chapter 01 - answer.doc

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MANAGEMENT ACCOUNTING (VOLUME I) - Solutions Manual

CHAPTER 1

MANAGEMENT ACCOUNTING: AN OVERVIEW

I. Questions

1. Use of the word need in the quoted passage is pejorative. It implies anunlimited level of demand for information. However, rational managersapply a cost-benefit criterion to information and will only want accountinginformation if its benefits exceed its costs. Accounting informationprovides benefits by improving decision making and controlling behavior

in organizations. In most organizations, accounting information is veryprevalent which implies that its benefits exceed its costs. Hence,successful managers will find it in their self-interest to learn how to useaccounting information in these organizations.

Clearly, this statement is incurred in those firms where accountinginformation has very limited usefulness (e.g., if the accountinginformation is often wrong or is not produced in a timely fashion). Inthese organizations, managers do not find the accounting information tohave benefits in excess of its costs, will not use it, do not need to knowhow to use it, and definitely do not need it.

2. a. Historical costs are of limited use in making planning decisions in a

rapidly changing environment. With changing products, processesand prices, the historical costs are inadequate approximations of theopportunity costs of using resources.

Historical costs may, however, be useful for control purposes, as theyprovide information about the activities of managers and can be usedas performance measures to evaluate managers.

b. The purpose of accounting systems is to provide information forplanning purposes and control. Although historical costs are notgenerally appropriate for planning purposes, additional measures arecostly to make. An accounting system should include additionalmeasures if the benefits of improved decision making are greater than

the costs of the additional information.3. Finance and economics textbooks traditionally state that the goal of a

profit organization is to maximize shareholder wealth. Managers arefrequently presumed to act in the best interest of the shareholder, although

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Chapter 1 Management Accounting: An Overview

recent finance literature recognizes that appropriate incentives are

necessary to align manager interests with shareholder interests. The goal,however, are not very clear as to how this is achieved. Most financetextbooks focus on financing decisions and not on the use of assets anddealing with customers.

Marketings goal of satisfying customers recognizes that customers arethe source of revenues for the organization, and therefore the meansthrough which shareholder value is increased. However, customersatisfaction is only valuable insofar as it creates shareholder wealth. Thefurther goal of marketing is to ensure that customer satisfaction ismaximized without compromising the organizations profitability.

4. Yes. Planning is really much more vital than control; that is, superior

control is fruitless if faulty plans are being implemented. However,planning and control are so intertwined that it seems artificial to drawrigid lines of separation between them.

5. Yes. The controller has line authority over the personnel in his owndepartment but is a staff executive with respect to the other departments.

6. Line authority is exerted downward over subordinates. Staff authority isthe authority to advise but not command others; it is exercised laterally orupward. Functional authority is the right to command action laterally anddownward with regard to a specific function or specialty.

7. Cost accounting is the controllers primary means of implementing the 7-point concept of modern controllership. Cost accounting is intertwinedwith all seven duties to some extent, but its major focus is on the firstthree.

8. Bettina Company

President

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14. By reporting and interpreting relevant data, the controller exerts a force or

influence that impels management toward making better-informeddecisions.

The controller of one company described the job as a business advisortohelp the team develop strategy and focus the team all the way throughrecommendations and implementation.

15.Financial Accounting

Audience: External: shareholders, creditors, taxauthorities

Purpose: Report on past performance to external parties;basis of contracts with owners and lenders

Timeliness: Delayed; historical

Restrictions: Regulated; rules driven by generally acceptedaccounting principles and governmentauthorities

Type of Information: Financial measurements only

Nature of Information: Objective, auditable, reliable, consistent,precise

Scope: Highly aggregate; report on entire organization

Managerial Accounting

Audience: Internal: Workers, managers, executives

Purpose: Inform internal decisions made by employeesand managers; feedback and control onoperating performance

Timeliness: Current, future oriented

Restrictions: No regulations; systems and informationdetermined by management to meet strategicand operational needs

Type of Information: Financial, plus operational and physicalmeasurements on processes, technologies,suppliers customers, and competitors

Nature of Information: More subjective and judgmental; valid,

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Management Accounting: An Overview Chapter 1

relevant, accurate

Scope: Disaggregate; inform local decisions andactions

16. The competitive environment has changed dramatically. Companiesencountered severe competition from overseas companies that offeredhigh-quality products at low prices. Activity-based costing systems areintroduced in many manufacturing and service organizations to overcomethe inability of traditional cost systems to accurately assign overheadcosts. Activity-based management is a viable approach for managers tomake decisions based on ABC information. There has been improvementof operational control systems such that information is more current andprovided more frequently. The nature of work has changed fromcontrolling to informing. Firms are concerned about continuousimprovement, employee empowerment and total quality. Nonfinancialinformation has become a critical feedback measure. Finally, the focus ofmany firms is on measuring and managing activities.

