Blocher Preface

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Cost Management

A Strategic Emphasis

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Cost Management

A Strategic Emphasis Fourth Edition

Edward J. Blocher University of North Carolina at Chapel Hill Kenan-Flagler Business School

David E. Stout Youngstown State University Williamson College of Business Administration

Gary Cokins Strategist, Performance Management Solutions SAS/Worldwide Strategy

Kung H. Chen University of Nebraska—Lincoln School of Accountancy

Boston Burr Ridge, IL Dubuque, IA Madison, WI New York San Francisco St. LouisBangkok Bogotá Caracas Kuala Lumpur Lisbon London Madrid Mexico CityMilan Montreal New Delhi Santiago Seoul Singapore Sydney Taipei Toronto

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COST MANAGEMENT: A STRATEGIC EMPHASIS

Published by McGraw-Hill/Irwin, a business unit of The McGraw-Hill Companies, Inc., 1221Avenue of the Americas, New York, NY, 10020. Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. No part of this publication may be reproduced or distributed in any form or by any means, or stored in a database or retrieval system, without the prior written consent of The McGraw-Hill Companies, Inc., including, but not limited to, in any network or other electronic storage or transmission, or broadcast for distance learning.

Some ancillaries, including electronic and print components, may not be available to customers outside the United States.

This book is printed on acid-free paper.

1 2 3 4 5 6 7 8 9 0 CCW/CCW 0 9 8 7 6

ISBN: 978-0-07-312815-3 MHID: 0-07-312815-5

Editorial director: Stewart Mattson Executive editor: Tim Vertovec Developmental editor: Daryl Horrocks Executive marketing manager: Krista Bettino Senior media producer: Victor Chiu Project manager: Bruce Gin Production supervisor: Gina Hangos Designer: Cara David Supplement producer: Ira C. Roberts Media project manager: Matthew Perry Cover design: Dave Seidler Typeface: 10/12 Times Roman Compositor: Laserwords Private Limited, Chennai, India Printer: Courier Westford

Library of Congress Cataloging-in-Publication Data

Cost management: a strategic emphasis/Edward J. Blocher . . . [et al.].—4th ed. p. cm. Includes index. ISBN: 978-0-07-312815-3 (alk. paper) MHID: 0-07-312815-5 (alk. paper) 1. Cost accounting. 2. Managerial accounting. I. Blocher, Edward. HF5686.C8B559 2008 658.15'52—dc22

2006017239

www.mhhe.com

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We dedicate this edition . . .

To my wife Sandy, and our children Joseph and David

Ed Blocher

To my wife Anne, and our children David John and Kevin Michael

David E. Stout

To my wife Pam Tower, and my mentor Robert A. Bonsack, a true craftsman in the field of cost management

Gary Cokins

To my wife Mary, and our children Robert and Melissa

Kung Chen

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vi

Meet the Authors

Edward J. Blocher is Professor of Accounting at the Kenan-Flagler Business School at the University of North Carolina. He received his bachelor’s degree in economics from Rice University, his MBA degree from Tulane University, and his PhD in accounting from the University of Texas at Austin. He has been a faculty member at the University of North Carolina since 1976. He has also been on the faculty of Northwestern University. Professor Blocher presents regularly on strategic cost management at the national meetings of both the American Accounting Association and the Institute of Management Accountants.

While he is involved in a number of accounting organizations, Professor Blocher has been most continually active in the Institute of Management Accountants (IMA), where he is now a trustee of the IMA/FAR (Foundation for Applied Research). He is a Certifi ed Management Accountant (CMA), has taught review courses for the CMA exam, and has served on the Institute’s national education committee. He also presents regularly at the annual national conference of the IMA. Professor Blocher is the author or coauthor of several articles appear-ing in various journals.

Putting research and teaching into practice is important to Professor Blocher, who has worked closely with other fi rms and organizations in developing products, publications, and teaching materials. He was the principal designer of an accounting analysis system developed by Financial Audit Systems, Inc. Also, he has worked with Blue Cross and Blue Shield of North Carolina, the American Institute of CPAs, KPMG Peat Marwick, Grant Thornton, and the Chancellor’s Offi ce at the University of North Carolina at Chapel Hill, among others.

David E. Stout is the John S. and Doris M. Andrews Professor of Accounting, Williamson College of Business Administration, Youngstown State University. Previously, he held the position of the John M. Cooney Professor of Accounting, College of Commerce & Finance, Villanova University. David earned his PhD (1982) from the University of Pittsburgh and teaches primarily in the cost/managerial accounting area. He served previously as editor of Issues in Accounting Education and serves currently as an associate editor of the Journal of Accounting Education and as a member of the editorial board of: Issues in Accounting Education; the Journal of International Accounting, Auditing & Taxation; China Finance and Accounting Review, and Management Accounting Quarterly/Strategic Finance. In addition, he serves as a member of the editorial advisory board of Accounting Education: An International Journal. Professor Stout has published over 60 articles in numerous professional and academic journals including Advances in Accounting Education, Issues in Accounting Education , the Journal of Accounting Education, The Accounting Educators’ Journal, Advances in Accounting Education, Behavioral Research in Accounting, Educational and Psychological Measurement, Management Accounting, Management Accounting Quarterly, Financial Practice and Education, Strategic Finance, and Advances in Accounting . David is past president of the Teaching and Curriculum (T&C) Section of the AAA, and president-elect of the Academy of Business Education (ABE).

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Meet the Authors vii

Gary Cokins is a strategist in performance management solutions with SAS, the world’s largest privately owned software vendor. He is an internationally recognized expert, speaker, and author in advanced cost management and performance improvement systems. Gary received a BS degree with honors in Industrial Engineering/Operations Research from Cornell University in 1971. He received his MBA from Northwestern University’s Kellogg School of Management in 1974.

Gary serves on activity-based information committees including CAM-I, APICS, the Supply Chain Council, the Council for Logistics Management (CLM), the Institute of Management Accountants (IMA), the American Society for Quality (ASQ), the Purchasing Management Association of Canada (PMAC), the Institute of Industrial Engineers (IIE), Association for Management Information in Financial Services (AMI/fs), and the American Institute of CPAs (AICPA).

Kung H. Chen is the Steinhardt Foundation Professor of Accounting and the Director of Graduate Programs in the School of Accountancy at the University of Nebraska-Lincoln. A graduate of National Taiwan University, he earned his MBA degree from West Virginia University and a PhD from the University of Texas-Austin.

Professor Chen has published his research in various journals, including The Account-ing Review, Encyclopedia of Accounting, Internal Auditor, Journal of Business Finance and Accounting, Behavioral Research in Accounting, Journal of Accounting Literature, Advances in Accounting, Financial Management , and the International Journal of Accounting and has presented research papers to audiences in several countries including the United States, New Zealand, Japan, Taiwan, Korea, and China.

