Management Accounting

About the Authors xii

Preface xiii

Part 1

Management accounting and cost management 1

Chapter 1

The role of accounting information in management decision making 2

1.1 Management decision making 3

Organisational vision 3

Organisational core competencies 3

Organisational strategies 3

Operating plans 4

Actual operations 4

Measuring, monitoring and motivating performance 4

1.2 Cost and management accounting for decision making 4

Key influences on management accounting system structure 6

Cost and management accounting, yesterday and tomorrow 6

Relevant information for decision making 9

1.3 Management accounting information and the quality of decision making 9

1.4 Value chain analysis: a framework for management accounting 10

Cost objects and cost drivers 13

The value chain and organisational structure 13

Summary 16

Key terms 18

Self-study problems 19

Questions 20

Exercises 20

Problems 21

Endnotes 26

Acknowledgements 26

Appendix 1A Excel primer b27

Chapter 2

Cost concepts, behaviour and estimation 85

2.1 Cost behaviour 86

2.2 Variable, fixed and mixed costs 86

Relevant range 87

Cost functions 88

2.3 Cost estimation techniques 89

Engineered estimate of cost 89

Analysis at the account level 90

Graphical technique — scatter plots 90

Two-point method 91

High-low method 91

2.4 Estimating the cost function 91

2.5 Regression analysis 95

Simple regression analysis 95

Interpreting simple regression results 95

2.6 Uses and limitations of cost estimates 100

Information quality 101

Average costs 101

Quality of estimation techniques 101

Reliance on cost estimates 102

Data limitations 103

Appendix 2A Regression analysis — additional topics 104

Summary 108

Key terms 109

Self-study problems 110

Questions 112

Exercises 112

Problems 114

Acknowledgement 121

Chapter 3

A costing framework and cost allocation 123

3.1 Cost objects — need for cost information 124

3.2 Direct and indirect costs 125

Direct costs 125

Indirect costs 125

3.3 Process of indirect cost allocation 126

Cost drivers 126

Determining the allocation rate 127

3.4 A costing framework 128

3.5 Applying the costing framework in a service entity setting 128

3.6 Applying the costing framework in a support department setting 132

Allocation methods 132

Comparing the direct, step-down and reciprocal methods 140

3.7 Limitations of cost allocation data 140

Appendix 3A Single- versus dual-rate allocations 141

Appendix 3B Using Solver to calculate simultaneous equations for the reciprocal method 145

