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Eleventh Edition

Ray H. Garrison, D.B.A., CPA

Professor Emeritus
Brigham Young University

Eric W. Noreen, Ph.D., CMA

Professor Emeritus
University of Washington

Peter C. Brewer, Ph.D., CPA

Miami UniversityOxford, Ohio

Boston Burr Ridge, IL Dubuque, IA Madison, WI New York San Francisco St. Louis
Bangkok Bogot Caracas Kuala Lumpur Lisbon London Madrid Mexico City
Milan Montreal New Delhi Santiago Seoul Singapore Sydney Taipei Toronto
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To our families and
to our many colleagues who use this book.

Published by McGraw-Hill/Irwin, a business unit of The McGraw-Hill Companies, Inc.,
1221 Avenue of the Americas, New York, NY, 10020. Copyright 2006, 2003, 2000,
1997, 1994, 1991, 1988, 1985, 1982, 1979, 1976 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 DOW/DOW 0 9 8 7 6 5 4
ISBN 0-07-283494-3 (student edition)
Editorial director: Brent Gordon
Publisher: Stewart Mattson
Executive editor: Tim Vertovec
Developmental editor I: Sarah Wood
Marketing manager: Marc Chernoff
Media producer: Elizabeth Mavetz
Lead project manager: Pat Frederickson
Production supervisor: Debra R. Sylvester
Lead designer: Pam Verros
Photo research coordinator: Kathy Shive
Photo researcher: Charlotte Goldman
Senior supplement producer: Carol Loreth
Senior digital content specialist: Brian Nacik
Cover photograph: Daryl Benson/Masterfile
Typeface: 10.5/12 Times Roman
Compositor: Cenveo Indianapolis
Printer: R. R. Donnelley
Library of Congress Cataloging-in-Publication Data
Garrison, Ray H.
Managerial accounting / Ray H. Garrison, Eric W. Noreen.11th ed. / Ray H. Garrison,
Eric W. Noreen, Peter C. Brewer.
p. cm.
Various multi-media instructional materials are available to supplement the text.
Includes index.
ISBN 0-07-283494-3 (alk. paper) ISBN 0-07-298617-4 (aie : alk. paper)
1. Managerial accounting. I. Noreen, Eric W. II Brewer, Peter C. III. Title.
HF5657.4G37 2006
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GarrisonLeading Textbook,
Leading Technology
The wide array of technology assets that come with Managerial Accounting arent add-ons thrown in at the
last minute: Theyre extensions of the textbook itself, that work in unison to make managerial accounting
as easy as possible to learn.

You may be tempted to put aside your CD and registration cards, planning to get to them later; you may
even want to discard them outright. Dont do it! These supplements can offer you tremendous help as
you go through the course; the sooner you become familiar with them, the sooner you can enjoy the
immense benefits they have to offer.

Heres what you need to know to get the most out of Managerial Accountings technology package.

To p i c Ta c k l e r P l u s
Topic Tackler provides focused help on the two most challenging topics
in every chapter. How do you use Topic Tackler? Take your pick:

Watch a short, high-quality video presentation.

Review the topic highlights with a graphical slide show.
Practice on numerous interactive exercises.
Follow the links to more information on the World Wide Web.

However you want to use it, Topic Tackler is the perfect tool for review
sessions, or just for some quick reinforcement as you read. Look for
the Topic Tackler icon while you readthat means youll find Topic
Tackler ready to help you on that particular subject.

Turn to the inside front cover to learn how to get started using
Topic Tackler!

OnePass eliminates the frustration of remembering multiple access

codes for different online resources. Now students can use the access
code found on their OnePass card to register and create one password
for access to their books online resources. By having just one access
code for everything, students can go back and forth between tutorials
as they study.

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McGraw-Hills Homework Online Learning Center (OLC)

Manager When it comes to getting the most out of your textbook, the
Practice makes perfect, and when it comes to managerial Online Learning Center is the place to start. The OLC follows
accounting, theres often no better practice than working with Managerial Accounting chapter by chapter, offering all kinds
the numbers yourself. Managerial Accounting provides a great of supplementary help for you as you read. OLC features
many problems for your instructor to assign or for you to do on include:
your own, but there are only so many problems you can fit into
a textbook. Thats where McGraw-Hills Homework Manager Learning objectives
comes in. Chapter overviews
Internet-based activities
McGraw-Hills Homework Manager duplicates problems from Self-grading quizzes
the textbook in a convenient, online format. You can work Links to text references
problems and receive instant feedback on your answers, tak- Links to professional resources on the Web
ing as many tries as you want. Because McGraw-Hills Home- Job opportunity information
work Manager uses specialized algorithms to generate values Internet factory tours
for each problem, it can produce infinite variations of certain
text problems just by changing the valuesyou can practice Before you even start reading Chapter 1, go to this address
on the same problem as many times as you need to, with and bookmark it:
fresh figures to work with every time.
Your instructor will have already decided whether to make
McGraw-Hills Homework Manager a part of your course, and Remember, your Online Learning Center was created
he or she will create a course account and generate the as- specifically to accompany Managerial Accountingso dont
signments for you to do. Your McGraw-Hills Homework Man- let this great resource pass you by!
ager user guide will include an access code enabling you to
enroll; refer to the guide for help in creating your account.
Talk to your instructor to be sure McGraw-Hills Homework
Manager is available for you as you begin the course.

