Chapter 1 Fundamentals of Cost Accounting

Chapter One LEARNING OBJECTIVES After reading this chapter, you should be able to: LO 1-1 Describe the way managers use accounting information to create value in organizations. LO 1-2 Distinguish between the uses and users of cost accounting and financial accounting information. LO 1-3 Explain how cost accounting information is used for decision making and performance evaluation in organizations. LO 1-4 Identify current trends in cost accounting . LO 1-5 Understand ethical issues faced by accountants and ways to deal with ethical problems that you face in your career.© Fancy PhotographyNeer, RF

, , I opened this store on Main Street shortly after I cost accounting class. I know a little bit about the sub-graduated. This is a tourist town, and I knew that a ject, but I know there is a lot more to learn. I'm curious,cookie store would attract people. I've seen it grow a though, how this class will help me and how what I willbit over the last few years, but the return has always learn will further my career, whether I remain an ownerbeen small. or move into management at a larger organization. ,, I read recently that most small businesses fail within Carmen Diaz is the founder of Carmen's Cookies, whichthree years. (See the Business Application item \"The she opened three years ago. Recently, she returned to schoolImportance of Understanding Costs:') I went back to for a business degree. The store has been marginally profit-school last year hoping to learn some business skills able, but Carmen knows she must make a decision soon .that will help me really take control and increase the Should she work on making the store more profitable, or shouldstore's value. One thing I need to do is develop a better she abandon it and seek employment with another firm?understanding of my costs. This semester I'm taking aCarmen, like all managers, wants to add value to her company and is looking forknowledge that will help her do this. Like you, she is now studying cost accountingas one of the disciplines that she will use. Carmen knows that the world is a fast-changing place. She wants to learn not only what is current but also a way to thinkabout problems that she can apply throughout her career. To do this, she knows thatshe has to develop an intuition about the subject. She cannot just learn a few factsthat she is sure to forget soon. After developing this intuition, she will be able toevaluate the value of new cost accounting methods introduced throughout her career. In this chapter, we give an overview of cost accounting and illustrate a numberof the business situations we will study to put the topic in perspective. The exampleswe use and the description of how they apply to larger organizations (or to not-for-profit organizations or government agencies) are discussed in more detail in individ-ual chapters. The examples also illustrate how the discipline of cost accounting canmake a person a more valuable part of any organization.Understanding Costs in a Small Business Business ApplicationOpening a small business , such as a new restaurant, is always businesses without making allowances for suddenrisky. In Los Angeles, for example , \"new restaurants tend to surges in ingredient costs , changing worker compen-make investment experts wary. More than half of restaurants sation rules , broken dish-ware and kitchen upgradefail within their first five years .\" Understanding the costs and expenses.other financial issues is a large part of the problem: Source : T. Hsu and S. Masunaga , \"For Novic e Restaurateurs, Despite entering an industry notorious for its slim profit Ri sk of Fai lure is High ,\" The Los Angeles Times, July 25, margins and volatility, many new restaurateurs launch 201 5. Value Creation in OrganizationsWhy Start with Value Creation? LO 1-1 Describe the wayWe start our discussion with the concepts of value creation and the value chain because managers usein cost accounting our goal is to assist managers in achieving the maximum value for accounting informationtheir organizations. Measuring the effects of decisions on the value of the organization to create value inis one of the fundamental services of cost accounting. As providers of information organizations.(accountants) or as the users of information (managers), we have to understand howthe information can and will be used to increase value. We can then come back to ques- 3tions about how to design accounting systems that accomplish this goal.