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viii

Clarity of vision and the proper perspective can often mean the difference between confusion and understanding. Viewed up close, the eye chart featured on the cover of Cost Management: A Strategic Emphasis appears like a normal examination tool. Taken at a distance, though, the message is clear. Bringing the big picture into focus is a guiding principle not only in this textbook, but also in the busi-ness of cost management. The function of cost accounting is to organize unclear data and use sound judgment to supply managers with useful and timely information. The goal of Cost Management is to provide cost accountants with the tools they need to make this happen.

Cost Management by Blocher, Stout, Cokins, and Chen uses a strategic emphasis to make the connec-tions between concepts and procedures clear to students. Making students see the relevance of cost management concepts and procedures, and demonstrating how they will use this information in the future, is a recurring theme of each chapter.

Once viewed simply as technical experts in accounting methods and procedures, accountants now play a critical role as participants on multifunctional management teams. Along with the important tradi-tional cost management methods and procedures, Cost Management provides a context for students by using a unique strategic framework. This organization helps students gain an understanding of how learning cost accounting techniques can better serve the company as a whole:

Strategic Framework

Part I: Introduction to Cost Management

Part II: Planning and Decision Making

Part III: Process Costing and Cost Allocation

Parts IV and V: Operational Control and Management Control

Part VI: Advanced Topics in Cost Management

The introductory chapters develop important strategic concepts like strategy development and implementation, the Value Chain, Cost Concepts, the Balanced Scorecard,

and Activity-Based Costing (ABC)

Part II examines how cost estimation, budgeting, and decision making help companies maintain a competitive

advantage

Parts IV and V examine performance measurement at the operational and managerial level, with the goal of linking

management incentives to strategy

Part III examines how process costing and cost allocation are used to determine product costs and to

evaluate a company’s operations

Part VI examines three strategically important advanced areas in cost management: executive compensation,

business valuation, and capital budgeting

Blocher/Stout/Cokins/Chen:

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Bringing the Big Picture into Focus for Your Students

REAL-WORLD FOCUS Commodities and Cost Leadership: PCs, Cell Phones, and Airlines

A commodity is a product or service that is difficult to differentiate and, as a result, becomes a natural for cost leadership competition. Exam-ples include building materials, many consumer electronics products, and many of the things we buy in supermarkets. Thomas L. Friedman, award-winning columnist and author, has addressed the issue of com-modities in the current business environment in his new book, TheWorld Is Flat. One reason the “world is flat” is because any product or service that is a commodity will find its low-cost supply anywhere in the world—wherever there is the lowest cost. Commenting on India’s growth in outsourcing work from other countries, Friedman notes that the portion of work that can be digitized is a good candidate for out-sourcing. He provides examples from the accounting profession (tax return preparation) and journalism (press releases, company reports); these activities are being outsourced to the low-cost supplier. The ac-countant or journalist instead provides value-adding services to the customer (such as tax planning, financial analysis, and news analy-sis). Some parts of the work are in effect “commoditized.”

Other examples of commodities include personal computers (PCs), cell phones, and airlines. The PC industry, dominated by Dell Computer, has seen sales rise while profits fall. Dell manages to main-

tain its growth in profits and sales by moving successfully into new markets (China) and product lines (television sets and digital music players).

As in the PC industry, where prices have fallen as product per-formance has risen, prices and cost competition have increased in the cell phone industry as new manufacturers have entered the mar-ket and regulatory changes in the United States make it easier for users to switch providers.

The airline industry continues to move in the direction of the low-cost carriers, as shown by the trend by the carriers to charge for once-free items such as pillows, meals, and headsets.

Source: Thomas L. Friedman, The World Is Flat: A Brief History of the Twenty-First Century, Farrar, Straus, and Giroux, New York 2005; “Less Friendly Skies,” BusinessWeek, July 11, 2005, p. 16; “Pricing Pressure Squeezes Cellphone Makers World-Wide,” The Wall Street Journal, January 15, 2005, p. B1; “Dell Effect Is under Strain as PC Maker Swells,” by Gary McWilliams, The Wall Street Journal, August 17, 2005, p. C1; “For Dell, Success in China Tells Tale of Maturing Market,” The Wall Street Journal , July 5, 2005, p. 1; “PC Makers: More Sales, Fewer Profits,” BusinessWeek, September 3, 2003, pp. 46–47; Pete Engardio, “The Future of Outsourcing,” BusinessWeek, January 30, 2006, pp. 50–64.

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Real-World Focus. All firms strive to have a competitive edge—for some it may be low cost, for others it might be high quality or unique product features. Cost Management, 4e teaches how accounting systems can add value to the organization by providing relevant data for planning, control, and decision-making. The Real-World Focus boxes take real companies and demonstrate strategy in action.

In areas related to the management accounting function, the Financial Executives Institute (FEI) provides services much like those provided by the IMA for financial managers, includ-ing controllers and treasurers.

Because one of the management control responsibilities of the management accountant is to develop effective systems to detect and prevent errors and fraud in the accounting records, the management accountant commonly has strong ties to the control-oriented organizations such as the Institute of Internal Auditors (IIA).

Even if you’re on the right track, you’ll get run over if you just sit there. Will Rogers

Cost Management in Action A Case in Competitive Strategy: Wal-Mart and Target

Wal-Mart and Target are two of the most successful retailers in the United States Wal-Mart bears the slogan, “Always Low Prices,” while Target stores say “Expect More, Pay Less.” If you have shopped at either of these stores you will likely have formed an opinion about the stores and how they compete.

Required

Based on your experience, explain what you think are the competitive strategies of these retailers. Are they key competitors, targeting the same customers? Do you think each firm has adopted the most effec-tive strategy? Why or why not?

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Recently Wal-Mart has begun to advertise in the high-fashion maga-zine Vogue. How does this fi t the fi rm’s strategy, or does it? While customer’s are pleased with Wal-Mart’s low prices, there is ongoing controversy about the firm’s negative effect on other retail-ers where Wal-Marts are located. For example, the closing of 30 su-permarkets in Oklahoma City in recent years has been attributed to Wal-Mart’s arrival. What are your thoughts on the controversy? Are the ethical principles and standards of the management accountant relevant in this context?

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3.

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To augment this coverage, the Blocher team encourages students to further explore real-world companies through

Cost Management in Action boxes. This feature poses important questions that make students think critically about how cost accounting affects management strategy. The authors then supply their comments for the Cost Management in Action boxes at the end of each chapter.

Problem Material. The Blocher team has taken great care to develop problems and cases that effectively demonstrate the strategic issues presented in each chapter. Included is a variety of exercises and problems that deal with strategic, international, service, and ethics issues. All problems are marked appropriately for easy identification, including problems that require the use of Excel:

y, g p p , y gpackers work full-time on that jacket, the fi rm could manufacture only 36,000 units ofbecause of limited capacity on the sewing machine.