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To p i c Ta c k l e r P l u s C D - R O M Working Papers
ISBN 0072986166 ISBN 0072986123
Free with the text, the Topic Tackler CD-ROM helps students This study aid contains forms that help students organize
master difficult concepts in managerial accounting through their solutions to homework problems.
a creative, interactive learning process. Designed for study
outside the classroom, this multimedia CD delves into chap-
ter concepts with graphical slides and diagrams, Web links, E x c e l Te m p l a t e s
video clips, and animations, all centered around engaging
Prepared by Jack Terry of ComSource Associates, Inc., this
exercises designed to put students in control of their learn-
spreadsheet-based software uses Excel to solve selected
ing of managerial accounting topics.
problems and cases in the text. These selected problems
and cases are identified in the margin of the text with an
appropriate icon. The Student Excel Templates are only
Workbook/Study Guide available on the texts Web site.
ISBN 0072986131
This study aid provides suggestions for studying chapter
Te l e c o u r s e G u i d e
material, summarizes essential points in each chapter, and
tests students knowledge using self-test questions and ISBN 0072986115
This study guide ties the Dallas County Community College
Telecourse directly to this text.
Ready Notes
ISBN 0073080667
This booklet provides Ready Slide exhibits in a workbook
format for efficient note taking.

Student Lecture Aid

ISBN 007298614X
Much like the Ready Notes, this booklet offers a hard-copy
version of all the Teaching Transparencies. Students can
annotate the material during the lecture and take notes in
the space provided.

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Suggestions have been received from many of our colleagues throughout the world who have used the prior edition of
Managerial Accounting. This is vital feedback that we rely on in each edition. Each of those who have offered comments
and suggestions has our thanks.

The efforts of many people are needed to develop and improve a text. Among these people are the reviewers and
consultants who point out areas of concern, cite areas of strength, and make recommendations for change. In this
regard, the following professors provided feedback that was enormously helpful in preparing the eleventh edition of
Managerial Accounting:

Noel Addy, Mississippi State University Dennis Elam, Southwest Texas University
Jack Bailes, Oregon State University Jack R. Fay, Pittsburgh State University
Mohamed Bayou, University of Michigan - Dearborn Richard Fleischman, John Carroll University
Linda Benz, Jefferson Community College Karen M. Foust, Tulane University
Karen Bird, University of Michigan Susan Coomer Galbreath, Lipscomb University
Phillip A. Blanchard, University of Arizona Les Heitger, Indiana University - Bloomington
Lisa Bonitati Church, Rhode Island College Sharon J. Huxley, Teikyo Post University
Arthur Braza, Three Rivers Community College Wayne Ingalls, University of Maine
Sarah Brown, University of North Alabama Gene Johnson, Clark College
George R. Cash, Alabama A&M University Celina Jozsi, University of South Florida
Kimberly Charron, University of Nevada Las Vegas Carl Keller, Indiana University - Purdue University at Ft. Wayne
Julie Chenier, Louisiana State University - Baton Rouge Zafar Khan, Eastern Michigan University
Richard Claire, Caada College Mike Klickman, University of Dallas
Antoinette Clegg, Palm Beach Community College Frank Kopczynski, Plymouth State University
Nolan Clemens, Jr., University of Dallas Barbara Kren, Marquette University
Deb Cosgrove, University of Nebraska - Lincoln Kip Krumwiede, Brigham Young University
Rita Counts, Radford University Sandra S. Lang, McKendree College
Kraeg Danvers, Wayne State University Chor T. Lau, California State University - Los Angeles
Betty David, Francis Marion University Keith Leeseberg, Manatee Community College
Charles Davis, Baylor University C. Angela Letourneau, Winthrop University
Dr. Henry Day, Mount Olive College Robert Lin, California State University - Hayward
Patricia A. Doherty, Boston University Larry Logan, University of Massachusetts - Dartmouth
Carleton Donchess, Bridgewater State College Dr. Tim Lowder, Francis Marion University
Roger Doost, Clemson University Suzanne Lowensohn, Colorado State University
Robert Deutsch, Campbell University Gina Lord, Santa Rosa Junior College
Barbara Eide, University of Wisconsin - La Crosse Dorinda Lynn, Pensacola Jr. College