Summary 146

Key terms 148

Self-study problems 148

Questions 152

Exercises 152

Problems 157

Acknowledgements 164

Chapter 4

Cost–volume–profit (CVP) analysis 165

4.1 Cost–volume–profit (CVP) analysis 166

Profit equation and contribution margin 166

4.2 Breakeven point 166

4.3 CVP analysis for a single product 167

Calculating breakeven in units and total revenue 167

Achieving a targeted pre-tax profit 168

Looking at after-tax profit 168

Cost–volume–profit (CVP) graph 168

4.4 CVP analysis for multiple products 169

Discretionary expenditure decision 170

4.5 Assumptions and limitations of CVP analysis 171

4.6 Margin of safety and degree of operating leverage 171

Margin of safety 171

Degree of operating leverage 172

Appendix 4A Performing CVP analysis with the use of a spreadsheet 177

Summary 180

Key terms 182

Self-study problems 182

Questions 186

Exercises 186

Problems 193

Acknowledgements 199

Chapter 5

Planning — budgeting and behaviour 201

5.1 The role of planning and budgeting for improved performance and value creation: testing alternative actions 202

5.2 Impact of likely actions on profit, assets and cash flow management 202

Sales/revenue estimation 202

Operating expenses 204

New investment 204

The operating cycle 204

5.3 Planning in cost centres 207

5.4 Contemporary approaches to budgeting 208

Program budgeting 208

Zero-based budgeting 208

Rolling budgeting 209

Activity-based budgeting 210

Kaizen budgeting 210

5.5 The behavioural implications of budgeting 210

5.6 Beyond Budgeting 212

Beyond Budgeting in practice: managing without budgets 213

Summary 215

Key terms 215

Self-study problems 216

Questions 216

Exercises 217

Problems 219

Endnotes 225

Acknowledgement 225

Chapter 6

Operational budgets 227

6.1 Budgeting — a tool for short- and long-term planning 228

Budget cycle 228

6.2 The role of the master budget 229

Developing a master budget 230

Budgeting in non-manufacturing entities 234

6.3 Developing a cash budget 234

Operating cash receipts and disbursements 235

Other planned cash flows 235

Short-term borrowing or investing 235

6.4 Budgets as performance benchmarks 238

Budget variances and uncertainties 238

Static and flexible budgets 239

6.5 Budgets, incentives and rewards 241

Participative budgeting 241

Budget manipulation 241

Budget responsibility 242

Budget and variance adjustments to measure performance 242

Summary 244

Key terms 247

Self-study problems 247

Questions 252

Exercises 252

Problems 257

Endnotes 263

Acknowledgements 263

Chapter 7

Job costing systems 265

7.1 The flow of costs through the manufacturing process 266

7.2 Calculating the inventoriable product cost for customised products 267

Computerised and manual job costing systems 269

7.3 Allocating manufacturing overhead 269

1. Identify the relevant cost object 269

2. Identify one or more overhead cost pools and allocation bases 269

3. For each overhead cost pool, calculate an overhead allocation rate 270

4. For each overhead cost pool, allocate costs to the cost object 271

Overapplied and underapplied overhead 271

Recording transactions in the financial accounting system 273

7.4 Spoilage, rework and scrap in job costing 276

Normal and abnormal spoilage 276

Rework 277

Scrap 277

Spoilage opportunity costs 278

7.5 Uses and limitations of job cost information 278

Uncertainties in measuring job costs 278

Uncertainties in estimating future job costs 279

Summary 280

Key terms 281

Self-study problems 282

Questions 284

Exercises 285

Problems 288

Acknowledgement 291

Chapter 8

Process costing systems 293

8.1 Accounting for the cost of mass-produced goods 294

Assigning direct materials and conversion costs 294

8.2 Work in process and equivalent units 294

8.3 Process costing methods 296

Process cost reports without beginning or ending WIP — first month (March) 297

Process cost reports with ending WIP — second month (April) 299

Process cost reports with beginning and ending WIP — third month (May) 300

Journal entries for process costing 302

8.4 Production costs and multiple production departments 303

Transferred-in costs and timing of direct materials 303

8.5 Accounting for spoilage in process costing 306

8.6 Uses and limitations of process costing information 308

Monitoring process quality and costs 309

Process costing information and decision making 309

Uncertainties and mismeasurement of cost flows 309

Work in process units at different stages of completion 309

Hybrid costing systems and operation costing 310

Appendix 8A Standard costing use in mass production 311

Summary 312

Key terms 313

Self-study problems 314

Questions 316

Exercises 317

Problems 318

Acknowledgement 324

Chapter 9

Absorption and variable costing 325

9.1 Different measures of cost for different purposes 326

Absorption costing 326

Variable costing 327

Absorption costing compared to variable costing 328

Reconciling absorption and variable costing incomes 330

Incentives to build up inventories 332

Disincentives to build up inventories 332

Uncertainties about desirable inventory levels 332

9.2 A closer look at absorption costing using normal costing 332

Motivation for normal costing 333

Allocation rate denominator considerations 333

Volume variance with normal costing 334

Evaluating denominator choices 334

9.3 Comparison of absorption and variable costing 335

Summary 339

Key terms 340

Self-study problems 340

Questions 344

Exercises 344

Problems 347

Acknowledgement 351

Chapter 10

Flexible budgets, standard costs and variance analysis 353

10.1 Flexible budgets 354

10.2 Standard costs 354

Developing standard costs 354

10.3 Variance analysis 355

Price variances 356

Efficiency variances 356

Deciding which variances to investigate 357

Analysing interactions between incentives and variances 357

10.4 Flexible budgeting in practice 358

Manager conclusions and actions 360