The production planner can determine the best production mix by examining all of thsible production possibilities in the darker shaded area, from 36,000 on the Gale axis toA where the constraints intersect, and then to the point 22,400 on the Windy axis. Themix with the highest contribution must be one of these three points: 36,000 of Gale, poor 22,400 units of Windy. The solution, called the corner point analysis, is obtained by fi the total contribution at each point and then choosing the point with the highest contrib

EXHIBIT 9.22Windbreakers Production and Sales PossibilitiesTwo Production Constraints—Sewing Machine and Inspection

36,000

67,200

Units

of S

ales

for G

ale

24,00022,400

Units of Sales for Windy

Production constraint for inspection and packaging

A (4,800 Gale, 20,800 Windy)

Production constraint for sewing machine

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Clear and concise exhibits help illustrate basic and complicated topics throughout the book.

The supplemental Cases and Readings manual challenges students to think about and use cost management information in a real-world setting. The longer articles in the manual help integrate case studies and articles into more detailed discussions about cost management.

Strategy International Service Ethics Excel

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In this edition, the authors made extensive changes to nearly every chapter. They increased focus on the strategic role of

cost management, both in the text and in the exercises and problems for each chapter. Careful revisions were made in each

chapter to enhance the clarity and exposition, with the goal of presenting the content in a student-friendly manner. Numerous

Real-World Focus items were added or revised in each chapter, along with additional Cost Management in Action boxes. The

Blocher team also made these critical changes for this edition:

New brief exercises (10–12 per chapter) provide a valuable resource for the instructor to ask short questions, most of which require a short calculation. These can be used to assess student preparation of the material or to begin the class discussion with some focused questions on the chapter material. In contrast to the questions, the brief exercises focus on calculation; in contrast to the exercises, brief exercises can be used in class without prior assignment to the students.

A new supplement, the Excel Solutions Manual, is provided for all end-of-chapter problems and exercises. This manual is provided in two versions: an instructor version (containing both data inputs and solutions) and a student version (containing data inputs only). Instructors now have the fl exibility to make assignments

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where students prepare Excel solutions to any exercise or problem in the text. Because all input data are provided to students, data-entry errors on the part of students are minimized—all students begin each spreadsheet assignment with the same set of data. At the instructor’s discretion, completed spreadsheets can be printed or posted to the Web for access by students.

A signifi cantly enhanced Test Bank features new multiple-choice questions and problems linked to learning objectives and level of diffi culty.

New cases are provided for use with the activity-based

casting software of SAS Institute; improvements in the tutorials and materials have been made for increased ease-of-use, by students and instructors alike.

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What’s NEW about the 4th edition of

Chapter 1New Real-World Focus examples, including surveys of current practice

Update of section on ethics for new IMA Code of Professional Conduct

New self-study question, and new exercises and problems focusing on strategy and on ethics

Chapter 2New Real-World Focus examples, including surveys of current practice

Enhanced material on implementing the balanced scorecard (BSC)

New exercises and problems with an emphasis on strategy and the balanced scorecard

Chapter 3Clarification of the discussion on cost drivers

Coverage of risk preferences removed from Chapter 3 and now enhanced in Chapter 17

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New Real-World Focus examples, including an extensive example of cost terms used in agriculture

New discussion of the cost of capacity

New exercises and problems

Chapter 4Coverage of departmental overhead rates moved from Chapter 5; related exercise and problem material added on departmental overhead rates

Clarification of accounting for normal spoilage with the addition of an example in the text

New Real-World Focus examples

New exercises and problems with a focus on service industries

Chapter 5 Significant revision to shorten

and focus this chapter; customer profitability analysis has been shortened and is now more focused

Coverage of departmental overhead rates is moved to Chapter 4; learning objectives are condensed and focused;

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the strategic role of ABC/M is enhanced and moved to the front of the chapter

All new illustrations in the text, including examples in service and governmental organizations

New exhibits to clarify the two-stage procedure under volume-based and activity-based costing

Several new Real-World Focus examples, including surveys of current practice

New coverage of the cost of capacity and the role of ABC costing in managing the cost of capacity

Several new exercises and problems, with a focus on the cost of capacity

New exercises and problems that include resource-consumption as well as activity-consumption cost drivers

New coverage of time-driven ABC costing

New coverage of multiple-activity ABC costing

New exercises and problems focusing on strategy, the cost of capacity, resource consumption cost drivers, and ethics

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Chapter 6New discussion of simple vs. multiple linear regression

New coverage of time-series vs. cross-sectional regression

Several new Real-World Focus examples

Expanded coverage of the learning curve, with discussion of the general learning model

New exercises and problems with a focus on interpreting regression results, including those from cross-sectional regression analysis

Chapter 7Notation is clarified and changed to closely correspond with symbols used in Chapter 6


New problems and examples

Expanded coverage of Excel’s Goal Seek option for conducting sensitivity analysis

Clarification of the coverage of activity-based CVP and multiple-product CVP

Chapter 8Completely new set of Real-World Focus examples

Additional end-of-chapter material dealing with ethical considerations, budgeting for not-for-profit organizations, and sensitivity analysis

Explicit linkage to financial accounting (accounting for sales discounts)

Inclusion of additional Excel-based assignments

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Chapter 9Updated Real-World Focus examples

New exercises and problems with a focus on strategy and on applications in the service industries

Chapter 10New coverage of quality function deployment (QFD), including several illustrations

New and updated Real-World Focus examples

New exercises and problems with a focus on strategy and on service industries

Additional coverage of Takt time with a new illustration and problem material

Chapter 11Additional coverage of backflush costing with a new illustration and problem material

New problem material with a focus on service industries

Chapter 12New Real-World Focus examples

New problems

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Chapter 13Expanded introductory discussion of control systems in general and operational control systems in particular

Expanded discussion of the difference between standard costs and a standard cost system

Presentation of a general model for analyzing variable cost variances (Exhibit 13.7)

Broader mix of end-of-chapter assignment material (including additional Excel-based assignments, ethics, and behavioral considerations)

Movement of journal-entry material to an appendix

Chapter 14New discussion of the difference between the product-costing and control purposes of standard costs for factory overhead

Expanded discussion of the variance-disposition question

New diagrammatical approach for overhead variance analysis (Exhibits 14.4 and 14.5), and associated end-of-chapter assignment material

New alternative diagrammatical approach for overhead variance analysis (Exhibit 14.18)

Expanded set of Excel-based end-of-chapter assignment material

Significant expansion of Real-World Focus items

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Cost Management?

David E. Stout has joined the Blocher author team for the fourth edition. Dr. Stout brings years of teaching experience at Rider University, Villanova University, and most recently Youngstown State University, to this new edition. David earned his PhD degree (1982) from the University of Pittsburgh and teaches primarily in the cost/managerial accounting area.

