Management Accounting

Sixteenth Edition

Charles T. Horngren Stanford University

Gary L. Sundem University of Washington – Seattle

David Burgstahler University of Washington – Seattle

Jeff Schatzberg University of Arizona

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Library of Congress Cataloging-in-Publication Data Horngren, Charles T. Introduction to management accounting / Charles T. Horngren, Stanford University; Gary L. Sundem, University of Washington – Seattle; David Burgstahler, University of Washington – Seattle; Jeff Schatzberg, University of Arizona. — Sixteenth edition. pages cm Includes index. ISBN 978-0-13-305878-9 (casebound) 1. Managerial accounting. I. Title. HF5635.H814 2014 658.15’11–dc23 2012047454

ISBN 13: 978-0-13-305878-9 ISBN 10: 0-13-305878-6

10 9 8 7 6 5 4 3 2 1

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About the Authors

Charles T. Horngren was the Edmund W. Littlefield Professor of Accounting, emeritus, at Stanford University. A graduate of Marquette University, he received his MBA from Harvard University and his PhD from the University of Chicago. He also received honorary doctorates from Marquette University and DePaul University.

A certified public accountant, Horngren served on the Accounting Principles Board, the Financial Accounting Standards Board Advisory Council, and the Council of the American Institute of Certified Public Accountants and served as a trustee of the Financial Accounting Foundation, which oversees the Financial Accounting Standards Board and the Government Accounting Standards Board. He is a member of the Accounting Hall of Fame.

Horngren served the American Accounting Association as its president and as director of research. He received the association’s first annual Outstanding Accounting Educator Award. He also received its Lifetime Contribution to Management Accounting Award.

The California Certified Public Accountants Foundation gave Horngren its Faculty Excellence Award and its Distinguished Professor Award. He is the first person to have received both awards. The American Institute of Certified Public Accountants presented him with its first Outstanding Educator Award. He was also named Accountant of the Year, Education, by the national professional accounting fraternity, Beta Alpha Psi.

Professor Horngren was a member of the Institute of Management Accountants, where he received its Distinguished Service Award. He was a member of the Institute’s Board of Regents, which administers the Certified Management Accountant examinations.

Horngren authored several other accounting books published by Prentice Hall: Cost Accounting: A Managerial Emphasis , Introduction to Financial Accounting , Accounting , and Financial Accounting . He was also the Consulting Editor for the Charles T. Horngren Series in Accounting.

Gary L. Sundem is professor of accounting emeritus at the University of Washington, Seattle. He received his BA from Carleton College and his MBA and PhD from Stanford University.

Professor Sundem has served as President of the American Accounting Association, Executive Director of the Accounting Education Change Commission, and Editor of The Accounting Review . He is currently president of the International Association for Accounting Education and Research.

Sundem is a past president of the Seattle chapter of the IMA (formerly the Institute of Management Accountants). He has served on IMA’s national board of directors and chaired its Academic Relations and Professional Development committees. He has chaired the AACSB’s Accounting Accreditation Committee He currently serves on the Board of Trustees of Rainier Mutual Funds and the Board of Trustees of Carleton College, where he chairs the audit committee. He received the Carleton College Outstanding Alumni award in 2002.

Professor Sundem has numerous publications in accounting and finance journals including Issues in Accounting Education , The Accounting Review , Journal of Accounting Research , and Journal of Finance . He was selected as the Outstanding Accounting Educator by the American Accounting Association in 1998 and by the Washington Society of CPAs in 1987.

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David Burgstahler is the Julius A. Roller Professor of Accounting at the University of Washington, Seattle. He received his BA degree from the University of Minnesota–Duluth, and his PhD from the University of Iowa. He has been associate dean for masters programs and executive education and acting dean at the University of Washington Business School. He has served on more than 40 PhD supervisory committees and has been recognized multiple times as Beta Alpha Psi Professor of the Year and as MBA Professor of the Quarter at the University of Washington.

Professor Burgstahler was 2007–2009 vice president of publications of the American Accounting Association and has served on a number of Association committees.

Professor Burgstahler received the American Accounting Association’s American Institute of Certi+ ed Public Accountants Notable Contributions to Accounting Literature Award in 2002. He has numerous publications in journals including The Accounting Review , Journal of Management Accounting Research , Journal of Accounting Research , Journal of Accounting and Economics , Contemporary Accounting Research , Auditing: A Journal of Practice and Theory , Behavioral Research in Accounting , and The CPA Journal .