17. As measurements are made on operations and, especially, on individualsand groups, the behavior of the individuals and groups are affected.People will react to the measurements being made by focusing on thevariables or behavior being measured. In addition, if managers attempt tointroduce or redesign cost and performance measurement systems, peoplefamiliar with the previous system will resist. Management accountantsmust understand and anticipate the reactions of individuals to information

and measurements. The design and introduction of new measurementsand systems must be accompanied with an analysis of the likely reactionsto the innovations.

II. Exercises

Exercise 1

a. (1) Problem solvingb. (3) Attention-directingc. (1) Problem solvingd. (2) Scorekeeping

Exercise 2

a. (4) Marketingb. (3) Productionc. (6) Customer service

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d. (5) Distribution

Exercise 3

a. (4) Marketingb. (3) Productionc. (5) Distributiond. (4) Marketinge. (5) Distributionf. (3) Productiong. (1) Research and developmenth. (2) Design

III. Problems

Problem 1 (Problem Solving, Scorekeeping, and Attention Directing)

Because the accountants duties are often not sharply defined, some of theseanswers might be challenged:

1. Scorekeeping2. Attention directing3. Scorekeeping4. Problem solving5. Attention directing6. Attention directing7. Problem solving8. Scorekeeping (depending on the extent of the report) or attention

getting9. This question is intentionally vague. The give-and-take of the

budgetary process usually encompasses all three functions, but itemphasizes scorekeeping the least. The main function is attentiondirecting, but problem solving is also involved.

10. Problem solving

Problem 2 (Management Accounting Information System)

1. Inputs: b, g, i, m2. Processes: a, d, f, j

3. Outputs: e, k, n4. System objectives: c, h, l

Problem 3 (Role of Management Accountants)

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Planning. The management accountant gains an understanding of the impacton the organization of planned transactions (i.e., analyzing strengths andweaknesses) and economic events, both strategic and tactical, and setsobtainable goals for the organization. The development of budgets is anexample of planning.

Controlling. The management accountant ensures the integrity of financialinformation, monitors performance against budgets and goals, and providesinformation internally for decision making. Comparing actual performanceagainst budgeted performance and taking corrective action where necessary isan example of controlling. Internal auditing is another example.

Evaluating Performance. The management accountant judges and analyzesthe implication of various past and expected events, and then chooses theoptimum course of action. The management accountant also translates dataand communicates the conclusions. Graphical analysis (such as trend, barcharts, or regression) and reports comparing actual costs with budgeted costsare examples of evaluating performance.

Ensuring Accountability of Resources. The management accountantimplements a reporting system closely aligned to organizational goals thatcontribute to the measurement of the effective use of resources andsafeguarding of assets. Internal reporting such as comparison of actual tobudget is an example of accountability.

External Reporting. The management accountant prepares reports inaccordance with generally accepted accounting principles and thendisseminates this information to shareholders, creditors, and regulatory taxagencies. An annual report or a credit application are examples of externalreporting.

Problem 4 (Line Versus Staff)

Jamie Reyes is staff. She is in a support role she prepares reports and helpsexplain and interpret them. Her role is to help the line managers moreeffectively carry out their responsibilities.

Stephen Santos is a line manager. He has direct responsibility for producing agarden hose. Clearly, one of the basic objectives for the existence of amanufacturing firm is to make a product. Thus, Stephen has directresponsibility for a basic objective and therefore holds a line position.

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Problem 5 (Professional Ethics and End-of-Year Games)

Requirement 1

The possible motivations for the snack foods division wanting to play end-of-year games include:

(a) Management incentives. Yummy Foods may have a division bonusscheme based on one-year reported division earnings. Efforts to front-endrevenue into the current year or transfer costs into the next year canincrease this bonus.

(b) Promotion opportunities and job security. Top management of YummyFoods likely will view those division managers that deliver high reportedearnings growth rates as being the best prospects for promotion. Divisionmanagers who deliver unwelcome surprises may be viewed as lesscapable.

(c) Retain division autonomy. If top management of Yummy Foods adopts amanagement by exception approach, divisions that report sharpreductions in their earnings growth rates may attract a sizable increase intop management supervision.