Summary 365

Key terms 366

Self-study problems 366

Questions 368

Exercises 368

Problems 370

Acknowledgement 373

Chapter 11

Variance analysis: revenue and cost 375

11.1 Identifying variances 376

11.2 Profit- and revenue-related variances 377

Profit variance 377

Revenue variance 377

Sales price and sales quantity variances 378

Sales volume and profit variance 378

11.3 Direct cost variances 382

Direct materials price variance 382

Direct materials efficiency variance 383

Summary of direct material variances 384

Direct labour price variance 384

Direct labour efficiency variance 384

Summary of direct labour variances 384

Journal entries for direct costs and variances 385

11.4 Analysing direct cost variance information 385

Identifying reasons for direct cost variances 385

11.5 Overhead variances 387

Variable overhead spending variance 388

Variable overhead efficiency variance 389

Fixed overhead spending variance 390

Production volume variance 390

Summary of overhead variances 391

Journal entries for overhead costs and variances 391

11.6 Using overhead variance information 391

Analysing overhead spending variances 391

Interpreting the variable overhead efficiency variance 391

Interpreting the production volume variance 392

11.7 Cost variance adjustments in the general ledger 393

Summary 399

Key terms 401

Self-study problems 402

Questions 405

Exercises 405

Problems 409

Acknowledgement 414

Chapter 12 Activity analysis: costing and management 415

12.1 Activity-based costing (ABC) and conventional costing 416

Conventional cost accounting systems 416

Activity-based costing systems 417

12.2 ABC cost hierarchy 418

Organisation-sustaining activities 419

Facility-sustaining activities 419

Customer-sustaining activities 419

Product-sustaining activities 419

Batch-level activities 419

Unit-level activities 419

12.3 Understanding and implementing an ABC model 420

12.4 Activity-based management (ABM) 423

Managing customer profitability 423

Managing product and process design 424

Managing environmental costs 424

Managing constrained resources 424

Managing resources supplied and consumed 424

12.5 Benefits, costs and issues related to ABC 425

Benefits of ABC 425

Costs of ABC 425

Issues related to ABC 426

Summary 435

Key terms 436

Self-study problems 436

Questions 438

Exercises 439

Problems 443

Endnotes 447

Acknowledgements 447

Chapter 13

Relevant costs for decision making 449

13.1 Non-routine operating decisions 450

13.2 Special orders 452

General rule for special order decisions 452

13.3 Product line and business segment (keep or drop) decisions 454

General rule for keep or drop decisions 454

13.4 Insource or outsource (make or buy) decisions 455

General rule for make or buy decisions 455

13.5 Constrained resources 457

General rule for choosing the product mix when resources are constrained 457

General rule for relaxing constraints for one or two products 458

13.6 Qualitative factors important to non-routine operating decisions 459

Quality of decision process 461

13.7 Joint products and costs 461

Allocating joint costs 462

Choosing an appropriate joint cost allocation method 465

Pros and cons of alternative allocation methods 465

Processing a joint product beyond the split-off point 467

Uncertainty and bias in incremental revenue and cost estimates 468

Joint products and by-products 468

Joint product costing with a sales mix 470

Uses and limitations of joint cost information 472

Summary 474

Key terms 477

Self-study problems 477

Questions 481

Exercises 482

Problems 489

Acknowledgement 497

Part 2

Management accounting, extending performance measurement and strategy 499

Chapter 14

Strategy and control 500

14.1 Management accounting and control in a dynamic world 501

14.2 Introduction to strategy and control 502

14.3 Frameworks for strategy and control 504

Ferreira and Otley’s performance management systems framework 504

Simons’ levers of control framework 506

Kaplan and Norton’s strategy map framework 507

Ittner and Larcker’s value-based management framework 508

Flamholtz’s control system framework 509

14.4 Management responsibility and accountability practices 511

Strategy, control and remaining chapters 512

Summary 514

Key term 514

Self-study problem 514

Questions 515

Exercises 515

Problems 516

Endnotes 517

Acknowledgements 518

Chapter 15

Capital budgeting and strategic investment decisions 519

15.1 Capital investment decisions 520

Capital budgeting 520

Decision alternatives 520

15.2 Relevant cash flows 521

15.3 Net present value (NPV) method 522

Present value of a series of cash flows 522

Net present value of a project 523

Identifying a reasonable discount rate 524

15.4 Uncertainties and sensitivity analysis 524

Cash flow uncertainties 524

Project life and discount rate uncertainties 525

Estimation bias 525

Sensitivity analysis 525

15.5 Alternative methods used for capital investment decisions 527

Internal rate of return 527

Comparison of NPV and IRR methods 528

Payback method 528

Accrual accounting rate of return method 529

15.6 Strategic considerations for investment decisions 529

The type of information required in decision making 529

Moving baseline concept 530

Project champion 530

Cost of reversing the decision 530

Reputation, risks, environment, quality and community 530

Making and monitoring investment decisions 534

15.7 Income taxes and the net present value method 535

Calculating incremental tax cash flows 535

15.8 Inflation and the net present value method 536

Real and nominal methods for NPV analysis 536

Appendix 15A Present and future value tables 538

Summary 546

Key terms 547

Self-study problems 548

Questions 551

Exercises 552

Problems 556

Endnotes 561

Acknowledgements 562

Chapter 16

The strategic management of costs and revenues 563