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xii

Chapter 15Significant revision including new material and a new focus on the flexible budget; the chapter is now integrated into the flexible budget concept used in the prior two chapters, and there is a new emphasis on the strategic role of the analysis of sales performance and productivity

The coverage of strategic profitability analysis has been removed and replaced by a framework that is consistent with the flexible budget approach

Duplication between Chapters 15 and 13 removed for the new edition


New end-of-chapter exercise and problem material with a focus on the application of the flexible budget concept in the analysis of productivity and sales performance

Chapter 16Development of a comprehensive framework (Exhibit 16.3) for managing and controlling quality, which is used to anchor the discussion of all topics covered in the chapter

New discussion regarding the role of management accounting in the management and control of quality

Expanded discussion of nonfinancial performance indicators

New discussion of Six Sigma, including implementation issues and the application of Six Sigma to the accounting/finance function

Many new Real-World Focus items

New discussion of the application of COQ to environmental quality

Greatly expanded mix of end-of-chapter assignment material

Repositioning of Taguchi loss function analysis to an appendix

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Chapter 17Coverage of risk preferences repositioned to this chapter from Chapter 3; this material, including related assignment material, has been updated and enhanced

New and updated Real-World Focus examples, including surveys from practice

New coverage of the role of strategy in the determination of the cost, profit, or revenue SBU, with new exhibit to illustrate the differences across these responsibility units

Extended coverage of the implementation of the balanced scorecard (BSC) for performance measurement

Chapter 18New coverage and illustration of the relationship between the components of return on assets: return on sales and asset turnover


New exercises and problems with a focus on economic profit, residual income, and EVA®

New coverage of intangible assets and the use of ROA for innovative companies

Chapter 19New and updated Real-World Focus examples, including surveys from practice

Updated discussion of reporting requirements for stock options

Significant revision of the coverage on business valuation; new focus on determining the market value of equity

Expanded coverage of the discounted cash flow method (DCF) for valuing a firm

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Chapter 20Expanded discussion of the strategic role of capital budgeting

New discussion of the role of the management accountant in the capital budgeting process

Reference to the analytic hierarchy process (AHP) in conjunction with the capital budgeting process

Consistent with the revisions in Chapter 19, reorientation of material to provide greater focus on discounted cash flow (DCF) decision models

Expanded discussion of the calculation of the weighted-average cost of capital (WACC)

Many new Real-World Focus examples pertaining to the capital budgeting process

New discussion regarding sensitivity analysis

Integration of Excel-based financial formulas for solving capital budgeting problems

Advanced issues in capital budgeting analysis are repositioned to an appendix

Expanded discussion of behavioral considerations associated with the capital-budgeting process

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For Instructors…

For Students…

SupplementsInstructor’s Resource CD-ROM (ISBN 0073128163): Contains all essential course

supplements such as the Instructor’s Resource Manual, Solutions Manual, Test Bank Word

Files, Diploma Test Bank, PowerPoint® Presentations, and Excel Solutions Manual. All

instructor supplements are prepared by the authors.

Online Learning Center: www.mhhe.com/blocher4e. The Instructor Edition of the Cost Management: A Strategic Emphasis, 4e OLC

is password-protected and another convenient place for instructors to access

course supplements. Resources for professors include: the Instructor and Student

Solutions Manual, transparency masters, teaching notes for the casebook, links to

professional resources, sample syllabi, text updates, solutions to the Instructor and

Student Excel Spreadsheets, and solutions to Internet exercises.

Cases and Readings for use with Cost Management: A Strategic Emphasis, 4e (ISBN 0073128198): This manual contains an extensive set of longer cases

covering a variety of important topics. These case scenarios put students in situations that

allow them to think strategically and to apply concepts they’ve learned in the course. Key

readings have been chosen to give students more background into the evolution of strategic

cost management topics.

Study Guide (ISBN 0073128171): Prepared by Roger Doost (Clemson University),

the Study Guide reviews the highlights of each chapter in Cost Management: A Strategic

Emphasis, 4e and includes a variety of self-study questions for student review. Every chapter

includes short-answer questions organized by learning objective, multiple-choice questions,

and thorough exercises. Suggested answers to all questions and exercises are included.

Online Learning Center: www.mhhe.com/blocher4e. The Student

Edition of the Cost Management: A Strategic Emphasis, 4e OLC contains many tools

designed to help students study including: check fi gures, text updates, links to professional

resources, chapter overviews, chapter objectives, multiple-choice quizzes, fl ashcard key term

review, Internet exercises, Excel spreadsheets with data only (for use by students with Excel

assignments), and PowerPoint® presentations.

SAS Software: SAS’s Activity-Based Costing (ABC) software is used worldwide for

performance management functions and analysis. Cost Management fully incorporates SAS

Software in its case material to prepare students for calculating ABC costs, creating cost driver

assignments, and organizing cost information in an electronic environment. Visit the Blocher

OLC today to learn more!

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xiv

Acknowledgments

Our Sincerest Thanks . . . In writing this book, we were fortunate to have received extensive feedback from a number of accounting educators. We want to thank our colleagues for their careful and complete review of our work. The comments that we received were invaluable in helping us to shape the manu-script. We believe that this collaborative development process helped us to create a text that will truly meet the needs of today’s students and instructors. We are sincerely grateful to the following individuals for their participation in the process:

Reviewers for 4e:

Stephen Makar, University of Wisconsin–Oshkosh

Michael Flores, Wichita State University

Jay D. Forsyth, Central Washington University

Jay Holmen, University of Wisconsin–Eau Claire

Jennifer Niece, Assumption College

David R. Honodel, University of Denver

Dennis Caplan, Oregon State University

David Eichelberger, Austin Peay State University

Jerry W. Ferry, University of North Alabama

Laurie B. McWhorter, Mississippi State University

Randall E. LaSalle, West Chester University of Pennsylvania

Vidya N. Awasthi, Seattle University

Bambi Hora, University of Central Oklahoma

Jerry Thorne, North Carolina A&T State University

Olen L. Greer, Southwest Missouri State University

Marvin L. Bouillon, Iowa State University

Bea Chiang, The College of New Jersey

Alan B. Czyzewski, Indiana State University

Judith A. Harris, Nova Southeastern University

Aleecia Hibbets, University of Louisiana–Monroe

Sanford R. Kahn, University of Cincinnati

Mehmet C. Kocakulah, University of Southern Indiana

Laura Jean Kreissl, University of Wisconsin–Parkside

Dan Law, Gonzaga University

Brian L. McGuire, University of Southern Alabama

Yaw M. Mensah, Rutgers University

Kenneth P. Sinclair, Lehigh University

Larry N. Killough, Virginia Polytechnic Institute and State University

Sandra S. Lang, McKendree College

Mike Grayson, Jackson State University

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Acknowledgments xv

Brian L. McGuire, University of Southern Indiana

Cheryl E. Mitchem, Virginia State University

Margaret O’Reilly-Allen, Rider University

Chei M. Paik, George Washington University

Hugh Pforsich, University of Idaho

Shirley Polejewski, University of St. Thomas

Jenice Prather-Kinsey, University of Missouri–Columbia

Dennis Shanholtzer, Metropolitan State University

John L. Stancil, Florida Southern College

Ronald A. Stunda, Birmingham-Southern College

Previous Edition Reviewers:

K.R. Balachandran, New York University

Mohamed E. Bayou, School of Management–University of Michigan–Dearborn

Wayne Bremser, Villanova University

Robert J. DePasquale, Saint Vincent College

Robert W. Duron, Chadron State College

Donald C. Gribbin, Southern Illinois University

Linda Holmes, University of Wisconsin–Whitewater

Norma C. Holter, Towson University

Paul Juras, Wake Forest University

We also want to recognize the special efforts of:

Daniel Flaningan

Keith Folken

Kristin Hawkins

Taylor Henry

Jessie Kinsley

Andrew Stulce

Finally, we are most appreciative of the outstanding assistance and support provided by the professionals of McGraw-Hill/Irwin: Stewart Mattson, our editorial director, and Tim Vertovec, Executive Editor, for their guidance; our developmental editor, Daryl Horrocks, for his invaluable suggestions; Krista Bettino, our marketing manager, for her signifi cant promo-tional efforts; Bruce Gin, our project manager, for his attention to detail; Cara David, for the outstanding presentation of the text; Ira Roberts, our supplements coordinator, for his timeli-ness and accuracy in delivering the support material; and Victor Chiu, our media producer, and Matthew Perry, our media project manager, for their technical expertise in delivering our multimedia material. An added thanks to Beth Woods and Alice Sineath for their signifi cant contributions to the accuracy of our text.

Ed Blocher

David E. Stout

Gary Cokins

Kung Chen

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xvi

Brief Contents

PART ONE Introduction to Cost Management 2

1 Cost Management and Strategy: An Overview 2

2 Implementing Strategy: The Balanced Scorecard and the Value Chain 30

3 Basic Cost Management Concepts 54

4 Job Costing 84

5 Activity-Based Costing and Management 120

PART TWO Planning and Decision Making 170

6 Cost Estimation 170

7 Cost-Volume-Profi t Analysis 218

8 Strategy and the Master Budget 254

9 Decision Making with Relevant Costs and a Strategic Emphasis 316

10 Cost Planning for the Product Life Cycle: Target Costing, Theory of Constraints, and Strategic Pricing 360

PART THREE Process Costing and Cost Allocation 404

11 Process Costing 404

12 Cost Allocation: Service Departments and Joint Product Costs 454

PART FOUR Operational Control 494

13 The Flexible Budget and Standard Costing: Direct Materials and Direct Labor 494

14 The Flexible Budget: Factory Overhead 550

15 The Flexible Budget: Further Analysis of Productivity and Sales 610

16 The Management and Control of Quality 648

PART FIVE Management Control 698

17 Management Control and Strategic Performance Measurement 698

18 Strategic Investment Units and Transfer Pricing 742

PART SIX Advanced Topics in Cost Management 784

19 Management Compensation, Business Analysis, and Business Valuation 784

20 Capital Budgeting 818

PRESENT VALUE TABLES 870

GLOSSARY 872

INDEX 882

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Contents

PART ONE INTRODUCTION TO COST MANAGEMENT 2

Chapter 1 Cost Management and Strategy: An Overview 2

The Uses of Cost Management 3 The Four Functions of Management 4 Strategic Management and Strategic Cost Management 6 Types of Organizations 6

The Contemporary Business Environment 7 The Global Business Environment 7 Manufacturing Technologies 8 The New Economy: Use of Information Technology, the Internet, and E-Commerce 8 Focus on the Customer 8 Management Organization 9 Social, Political, and Cultural Considerations 9

The Strategic Focus of Cost Management 10 Contemporary Management Techniques 10

Benchmarking 10 Total Quality Management 11 Business Process Improvement 11 Activity-Based Costing and Management 11 Reengineering 11 The Theory of Constraints 11 Mass Customization 12 Target Costing 12 Life-Cycle Costing 12 The Value Chain 12 The Balanced Scorecard 12

How a Firm Succeeds: The Competitive Strategy 13 Strategic Measures of Success 14

Developing a Competitive Strategy: Strategic Positioning 15

Cost Leadership 15 Differentiation 16 Other Strategic Issues 16

The Professional Environment of Cost Management 17 Professional Organizations 17 Professional Certifi cations 19 Professional Ethics 20

Summary 21 Appendix A: More about Strategy 22 Key Terms 23 Comments on Cost Management in Action 23 Self-Study Problem 24 Questions 24 Brief Exercises 25 Exercises 25

Problems 26 Solution to Self-Study Problem 29

Chapter 2 Implementing Strategy: The Balanced Scorecard and the Value Chain 30

Strengths-Weaknesses-Opportunities-Threats (SWOT) Analysis 31 Execution 33Value-Chain Analysis 35

Value-Chain Analysis in Computer Manufacturing 37 The Balanced Scorecard 38

The Balanced Scorecard Refl ects Strategy 39 The Strategy Map 40 Expanding the Balanced Scorecard Sustainability 42

Summary 43 Key Terms 43 Comments on Cost Management in Action 43 Self-Study Problems 44 Questions 44 Brief Exercises 45 Exercises 45 Problems 45 Solutions to Self-Study Problems 52

Chapter 3 Basic Cost Management Concepts 54

Cost Drivers, Cost Pools, and Cost Objects 55 Cost Assignment and Cost Allocation: Direct and Indirect Costs 55 Cost Drivers and Cost Behavior 58 Activity-Based Cost Drivers 58 Volume-Based Cost Drivers 59 Structural and Executional Cost Drivers 63

Cost Concepts for Product and Service Costing 64 Cost Accounting for Products and Services 64 Product Costs and Period Costs 64 Manufacturing, Merchandising, and Service Costing 65

Cost Concepts for Planning and Decision Making 68 Relevant Cost 68 Attributes of Cost Information for Decision Making 69

Cost Concepts for Management and Operational Control 70

Controllability 70 Summary 70 Key Terms 71 Comments on Cost Management in Action 71 Self-Study Problem 71 Questions 72 Brief Exercises 72 Exercises 73 xvii

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xviii Contents


Chapter 4 Job Costing 84

Product Costing Systems 84 Cost Accumulation: Job or Process Costing? 85 Cost Measurement: Actual, Normal, or Standard Costing 85 Overhead Assignment under Normal Costing: Volume-Based or Activity-Based? 85

The Strategic Role of Product Costing 86 Job Costing: The Cost Flows 86

Direct Materials Costs 87 Direct Labor Costs 89 Factory Overhead Costs 91 Actual Costing 91 Normal Costing 91

The Application of Factory Overhead in Normal Costing 93

Cost Drivers for Factory Overhead Application 93 Applying Factory Overhead Costs 93 Departmental Overhead Rates 94 Disposition of Underapplied and Overapplied Overhead 96