Requirement 2

The Standards of Ethical Conduct require management accountants to:

Refrain from either actively or passively subverting the attainment of

the organizations legitimate and ethical objectives, and

Communicate unfavorable as well as favorable information and

professional judgment or opinions.

Several of the end-of-year games clearly are in conflict with theserequirements and should be viewed as unacceptable by Tan:

(a) The fiscal year-end should be closed on midnight of December 31.Extending the close falsely reports next years sales as this years sales.

(b) Altering shipping dates is falsification of the accounting reports.(c) Advertisements run in December should be charged to the current year.

The advertising agency is facilitating falsification of the accountingrecords.

The other end-of-year games occur in many organizations and may fall intothe gray to acceptable area. However, much depends on the

circumstances surrounding each one:

(a) If the independent contractor does not do maintenance work in December,there is no transaction regarding maintenance to record. The

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responsibility for ensuring that packaging equipment is well maintained is

that of the plant manager. The division controller probably can do littlemore than observe the absence of a December maintenance charge.

(d) In many organizations, sales are heavily concentrated in the final weeks ofthe fiscal year-end. If the double bonus is approved by the divisionmarketing manager, the division controller can do little more than observethe extra bonus paid in December.

(e) If TV spots are reduced in December, the advertising cost in Decemberwill be reduced. There is no record falsification here.

(g) Much depends on the means of persuading carriers to accept themerchandise. For example, if an under-the-table payment is involved, it isclearly unethical. If, however, the carrier receives no extra considerationand willingly agrees to accept the assignment, the transaction appearsethical.

Each of the (a), (d), (e) and (g) end-of-year games may well disadvantageYummy Foods in the long run. For example, lack of routine maintenance maylead to subsequent equipment failure. The divisional controller is well advisedto raise such issues in meetings with the division president. However, ifYummy Foods has a rigid set of line/staff distinctions, the division president isthe one who bears primary responsibility for justifying division actions tosenior corporate officers.

Requirement 3

If Tan believes that Ryan wants her to engage in unethical behavior, sheshould first directly raise her concerns with Ryan. If Ryan is unwilling tochange his request, Tan should discuss her concerns with the CorporateController of Yummy Foods. Tan also may well ask for a transfer from thesnack foods division if she perceives Ryan is unwilling to listen to pressurebrought by the Corporate Controller, CFO, or even President of YummyFoods. In the extreme, she may want to resign if the corporate culture ofYummy Foods is to reward division managers who play end-of-year gamesthat Tan views as unethical and possibly illegal.

Problem 6

James Torres has come up with a scheme that involves a combination of datafalsification and smoothing! Not only has he made up the revenue numbers,but also he has had the gall to defer some of them to the next period. Makingup such numbers is clearly illegal. Smoothing, in this example is also illegalbecause the numbers are fictitious.

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Problem 7

Clearly the vice-president will lose his or her job if you turn him or her in.Given that this is a major violation of the code of ethics and a violation patentlaw, the vice-president could go to jail. Your best course of action is to checkyour information and if the vice-president is definitely involved, goimmediately to the VPs superior (who is probably a senior VP or thecompany president). The organizations attorneys will take over from there.

Problem 8

One option is to do nothing and ignore what you saw, however, this mayviolate your own code of ethics and your ethical responsibilities under theorganizations code of ethics. Given that you want to do something, it isprobably best to start by talking to employees in your organization whose jobit is to deal with ethical issues. If no such employees exist or are available,you might start by using a decision model. This model incorporated thefollowing steps:

1. Determine the Facts What, Who, Where, How2. Define the Ethical Issue3. Identify Major Principles, Rule, Values4. Specify the Alternatives.5. Compare Values and Alternatives, See if Clear Decision6. Assess the Consequences.7. Make Your Decision.

IV. Cases

Case 1 (Financial vs. Managerial Accounting)

Requirement (a)

Other forward looking information desired in addition to the income statementinformation are

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1. Disclosure of the components of financial performance, i.e., nature

and source of revenues, various activities, transactions, and otherrelevant events affecting the company.

2. Nature and function of the components of income and expenses

Requirement (b)

No. GAAP does not allow capitalization of employee training and advertisingcosts even if management feels that they increase the value of the companysbrand name. The reasons are uncertainty of the future benefits that may bederived therefrom and difficulty and reliability of their measurement.

