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The GAP in GAAPThe IMA Northern Lights Regional Conference, April 27, 2012Olen L. Greer, Ph.D., CMAProfessor of AccountancyOpening comments, Chauffeur story.1Heartland Regional Council Professional Education ConferenceWhen:September 19 and 20, 2012Where: University Plaza Hotel & Convention Center, Springfield, MissouriConference Details:16 hours of CPE.Nationally known speakers (e.g. Chester Elton, author of The Carrot Principle, Tom Schweich, MO State Auditor, Economist Anirban Basu and many others).Includes 10 general sessions and 6 sets of 3 concurrent sessions.Registration ($370/$395) includes breakfast, lunch & breaks for both days.Corporate Discounts available.

BACKGROUND and PROBLEM DEVELOPMENTRespect and The Accounting ProfessionThe Way We Were as of 1986(per the President of the MSCPAs)Clergy Medical DoctorsAttorneysAccountants

THE MOST RESPECTED PROFESSIONALS: __________

The way we wererelate the survey results reported in 1986 by the President of the MSCPAs.4Respect and The Accounting ProfessionThen came Enron, World Com, Tyco, etc.

5Respect and The Accounting Profession, ContinuedUltimately, the accounting profession sacrificed the public confidence that underpinned its reputation. Now, accountants wallow at the bottom among professions in public-opinion polls they topped 20 years ago. The business is drawing fewer top students, more government scrutiny and bad jokes.No Taste for Accounting, I. J. Dugan, WSJRespect and The Accounting Profession, ContinuedHard hit by industry scandals, industry leaders and individual accountants will need to put their best feet forward to rebuild a now tarnished image and restore public faith in what was once a most trusted profession.If the Shoe Fits, C. Fitzgerald, InsightCentral Scandal Theme:________________________________And check for this red flag: Are net earnings (as reported on the income statement) increasing while cash flow is declining? That could signal the use of creative accounting practices designed to ____________________________________________________. Exhibit A: Enron.

10 Questions Every Investor Should Ask Before Buying a Stock, J. Revell, FortuneWhen it comes to reporting earnings, U.S. companies have about as much credibility these days as the judges of Olympic figure skating. So how do you begin to restore investor confidence post-Enron, post-Tyco, post-you-name-it? By having companies state profits in a way that is more meaningful and _____________________________________________________.System Failure, Joseph Nocera, FortuneWhat was the fix?Sarbanes-Oxley (2002)SOX legislation impact:The compliance burden on MAs has increased, to the point that they have little-to-no time to focus on managements needs.Management must now survive 3 audit opinions, instead of one.Corporate America has already (as of 2006) spent over $280 billion complying with SOX (Non-value adding costs).

Source: Surviving Three SOX Opinions, Crawford, Klamm & Watson, Strategic Finance, May, 2007.

SOX legislation impact, Continued:

The cost per company, per year, ranges from _______to well over ____________. This is a totally non-value adding expense.

Source: 2011 Sarbanes-Oxley Compliance Survey, conducted and published by PROVITY Risk and Business Consulting.

GAAP14Purposes of PresentationTo examine income measurement problems CREATED BY GAAP-REQUIRED COSTING METHODOLOGIES.

To demonstrate how GAAP encourages and incentivizes managers to manipulate income in LEGAL ways that can be extremely harmful to the organization.The Income EquationRevenue EXPENSES = Profit-COST-A sacrifice made (economic or otherwise) to obtain a desired benefit.Cost Accounting 101GAAP Product Costing-Absorption CostingProduct Costs_______________________________________________________________________________________________________________Period Costs__________________________________________________________________________

Review Quiz Results6. ___________________ = ___________________ ___________________Sources of Variation (GAAP)Cost flow assumptions (FIFO, LIFO, etc.)Cost Allocation MethodsActual vs. Normal vs. Standard Cost SystemsService Department Cost Allocations: Direct vs. Step vs. Algebraic MethodsJoint Cost Allocations: Physical vs. Sales Value at Splitoff vs. Approximated Net Realizable ValueActivity-Based Costing vs. Traditional MethodsETC. . . . . . . . . . . . . . . . . .Traditional Income Formula:

Sales Cost of Goods Sold = Gross Margin

Gross Margin S&A Expenses = Operating IncomePracticum No. 1The Olga Bonemarrow Company

The Olga Bonemarrow Wood Spirits Company produces two products, turpentine and methanol (wood alcohol), by a joint process.Joint costs amount to $120,000 per batch of output.Each batch totals 10,000 gallons, 25% methanol and 75% turpentine.Both products are processed further without gain or loss in volume.Separable processing costs: Methanol, $3 per gallon; Turpentine, $2 per gallon.Methanol sells for $21 per gallon; Turpentine sells for $14 per gallon.Bonemarrow uses the approximated net realizable value method for allocating joint costs to main products.

