Summary Management Accounting
Accounting for Decision Making and Control
Jerold Zimmerman
Chapters: 1, 2, 4, 5, 6, 7, 8, 9, 10, 11, 12
Chapter 1: Introduction
A. Managerial accounting: decision making and control
Managers have to make decisions. Information about frms’ future costs and revenues is not readily
available and must be estimated by managers. Organizations must obtain and disseminate the
knowledge to make decisions.
Information system a network, usually within an organization, by which information is
generated and circulated. This network involves computer systems as well as other mechanisms,
such as payroll records, purchasing documents, and managers’ impressions and specifc
knowledge.
Higher-level managers of larger frms come to rely more and more on formal operating reports.
Internal accounting system the accounting system that collects, aggregates, and generates
and distributes budgeted and actual fnancial and cost information within the frm for use by
executives and managers for both decision making and control.
No matter what the frm’s objective, the organization will survive only if its infow of resources (such
as revenue) is at least as large as the outfow. Accounting information is useful to help manage the
infow and outfow resources and help align the owners’ and employees’ interests, no matter what
objectives the owners with to pursue.
To control the confict between owners of a frm (who want higher profts) and employees (who
want easier jobs, higher wages, and more fringe benefts), senior managers and owners design
systems to monitor employees’ behavior and incentive schemes that reward employees for
generating more profts.
Control system those procedures that help ensure self-interested agents of the organization
maximize the value of the organization. For example: performance measures and incentive
compensation systems, promotions, demotions, and terminations, security guards and video
surveillance, internal auditors, and the frm’s internal accounting system.
Internal accounting systems serve two purposes:
1. Decision making: to provide the knowledge necessary for planning and making decisions.
2. Control: to help motivate and monitor people in organizations.
The most basic control use of accounting is to prevent fraud and embezzlement.
Firms use their internal accounting system both for decision making (strategic planning, cost
reduction, fnancial management) and for controlling behavior (internal reporting and performance
evaluation).
B. Design and use of cost systems
Both managers and accountants must understand the strengths and weaknesses of current
accounting systems. An internal accounting system should have the following characteristics:
1. Provide the information necessary to assess the proftability of products or services and to
optimally price and market these products or services.
2. Provide information to detect production inefciencies to ensure that the proposed products
and volumes are produced at minimum cost.
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, 3. When combined with the performance evaluation and reward system, create incentives for
managers to maximize frm value.
4. Support the fnancial accounting and tax accounting reporting functions.
5. Contribute more to frm value than it costs.
The Securities and Exchange Commission (SEC) and the Financial Accounting Standards Board
(FASB) regulate the fnancial statements issued to shareholders. The Internal Revenue Service (IRS)
administers the accounting procedures used in calculating corporate income tax.
Differences between internal and external reporting:
1. The internal accounting system affords a more disaggregated view of the company.
2. The internal reports are generated more frequently.
3. The internal reports offer costs and profts by specifc products, customers, lines of
business, and divisions of the company.
Using the same accounting system for multiply purposes (decision making, performance evaluation,
external reporting) increases the credibility of the fnancial reports for each purpose.
More than 80% of CFOs report using the same accounting methods and report the same earnings
internally and externally. Most frms use ‘one number’ for both external and internal
communications. The most important reason for this is it allows reclassifcation of the data.
C. Marmots and grizzly bears
Question: Why do managers persist in using (presumably inferior) accounting information?
The marmot-and-bear parable bears are searching for marmots to eat them, but the calories
expended for this exceeds the calories obtained from their consumption. You can say these bears
should become extinct. However, bears’ claws might be sharpened as a by-product of the diging
involved in hunting for marmots and sharp claws are useful in searching for food under the ice after
winter’s hibernation. The result is that bears will survive.
Answer to the question of this paragraph: In a competitive world, if surviving organizations use
some operating procedure (such as historical cost accounting) over long periods of time, then this
procedure likely yields benefts in excess of its costs.
The parable of above is an important proposition in the social science ‘economic Darwinism’. It
suggest that in successful (surviving) frms, things should not be fxed unless they are clearly
broken.
Two caveats must be raised concerning too strict an application of economic Darwinism:
1. Some surviving operating procedures can be neutral mutations. Just because a system
survives does not mean that its benefts exceed its costs. Benefts less costs might be close
to zero.
2. Just because a given system survives does not mean it is optimal. A better system might
exist but has not yet been discovered.
D. Management accountant’s role in the organization
Chief fnancial ofcer the design and operation of the internal and external accounting systems.
He oversees all the fnancial and accounting functions and reports directly to the president (CEO).
The fnancial functions are:
Controllership: tax administration, internal and external accounting reports, planning and
control systems (including budgeting).
Treasury: short- and long-term fnancing, banking, credit and collections, investments,
insurance, capital budgeting.