Requirement (c)

Detailed information that managers would likely request are analysis of thesignificant increases in

1. Sales2. Cost of sales3. Payroll4. Stock and option based compensation5. Advertising and promotion.

Requirement (d)

Nonmonetary measures:

1. Change in number and profile of customers2. Share in the market3. Who, what and how many are the competitors4. Product lines offered by the entity vs. Product lines of competitors5. Sales promotion and advertising activities

Requirement (e)

1. Competitors2. Employees3. Prospective creditors

Case 2 (You get what you measure!)

Requirement (a)

Increase in sales to new customers to sales

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Too much emphasis on this ratio may lead the sales manager to spend more

time developing business with new customers and disregard the needs ofexisting customers. It is therefore possible to lose the business of several keyaccounts.

Requirement (b)

Decrease in cost of goods sold to sales

This performance measure could create the following problems:

1. Purchasing goods with poor quality at lower cost and selling them forthe same price.

2. Indiscriminately increasing selling price to widen the profit marginwithout regard to competitors current prices.

3. If the entity is manufacturing its own goods, managers could try toeconomize on costs, i.e., buying poorer quality of materials,employing unskilled workers, etc. thereby causing deterioration of thequality of the finished products.

In all of the above situations, customer patronage could eventually beadversely affected.

Requirement (c)

Decrease in selling and administrative expense to sales

Cost-cutting is generally advisable for as long as the quality of goods andservices are not compromised. Likewise, certain cost-saving measures coulddemotivate sales people and other employees and could lead to counter-productive activities.

Case 3 (The Roles of Managers and Management Accountants)

1. Managerial accounting, Financial accounting2. Planning3. Directing and motivating4. Feedback5. Decentralization6. Line7. Staff

8. Controller9. Budgets10. Performance report11. Chief Financial Officer

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12. Precision; Nonmonetary data

Case 4 (Ethics in Business)

If cashiers routinely short-changed customers whenever the opportunitypresented itself, most of us would be careful to count our change beforeleaving the counter. Imagine what effect this would have on the line at yourfavorite fast-food restaurant. How would you like to wait in line while eachand every customer laboriously counts out his or her change? Additionally, ifyou cant trust the cashiers to give honest change, can you trust the cooks totake the time to follow health precautions such as washing their hands? If youcant trust anyone at the restaurant would you even want to eat out?

Generally, when we buy goods and services in the free market, we assume weare buying from people who have a certain level of ethical standards. If wecould not trust people to maintain those standards, we would be reluctant tobuy. The net result of widespread dishonesty would be a shrunken economywith a lower growth rate and fewer goods and services for sale at a loweroverall level of quality.

Case 5 (Ethics and the Manager)

Requirement 1

Failure to report the obsolete nature of the inventory would violate theStandards of Ethical Conduct as follows:

Competence

Perform duties in accordance with relevant technical standards.

Prepare complete reports using reliable information.

By failing to write down the value of the obsolete inventory, Perez would notbe preparing a complete report using reliable information. In addition,generally accepted accounting principles (GAAP) require the write-down ofobsolete inventory.

Integrity

Avoid conflicts of interest.

Refrain from activities that prejudice the ability to perform dutiesethically.

Refrain from subverting the legitimate goals of the organization.

Refrain from discrediting the profession.

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Members of the management team, of which Perez is a part, are responsible

for both operations and recording the results of operations. Since the teamwill benefit from a bonus, increasing earnings by ignoring the obsoleteinventory is clearly a conflict of interest. Perez would also be concealingunfavorable information and subverting the goals of the organization.Furthermore, such behavior is a discredit to the profession.

Objectivity

Communicate information fairly and objectively.

Disclose all relevant information.

Hiding the obsolete inventory impairs the objectivity and relevance of financialstatements.

Requirement 2

As discussed above, the ethical course of action would be for Perez to insiston writing down the obsolete inventory. This would not, however, be an easything to do. Apart from adversely affecting her own compensation, the ethicalaction may anger her colleagues and make her very unpopular. Taking theethical action would require considerable courage and self-assurance.

Case 6 (Preparing an Organization Chart)

Requirement 1

See the organization chart on page 17.

Requirement 2

Line positions would include the university president, academic vice-president,the deans of the four colleges, and the dean of the law school. In addition, thedepartment heads (as well as the faculty) would be in line positions. Thereason is that their positions are directly related to the basic purpose of theuniversity, which is education. (Line positions are shaded on the organizationchart.)

