THOMSON LEARNING CHAPTER 1 PDF

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THOMSON LEARNING CHAPTER 1...

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C h a p te r 1

LEARNING OBJECTIVES After studying the material in this chapter, you should be able to:

LO1 Understand the uses and users of accounting information

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A Preview of This Chapter In Chapter 1, we begin the study of managerial accounting by discussing what is meant by accounting information and how accounting information is used by both internal and external users to make decisions. The chapter also describes the decision-making role of managers in organizations, provides a decision framework for assessing those decisions, and discusses the role of relevant factors, risk, and ethics in decision making.

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S tud y To o l s

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ACCOUNTING I NFORMATION AND M ANAGERIAL D ECISIONS

Key concepts include: • Accounting information includes both financial (quantitative) and nonfinancial (qualitative) information used by decision makers. • Managerial accountants facilitate management decision making. • Accounting information systems are continually evolving to meet the changing demands of their users. • Never make decisions with just the numbers! Always consider nonnumerical (qualitative) information. • Sunk costs are not relevant. • Future costs that do not differ between alternatives are not relevant. • Opportunity costs are relevant. A Preview of Upcoming Chapters Chapters 2 through 4 provide an introduction into the basics of production processes used by manufacturing companies, cost flows in manufacturing, merchandising and service companies, and basic product and service costing methods used in various types of organizations.

LO2 Understand the decision-making role of managers LO3 Apply a basic four-step decision-making model LO4 Evaluate the role of relevant factors and decision making LO5 Understand and evaluate the role of risk in decision making LO6 Understand and evaluate the role of ethics in decision making

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The main focus of accounting is decision making. In fact, the American Accounting Association defines accounting as “the process of identifying, measuring and communicating

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economic information to permit informed judgments and decisions by users of information” (A Statement of Basic Accounting Theory, 1966, 1). All organizations—large and small; manufacturing, merchandising, or service; profit or nonprofit—have a need for

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accounting information. The primary role of accounting is to provide useful information for the decision-making needs of investors, lenders, owners, managers, and others both inside and outside the company. However, the needs of internal users and external users often differ. This chapter defines accounting information and its application by both external

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and internal users. The chapter then describes the decision-making role of management in planning, operating, and controlling and provides a framework for assessing decisions that commonly face managers of organizations. The chapter also provides a discussion of the role of relevant factors, risk, and ethics as they pertain to decision making.

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4 Managerial Accounting: A Focus on Decision Making

I NTRODUCTION

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All types of organizations, from large multinational manufacturing companies like Ford Motor Company to small custom-furniture manufacturers, have a need for accounting information. Retailers, such as Wal-Mart and locally owned hardware stores; large service companies, such as FedEx and local CPA and law firms; and even nonprofit organizations, such as the American Red Cross and small local museums and homeless shelters, need accounting information. This information is used by internal managers in their dayto-day decision making and also by external users, such as investors, creditors, donors, and even the Internal Revenue Service.

ACCOUNTING I NFORMATION

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Accounting information is provided by a company’s accounting information system (AIS). Traditionally, the AIS was simply a transaction processing system that captured financial data resulting from accounting transactions. For example, the AIS would document a transaction to purchase materials by recording a journal entry showing the date of purchase, a debit to raw materials inventory, and a credit to accounts payable or cash. Under this view of AIS, accounting information was simply financial information (sales, net income, total assets, costs of products, etc.) expressed in terms of dollars or other monetary units (e.g., yen, francs, pesos). Other nonmonetary information—such as (1) the number of units of materials or inventory on hand, (2) the number of budgeted labor hours to produce a product, (3) the number of units necessary to break even, and (4) the time it takes to manufacture a product—were likely collected and processed outside the traditional accounting information system. The use of multiple information systems within a company causes a number of problems. It is costly to support multiple systems. Perhaps more important, it is difficult to integrate information coming from various systems and to make decisions for a company with multiple sources of information. In addition, other useful information concerning transactions—such as the quality of the material purchased, the timeliness of its delivery, or customer satisfaction with an order— might not be captured at all and therefore not evaluated by management. Over the past few years, enterprise resource planning (ERP) systems have been developed in an attempt to address these shortcomings. ERP systems integrate the traditional AIS with other information systems to capture both quantitative and qualitative data, to collect and organize that data into useful information, and to transform that information into knowledge that can be communicated throughout an organization (see Exhibit 1-1). These systems can be customized to provide specific and relevant information to various types of users. For example, information for tax-reporting purposes must conform to the requirements of federal, state, and local taxing authorities, whereas information used in preparing financial statements and annual reports for shareholders and creditors must meet the requirements of generally accepted accounting principles (GAAP) and the Securities and Exchange Commission (SEC). On the other hand, information provided to internal users (managers) is thoroughly integrated across the organization and yet is customized to the needs and desires of the particular user. With an ERP system, the sale of a product not only generates financial information by updating the cost of goods sold and profits but also updates inventory records, adjusts production schedules if necessary, and orders raw materials. In addition, delivery time, warranty claims, and service calls can be tracked and are available to managers across the organization. Therefore, production managers would know when to expect shipments of materials. Sales representatives could access information about expected delivery times to their customers, and customer service representatives could see records of previous service calls. All this information contributes to the cost-effective management of a company and to better decision making. Throughout our study of managerial accounting information and its use in decision making, the importance of considering both quantitative and qualitative information is