4 Part I Introduction and Overviewvalue chain Value ChainSet of activities thattransforms raw resources into The value chain is the set of activities that transforms raw resources into the goodsthe goods and services that and services end users (households, for example) purchase and consume. It alsoend users purchase and includes the treatment or disposal of any waste generated by the end users. As anco nsume . example, the value chain for gasoline stretches from the search and drilling for oil, through refining the oil into gasoline, to the distribution of gasoline to retail outletsvalue-added activities such as convenience stores, and, finally, to the treatment of the emissions producedThose activities that by automobiles or the waste oil recycled at a service station.custome rs perceive asad ding utility to the goods or In much of our discussion about cost accounting, we will be concerned with the partservices they purchase. of the value chain that comprises the activities of a single organization (a firm, for exam- ple). However, an important objective of modern cost accounting is to ensure that the entire value chain is as efficient as possible. It is necessary for the firm to coordinate with vendors and suppliers and with distributors and customers to achieve this objective. In the gasoline example, ExxonMobil must work with suppliers of drilling equipment to ensure the equipment is available when needed. It also needs to work with owners of its On the Run franchises to ensure that gasoline is delivered to the stations as needed. The cost accounting system provides much of the information necessary for this coordination. Therefore, at times we will also consider where in the value chain it is most efficient to perform an activity. The value-added activities that the firms in the chain perform are those that cus- tomers perceive as adding utility to the goods or services they purchase. The value chain comprises activities from research and development (R&D) through the pro- duction process to customer service. Managers evaluate these activities to determine how they contribute to the fin al product's service, quality, and cost. Exhibit 1.1 identifies the individual components of the value chain and provides examples of the activities in each component, along with some of the costs associ- ated with these activities. Although the list of value chain components in Exhibit 1.1 suggests a sequential process, many of the components overlap. For example, the R&D and design processes might take place simultaneously. Feedback fromExhibit 1.1 The Value Chain Components, Example Activities , and Example CostsComponent Example Activities Example Costs• Research and • The creation and development of ideas • Research personnel development (R&D) related to new products, services, or • Patent applications• Design processes. • Laboratory facilities• Purchasing • The detailed development and • Design center• Production engineering of products, services, • Engineering facilities used to or processes.• Marketing and sales develop and test prototypes • The acquisition of goods and services• Distribution needed to produce a good or service. • Purchasing department personnel • Vendor certification • The collection and assembly of resou rces to produce a product or • Machines and equipment deliver a service. • Factory personnel • The process of informing potential cus- • Advertising tomers about the attributes of products • Focus group travel or services that leads to their sale. • Product placement • The process for delivering products • Trucks or services to customers. • Fuel • Web site creation , hosting, and• Customer service • The support activities provided to customers for a product or service. maintenance • Call center personnel • Returns processing • Warranty repairs

Chapter 1 Cost Accounting : Information for Decision Making 5production workers on existing products might be incorporated in the developmentof new models of a product. Companies such as Apple solicit \"feature requests\"from customers for new versions of software. Most organizations operate under the assumption that each of the value chaincomponents adds value to the product or service. Before product ideas are formu-lated, no value exists. Once an idea is established, however, value is created. Whenresearch and development of the product begins, value increases. As the productreaches the design phase, value continues to increase. Each component adds value tothe product or service. You may have noticed that administrative functions are not included as part ofthe value chain. They are included instead in every business function of the valuechain. For example, human resource management is involved in hiring employees forall business value chain functions. Accounting personnel and other managers use costinformation from each business function to evaluate employee and departmentalperformance. Many administrative areas cover each value chain business function.Supply Chain and Distribution ChainFirms buy resources from suppliers (other companies, employees, etc.). These suppli- supply chainers form the supply chain for the firm. Firms also sell their products to distributors Set of firm s and individualsand customers. This is the distribution chain of the firm. At times in our discussion, that sells goods and serviceswe will consider the companies and individuals supplying to or buying from a firm to the firm.and the effect of the firm's decisions on these suppliers and customers. We can thinkof these suppliers and customers as being on the firm's boundaries. Thus, the supply distribution chainchain and distribution chain are the parts of the value chain outside the firm. Set of firms and individuals that buys and distributes The value chain is important because it creates the value for which the customer is goods and services fromwilling to pay. The customer is not particularly concerned with how work is divided the firm.among firms producing the product or providing the service. Therefore, one decisionfirms must make is where in the value chain a value-added component is performedmost cost effectively. Suppose, for example, that some inventory is necessary to providetimely delivery to the customer. Managers need accounting systems that will allow themto determine whether the firm or its supplier can hold the inventory at the lower cost.Focus on the Supply ChainCustomers are concerned with the total cost of producing a over three years . John Campi, executive vice president forproduct or servi ce (because of the effect on its price), but procurement. explains that this does not mean that Chryslerare not concerned about which firm in the supply chain wi ll simply pay its suppliers 25 percent less, but, \"[l]t means,incu rred the cost. Therefore, companies think about not only between us, we have to find ways to improve our supplyreducing their own costs but also reducing costs in the entire chain operations .\"chain . The supply chain for cars and trucks includes multi-ple suppliers of parts and components. Chrysler LLC has Source : P. Gupta, \"Chrysler Aims to Cut Supply Chain Costs byset a goal of reducing its supply chain costs by 25 percent 25 Percent,\" Reuters, Aug ust 15, 2008 .Using Cost Information to Increase ValueHow can cost information add value to the organization? The answer to this questiondepends on whether the information provided improves managers' decisions. Sup-pose a production process is selected based on cost information indicating that theprocess would be less costly than all other options. Clearly, the information addsvalue to the process and its products. The measurement and reporting of costs is avaluable activity. Suppose cost information is received too late to help managersmake a decision. Such information would not add value.