Jeff Schatzberg is the Vice-Dean and Eller Professor of Accounting in the Eller College of Management at the University of Arizona. Professor Schatzberg received his BA (in philoso- phy), MA (in accounting), and PhD (in business administration), all at the University of Iowa. Professor Schatzberg has numerous publications in the most prestigious accounting and business journals, including the Journal of Accounting Research , The Accounting Review, Contemporary Accounting Research , Auditing: A Journal of Practice and Theory, Journal of Management Accounting Research, and Issues in Accounting Education . His teaching and research interests are in managerial accounting and auditing. He has given numerous seminars at several U.S. uni- versities and international schools in Canada, England, Wales, Norway, France, Germany, and Switzerland. Schatzberg has also served on the editorial board of several scholarly accounting journals.

Professor Schatzberg has been teaching undergraduate, graduate, and MBA managerial accounting courses at the University of Arizona for the past 26 years. He has extensive expe- rience in executive education worldwide (e.g., United States, China, Korea, Taiwan, Mexico, and Peru), has developed customized managerial accounting programs and performed consult- ing for numerous companies (e.g., Raytheon, Honeywell, Microsoft, and Intel), and has taught executives from many multinational firms (e.g., IBM, Motorola, LG, BenQ, Acer, and Mattel). Professor Schatzberg has received the MBA Faculty of the Year Award from the Eller Graduate School of Business at the University of Arizona on seven occasions and is the recipient of the Arizona Society of CPA’s Excellence in Teaching Award. He is a CPA and worked for several years as an auditor and tax accountant in the Phoenix office of KPMG Peat Marwick. His work experience includes both manufacturing and service industry firms, as well as not-for-profit institutions.

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Brief Contents

PART 1 Focus on Decision Making Chapter 1 Managerial Accounting, the Business Organization, and

Professional Ethics 2 Chapter 2 Introduction to Cost Behavior and Cost-Volume-Profit

Relationships 36 Chapter 3 Measurement of Cost Behavior 86 Chapter 4 Cost Management Systems and Activity-Based Costing 122 Chapter 5 Relevant Information for Decision Making with a Focus on

Pricing Decisions 180 Chapter 6 Relevant Information for Decision Making with a Focus on

Operational Decisions 226

PART 2 Accounting for Planning and Control Chapter 7 Introduction to Budgets and Preparing the Master Budget 270 Chapter 8 Flexible Budgets and Variance Analysis 310 Chapter 9 Management Control Systems and Responsibility

Accounting 352 Chapter 10 Management Control in Decentralized Organizations 390

PART 3 Capital Budgeting Chapter 11 Capital Budgeting 434

PART 4 Product Costing Chapter 12 Cost Allocation 480 Chapter 13 Accounting for Overhead Costs 532 Chapter 14 Job-Order Costing and Process-Costing Systems 576

PART 5 Basic Financial Accounting Chapter 15 Basic Accounting: Concepts, Techniques, and Conventions 618 Chapter 16 Understanding Corporate Annual Reports: Basic Financial

Statements 660 Chapter 17 Understanding and Analyzing Consolidated Financial

Statements 716

Appendix A Recommended Readings A1 Appendix B Fundamentals of Compound Interest and the Use of Present-

Value Tables A5 Appendix C Excerpts from Form 10-K of Nike, Inc. A11

Glossary G1 Subject Index I1 Company Index I11

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Contents

Preface xiv Acknowledgements xviii

PART 1 Focus on Decision Making

Chapter 1 Managerial Accounting, the Business Organization, and Professional Ethics 2

Starbucks 2

Management Accounting and Your Career 3

Roles of Accounting Information 4

Management by Exception 6

Cost-Benefit and Behavioral Considerations 9

Planning and Control for Product Life Cycles and the Value Chain 9

Accounting’s Position in the Organization 12

Adaptation to Change 15

Ethical Conduct for Professional Accountants 18

Accounting Vocabulary 24 • Fundamental Assignment Material 24 • Additional Assignment Material 26

Chapter 2 Introduction to Cost Behavior and Cost-Volume-Profit Relationships 36

Boeing Company 36

Identifying Activities, Resources, Costs, and Cost Drivers 37

Variable-Cost and Fixed-Cost Behavior 39

Cost Behavior: Further Considerations 42

Cost-Volume-Profit Analysis 45

Additional Uses of CVP Analysis 55

Contribution Margin and Gross Margin 58

Appendix 2A: Sales-Mix Analysis 61

Appendix 2B: Impact of Income Taxes 62

Accounting Vocabulary 63 • Fundamental Assignment Material 64 • Additional Assignment Material 67

