current period may mislead investor’s to believe that the company’s financial well-being is better than the actual results achieved. This practice would violate the IMA’s standards of credibility and integrity. Channel stuffing is frequently considered a fraudulent practice. e. Record the executive year-end bonus compensation for the current year in the next year when it is paid until after the December fiscal year-end. GAAP requires expenses to be recorded (accrued) when incurred, not when paid (cash basis accounting). Therefore, failure to record the executives’ year-end bonus would violate the IMA’s standards of credibility and integrity.

f. Recognize sales revenues on orders received but not shipped as of the end of the year. GAAP requires income to be recorded (accrued) when the four criteria of revenue recognition have been met:

1. The company has completed a significant portion of the production and sales effort. 2. The amount of revenue can by objectively measured. 3. The major portion of the costs has been incurred, and the remaining costs can be reasonably estimated. 4. The eventual collection of the cash is reasonably assured.

Because criteria 1 and 3 have not been met at the time the order is placed, the revenue should not be recognized until after year-end. Therefore, recording next year’s revenue in the current year would be a violation of GAAP and would be falsifying revenue. This would be a violation of the IMA’s standards of credibility and integrity and may be considered fraudulent.

The other “year-end” actions occur in many organizations and fall into the “gray” to “acceptable” area. Much depends on the circumstances surrounding each one, however, such as the following:

a. Stop all transatlantic shipping efforts. The start-up costs for the new operations are hurting current profit margins. While this method may result in better short-term financial results for Andahl, it may do harm to the long-term financial condition of the corporation as a whole. b. Make deep cuts in pricing through the end of the year to generate additional revenue. Again, this is only a short-term tactic to improve this year’s financial results. Investors may be content in the short run, but in the long run, the new shipping company will see reduced margins from these actions. d. Sell-off distribution equipment prior to year-end. The sale would result in one-time gains that could offset the company’s lagging profits. The owned equipment could be replaced with leased equipment at a lower cost in the current year. While this course of action does not necessarily violate the IMA’s code of ethical standards, it may be only a short-term tactic to improve this year’s financial results. Chang will need to weigh his options long term to make the most cost effective decision for his company. g. Establish corporate headquarters in Ireland before the end of the year, lowering the company’s corporate tax rate from 28 percent to 12.5 percent. Chang may have other legitimate reasons for relocating his company to Ireland, but doing so only to reduce his tax liability would likely be considered an evasion of taxes in the company’s home country. Chang should seek the advice of skilled consultants in the area of international tax before making any such move. The company could face large fines and even criminal charges for evading corporate income taxes of the home country.