Job Costing in Service Industries 97 Operation Costing 98 Summary 100 Appendix A: Spoilage, Rework, and Scrap in Job Costing 101 Key Terms 103 Comments on Cost Management in Action 103 Self-Study Problem 103 Questions 104 Brief Exercises 104 Exercises 105 Problems 108 Solution to Self-Study Problem 118

Chapter 5 Activity-Based Costing and Management 120

The Strategic Role of Activity-Based Costing 120 Role of Volume-Based Costing 121 Activity-Based Costing 122

Resources, Activities, Resource Consumption Cost Drivers, and Activity Consumption Cost Drivers 122 What Is Activity-Based Costing? 122 The Two-Stage Cost Assignment Procedure 123

Steps in Developing an Activity-Based Costing System 124 Step 1: Identify Resource Costs and Activities 124 Step 2: Assign Resource Costs to Activities 125 Step 3: Assign Activity Costs to Cost Objects 126

Benefi ts and Limitations of Activity-Based Costing 126 Benefi ts 126 Limitations 127

A Comparison of Volume-Based and Activity-Based Costing 128

Volume-Based Costing 128 Activity-Based Costing 129

Activity-Based Management 130 What Is Activity-Based Management? 130 Activity Analysis 131 Value-Added Analysis 131

Activity-Based Costing/Management (ABC/M) Applications 133

ABC/M in Manufacturing: Industrial Air Conditioner Units 133 ABC/M Application in the Service Industry: A Retirement and Assisted Living Community 135 ABC/M Applications in Government 136

Customer Profi tability Analysis 138 Customer Cost Analysis 139 Customer Profi tability Analysis 140 Customer Value Assessment 141

Implementation Issues 142 Multiple-Stage Activity-Based Costing 143 Time-Driven Activity-Based Costing 143

Summary 144 Key Terms 144 Comments on Cost Management in Action 145 Self-Study Problem 145 Questions 146 Brief Exercises 146 Exercises 147 Problems 153 Solution to Self-Study Problem 167

PART TWO PLANNING AND DECISION MAKING 170

Chapter 6 Cost Estimation 170

Strategic Role of Cost Estimation 170 Using Cost Estimation to Predict Future Costs 171 Using Cost Estimation to Identify Cost Drivers 171

Six Steps of Cost Estimation 172 Step 1: Defi ne the Cost Object to Be Estimated 172 Step 2: Determine the Cost Drivers 172 Step 3: Collect Consistent and Accurate Data 172 Step 4: Graph the Data 172 Step 5: Select and Employ the Estimation Method 173 Step 6: Assess the Accuracy of the Cost Estimation 173

Cost Estimation Methods 173 An Illustration of Cost Estimation 173 High-Low Method 173 Work Measurement 176 Regression Analysis 176 Using Spreadsheet Software for Regression Analysis 182

Data Requirements and Implementation Problems 183 Data Accuracy 183 Selecting the Time Period 183 Nonlinearity Problems 184

Summary 185 Appendix A: Learning Curve Analysis 186 Appendix B: Regression Analysis 189 Key Terms 195

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Contents xix

Comments on Cost Management in Action 195 Self-Study Problem 196 Questions 197 Brief Exercises 198 Exercises 199 Problems 202 Solutions to Self-Study Problems 214

Chapter 7 Cost-Volume-Profi t Analysis 218

Cost-Volume-Profi t Analysis 218 Contribution Margin and Contribution Income Statement 219

Strategic Role of CVP Analysis 220 CVP Analysis for Breakeven Planning 222

Equation Method: For Breakeven in Units 222 Equation Method: For Breakeven in Dollars 222 Contribution Margin Method 223

CVP Analysis for Profi t Planning 225 Revenue Planning 225 Cost Planning 225 Including Income Taxes in CVP Analysis 228

CVP Analysis for Activity-Based Costing 229 Sensitivity Analysis of CVP Results 231

What-If Analysis of Sales: Contribution Margin and Contribution Margin Ratio 231 Margin of Safety 231 Operating Leverage 232

CVP Analysis with Two or More Products 234 CVP Analysis for Not-for-Profi t Organizations 236 Assumptions and Limitations of CVP Analysis 236

Linearity and the Relevant Range 236 Identifying Fixed and Variable Costs for CVP Analysis 236

Summary 238 Key Terms 239 Comments on Cost Management in Action 239 Self-Study Problem 239 Questions 239 Brief Exercises 240 Exercises 240 Problems 242 Solution to Self-Study Problem 253

Chapter 8 Strategy and the Master Budget 254

Role of Budgets 255 Strategy, the Long-Term Plan, and the Master Budget 256

Importance of Strategy in Budgeting 256 Formulation of Strategy 258 Strategic Goals and Long-Term Objectives 258 Short-Term Objectives and the Master Budget 258

Budgeting Process 260 Budget Committee 260 Budget Period 261 Budget Guidelines 262 Initial Budget Proposal 262 Negotiation, Review, and Approval 262 Revision 263

Master Budget 263 Sales Budget 263 Manufacturing Budgets 265 Merchandise Purchases Budget 269 Selling and General Administrative Expense Budget 271 Cash Receipts (Collections) Budget 272 Cash Budget 272 Budgeted Income Statement 274 Budgeted Balance Sheet 274

Budgeting in Service Companies and International Firms, and Not-for-Profi t Organizations 276

Budgeting in Service Industries 276 Budgeting in Not-for-Profi t Organizations 278 Budgeting in International Settings 278

Alternative Budgeting Approaches 279 Zero-Base Budgeting (ZBB) 279 Activity-Based Budgeting (ABB) 280 Kaizen (Continuous Improvement) Budgeting 281

Computer Software in Budgeting and Planning 282 Ethical and Behavioral Issues in Budgeting 284

Ethics in Budgeting 284 Goal Congruence 284 Diffi culty Level of the Budget Target 285 Authoritative or Participative Budgeting? 286 Role of the Budget Department or Controller 286


Chapter 9 Decision Making with Relevant Costs and a Strategic Emphasis 316

The Decision-Making Process 317 Relevant Cost Analysis 318

Relevant Cost Information 318 Batch-Level Cost Drivers 319 Fixed Costs and Depreciation 320 Other Relevant Information: Opportunity Costs 320

Strategic Cost Analysis 321 Special-Order Decisions 322

Cost Analysis 322 Strategic Analysis 323 Is TTS Now Operating at Full Capacity? 323 Excessive Relevant Cost Pricing 324 Other Important Factors 325

Make, Lease, or Buy Decision 325 Cost Analysis 325 Strategic Analysis 327

Sell Before or After Additional Processing 327 Cost Analysis 327 Strategic Analysis 328

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xx Contents

Profi tability Analysis 329 Profi tability Analysis: Keep or Drop a Product Line 329 Strategic Analysis 330 Profi tability Analysis: Evaluating Programs 331 Profi tability Analysis: Service and Not-for-Profi t Organizations 331