6 Part I Introduction and Overview Accounting and the Value Chain If you have taken a financial accounting course, you focused , for the most part, on preparing and interpreting financial statements for the firm as a whole. You were probably not concerned with what stage in the value chain produced profits. In cost accounting, as we will see, we need to understand how the individual stages contribute to value and how to work with other managers to improve performance. Although financial accounting and cost accounting are related, there are important differences.Accounting Systems LO 1-2 All accounting systems are designed to provide information to decision makers. Distinguish between the However, it is convenient to classify accounting systems based on the primary user of the information. Investors (or potential investors), creditors, government agencies, uses and users of cost tax authorities, and so on are outside the organization. Managers are inside the orga- accounting and nization. The classification of accounting systems into financial and cost (or mana- gerial) systems captures this distinction between decision makers. financial accounting information. Financial Accountingfinancial accounting Financial accounting information is designed for decision makers who are notField of accounting that directly involved in the daily management of the firm . These users of the informa-reports financial position and tion are often external to the firm. The information, at least for firms that are pub-income according to licly traded, is public and typically available on the company's Web site. Theaccounting rules. managers in the company are keenly interested in the information contained in the financial accounting reports generated. However, the information is not sufficient for making operational decisions. Individuals making decisions using financial accounting data are often interested in comparing firms, deciding whether, for example, to invest in Bank of America or Wells Fargo Bank. An important characteristic of financial accounting data is that it be comparable across firms. That is, it is important that when an investor looks at, say, revenue for Bank of America, it represents the same thing that revenue for Wells Fargo Bank does. As a result, financial accounting systems are characterized by a set of rules that define how transactions will be treated.cost accounting Cost AccountingField of accounting thatmeasures , records, and Cost accounting information is designed for managers. Because the managers arereports information about making decisions only for their own organization, there is no need for the informa-costs . tion to be comparable to similar information in other organizations. Instead, the important criterion is that the information be relevant for the decisions that manag- ers operating in a particular business environment with a particular strategy make. Cost accounting information is commonly used in developing financial accounting information, but we are concerned primarily with its use by managers to make decisions. This book is about accounting for costs; it is for those who currently (or will) use or prepare cost information. The book's perspective is that managers (you) add value to the organization by the decisions they (you) make. From a different perspective, accountants (you) add value by providing good information to managers making the decision. The better the decisions, the better the performance of your organization, whether it is a manufacturing firm, a bank, a not-for-profit hospital, a government agency, a school club, or, yes, even a business school. We have already identified some of the decisions managers make and will discuss many of the current trends in cost accounting. We do this to highlight the theme we follow throughout: The cost account- ing system is not designed in a vacuum. It is the result of the decisions managers in an organization make and the business environment in which they make them.