Chapter 3 Measurement of Cost Behavior 86 America West 86

Cost Drivers and Cost Behavior 87

Management Influence on Cost Behavior 88

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Cost Functions 90

Methods of Measuring Cost Functions 93

Appendix 3: Use and Interpretation of Least-Squares Regression 102

Accounting Vocabulary 106 • Fundamental Assignment Material 106 • Additional Assignment Material 107

Chapter 4 Cost Management Systems and Activity-Based Costing 122 Dell 122

Cost Management Systems 123

Cost Accounting Systems 124

Cost Terms Used for Strategic Decision Making and Operational Control Purposes 126

Cost Terms Used for External Reporting Purposes 131

Traditional and Activity-Based Cost Accounting Systems 134

Activity-Based Management: A Cost Management System Tool 142

Appendix 4: Detailed Illustration of Traditional and Activity-Based Cost Accounting Systems 145

Accounting Vocabulary 154 • Fundamental Assignment Material 154 • Additional Assignment Material 160

Chapter 5 Relevant Information for Decision Making with a Focus on Pricing Decisions 180

Grand Canyon Railway 180

The Concept of Relevance 181

Pricing Special Sales Orders 186

Basic Principles for Pricing Decisions 191

Influences on Pricing in Practice 194

Cost-Plus Pricing 195

Target Costing 201

Accounting Vocabulary 205 • Fundamental Assignment Material 205 • Additional Assignment Material 209

Chapter 6 Relevant Information for Decision Making with a Focus on Operational Decisions 226

Nantucket Nectars 226

Analyzing Relevant Information: Focusing on the Future and Differential Attributes 227

Make-or-Buy Decisions 229

Deletion or Addition of Products, Services, or Departments 234

Optimal Use of Limited Resources: Product-Mix Decisions 236

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Joint Product Costs: Sell or Process Further Decisions 238

Keeping or Replacing Equipment 240

Identify Irrelevant or Misspecified Costs 242

Conflicts Between Decision Making and Performance Evaluation 244

Accounting Vocabulary 246 • Fundamental Assignment Material 246 • Additional Assignment Material 250

PART 2 Accounting for Planning and Control

Chapter 7 Introduction to Budgets and Preparing the Master Budget 270

Ritz-Carlton 270

Budgets and the Organization 271

Types of Budgets 277

Preparing the Master Budget 279

Budgets as Financial Planning Models 290

Appendix 7: Use of Spreadsheet Models for Sensitivity Analysis 292

Accounting Vocabulary 294 • Fundamental Assignment Material 294 • Additional Assignment Material 296

Chapter 8 Flexible Budgets and Variance Analysis 310 McDonald’s 310

Using Budgets and Variances to Evaluate Results 311

Revenue and Cost Variances 316

The Role of Standards in Determining Variances 318

Finding Explanations for Variances 319

More Detailed Analysis of Flexible-Budget Variances 322

Overhead Variances 327

Accounting Vocabulary 331 • Fundamental Assignment Material 332 • Additional Assignment Material 334

Chapter 9 Management Control Systems and Responsibility Accounting 352

Health Net 352

Management Control Systems 353

Management Control Systems and Organizational Goals 353

Designing Management Control Systems 355

Controllability and Measurement of Financial Performance 360

Measurement of Nonfinancial Performance 365

The Balanced Scorecard 370

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Management Control Systems in Service, Government, and Nonprofit Organizations 372

Future of Management Control Systems 373

Accounting Vocabulary 374 • Fundamental Assignment Material 375 • Additional Assignment Material 377

Chapter 10 Management Control in Decentralized Organizations 390 NIKE 390

Centralization Versus Decentralization 391

Performance Metrics and Management Control 393

Measures of Segment Performance 396

Economic Profit and Economic Value Added (EVA) 400

Incentives from Income, ROI, or Economic Profit 402

Transfer Pricing 404

Keys to Successful Management Control Systems 413

Accounting Vocabulary 416 • Fundamental Assignment Material 416 • Additional Assignment Material 419