QUESTIONSWhat amounts of Joint Costs would be allocated to Methanol? Turpentine?________________________________________________________________________________________________________________________________________________________________________QUESTIONS, ContinuedWhat is the total cost of each product and the per unit cost of each product?________________________________________________________________________________________________________________________________________________________________________QUESTIONS, ContinuedWhat is the Gross Margin on each product and the Gross Margin percentage?____________________________________________________________________________________________________________________________________________Suppose that you are the manager of the Methanol Division.Furthermore, suppose that you and your staff worked hard to develop a process by which the methanol could be made into a pleasant-tasting beverage.The new selling price would be $48 per gallon (net of Excise Tax).The additional separable cost of the new process would be $9.00, bringing the total separable cost per gallon to $12.00 ($9 + $3).QUESTIONSWhat amounts of Joint Costs would be allocated to the new product? Turpentine?________________________________________________________________________________________________________________________________________________________________________QUESTIONS, ContinuedWhat is the total cost of each product and the per unit cost of each product?________________________________________________________________________________________________________________________________________________________________________QUESTIONS, ContinuedWhat is the Gross Margin on each product and the Gross Margin percentage?____________________________________________________________________________________________________________________________________________Olga Bonemarrow SummaryUse of a GAAP-sanctioned cost allocation method resulted ______ __________________________.Long-term impact: ___________ __________________________.REMEMBER: Allocated joint costs are generally _________ to product decisions.ASSERTION:The GAAP answer to the Cost Question is, in many if not most cases, the WRONG answer, when it comes to decision making.The Fixed Cost DilemmaGAAP requires FFOH to be allocated to products.By allocating FFOH to products, were forcing a fixed cost to behave ____________ ____________________________________.The amount we allocate to each unit is dependent on _________________________.We dont know how many units were going to produce until the end of the period!!Practicum No. 2The Brassinni Company

36The Brassinni Company began operations in 2010 as a manufacturer with a capacity of 40 million units of product.In 2010, 10 million units of product were manufactured and sold. Brassinni Companys income statement for 2010 follows:

BRASSINNI COMPANYIncome StatementYear ending December 31, 2010Sales (10 million units @ $6)$60,000,000Cost of Goods Sold: Variable (10,000,000 @ $2) $20,000,000 Fixed 48,000,000 Total 68,000,000Gross Margin($8,000,000)Less: Marketing & Admin. Costs 10,000,000 Operating Profit (Loss) ($18,000,000)The board of directors is concerned about the $18 million loss. A consultant approached the board with following offer: I agree to become president for no fixed salary. But, I insist on a year-end bonus of 10 percent of operating profit (before considering the bonus). The board of directors agreed to these terms and hired the consultant.The new president promptly stepped up production to an annual rate of 30 million units. Sales for 2011 remained at 10 million units. The income statement for Brassinni Company for 2011 follows:

BRASSINNI COMPANYIncome StatementYear ending December 31, 2011Sales (10 million units @ $6)$60,000,000Cost of Goods Sold: Variable (30,000,000 @ $2)$_________ Fixed 48,000,000 Cost of Goods Mfd$_________ Less: Ending Inventory: Variable (20,000,000 x $2)$_________ Fixed (20/30 x 48,000,000) _________ Total, Ending Inventory _________ Cost of Goods Sold __________Gross Margin$__________Less: Marketing & Admin. Costs 10,000,000 Operating Profit before Bonus$__________Less: Bonus __________ Operating Profit after Bonus$__________The day after the statement was verified, the president took his check for $1,400,000 and resigned to take a job with another corporation. He remarked, I enjoy challenges. Now that Brassinni Company is in the black, Id prefer tackling another challenging situation. (His contract with his new employer is similar to the one he had with Brassinni Company.)Whats WRONG with this picture?BRASSINNI COMPANYVariable Costing Income StatementYear ending December 31, 2011Sales (10 million units @ $6)$60,000,000____________________: _________________________________________ _______________________________________ Less: Ending Inventory: _________________________________________Variable Cost of Goods Sold 20,000,000Contribution Margin$_________Less: Fixed Costs: ________________________________________ Marketing & Admin. Costs 10,000,000 Total Fixed Costs: _________ Operating Profit (Loss) before Bonus __________Less: Bonus __________ Operating Profit (Loss) after Bonus___________Cost Accounting 201Variable CostingBasic Premise of Variable Costing: FFOH (Capacity Costs) are costs of being in business.Therefore, FFOH should be treated as a Period Cost, rather than a Product Cost (as required by GAAP and Absorption Costing).Cost Accounting 201Variable Costing, ContinuedProducts inventoried using variable production costs only (direct material, direct labor, and variable factory overhead).Income Statement Format: Contribution Margin Format.Cost Accounting 201Variable Costing, ContinuedIncome Formula:

Sales Variable Expenses = Contribution Margin

Contribution Margin Fixed Expenses = Operating IncomeThe Brassinni CompanyVariable Costing Income StatementYear ending December 31, 2011Sales (10 million units @ 6$) $60,000,000Variable Cost of Goods Sold: Variable (30 mil @ 2$) $60,000,000 Variable Cost of Goods Mfd $60,000,000 Less: Ending Inventory: Variable Costs (20 mil x $2) $40,000,000Variable Cost of Goods Sold 20,000,000Contribution Margin $40,000,000The Brassinni CompanyVariable Costing Income Statement, ContinuedYear ending December 31, 2011Contribution Margin $40,000,000Less: Fixed Costs: Fixed Factory Overhead$48,000,000 Marketing & Admin. Costs 10,000,000 Total Fixed Costs: 58,000,000 Operating Profit (Loss) before Bonus ($18,000,000)Less: Bonus 1,400,000 Operating Profit (Loss) after Bonus ($19,400,000)The Brassinni Company, SummaryTotal impact of actions by President of Brassinni Company on:Reported Net Income: __________________________________________________________________________________________Cash Flow:____________________________________________________________________________________________________________________________________________________________________________________Absorption CostingIncome is a function of____________________________________________________________Income can be manipulated by ___________ ____________________________________.Phantom Profits are created.Cash Flow is destroyed!Variable CostingIncome is a function of ______________ only.Managers cannot ____________ with production.Is consistent with Cost-Volume-Profit Analysis.Contribution Margin Format for Income Statement.CM is a concrete measure, whereas Gross Margin is a moving target.Simplicity.Income measurement differences:If P > S, NIABS ____ NIVAR

If P < S, NIABS ____ NIVAR

If P = S, NIABS ____ NIVAR

4.In the long run, NIABS ______ NIVARI REPEAT:The GAAP answer to the Cost Question is, in many if not most cases, the WRONG answer, when it comes to decision making.Review Quiz Results7. ___________________ ___________________=

____________________Respect and The Accounting Profession TodayRespondents to the 2011 Fifth Annual Global Leadership Survey conducted by the International Federation of Accountants (IFAC) rated the Accountancy Profession 7 on a 1-10 scale.Respect and The Accounting Profession Today, ContinuedAccountants in North America received the highest rating (8.7 on a 1-10 scale).

Accountants in Europe received the lowest rating (6.7).Respect and The Accounting Profession Today, ContinuedThe top concern for the second consecutive year was:_____________________________________________Respect and The Accounting Profession Today, ContinuedProviding management with accurate, relevant information for decision-making is the ethical obligation of the management accountant.Recognizing when and when not to use GAAP methodologies will reestablish the relevance and the reputation of the management accountant.Conclusions/RecommendationsTo management accountants: Your time has come!! SOX has increased the responsibility of management (and thus, management accountants) for the numbers on financial statements. We need to assert ourselves and our methodologies in instances where those methodologies are clearly superior to those currently required by the financial accounting governing bodies.Conclusions/Recommendations, ContinuedTo managers: Use Variable Costing for a True measure of income.

To the Rule Makers (FASB, SEC): ADOPT VARIABLE COSTING FOR EXTERNAL REPORTING PURPOSES!!On Enrons Financial Tactics:

What were looking at here is an example of superbly complex financial reports. They didnt have to lie. All they had to do was to obfuscate it with sheer complexityalthough they probably lied too.

Congressman John Dingell, MI in FORTUNE, 12/24/011st World Congress of Accountants, 1904, St. Louis, Missouri. The . . . . accountant touches business life on every side . . . . The crowning glory of our profession is that it must ever stand for the highest ideals in the life of the individual and for the slow but sure evolution of society into a state where honor and honesty shall not be mere abstractions.Joseph Sterrett, Chairman of the Congress