Internal audit: to seek out and eliminate internal fraud and to provide internal consulting
and risk management.
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,Internal and external auditors’ frst responsibility is to test the integrity of the frm’s internal
controls. Fraud and theft are prevented by having security guards, door locks, internal procedures,
codes of conduct, policies that prohibit corruption, bribery, and kickbacks.
E. Evolution of management accounting: a framework for change
1800: management accounting was less important to the small, family-operated organizations. The
owner could directly observe the organization’s entire environment, the owner had no need to
devise elaborate formal systems to motivate employees.
1825-1925: the developing of systems to measure the cost per yard or per pound for the separate
manufacturing processes. These measures allowed managers to compare the cost of conducting a
process inside the frm versus purchasing the process from external vendors.
1850-1970: the developing of cost systems that reported cost per ton-mile and operating expenses
per dollar of revenue. These measures allowed managers to increase their operating efciencies.
Early 1900s: the developing of a cost system that reported detailed unit cost fgures for material
and labor on a daily and weekly basis. This allowed senior managers to maintain very tight controls
on operations and gave them accurate and timely information on costs for pricing decisions.
1925-1975: management accounting was heavily infuenced by external considerations. Income tax
and accounting requirements were major factors affecting management accounting.
Since 1975: factory automation and computer/information technology and global competition are
environmental changes that force managers to reconsider their organization structure and their
management accounting procedures.
An organization’s architecture is composed of three related processes:
1. The assignment of decision-making responsibilities:
2. The measurement of performance
3. The rewarding of individuals within the organization
F. Vortec medical probe example
Estimated incremental cost per unit = change in total cost
change in volume
Robinson-Patman Act a federal law that prohibits charging customers different prices if it is
injurious to competition in the market.
Chapter 2: The Nature of Costs
A. Opportunity costs
Opportunity cost the receipts from the next most valuable forgone alternative when making a
decision or choice among many options / the beneft forgone as a result of choosing one course of
action rather than another.
Opportunity costs can be determined only within the context of a specifc decision and only after
specifying all the alternative actions.
Opportunity costs are forward looking. In contrast, accounting is based on historical costs (the
actual costs incurred to acquire resources). Accounting systems measure historical costs, not
opportunity costs.
Financial accounting is concerned with matching expenses to revenues. In decision making, the
concern is with estimating the opportunity cost of a proposed decision.
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, Situations of opportunity costs:
When there is no alternative use and there are no storage or disposal cost, the opportunity
cost is zero.
When the frm incurs costs for storing the product and if disposal is costly, the opportunity
cost is negative.
If the materials will be used in another order, using them now requires us to replace them
in the future. The opportunity cost is the cost of replacement.
Opportunity cost also contains the interest forgone on the additional inventory products and
parts the frm carries as part of the normal operations of manufacturing and selling the
products.
The opportunity cost of labor is the value of the best forgone alternative use of the
employees’ time.
The opportunity cost of using an asset is the decline in its value.
If an asset can be sold, then interest should be included as an opportunity cost.
The opportunity cost of increasing the plant’s expected utilization, say from 75% to 85% of
capacity, is the higher production cost imposed on the existing units that currently utilize
75% of the capacity.
When introducing a new product: if management expects competitors to introduce a device
that compete with the old product, meaning that the company is likely to have lost those
units anyway, then the profts forgone on the sales fall are not an opportunity cost of
introducing a new product.
Sunk costs costs that were incurred in the past, cannot be recovered, and are therefore
irrelevant for decision making (unless you are the one who sunk them).
B. Cost variation
Fixed costs the cost of initiating production, which does not vary with the number of units
produced / the cost when there is no production.
Marginal cost the incremental cost of the last unit produced, which in most cases varies as
volume changes / the cost of producing one more unit.
High for the frst few units: employees must be hired, suppliers must be found, marketing
channels must be opened.
High for the last few units: constraints on the use of space, machines, and employees.
Average cost the total costs of production divided by the number of units produced. This cost is
very high at low levels of output but declines as output increases.
Variable costs additional costs incurred when unit production increases. Variable costs per unit
usually are assumed not to vary with volume.
Relevant range encompasses the rates of output for which the sum of fxed and variable costs
closely approximates total cost (see fgure 2-3 page 32).
Marginal cost per unit and variable cost per unit are equal when marginal cost per unit does not
vary with volume.
Total cost (TC) = Fixed cost (FC) + Variable cost (VC) x Units produced (Q)
Step costs a cost that is constant over ranges of production and increases by discrete amounts
as volume increases from one interval to the next. For example: expenditures on computers.
Mixed or semivariable costs cost that cannot be classifed as being purely fxed of purely
variable. For example: utilities, the cost of electricity used by a frm.
Cost vary based on units produced as well as on the size, weight, and complexity of the product.
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