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Lois Mahoney, University of Central Florida Kenneth Sinclair, Lehigh University

Robert McConkie, Bethany College Douglas L. Smith, Samford University
Helga M. Mervine, Mercyhurst College Toni Smith, University of New Hampshire
Betty K. Mullins, Hesser College Beverly Soriano, Framingham State College
Kevin Nathan, Oakland University Philip Stickney, Cochise College
Marguerite Nagy, Cuyahoga Community College Jeffrey M. Storm, Lincoln Land Community College
Kevin Nathan, Oakland University Suzy Summers, Furman University
Emeka T. Nwaeze, Rutgers University Lateef Syed, Dominican University
Margaret OReilly-Allen, Rider University Rita N. Taylor, University of Cincinnati
Janet L. OTousa, University of Notre Dame Gerald Thalman, North Central College
Emil A. Radosevich, Alberquerque Technical Vocational Ralph Tower, Wake Forest University
Institute Michael Tyler, Barry University
Judy Ann Ramage, Christian Brothers University Sankaran Venkateswar, Trinity University
Martha Rassi, Glendale Community College Ron Vogel, College of Eastern Utah
Dr. David Remmele, University of Wisconsin-Whitewater Frank Walker, Lee University
Kimberley A. Richardson, James Madison University Dan Ward, University of Louisiana at Lafayette
John C. Roberts, St. Johns River Community College Marcia Weidenmier, Texas Christian University
Marilyn Salter, University of Central Florida Charles Wellens, Fitchburg State College
Angela Sandberg, Jacksonville State University Micheline West, New Hampshire Community Technical
George Schmelzle, Indiana Purdue Fort Wayne College - Manchester
James A. Schweikart, Boston University Jack Wiehler, San Joaquin Delta College
Ann Selk, University of Wisconsin, Green Bay Priscilla Wisner, American Graduate School of International
Lewis Shaw, Suffolk University Business

Jeff Shields, University of Southern Maine Dr. Rahnl Wood, Northwest Missouri State University

John W. Shishoff, University of Dayton Eric Yap, Ohlone College

Khim L. Sim, Western New England College Jennifer Yin, Rutgers University

Bonnie Simmons, Elmhurst College

We are grateful for the outstanding support from McGraw-Hill/Irwin. In particular, we would like to thank Brent Gordon, Editorial Director;
Stewart Mattson, Publisher; Tim Vertovec, Executive Editor; Sarah Wood, Developmental Editor; Marc Chernoff, Marketing Manager;
Pat Frederickson, Lead Project Manager; Debra Sylvester, Production Supervisor; Pam Verros, Lead Designer; Carol Loreth, Senior
Supplement Producer; Kathy Shive, Photo Research Coordinator, Elizabeth Mavetz, Media Producer; Dan Wiencek, Advertising Manager; and
Erwin Llereza, Advertising Manager.

Finally, we would like to thank Beth Woods and Barbara Schnathorst for working so hard to ensure an error-free eleventh edition.

We are grateful to the Institute of Certified Management Accountants for permission to use questions and/or unofficial answers from past
Certificate in Management Accounting (CMA) examinations. Likewise, we thank the American Institute of Certified Public Accountants, the
Society of Management Accountants of Canada, and the Chartered Institute of Management Accountants (United Kingdom) for permission to
use (or to adapt) selected problems from their examinations. These problems bear the notations CPA, SMA, and CIMA respectively.

Ray H. Garrison Eric Noreen Peter Brewer

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Managerial Accounting and the
Problems 31
Group and Internet Exercises 33