Multiple Products and Limited Resources 332 Case 1: One Production Constraint 332 Case 2: Two or More Production Constraints 333

Behavioral and Implementation Issues 335 Consideration of Strategic Objectives 335 Predatory Pricing 335 Replacement of Variable Costs with Fixed Costs 336 Proper Identifi cation of Relevant Factors 336

Summary 337 Appendix A: Linear Programming and the Product Mix Decision 337 Key Terms 340 Comments on Cost Management in Action 340 Self-Study Problems 340 Questions 341 Brief Exercises 341 Exercises 342 Problems 346 Solutions to Self-Study Problems 358

Chapter 10 Cost Planning for the Product Life Cycle: Target Costing, Theory of Constraints, and Strategic Pricing 360

Target Costing 362 Value Engineering 363 Target Costing and Kaizen 365 An Illustration: Target Costing in Health Product Manufacturing 366 An Illustration Using Quality Function Deployment (QFD) 367 Benefi ts of Target Costing 368

The Theory of Constraints 369 The Use of the Theory of Constraints Analysis in Health Product Manufacturing 370 Steps in the Theory of Constraints Analysis 370 Theory of Constraints Reports 375 Activity-Based Costing and the Theory of Constraints 375

Life-Cycle Costing 376 The Importance of Design 377 The Use of Life-Cycle Costing in a Software Firm 378

Strategic Pricing Using the Product Life Cycle 379 Pricing Using the Cost Life Cycle 379 Strategic Pricing for Phases of the Sales Life Cycle 381 The Use of the Sales Life Cycle in Computer Manufacturing 381

Summary 382 Appendix A: Using the Flow Diagram to Identify Constraints 382 Key Terms 384 Comments on Cost Management in Action 384 Self-Study Problem 384

Questions 385 Brief Exercises 385 Exercises 386 Problems 391 Solution to Self-Study Problem 401

PART THREE PROCESS COSTING AND COST ALLOCATION 404

Chapter 11 Process Costing 404

Characteristics of Process Costing Systems 405 Equivalent Units 405 Flow of Costs in Process Costing 406 Steps in Process Costing 407 Process Costing Methods 408

Illustration of Process Costing 408 Weighted-Average Method 409 First-In, First-Out (FIFO) Method 412

Comparison of Weighted-Average and FIFO Methods 419 Process Costing with Multiple Departments 419

Transferred-In Costs 420 Weighted-Average Method 420 The FIFO Method 422

Journal Entries for Process Costing 425 Implementation and Enhancement of Process Costing 426

Activity-Based Costing and the Theory of Constraints 426 Just-in-Time Systems and Backfl ush Costing 427

Summary 428 Appendix A: Spoilage in Process Costing 428 Key Terms 432 Comments on Cost Management in Action 432 Self-Study Problems 432 Questions 433 Brief Exercises 434 Exercises 434 Problems 437 Solutions to Self-Study Problems 448

Chapter 12 Cost Allocation: Service Departments and Joint Product Costs 454

The Strategic Role of Cost Allocation 455 The Ethical Issues of Cost Allocation 456 Cost Allocation to Service and Production Departments 456

Departmental Approach 457 Cost Allocation in Service Industries 468 Joint Product Costing 470

Methods for Allocating Joint Costs to Joint Products 471 Summary 475 Appendix A: By-Product Costing 475 Key Terms 478 Comments on Cost Management in Action 478 Self-Study Problem 478 Questions 478

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Contents xxi

Brief Exercises 479 Exercises 480 Problems 481 Solution to Self-Study Problem 492

PART FOUR OPERATIONAL CONTROL 494

Chapter 13 The Flexible Budget and Standard Costing: Direct Materials and Direct Labor 494

Management Accounting and Control Systems 495 Evaluating Operating Performance 495

Effectiveness 495 Standard Costs 497

Standard Costs versus a Standard Cost System 497 Types of Standards 498 Selection of Standards 499 Sources of Standards 499 Standard-Setting Procedures 501 Establishing Standard Costs 501 Standard Cost Sheet 502

Flexible Budgets and Operational Control 504 The Flexible Budget 504 Assessing Effi ciency 505 Breakdown of the Total Flexible Budget Variance 507 Selling Price Variance 508 Variable Cost Flexible Budget Variances 508 Further Analysis of the Total Variable Cost Flexible Budget Variance 509

General Model for Analysis of Variable Cost Variances 509

Direct Materials Variances 510 Direct Labor Variances 513 Timing of Variance Recognition 515 Effect of the New Manufacturing Technology 516

Behavioral and Implementation Issues 516 Summary 517 Appendix A: Recording Cost Flows and Variances in a Standard Cost System 519 Key Terms 522 Comments on Cost Management in Action 522 Self-Study Problems 523 Questions 524 Brief Exercises 525 Exercises 526 Problems 534 Solutions to Self-Study Problems 547

Chapter 14 The Flexible Budget: Factory Overhead 550

Standard Overhead Costs: Planning versus Control 551 Variance Analysis for Factory Overhead Costs 552

Variable Overhead Cost Analysis 552 Interpretation and Implications of Variable Overhead Variances 554

Fixed Overhead Cost Analysis 555 Interpretation of Fixed Factory Overhead Variances 558 Alternative Analyses of Factory Overhead Variances 559 Summary of Factory Overhead Variances 561

Recording Standard Factory Overhead Costs 562 Journal Entries and Variances for Factory Overhead Costs 562 Variance Disposition 563

Standard Costs in Service Organizations 565 Overhead Variances in ABC Systems 568

ABC-Based Flexible Budgets for Control 569 Investigation of Variances 572

Type of Standard 572 Expectations of the Organization 572 Magnitude, Pattern, and Impact of a Variance 572 Causes and Controllability 573 Company Practices 576

Summary 576 Appendix A: Variance Investigation Decisions Under Uncertainty 578 Key Terms 580 Comments on Cost Management in Action 580 Self-Study Problems 581 Questions 582 Brief Exercises 583 Exercises 583 Problems 593 Solutions to Self-Study Problems 606

Chapter 15 The Flexible Budget: Further Analysis of Productivity and Sales 610

The Strategic Role of the Flexible Budget in Analyzing Sales and Productivity 610 Analyzing Productivity 612

Partial Productivity 613 Total Productivity 618

Analyzing Sales: Comparison with the Master Budget 619

Sales Volume Variance Decomposed: Sales Quantity and Sales Mix Variances 620 Sales Quantity Variance Decomposed: Market Size and Market Share Variances 624

Analyzing Sales: Comparison with Prior Year Results 627

Analysis of Selling Price and Volume Variances 628 Analysis of Mix and Quantity Variances 629 Analysis of Variable Cost Variances 629


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xxii Contents

Chapter 16 The Management and Control of Quality 648

The Strategic Importance of Quality 649 Baldrige Quality Award 649 ISO 9000 and ISO 14000 649 Quality and Profi tability: Conceptual Linkage 650 Empirical Evidence—Does TQM Matter? 651