PART 3 Capital Budgeting

Chapter 11 Capital Budgeting 434 Toyota Motor Corporation 434

Capital Budgeting for Programs or Projects 435

Discounted-Cash-Flow Models 435

Sensitivity Analysis and Risk Assessment in DCF Models 439

The NPV Comparison of Two Projects 440

Relevant Cash Flows 443

Income Tax Effects 445

Other Models for Analyzing Long-Range Decisions 452

Performance Evaluation 454

Appendix 11: Capital Budgeting and Inflation 457 Accounting Vocabulary 459 • Fundamental Assignment Material 460 • Additional Assignment Material 462

PART 4 Product Costing

Chapter 12 Cost Allocation 480 L.A. Darling 480

A General Framework for Cost Allocation 481

Allocation of Service Department Costs 483

Allocation of Costs to Product or Service Cost Objects 490

An ABC Approach 495

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Allocation of Costs to Customer Cost Objects to Determine Customer Profitability 498

Allocation of Central Corporate Support Costs 506

Allocation of Joint Costs and By-Product Costs 507

Accounting Vocabulary 510 • Fundamental Assignment Material 510 • Additional Assignment Material 513

Chapter 13 Accounting for Overhead Costs 532 DELL 532

Accounting for Factory Overhead 533

Illustration of Overhead Application 534

Problems of Overhead Application 536

Variable Versus Absorption Costing 539

Fixed Overhead and Absorption Costs of Product 544

Effect of Other Variances 548

Appendix 13: Comparisons of Production-Volume Variance with Other Variances 552

Accounting Vocabulary 554 • Fundamental Assignment Material 554 • Additional Assignment Material 557

Chapter 14 Job-Order Costing and Process-Costing Systems 576 Jelly Belly 576

Distinction Between Job-Order Costing and Process Costing 577

Illustration of Job Costing 577

Activity-Based Costing/Management in a Job-Costing Environment 582

Job Costing in Service and Nonprofit Organizations 585

Process Costing Basics 586

Application of Process Costing 591

Physical Units and Equivalent Units (Steps 1 and 2) 591

Calculation of Product Costs (Steps 3 to 5) 592

Effects of Beginning Inventories: Weighted-Average Method 594

Transferred-In Costs 595

Costing in a JIT System: Backflush Costing 598

Accounting Vocabulary 601 • Fundamental Assignment Material 601 • Additional Assignment Material 604

PART 5 Basic Financial Accounting

Chapter 15 Basic Accounting: Concepts, Techniques, and Conventions 618

General Mills 618

The Need for Accounting 619

Financial Statements—Balance Sheet and Income Statement 619

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Accrual Basis and Cash Basis 624

Adjustments to the Accounts 625

Adjustment Type I: Expiration of Unexpired Costs 625

Adjustment Type II: Recognition (Earning) of Unearned Revenues 629

Adjustment Type III: Accrual of Unrecorded Expenses 629

Adjustment Type IV: Accrual of Unrecorded Revenues 631

Dividends and Retained Earnings 632

Preparing Financial Statements 633

Sole Proprietorships and Partnerships 634

Generally Accepted Accounting Principles 635

Three Measurement Principles 638

Appendix 15A: Additional Accounting Concepts 641

Appendix 15B: Using Ledger Accounts 643

Accounting Vocabulary 646 • Fundamental Assignment Material 647 • Additional Assignment Material 649

Chapter 16 Understanding Corporate Annual Reports: Basic Financial Statements 660

NIKE 660

Classified Balance Sheet 661

Income Statement 669

Statement of Changes in Stockholders’ Equity 671

Statement of Cash Flows 674

Cash Flow from Operating Activities 680

Interpreting the Cash Flow Statement 685

Annual Reports 687

Appendix 16A: Accounting for Inventory 691

Appendix 16B: Shareholder Reporting, Income Tax Reporting, and Deferred Taxes 696

Accounting Vocabulary 698 • Fundamental Assignment Material 698 • Additional Assignment Material 701

Chapter 17 Understanding and Analyzing Consolidated Financial Statements 716

Berkshire Hathaway 716

Part One: Intercorporate Investments Including Consolidations 717

Market-Value and Equity Methods 717

Consolidated Financial Statements 719

Recognizing Income after Acquisition 720

Part Two: Analysis of Financial Statements 728

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Component Percentages 730

Uses of Ratios 731

Efficient Markets and Investor Decisions 735

Accounting Vocabulary 738 • Fundamental Assignment Material 738 • Additional Assignment Material 743