Business Environment 2
The Work of Management and the Need for Managerial Chapter
Accounting Information 4
Planning 5
Cost Terms, Concepts, and
Directing and Motivating 5
Classifications 34
Controlling 5
The End Results of Managers Activities 6 General Cost Classifications 36
The Planning and Control Cycle 6 Manufacturing Costs 36
Direct Materials 36
Comparison of Financial and Managerial Direct Labor 36
Accounting 6
Manufacturing Overhead 37
Emphasis on the Future 6
Nonmanufacturing Costs 38
Relevance of Data 8
Product Costs versus Period Costs 38
Less Emphasis on Precision 8
Product Costs 38
Segments of an Organization 8
Period Costs 39
Generally Accepted Accounting Principles
(GAAP) 9 Cost Classifications on Financial Statements 41
Managerial AccountingNot Mandatory 9 The Balance Sheet 41
Organizational Structure 9 The Income Statement 42
Decentralization 9 Schedule of Cost of Goods Manufactured 43
Line and Staff Relationships 10 Product Cost Flows 45
The Chief Financial Officer 11 Inventoriable Costs 45
The Changing Business Environment 12 An Example of Cost Flows 46
Just-In-Time (JIT) 12 Cost Classifications for Predicting Cost Behavior 48
JIT Consequences 14 Variable Cost 48
Benefits of a JIT System 15 Fixed Cost 49
Total Quality Management (TQM) 15 Cost Classifications for Assigning Costs to Cost
Process Reengineering 16 Objects 50
The Theory of Constraints (TOC) 17 Direct Cost 50
International Competition 18 Indirect Cost 50
E-Commerce 19 Cost Classifications for Decision Making 51
Professional Ethics 20 Differential Cost and Revenue 51
Code of Conduct for Management Accountants 22 Opportunity Cost 52
Company Codes of Conduct 24 Example 1 52
Codes of Conduct on the International Level 26 Example 2 52
The Certified Management Accountant (CMA) 27 Example 3 52
Sunk Cost 53
Summary 27
Summary 53
Glossary 28
Review Problem 1: Cost Terms 54
Questions 29 Review Problem 2: Schedule of Cost of Goods
Exercises 30 Manufactured and Income Statement 55
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Contents ix

Glossary 57 Use of Information Technology 112

Appendix 2A: Further Classification of Labor Costs 58 Summary 113
Appendix 2B: Cost of Quality 59 Review Problem: Job-Order Costing 114
Questions 68 Glossary 116
Exercises 69 Appendix 3A: The Predetermined Overhead Rate and
Problems 73 Capacity 117
Cases 82 Questions 118
Group and Internet Exercises 84 Exercises 119
Problems 126

Cases 138
Chapter Group and Internet Exercises 142

Systems Design: Job-Order Costing 86
Process and Job-Order Costing 88 Chapter
Process Costing 88
Job-Order Costing 89 Systems Design: Process Costing 144
Job-Order CostingAn Overview 89 Comparison of Job-Order and Process Costing 146
Measuring Direct Materials Cost 90 Similarities between Job-Order and Process
Job Cost Sheet 91 Costing 146
Measuring Direct Labor Cost 91 Differences between Job-Order and Process
Application of Manufacturing Overhead 93 Costing 146
Using the Predetermined Overhead Rate 94 A Perspective of Process Cost Flows 147
The Need for a Predetermined Rate 94 Processing Departments 147
Choice of an Allocation Base for Overhead Cost 96 The Flow of Materials, Labor, and Overhead Costs 148
Computation of Unit Costs 96 Materials, Labor, and Overhead Cost Entries 148
Summary of Document Flows 96 Materials Costs 149
Job-Order CostingThe Flow of Costs 98 Labor Costs 149
The Purchase and Issue of Materials 98 Overhead Costs 150
Issue of Direct and Indirect Materials 98 Completing the Cost Flows 150
Issue of Direct Materials Only 99 Equivalent Units of Production 152
Labor Cost 99 Weighted-Average Method 152
Manufacturing Overhead Costs 100 Production ReportWeighted-Average Method 153
The Application of Manufacturing Overhead 101 Step 1: Prepare a Quantity Schedule and Compute the
The Concept of a Clearing Account 101 Equivalent Units 155
Nonmanufacturing Costs 102 Step 2: Compute Costs per Equivalent Unit 156
Cost of Goods Manufactured 103 Step 3: Prepare a Cost Reconciliation 156
Cost of Goods Sold 103 Example of a Cost Reconciliation 156
Summary of Cost Flows 104 Operation Costing 159
Problems of Overhead Application 104 Summary 159
Underapplied and Overapplied Overhead 104 Review Problem: Process Cost Flows and Reports 160
Disposition of Under- or Overapplied Overhead Glossary 162
Balances 109 Appendix 4A: FIFO Method 162
Closed Out to Cost of Goods Sold 109 Questions 168
Allocated between Accounts 110
Exercises 169
A General Model of Product Cost Flows 110
Problems 174
Multiple Predetermined Overhead Rates 110
Cases 180
Job-Order Costing in Service Companies 111 Group and Internet Exercises 181
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x Contents