16.1 Value chain activities for continuous cost improvement 564

Value chain and supply chain analysis 564

16.2 Customer profitability 568

16.3 Building desired profit into decisions 573

Target costing 574

16.4 Kaizen costing 578

Using target and kaizen costing over time 580

16.5 Life cycle costing 581

16.6 Price management: pricing methods 582

Cost-based pricing 582

Market-based pricing 583

Cost-based versus market-based pricing 586

Other influences on price 587

Pricing in not-for-profit entities 587

Government regulations, ethics and pricing 588

Summary 589

Key terms 591

Self-study problems 592

Questions 593

Exercises 594

Problems 598

Endnotes 603

Acknowledgements 604

Chapter 17

Strategic management control: a lean perspective 605

17.1 Lean thinking philosophy 606

17.2 Theory of constraints 609

Throughput costing 610

TOC performance measurement 612

Benefits and limitations of the theory of constraints and throughput costing 613

17.3 Just-in-time (JIT) production 616

17.4 Total quality management (TQM): managing quality 619

Value chain approach to quality management 620

Summary 623

Key terms 624

Self-study problems 624

Questions 625

Exercises 626

Problems 631

Endnotes 632

Acknowledgements 633

Chapter 18

Responsibility accounting, performance evaluation and transfer pricing 635

18.1 Decision-making authority and responsibility 636

Centralised and decentralised entities 636

General versus specific knowledge 637

Technology and globalisation 638

18.2 Responsibility accounting 639

Cost centres 640

Revenue centres 640

Profit centres 641

Investment centres 641

Responsibility centres and suboptimal decision making 641

18.3 Income-based performance evaluation 641

Return on investment 642

Advantages and disadvantages of ROI 644

Residual income 645

Advantages and disadvantages of residual income 645

Economic value added 646

Advantages and disadvantages of EVA 647

Income-based performance evaluation in the public sector 648

18.4 Transfer pricing 648

Transfer prices and conflicts among managers 649

Setting an appropriate transfer price 651

18.5 Additional transfer price considerations 654

International income taxes 654

Transfer prices for support services 655

Setting transfer prices for internal services 655

Transfer of corporate overhead costs 655

Summary 656

Key terms 657

Self-study problems 658

Questions 659

Exercises 660

Problems 663

Endnotes 667

Acknowledgements 667

Chapter 19

The balanced scorecard and strategy maps 669

19.1 Measuring organisational performance 670

Financial and non-financial measures 670

19.2 Strategy maps 674

19.3 The balanced scorecard 675

Financial perspective and related measures 677

Customer perspective and related measures 677

Internal business process perspective and related measures 678

Learning and growth perspective and related measures 679

Role of social media performance measures 683

Using the balanced scorecard diagnostically or interactively (levers of control) 684

Belief systems, boundary systems and the balanced scorecard 684

19.4 Steps in implementing a balanced scorecard 684

Clarify vision, core competencies and strategies 684

Analyse perspectives to develop performance objectives and measures 685

Construct a strategy map to reinforce links between measures 686

Communicate, link throughout the organisation and refine 686

Establish performance targets and action plans 686

Collect and analyse scorecard data to monitor performance 686

Investigate variances and reward employees 687

Provide feedback and refine the balanced scorecard 687

19.5 Strengths and weaknesses of the balanced scorecard 691

Strengths 691

Weaknesses 691

How valuable is the balanced scorecard? 693

Summary 694

Key terms 696

Self-study problems 696

Questions 699

Exercises 699

Problems 703

Endnotes 708

Acknowledgements 709

Chapter 20

Rewards, incentives and risk management 711

20.1 Agency theory and rewards 712

Agency costs 712

Rewards 713

20.2 The structure of reward systems 713

20.3 Forms of incentives 714

Types of equity incentives 715

20.4 Structuring reward systems containing incentives 715

20.5 Emerging themes in reward systems 719

Relative performance evaluation 719

Pay-for-performance issues 719

Regulation and government intervention 720

Connecting the incentive to performance metrics 721

20.6 Risk management 721

Risk management and compliance 721

The integrated approach to risk management 722

Risk management principles — summary 723

Incentives, rewards and risk management 723

Effective risk management architecture 725

Summary 726

Key terms 727

Self-study problem 727

Questions 729

Exercises 730

Problems 732

Endnotes 739

Acknowledgements 740

Chapter 21

Sustainability management accounting 741

21.1 Sustainability and management accounting 742

Sustainability 742

United Nations Sustainable Development Goals 743

Mandatory and voluntary sustainability initiatives 743

Implications for management accounting 745

Sustainability management 748

Greenhouse gas (or carbon) accounting and monitoring 749

Carbon footprint 752

Sustainability management accounting 754

21.2 Sustainability, ethics and integrated thinking 756

21.3 Scope and benefits of sustainability management accounting 759

Sustainability scope considerations 759

Management decisions benefiting from sustainability management accounting 761

21.4 Sustainability management accounting tools 762

Sustainability value chain analysis 762

Sustainability cost allocation and full cost accounting 763

Sustainability life cycle costing 765

Internal carbon prices 766

Sustainability and capital budgeting 766

Sustainability balanced scorecard 768

21.5 Sustainability management accounting — issues relating to successful integration 770

Summary 773

Key terms 775

Self-study problems 776

Questions 777

Exercises 777

Problems 778

Endnotes 786

Acknowledgements 789

Index 791