Chapter 1 Cost Accounting: Information for Decision Making 7Exhibit 1.2 Comparison of Financial and Cost Accounting Financial Accounting Cost Accounting • Internal (managers)• Users of the information • External (investors, creditors, and so (decision makers) on) • Decision relevance {for managers) , timeliness• Important criteria • Comparability, decision relevance (for investors) • Managers• Who establishes or defines the system? • External standard-setting group (FASB • Relevance for decision in the U.S.) making• How to determine accounting treatment • Standards (rules) Exhibit 1.2 summarizes some of the major differences between financial and costacco unting.Cost Accounting, GAAP, and IFRSThe primary purpose of financial accounting is to provide investors (for example, share- generally acceptedholders) or creditors (for example, banks) information regarding company and manage- accounting principlesment performance. The financial data prepared for this purpose are governed by (GAAP)generally accepted accounting principles (GAAP) in the United States and international Rules , standards, andfinancial reporting standards (IFRS) in many other countries. GAAP and IFRS conventions that guide theprovide consistency in the accounting data used for reporting purposes from one preparation of financialcompany to the next. This means that the cost accounting information used to com- accounting statements forpute cost of goods sold, inventory values, and other financial accounting informa- firms registered in the U.S.tion used for external reporting must be prepared in accordance with GAAP orIFRS. Although GAAP and IFRS are converging, differences remain. For the reasons international financialdiscussed in the next paragraph, these differences are not important for our discussion, reporting standardsbut you should remain aware of them. (IFRS) Rules , standards, and In contrast to cost data for financial reporting to shareholders, cost data for conventions that guide themanagerial use (that is, within the organization) need not comply with GAAP or preparation of the financialIFRS. Management is free to set its own definitions for cost information. Indeed, the accounting statements inaccounting data used for external reporting are often entirely inappropriate for man- many other countries .agerial decision making. For example, managerial decisions deal with the future, soestimates of future costs are more valuable for decision making than are the histori-cal and current costs that are reported externally. Unless we state otherwise, weassume that the cost information is being developed for internal use by managers anddoes not have to comply with GAAP or IFRS. This does not mean there is no \"right\" or \"wrong\" way to account for costs. It doesmean that the best, or correct, accounting for costs is the method that provides relevantinformation to the decision maker so that he or she can make the best decision.Customers of Cost AccountingTo management, customers are the most important participants in a business.Without customers, the organization loses its ability and its reason to exist; cus-tomers provide the organization's focus. There are fewer and fewer markets inwhich managers can assume that they face little or no competition for the cus-tomer's patronage. Cost information itself is a product with its own customers. The customers aremanagers. At the production level, where products are assembled or services are per-formed, information is needed to control and improve operations. This informationis provided frequently and is used to track the efficiency of the activities being per-formed. For example, if the average defect rate is 1 percent in a manufacturing

8 Part I Introduction and Overview process and data from the cost accounting system indicate a defect rate of 2 percent on the previous day, shop-floor employees would use this information to identify what caused the defect rate to increase and to correct the problem. At the middle management level, where managers supervise work and make operating decisions, cost information is used to identify problems by highlighting when some aspect of operations is different from expectations. At the executive level, financial information is used to assess the company's overall performance. This infor- mation is more strategic in nature and typically is provided on a monthly, quarterly, or annual basis. Cost accountants must work with the users (or customers) of cost accounting information to provide the best possible information for managerial purposes. Many proponents of improvements in business have been highly critical of cost accounting practices in companies. Many of the criticisms- which we discuss through- out the book- are warranted. The problem, however, is more with the misuse of cost accounting information, not the information itself. The most serious problems with accounting systems appear to occur when managers attempt to use accounting infor- mation that was developed for external reporting for decision making. Making deci- sions often requires different information from that provided in financial statements to shareholders. It is important that companies realize that different uses of accounting information require different types of accounting information.Our Framework for Assessing Cost Accounting Systems Individuals form organizations to achieve some common goal. Although the focus in this book is on economic organizations, such as the firm, most of what we discuss applies equally well to social, religious, or political organizations. The ability of orga- nizations to remain viable and achieve their goals, whether profit, community well- being, or political influence, depends on the decisions made by managers of the organization. Throughout the text, we emphasize that it is individuals (people) who make deci- sions. This theme and the following framework give us a common basis we can use to assess alternative accounting systems: • Decisions determine the performance of the organization. Managers use information from the accounting system to make decisions. • Owners evaluate organizational and managerial performance with accounting information. LO 1-3 The Manager's Job Is to Make Decisions Explain how cost accounting Why do organizations employ people? What do they do to add value? For line information is used for employees, those directly involved in production or who interact with customers, the decision making and answer to this question is clear. They produce the product or service and deal withperformance evaluation the customer. The job of managers, however, is more difficult to describe because it in organizations. tends to be varied and ambiguous. The common theme among all managerial jobs, however, is decision making. Managers are paid to make decisions. Decision Making Requires Information Accounting systems are important because they are a primary source of information for managers. We describe here some common decisions that managers make. Many, if not most, decisions require information that is likely to come from the accounting system. Our concern with the accounting system is whether it is providing the \"best\"