Preparing the CVP Graph 233
Contribution Margin Ratio (CM Ratio) 235
Some Applications of CVP Concepts 236
Change in Fixed Cost and Sales Volume 236
Cost Behavior: Analysis and Use 182 Change in Variable Costs and Sales Volume 237
Types of Cost Behavior Patterns 184 Change in Fixed Cost, Sales Price, and Sales
Variable Costs 184 Volume 237
The Activity Base 185 Change in Variable Cost, Fixed Cost, and Sales
Extent of Variable Costs 186 Volume 238
True Variable versus Step-Variable Costs 187 Change in Regular Sales Price 239
True Variable Costs 187 Break-Even Analysis 239
Step-Variable Costs 187 Break-Even Computations 239
The Linearity Assumption and the Relevant Range 188 The Equation Method 239
Fixed Costs 188 The Contribution Margin Method 240
Types of Fixed Costs 190 Target Profit Analysis 241
Committed Fixed Costs 190 The CVP Equation 241
Discretionary Fixed Costs 191 The Contribution Margin Approach 242
The Trend toward Fixed Costs 192 The Margin of Safety 242
Is Labor a Variable or a Fixed Cost? 192 CVP Considerations in Choosing a Cost Structure 244
Fixed Costs and the Relevant Range 193 Cost Structure and Profit Stability 244
Mixed Costs 194 Operating Leverage 246
The Analysis of Mixed Costs 196 Structuring Sales Commissions 247
Diagnosing Cost Behavior with a Scattergraph Plot 198 The Concept of Sales Mix 248
The High-Low Method 201 The Definition of Sales Mix 248
The Least-Squares Regression Method 204 Sales Mix and Break-Even Analysis 248
Multiple Regression Analysis 206 Assumptions of CVP Analysis 250
The Contribution Format Income Statement 206
Summary 251
Why a New Income Statement Format? 206
The Contribution Approach 207 Review Problem: CVP Relationships 251
Glossary 254
Summary 207 Questions 254
Review Problem 1: Cost Behavior 208 Exercises 255
Review Problem 2: High-Low Method 209 Problems 260
Glossary 210 Cases 268
Appendix 5A: Least-Squares Regression Using Group and Internet Exercises 272
Microsoft Excel 210
Questions 212

Exercises 213
Problems 217 Chapter
Cases 223
Group and Internet Exercises 227 Variable Costing: A Tool for
Management 274

Cost-Volume-Profit Relationships 228
The Basics of Cost-Volume-Profit (CVP) Analysis 231
Overview of Absorption and Variable Costing 276
Absorption Costing 276
Variable Costing 276
Unit Cost Computations 277
Income Comparison of Absorption and Variable
Contribution Margin 231 Costing 278
CVP Relationships in Graphic Form 233 Extended Comparison of Income Data 280
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Contents xi

Effect of Changes in Production on Net Operating Comparison of Traditional and ABC Product
Income 284 Costs 330
Variable Costing 285 Product Margins Computed Using the Traditional Cost
Absorption Costing 285 System 330
Choosing a Costing Method 288 The Differences between ABC and Traditional Product
Costs 331
The Impact on the Manager 288
CVP Analysis and Absorption Costing 289 Targeting Process Improvements 335
Decision Making 290 Activity-Based Costing and External Reports 337
External Reporting and Income Taxes 290 The Limitations of Activity-Based Costing 338
Advantages of Variable Costing and the Contribution Summary 339
Approach 291
Review Problem: Activity-Based Costing 340
Variable Costing and the Theory of Constraints 292
Glossary 341
Impact of JIT Inventory Methods 292
Appendix 8A: ABC Action Analysis 342
Summary 293 Questions 350
Review Problem: Contrasting Variable and Absorption Exercises 351
Costing 293 Problems 361
Glossary 295 Cases 369
Questions 295 Group and Internet Exercises 375
Exercises 296
Problems 300
Cases 306
Group and Internet Exercises 310 Chapter
Profit Planning 376

Activity-Based Costing: A Tool to Aid
Decision Making 312
The Basic Framework of Budgeting 378
Personal Budgets 378
Difference between Planning and Control 378
Advantages of Budgeting 378
Responsibility Accounting 379
How Costs Are Treated under Activity-Based Choosing a Budget Period 380
Costing 315
The Self-Imposed Budget 381
Nonmanufacturing Costs and Activity-Based
Human Factors in Budgeting 382
Costing 315
Zero-Based Budgeting 382
Manufacturing Costs and Activity-Based Costing 315
Plantwide Overhead Rate 315 The Budget Committee 384
Departmental Overhead Rates 316 The Master Budget: An Overview 385
The Costs of Idle Capacity in Activity-Based The Sales Budget 385
Costing 317 The Cash Budget 385
Sales ForecastingA Critical Step 385
Designing an Activity-Based Costing (ABC)
System 317 Preparing the Master Budget 387
Step 1: Identify and Define Activities and Activity Cost The Sales Budget 389
Pools 320 The Production Budget 390
The Mechanics of Activity-Based Costing 323 Inventory PurchasesMerchandising Company 391
Step 2: Whenever Possible, Directly Trace Overhead The Direct Materials Budget 391
Costs to Activities and Cost Objects 323 The Direct Labor Budget 393
Step 3: Assign Costs to Activity Cost Pools 324 The Manufacturing Overhead Budget 394
Step 4: Calculate Activity Rates 327 The Ending Finished Goods Inventory Budget 395
Step 5: Assign Costs to Cost Objects 328 The Selling and Administrative Expense Budget 395
Step 6: Prepare Management Reports 330 The Cash Budget 396
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xii Contents