All other positions on the organization chart are staff positions. The reason isthat these positions are indirectly related to the educational process, and existonly to provide service or support to the line positions.

Requirement 3

All positions would have need for accounting information of some type. For

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example, the manager of central purchasing would need to know the level of

current inventories and budgeted allowances in various areas before doing anypurchasing; the vice president for admissions and records would need to knowthe status of scholarship funds as students are admitted to the university; thedean of the business college would need to know his/her budget allowances invarious areas, as well as information on cost per student credit hour; and soforth.


Requirement 1

No, Santos did not act in an ethical manner. In complying with the presidentsinstructions to omit liabilities from the companys financial statements he was

in direct violation of the IMAs Standards of Ethical Conduct forManagement Accountants. He violated both the Integrity and Objectivityguidelines on this code of ethical conduct. The fact that the president orderedthe omission of the liabilities is immaterial.

Requirement 2

No, Santos actions cant be justified. In dealing with similar situations, theSecurities and Exchange Commission (SEC) has consistently ruled that corporate officerscannot escape culpability by asserting that they acted asgood soldiers and cannot rely upon the fact that the violative conduct mayhave been condoned or ordered by their corporate superiors. (Quoted from:Gerald H. Lander, Michael T. Cronin, and Alan Reinstein, In Defense of the

Management Accountant, Management Accounting, May, 1990, p. 55)Thus, Santos not only acted unethically, but he could be held legally liable ifinsolvency occurs and litigation is brought against the company by creditorsor others. It is important that students understand this point early in thecourse, since it is widely assumed that good soldiers are justified by the factthat they are just following orders. In the case at hand, Santos should haveresigned rather than become a party to the fraudulent misrepresentation of thecompanys financial statements.

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Requirement 1

Andres Romero has an ethical responsibility to take some action in the matterof PhilChem, Inc. and the dumping of toxic wastes. The Standards of EthicalConduct for Management Accountants specifies that managementaccountants should not condone the commission of acts by their organizationthat violate the standards of ethical conduct. The specific standards that applyare as follows.

Competence. Management accountants have a responsibility toperform their professional duties in accordance with relevant laws andregulations.

Confidentiality. Management accountants must refrain fromdisclosing confidential information unless legally obligated to do so.However, Andres Romero may have a legal responsibility to takesome action.

Integrity. Management accountants have a responsibility to:- refrain from either actively or passively subverting the attainment

of the organizations legitimate and ethical objectives.- communicate favorable as well as unfavorable information and

professional judgments or opinions. Objectivity. Management accountants must fully disclose all relevant

information that could reasonably be expected to influence anintended users understanding of the reports, comments, andrecommendations.

Requirement 2

The Standards of Ethical Conduct for Management Accountants indicatesthat the first alternative being considered by Andres Romero, seeking theadvice of his boss, is appropriate. To resolve an ethical conflict, the first stepis to discuss the problem with the immediate superior, unless it appears thatthis individual is involved in the conflict. In this case, it does not appear thatRomeros boss is involved.

Communication of confidential information to anyone outside the company isinappropriate unless there is a legal obligation to do so, in which case Romeroshould contact the proper authorities.

Contacting a member of the Board of Directors would be an inappropriateaction at this time. Romero should report the conflict to successively higherlevels within the organization and turn only to the Board of Directors if the

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problem is not resolved at lower levels.

Requirement 3

Andres Romero should follow the established policies of the organizationbearing on the resolution of such conflict. If these policies do not resolve theethical conflict, Romero should report the problem to successively higherlevels of management up to the Board of Directors until it is satisfactorilyresolved. There is no requirement for Romero to inform his immediatesuperior of this action because the superior is involved in the conflict. If theconflict is not resolved after exhausting all courses of internal review, Romeromay have no other recourse than to resign from the organization and submitan informative memorandum to an appropriate member of the organization.

(CMA Unofficial Solution, adapted)

V. Multiple Choice Questions

1. D 11. D 21. B 31. D 41. A 51. B2. D 12. D 22. B 32. C 42. C 52. B3. D 13. D 23. A 33. D 43. D 53. A4. B 14. A 24. A 34. B 44. B 54. C5. D 15. A 25. B 35. D 45. C 55. D6. A 16. A 26. C 36. B 46. B 56. C7. B 17. D 27. B 37. C 47. A 57. C8. D 18. A 28. D 38. B 48. B 58. C9. D 19. D 29. B 39. A 49. C 59. A

10. A 20. D 30. C 40. A 50. D 60. B

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