Appendix A: Recommended Readings A1 Periodicals A1 Books in Management Accounting A1 Online Resources A4

Appendix B: Fundamentals of Compound Interest and the Use of Present- Value Tables A5

The Nature of Interest A5

Appendix C: Excerpts from Form 10-K of NIKE, Inc. A11 Part 1 A11 Management’s Annual Report on Internal Control Over Financial Reporting A37 Report on Independent Registered Public Accounting Firm A37 NIKE, Inc., Notes to Consolidated Financial Statements A44

Glossary G1 Subject Index I1 Company Index I11

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Preface

Now more than ever, managers have to understand how their decisions affect costs. Management accounting is an essential tool that enhances a manager’s ability to make effec-

tive economic decisions. Because understanding concepts is more important than memorizing techniques, Introduction to Management Accounting , 16th edition, describes both theory and practice so students understand how to produce and apply information that’s useful in day-to-day decision making. From the first chapter, we encourage students to think about the advantages and disadvantages of various techniques, not to simply memorize and apply the techniques.

Introduction to Management Accounting , 16th edition, deals with all business sectors— nonprofit, retail, wholesale, service, selling, and administrative situations—as well as manu- facturing. The focus is on planning and control decisions, not on product costing for inventory valuation and income determination.

Our Philosophy Introduce concepts and principles early, then revisit them at more complex levels as students gain understanding, and provide appropriate real-company examples at every stage.

In management accounting courses students learn how managers use accounting information to help make better business decisions. They begin their understanding of managerial decisions by asking, “How will my decisions affect the costs and revenues of the organization?” Students then progress to more complex questions: “What is the most appropriate cost-management system for the company?” “What products or services should we emphasize?” “What do our budget variances mean?” Introduction to Management Accounting presents the most basic cost concepts in chapters 1–6 and adds more complex analyses that build on these concepts in the remaining chapters.

Our goals are to choose relevant subject matter and to present it clearly and accessibly, using many examples drawn from actual companies. Examples from companies, such as Starbucks, Boeing, AT&T, McDonald’s, Microsoft, and more, help students understand management accounting concepts in a real-company context.

Introduction to Financial Accounting , 11th edition, and Introduction to Management Accounting , 16th edition, together provide a seamless presentation for any first-year accounting course. Please contact your Pearson representative about cost-saving discounts when adopting both books.

New Edition Enhancements and Updates The authors have made changes to both update the topic coverage and to add clarity to the discus- sion of various topics. Some noteworthy changes include the following:

d New and revised “Business First” boxes provide insights into operations at well-known organizations, including Microsoft, General Electric, Southwest Airlines, Harley-Davidson, Nortel Networks, and Harvard University.

d New and revised chapter-opening vignettes help students understand accounting’s role in current business practice. We revisit the chapter-opening company throughout the chapter so that students can see how accounting influences managers in real companies. Students will recognize many of the companies, such as Starbucks, Boeing, US Airways, McDonald’s, Nike, and Dell.

d A problem in each chapter based on Nike’s SEC Form 10-K. These problems illustrate how publicly available information can lead to insights about a company, its costs, and its management decisions.

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d Increased coverage of ethics , including an ethics problem in each chapter’s assignment material.

d End-of-chapter material includes new and significantly revised exercises and problems to provide fresh, new examples.

Chapter-Specific Updates Chapter 1 emphasizes the importance of accounting information for decision makers and the role of accounting systems in control. The chapter continues to emphasize the importance of ethics in business, with a section devoted to “Ethical Conduct for Professional Accountants.” We shortened the discussion of entry-level careers in accounting and expanded the discussion of trends in management accounting.

Chapter 2 is a major update in the 16th edition. The discussion of mixed-cost and step-cost behavior has been moved up to this chapter, immediately following the discussion of fixed- and variable-cost behavior. Also, degree of operating leverage is defined and illustrated with an example.

Chapter 3 has been reorganized and provides a more focused discussion of cost behavior and cost estimation, as well as an enhanced examination of regression analysis.

Chapter 4 uses Dell as the primary example throughout the chapter, and in this edition we discuss Dell’s strategic decision to shift their product mix away from consumer sales and toward enterprise solutions and services. We describe how cost management systems at Dell support strategic decisions as well as operational control. The discussion of cost categories and cost terminology has been rewritten and refined.

In Chapter 5 …

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