The Budgeted Income Statement 399 Common Characteristics of Balanced Scorecards 450
The Budgeted Balance Sheet 400 A Companys Strategy and the Balanced Scorecard 452
International Aspects of Budgeting 402 Tying Compensation to the Balanced Scorecard 454
Advantages of Timely and Graphic Feedback 454
Summary 403
Some Measures of Internal Business Process
Review Problem: Budget Schedules 403
Performance 456
Glossary 405 Delivery Cycle Time 456
Questions 406 Throughput (Manufacturing Cycle) Time 456
Exercises 406 Manufacturing Cycle Efficiency (MCE) 457
Problems 408 Some Final Observations Concerning the Balanced
Cases 421 Scorecard 458
Group and Internet Exercises 425 Summary 459
Review Problem: Standard Costs 459

Glossary 461
Appendix 10A: General Ledger Entries to Record
Variances 462
Questions 464
Standard Costs and the Balanced Exercises 465
Scorecard 426 Problems 471
Standard CostsManagement by Exception 429 Cases 484
Who Uses Standard Costs? 430 Group and Internet Exercises 488
Setting Standard Costs 431

Ideal versus Practical Standards 431
Setting Direct Materials Standards 432
Setting Direct Labor Standards 432
Setting Variable Manufacturing Overhead
Standards 434 Flexible Budgets and Overhead
Are Standards the Same as Budgets? 435 Analysis 490
A General Model for Variance Analysis 435 Flexible Budgets 492
Price and Quantity Variances 435 Characteristics of a Flexible Budget 492
Using Standard CostsDirect Materials Variances 436 Deficiencies of the Static Budget 493
Materials Price VarianceA Closer Look 438 How a Flexible Budget Works 494
Isolation of Variances 439 Using the Flexible Budgeting Concept in Performance
Responsibility for the Variance 439 Evaluation 495
Materials Quantity VarianceA Closer Look 440 The Measure of ActivityA Critical Choice 498
Using Standard CostsDirect Labor Variances 441 Variable Overhead VariancesA Closer Look 498
Labor Rate VarianceA Closer Look 441 Actual versus Standard Hours 498
Labor Efficiency VarianceA Closer Look 442 Spending Variance Alone 499
Interpreting the Spending Variance 500
Using Standard CostsVariable Manufacturing
Both Spending and Efficiency Variances 500
Overhead Variances 443
Interpreting the Efficiency Variance 500
Manufacturing Overhead VariancesA Closer Look 443
Control of the Efficiency Variance 501
Variance Analysis and Manangement by Activity-Based Costing and the Flexible Budget 502
Exception 445
Overhead Rates and Fixed Overhead Analysis 502
International Uses of Standard Costs 447
Flexible Budgets and Overhead Rates 502
Evaluation of Controls Based on Standard Costs 447 Denominator Activity 503
Advantages of Standard Costs 447 Computing the Overhead Rate 504
Potential Problems with the Use of Standard Costs 448 Overhead Application in a Standard Cost System 505
Balanced Scorecard 449 The Fixed Overhead Variances 505
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Contents xiii

The Budget VarianceA Closer Look 506 Evaluating Investment Center PerformanceReturn
The Volume VarianceA Closer Look 507 on Investment 555
Graphic Analysis of Fixed Overhead Variances 508 The Return on Investment (ROI) Formula 556
Cautions in Fixed Overhead Analysis 509 Net Operating Income and Operating Assets
Overhead Variances and Under- or Overapplied Defined 556
Overhead Cost 509 Understanding ROIThe DuPont Perspective 556
Example 1: Increased Sales without Any Increase in
Summary 509 Operating Assets 558
Review Problem: Overhead Analysis 510 Example 2: Decreased Operating Expenses with No
Glossary 512 Change in Sales or Operating Assets 559
Questions 513 Example 3: Decreased Operating Assets with No
Exercises 513 Change in Sales or Operating Expenses 559
Problems 519 Example 4: Invest in Operating Assets to Increase
Cases 531 Sales 560
Group and Internet Exercises 535 ROI and the Balanced Scorecard 560
Criticisms of ROI 561