Accounting’s Role in the Management and Control of Quality 652

Chapter Preview 652 Total Quality Management (TQM) 652

The Meaning of Quality 652 Characteristics of Total Quality Management 654 The Need for a New Accounting System 654

Comprehensive Framework for Managing and Controlling Quality 654

Knowledge of Business Processes 654 Role of the Customer 655 Financial Component 656 Nonfi nancial Performance Indicators 656 Feedback Loops 656 Relevant Cost Analysis 656 Link to Operations Management 656 Breadth of the System 656

Setting Quality-Related Expectations 657 Setting Quality Expectations: A Six Sigma Approach 657 Setting Quality Expectations: Goalpost versus Absolute Conformance Standards 659 Goalpost Conformance 659 Absolute Quality Conformance 660 Goalpost or Absolute Conformance? 660

Financial Measures and Costs of Quality 661 Relevant Cost Analysis 661 Cost of Quality (COQ) Reporting 662 Quality Cost Reports 664 Data Defi nition, Sources, and Collection 664 Report Format 665 Illustration of a Cost of Quality Report 665 COQ and Activity-Based Costing (ABC) 666

Nonfi nancial Quality Indicators 666 Internal Nonfi nancial Quality Metrics 666 External (Customer Satisfaction) Quality Metrics 667 Role of Nonfi nancial Performance Measures 667

Detecting and Correcting Poor Quality 668 Detecting Poor Quality 668 Taking Corrective Action 670

Summary 673 Appendix A: Taguchi Quality Loss Functions 673 Key Terms 676 Comments on Cost Management in Action 677 Self-Study Problems 677 Questions 678 Brief Exercises 679 Exercises 680

Problems 687 Solutions to Self-Study Problems 696

PART FIVE MANAGEMENT CONTROL 698

Chapter 17 Management Control and Strategic Performance Measurement 698

Performance Evaluation and Control 699 Operational Control versus Management Control 699 Objectives of Management Control 699 Employment Contracts 700

Design of Management Control Systems for Motivation and Evaluation 702

Informal Control Systems 703 Formal Control Systems 704

Strategic Performance Measurement 704 Decentralization 704 Types of Strategic Business Units 705 The Balanced Scorecard 706

Cost Strategic Business Units 706 Strategic Issues Related to Implementing Cost SBUs 706 Implementing Cost SBUs in Departments 708 Outsourcing Cost SBUs 710 Cost Allocation 710

Revenue Strategic Business Units 711 Profi t Strategic Business Units 712

Strategic Role of Profi t SBUs 712 The Contribution Income Statement 713 Variable Costing versus Full Costing 714

Strategic Performance Measurement and the Balanced Scorecard 716 Management Control in Service Firms and Not-for-Profi t Organizations 720 Summary 722 Key Terms 722 Comments on Cost Management in Action 722 Self-Study Problem 723 Questions 723 Brief Exercises 724 Exercises 725 Problems 727 Solution to Self-Study Problem 740

Chapter 18 Strategic Investment Units and Transfer Pricing 742

Part One: Strategic Investment Units 743 The Strategic Role of Investment Units 743 Return on Investment 744

ROI Equals Return on Sales Times Asset Turnover 744 Illustration of Evaluation Using Return on Investment 744 Use of Return on Investment 747 Strategic Issues in Using Return on Investment 751

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Contents xxiii

Residual Income 753 Limitations of Residual Income 754

Economic Value Added 755 Using Average Total Assets 755 Part Two: Transfer Pricing 756 When Is Transfer Pricing Important? 756 Objectives of Transfer Pricing 757

International Transfer Pricing Objectives 757 Transfer Pricing Methods 758

Choosing the Right Transfer Pricing Method 758 International Tax Issues in Transfer Pricing 761

The Arm’s-Length Standard 761 Advance Pricing Agreements 762


PART SIX ADVANCED TOPICS IN COST MANAGEMENT 784

Chapter 19 Management Compensation, Business Analysis, and Business Valuation 784

Part One: Management Compensation 784 Types of Management Compensation 785 Strategic Role and Objectives of Management Compensation 786

Design the Compensation Plan for Existing Strategic Conditions 786 Risk Aversion and Management Compensation 786 Ethical Issues 787 Objectives of Management Compensation 787

Bonus Plans 788 Bases for Bonus Compensation 788 Bonus Compensation Pools 790 Bonus Payment Options 790

Tax Planning and Financial Reporting 792 Management Compensation in Service Firms 793 Part Two: Business Analysis and Business Valuation 794 Business Analysis 795

The Balanced Scorecard 795 Financial Ratio Analysis 795

Business Valuation 798 The Discounted Cash Flow Method 798 Multiples-Based Valuation 800 Enterprise Value 800


Chapter 20 Capital Budgeting 818

Strategy and the Capital Budgeting Process 819 Underlying Nature of Capital Expenditures 819 Organizational Strategy and the Nature of Capital Investment Analysis 819 Effect of Capital Expenditures on Strategic Cost Drivers 820 Chapter Overview—Where Are We Headed? 821

The Role of Accounting in the Capital Budgeting Process 821

Linkage to Master Budget 821 Linkage to the Balanced Scorecard (BSC) 821 Generation of Relevant Financial Data for Decision-Making Purposes 823 Conducting Post-Audits 823

Identifi cation of Relevant Cash-Flow Data for Capital Expenditure Analysis 824

Why Focus on Cash Flows? 824 Cash Flows—A Framework for Analysis 825 Sample Data Set: Mendoza Company—Equipment Replacement Decision 825 Determining After-Tax Cash Flows for Capital Investment Analysis 827 Recap—Cash Flow Information for the Mendoza Company Investment Proposal 832

Discounted Cash Flow (DCF) Capital Budgeting Decision Models 832

Types of Capital Budgeting Decision Models 832 DCF Models: Specifying the Discount Rate 832 Estimating the WACC 834 Net Present Value (NPV) Decision Model 836 Internal Rate of Return (IRR) Decision Model 837 Comparison of NPV and IRR Methods: Which to Use? 839

Sensitivity Analysis 839 What-If Analyses 839 Scenario Analysis 841 Monte Carlo Simulation 841

Other Capital Budgeting Decision Models 842 Payback Period 842 Accounting (Book) Rate of Return 844

Behavioral Issues in Capital Budgeting 846 Common Behavioral Problems: Cost Escalation, Incrementalism, and Uncertainty Intolerance 846 Goal-Congruency Issues 847 Addressing the Goal-Congruency Problem 847

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xxiv Contents

Summary 848 Appendix A: DCF Models: Some Advanced Considerations 848 Key Terms 851 Comments on Cost Management in Action 851 Self-Study Problem 852 Questions 853 Brief Exercises 854 Exercises 855


Present Value Tables 870

Glossary 872

Index 882

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Cost Management

A Strategic Emphasis

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Documents

Blocher Preface