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LO1 Understand the uses and users of accounting information

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http://www.sec.gov

C HAPTER 1

Accounting Information and Managerial Decisions

E X H I B I T 1 - 1 A Contemporar y View of Accounting Information

Traditional Accounting Information

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Accounting Information

Qualitative Information Nonfinancial Information

Financial/Monetary Information

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Nonmonetary Quantitative Data

Other Quantitative Information

Qualitative Information

• Balance sheet • Income statement • Cost of goods manufactured • Gross margin • Operating expenses

• Sales returns • Percentage of defects • Number of customer complaints • Warranty claims • Units in inventory • Budgeted hours

• Customer satisfaction • Employee satisfaction • Product or service quality

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Financial Information

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emphasized. The uses of ERP systems as decision-making tools are discussed more fully in Chapter 13. At this point, it is important simply to understand that in order to provide managers with the information they need to effectively plan, operate, and control their businesses, financial data must be linked to nonfinancial (qualitative) data, transformed into useful information and knowledge, and communicated throughout an organization.

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Key Concept: Accounting information includes both financial (quantitative) and nonfinancial (qualitative) information used by decision makers.

T HE U SERS

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ACCOUNTING I NFORMATION

E XTERNAL U SERS

There are many different users of accounting information both external and internal to the organization. Stockholders, potential investors, creditors, government taxing agencies and regulators, suppliers, and customers are all external users. What type of information do external users need? Stockholders and potential investors want information to help them analyze the current and future profitability of an organization. Companies that have

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6 Managerial Accounting: A Focus on Decision Making

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© ANDY SACKS/STONE

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Automobile manufacturers must provide suppliers with detailed inventory records so that parts, such as these engine blocks, can be provided on a timely basis.

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Wal-Mart Stores Inc., which pioneered the idea of retailer and supplier sharing sales data, recently expanded the amount of data available to suppliers from five quarters to two years. WalMart shares data on sales, profit margin, and inventory levels with more than 7,000 suppliers that access Wal-Mart’s database 120,000 times per week (“WalMart Expands Access to Product Sales History,” Wall Street Journal, August 18, 1999, B8).

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http://www.redcross.org

issued stock to the public (or those that plan to) provide this information in the form of annual reports, registration statements, prospectuses, and other reports issued to shareholders, prospective investors, and the SEC. The information required in these reports and the accounting methods used to prepare them are governed by the SEC and GAAP. Although this information is primarily quantitative and monetary (sales and net income), it also may include nonmonetary information, such as units shipped and market share. It also may include qualitative information, such as “management’s discussion and analysis of financial condition and results of operations,” which is found in annual reports. What about smaller companies that are owned by just a few members of a family (closely held) or nonprofit organizations, such as the Red Cross? External users of financial information, such as banks or potential donors to nonprofit organizations, still need accounting information to make the proper decision about lending or donating money. However, their needs may differ from those of stockholders and potential investors. Creditors generally want to assess a company’s overall financial health and may be particularly interested in a company’s cash flow or ability to repay their loans. Potential contributors to nonprofit organizations may have a need for both monetary information, such as how much of the Red Cross’s budget is spent for charitable purposes, and nonmonetary information, such as how many women with children are served by the local homeless shelter. Government agencies (federal, state, and local) have very specific information needs, including the measurement of income, payroll, and assets for purposes of assessing taxes. This accounting information is typically provided on income tax returns, payroll reports, and other forms designed specifically to meet the requirements of each agency.1 Generally, accounting information provided to shareholders, creditors, and government agencies is characterized by a lack of flexibility (its content is often dictated by the user), the reporting of past events using historical costs (financial statements for the previous three years), and an emphasis on the organization as a whole. Suppliers and customers are also external users. However, their accounting information needs are likely to be very different from those of other external users and may be more clearly aligned with the needs of internal users. For example, suppliers of car parts to General Motors need detailed information on inventory levels of specific parts in order to know when to manufacture and ship parts. Bank customers may want to check on their account or loan balances before making a major purchase. Someone buying a new computer may want to check on the expected delivery date or whether a product is backordered before placing an order. This type of information needs to be much more detailed and timely than that provided to most other external users.