Residual Income 561
Motivation and Residual Income 563
Divisional Comparison and Residual Income 563

Segment Reporting and Summary 565

Decentralization 538 Review Problem 1: Segmented Statements 565
Review Problem 2: Return on Investment (ROI) and
Decentralization in Organizations 540
Residual Income 565
Advantages and Disadvantages of
Glossary 567
Decentralization 540
Appendix 12A: Transfer Pricing 568
Responsibility Accounting 541
Review Problem 3: Transfer Pricing 574
Cost, Profit, and Investment Centers 541
Questions 576
Cost Center 541
Exercises 576
Profit Center 541
Investment Center 542 Problems 582
An Organizational View of Responsibility Centers 542 Cases 594
Group and Internet Exercises 597
Decentralization and Segment Reporting 543
Building a Segmented Income Statement 543

Levels of Segmented Statements 546
Sales and Contribution Margin 546 Chapter
Traceable and Common Fixed Costs 548
Identifying Traceable Fixed Costs 548
Activity-Based Costing 548 Relevant Costs for Decision
Making 600
Traceable Costs Can Become Common Costs 550
Segment Margin 550 Cost Concepts for Decision Making 601
Segmented Financial Information on External Identifying Relevant Costs and Benefits 601
Reports 552 Different Costs for Different Purposes 602
Hindrances to Proper Cost Assignment 553 An Example of Identifying Relevant Costs and
Benefits 602
Omission of Costs 553
Reconciling the Total and Differential Approaches 606
Inappropriate Methods for Assigning Traceable Costs
among Segments 554 Why Isolate Relevant Costs? 608
Failure to Trace Costs Directly 554 Adding and Dropping Product Lines and Other
Inappropriate Allocation Base 554 Segments 609
Arbitrarily Dividing Common Costs among An Illustration of Cost Analysis 609
Segments 554 A Comparative Format 611
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xiv Contents

Beware of Allocated Fixed Costs 611 Using the Internal Rate of Return 662
The Make or Buy Decision 613 The Cost of Capital as a Screening Tool 662
Strategic Aspects of the Make or Buy Decision 613 Comparison of the Net Present Value and the Internal
An Example of Make or Buy 614 Rate of Return Methods 662
Opportunity Cost 615 Expanding the Net Present Value Method 663
The Total-Cost Approach 663
Special Orders 616
The Incremental-Cost Approach 665
Utilization of a Constrained Resource 618
Least-Cost Decisions 666
Contribution in Relation to a Constrained Resource 618
Uncertain Cash Flows 667
Managing Constraints 620
An Example 668
The Problem of Multiple Constraints 621
Real Options 668
Joint Product Costs and the Contribution
Approach 622 Preference DecisionsThe Ranking of Investment
Projects 669
The Pitfalls of Allocation 622
Internal Rate of Return Method 669
Sell or Process Further Decisions 622
Net Present Value Method 670
Activity-Based Costing and Relevant Costs 625
Other Approaches to Capital Budgeting Decisions 670
Summary 626 The Payback Method 671
Review Problem: Relevant Costs 626 Evaluation of the Payback Method 671
Glossary 627 An Extended Example of Payback 673
Questions 628 Payback and Uneven Cash Flows 674
Exercises 628 The Simple Rate of Return Method 674
Problems 634 Criticisms of the Simple Rate of Return 676
Cases 642
Postaudit of Investment Projects 676
Group and Internet Exercises 650
Summary 677
Review Problem 1: Basic Present Value

Computations 678
Chapter Review Problem 2: Comparison of Capital Budgeting
Methods 679
Glossary 680
Capital Budgeting Decisions 652
Appendix 14A: The Concept of Present Value 681
Capital BudgetingPlanning Investments 654 Appendix 14B: Inflation and Capital Budgeting 684
Typical Capital Budgeting Decisions 654 Appendix 14C: Future Value and Present Value Tables 687
The Time Value of Money 654 Appendix 14D: Income Taxes in Capital Budgeting
Discounted Cash FlowsThe Net Present Value Decisions 691
Method 655 Questions 695
The Net Present Value Method Illustrated 655 Exercises 696
Emphasis on Cash Flows 657 Problems 702
Typical Cash Outflows 657 Cases 710
Typical Cash Inflows 657 Group and Internet Exercises 714
Recovery of the Original Investment 658
Simplifying Assumptions 658
Choosing a Discount Rate 659
An Extended Example of the Net Present Value
Method 659
Discounted Cash FlowsThe Internal Rate of Return
Method 661
Service Department Costing: An
Activity Approach 716
The Internal Rate of Return Method Illustrated 661 Allocations Using the Direct and Step Methods 718
Salvage Value and Other Cash Flows 661 Selecting Allocation Bases 718
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Interdepartmental Services 719 Cash Flows: Gross or Net? 758

