CHAPTER ONE

Introduction

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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

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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

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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)

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Decision Making - PricingExamples Set selling price to achieve desired profits Set selling price to achieve positive cash flow

Related Topics Marketing Microeconomics - Price Theory Corporate Finance

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Decision Making - Cost ControlExamples Add new equipment Change production process Make internally versus buy externally (outsource)

Related Topics Process engineering Management information systems Activity-based costing (ABC)

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Control - IncentivesAssumptions 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

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Control - Performance EvaluationExamples Performance bonuses depend on accounting

results Benchmarking: comparisons to industry leaders

Related Topics Organizational behavior Human resources management

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Design - Multiple Role of Accounting

Study Figure 1-1.

Main point: Accounting reports are used for multiple purposes.

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Design - External ReportsUsers 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

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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

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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

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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.

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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.

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Design - Organizational StructureController 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.

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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

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Example - Vortec Special OrderWith no overtime and congestion

Current With Order Incremental Units produced and sold 100,000 102,000 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) 450,000 455.940 -5,940 Administrative expenses - 27,500 - 27,500 0 Net profit before taxes $ 22,500 $ 24,560 $ 2,060 Incremental revenue (2,000 units x $4.00) $8,000 Total cost @ 102,000 units (102,000 x $4.47) $455,940 Total cost @ 100,000 units (100,000 x $4.50) 450.000 Incremental cost of 2,000 units -5,940 Incremental profit of 2,000 units $2,060

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Example - Vortec Special OrderWith overtime and congestion

Current With Order Incremental Units produced and sold 100,000 102,000 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) 450,000 458,160 -8,160 Administrative expenses - 27,500 - 27,500 0 Net profit before taxes $ 22,500 $ 22,340 $ - 160 Incremental revenue (2,000 units x $4.00) $8,000 Total cost @ 102,000 units (100,000 x $4.50) plus (2,000 x $4.08) $458,160 Total cost @ 100,000 units (100,000 x $4.50) 450.000 Incremental cost of 2,000 units -8,160 Incremental profit of 2,000 units $ - 160

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Example - Beware of Average CostsAverage 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.

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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

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Example - Supplement Accounting Data

Supplement historical cost accounting data with other knowledge

Could include:– expected customer demands– competitors’ plans– future technology– government regulation

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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

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Outline of TextSee 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