1 It should be noted that many nonprofit organizations that do not pay income taxes are still required to provide the Internal Revenue Service with information that is available for use by donors and other interested parties.

C HAPTER 1

Accounting Information and Managerial Decisions

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I NTERNAL U SERS

T HE D ECISION -M AKING R OLE

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Internal users of accounting information include individual employees as well as teams, departments, regions, and top management of an organization. For convenience, these internal users are often just referred to as managers. Managers are involved in a variety of activities, including planning, operating, and controlling. These activities all involve making decisions both on an individual basis and in teams (see Exhibit 1-2).

M ANAGERS

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P LANNING

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Planning involves the development of both the short-term (operational) and the long-term (strategic) objectives and goals of an organization and an identification of the resources needed to achieve them. Operational planning involves the development of short-term objectives and goals (typically, those to be achieved in less than one year). Examples of operational planning for Ben & Jerry’s include planning the raw material and production needs for each type of ice cream for the next four quarters or determining the company’s shortterm cash needs. Operational planning for a hospital would include budgeting for the number of physicians, nurses, and other staff that are needed for the upcoming month or determining the appropriate level of medical supplies to have in inventory. Operational planning also involves the determination of short-term performance goals and objectives, including meeting customer service expectations, sales quotas, time budgets, and so on. Strategic planning addresses long-term questions of how an organization positions and distinguishes itself from competitors. For example, Ben & Jerry’s strategy for producing high-quality ice cream is very different from that used for producing a store brand of lower-priced ice cream. Long-term decisions about where to locate plants and other facilities, whether to invest in new state-of-the-art production equipment, and whether to introduce new products or services and enter new markets are strategic planning decisions. Strategic planning also involves the determination of long-term performance and profitability measures, such as market share, sales growth, and stock price.

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E X H I B I T 1 - 2 Percentage of IMA Sur vey Respondents Who Work on Cross- Functional Teams

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100 80

67%

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Percentage of Respondents 40

52%

55%

1–9 people

10–49 people

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50+ people

Size of Finance Organization (within a company) SOURCE: “Counting More, Counting Less: The 1999 Practice Analysis of Management Accounting,” Institute of Management Accountants, 10.

LO2 Understand the decision-making role of managers

http://www.benjerry.com

P A U S E &

Reflect

Identify some potential strategic planning decisions that would be made by a nonprofit organization whose mission is to provide medical services to the poor.

8 Managerial Accounting: A Focus on Decision Making

O PERATING

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Operating activities encompass what managers must do to run the business on a day-today basis. Operating decisions for manufacturing companies include whether to accept special orders, how many parts or other raw materials to buy (or whether to make the parts internally), whether to sell a product or process it further, whether to schedule overtime, which products to produce, and what price to charge. Other operating decisions affecting all organizations include assigning tasks to individual employees, whether to advertise (and the corresponding impact of advertising on sales and profits), and whether to hire full-time employees or to outsource.

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C ONTROLLING

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In 1996, the Institute of Management Accountants (IMA) commissioned a “Practice Analysis of Management Accounting.” Through surveys of 4,000 accountants working in organizations and detailed interviews of accountants at nine corporations, the IMA Practice Analysis provides a detailed view of what managerial accountants do and are expected to do in the future. This study was updated in 1999. So what do they do? Managerial accountants have traditionally been thought of as the bean counters or number crunchers in an organization. However, the Practice Analysis found that advances in accounting information systems and other changes in the past five or ten years have resulted in the automation of traditional accounting functions involving data collection, data entry, and data reporting and a corresponding shifting of those functions from management accounting to clerical staff. The study found that

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http://www.imanet.org

M ANAGERIAL ACCOUNTANT

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Controlling activities involve the motivation and monitoring of employees and the evaluation of people and other resources used in the organization’s operations. The purpose of control is to make sure that the goals of the organization are being attained. It includes using incentives and other rewards to motivate employees to accomplish an organization’s goals and mechanisms to detect and correct deviations from those goals. Control often involves the comparison of actual outcomes (cost of products, sales, etc.) with desired outcomes as stated in the organization’s operating and strategic plans. Control decisions include questions of how to evaluate performance, what measures to use, and what types of incentives to implement. For example, a company that emphasizes high-quality products and excellent customer service may evaluate and reward production workers who have exceeded goals based on these virtues (such goals, for example, may involve specifying the percentage of allowable defective unit...