Direct Method 720 Operating Activities: Direct or Indirect Method? 758
Step Method 721 Direct Exchange Transactions 759
Reciprocal Method 722 An Example of a Full-Fledged Statement of Cash
Revenue Producing Departments 723 Flows 759
Allocating Costs by Behavior 723 Eight Basic Steps to Preparing the Statement of Cash
Variable Costs 723 Flows 759
Fixed Costs 723 Setting Up the Worksheet (Steps 14) 761
Should Actual or Budgeted Costs Be Allocated? 724 Adjustments to Reflect Gross, Rather than Net, Amounts
A Summary of Cost Allocation Guidelines 725 (Step 5) 762
Implementing the Allocation Guidelines 725 Classifying Entries as Operating, Investing, or Financing
Base Allocation Techniques 725 Activities (Step 6) 764
Effect of Allocations on Operating Departments 727 The Completed Statement of Cash Flows
(Steps 7 and 8) 765
An Extended Example 728 Interpretation of the Statement of Cash Flows 765
Some Cautions in Allocating Service Department Depreciation, Depletion, and Amortization 766
Costs 729
Pitfalls in Allocating Fixed Costs 729 Summary 767
Beware of Sales Dollars as an Allocation Base 731 Review Problem 768
Glossary 770
Summary 732 Appendix 16A: The Direct Method of Determining the Net
Review Problem: Direct and Step Methods 733 Cash Provided by Operating Activities 771
Glossary 734 Questions 772
Questions 734 Exercises 773
Exercises 734 Problems 776
Problems 738 Group and Internet Exercises 783
Cases 743

Group and Internet Exercises 746


How Well Am I Doing? Statement of
Cash Flows 748
How Well Am I Doing? Financial
Statement Analysis 786
Limitations of Financial Statement Analysis 788
Comparison of Financial Data 788
The Basic Approach to a Statement of Cash Flows 750 The Need to Look beyond Ratios 788
Definition of Cash 750 Statement in Comparative and Common-Size
Constructing the Statement of Cash Flows Using Form 789
Changes in Noncash Balance Sheet Accounts 751 Dollar and Percentage Changes on Statements 789
An Example of a Simplified Statement of Cash Common-Size Statements 789
Flows 753 Ratio AnalysisThe Common Stockholder 794
Constructing a Simplified Statement of Cash Flows 753 Earnings per Share 794
The Need for a More Detailed Statement 755 Price-Earnings Ratio 794
Organization of the Full-Fledged Statement of Cash Dividend Payout and Yield Ratios 795
Flows 756 The Dividend Payout Ratio 795
Operating Activities 756 The Dividend Yield Ratio 795
Investing Activities 757 Return on Total Assets 795
Financing Activities 757 Return on Common Stockholders Equity 796
Other Issues in Preparing the Statement of Cash Financial Leverage 796
Flows 758 Book Value per Share 797
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Ratio AnalysisThe Short-Term Creditor 798 Determining the Markup Percentage 831
Working Capital 798 Problems with the Absorption Costing Approach 832
Current Ratio 798 Target Costing 833
Acid-Test (Quick) Ratio 799 Reasons for Using Target Costing 833
Accounts Receivable Turnover 800 An Example of Target Costing 834
Inventory Turnover 800
Summary 834
Ratio AnalysisThe Long-Term Creditor 801 Glossary 835
Times Interest Earned Ratio 801 Questions 835
Debt-to-Equity Ratio 802 Exercises 835
Summary of Ratios and Sources of Comparative Ratio Problems 836
Data 802

Summary 802
Review Problem: Selected Ratios and
Financial Leverage 804 Appendix
Glossary 807
Questions 807 Profitability Analysis 840
Exercises 807 Introduction 841
Problems 812 Absolute Profitability 841
Relative Profitability 841

Volume Trade-Off Decisions 844
Appendix Managerial Implications 846
Summary 847
Pricing Products and Services 824 Glossary 848
Introduction 825 Questions 848
The Economists Approach to Pricing 825 Exercises 848
Elasticity of Demand 826 Problems 849
The Profit-Maximizing Price 827 Cases 852
The Absorption Costing Approach to Cost-Plus
Pricing 830
Photo Credits 853
Setting a Target Selling Price Using the Absorption
Costing Approach 830 Index 854