Chapter 1 Cost Accounting: Information for Decision Making 9information to managers. The decisions managers make will be only as good as theinformation they have.Finding and Eliminating Activities That Don't Add ValueHow do managers use cost information to make decisions that increase value? In nonvalue-added activitiestheir quest to improve the production process, companies seek to identify and Activities that do not addeliminate nonvalue-added activities, which often result from the current product or val ue to the good or service .process design . If a poor facility layout exists and work-in-process inventory mustbe moved during the production process, the company is likely to be performing cost-benefit analysisnonvalue-added activities. Process of comparing benefits (often measured in Why do managers want to eliminate nonvalue-added activities? An important savings or increased profits)concept in cost accounting is that activities cause costs. Moving inventory is a non- with costs associated withvalue-added activity that causes costs (for example, wages for employees and costs a proposed change withinof equipment to move the goods). Reworking defective units is another common an organization.example of a nonvalue-added activity. In general, if activities that do not add valueto the company can be eliminated, then costs associated with them will also beeliminated. A well-designed cost accounting system also can identify nonvalue-added activi-ties that cross boundaries in the value chain. For example, companies such as Steel-case, an office furniture manufacturer, have found it worthwhile to allow customersto order products using automated systems such as electronic data interchange (edi)rather than preparing orders and sending them by fax. This change has eliminatedthe need for two organizations to enter an order into the production scheduling sys-tem. (One was the customer preparing the fax and the other was the manufacturerretyping or scanning the fax into the scheduling system.) Not only does this saveorder entry costs, but it reduces the chances of costly errors in the order. A major activity of managers is evaluating proposed changes in the organiza-tion. Ideas often sound reasonable, but if their benefits (typically measured in sav-ings or increased profits) do not outweigh the costs, management will likely decideagainst them. The concept of considering both the costs and benefits of a proposalis cost-benefit analysis. Managers should perform cost-benefit analyses to assesswhether proposed changes in an organization are worthwhile. The concept of cost-benefit analysis applies equally to deciding whether to implement a new costaccounting system. The benefits from an improved cost accounting system comefrom better decision making. If the benefits do not exceed the cost of implementingand maintaining the new system, managers will not implement it.Identifying Strategic OpportunitiesUsing Cost AnalysisUsing the value chain and other information about the costs of activities, companiescan identify strategic advantages in the marketplace. For example, if a company caneliminate nonvalue-added activities, it can reduce costs without reducing the value ofthe product to customers. By reducing costs, the company can lower the price itcharges customers, giving it a cost advantage over competitors. Or the company canuse the resources saved from eliminating nonvalue-added activities to provide betterservice to customers. Alternatively, a company can identify activities that customers value and whichthe company can provide at lower cost. Many logistics companies, such as Owens &Minor, a hospital supply company, offer their customers consulting services andinventory management. The idea here is simple. Look for activities that do or do not add value. If yourcompany can save money by eliminating those that do not, then do so. You will saveyour company money. Implement those activities that do. In both cases, you willmake the organization more competitive.

10 Part I Introduction and Overview Owners Use Cost Information to Evaluate Managers We have seen that it is important that managers make good decisions if they are to increase organizational value, but how will we know if they make good decisions? If managers own the organization, it is their money and resources that are at risk. We can assume that they will make decisions that are in their own interest. In other words, the interest of the organization and the owner-manager can be assumed to be the same, or aligned. However, most large organizations, especially businesses, are not owned by the managers but by a large number of shareholders. Most of these shareholders are not involved in managing the business. Therefore, there is a second role of the accounting system in addition to aiding managerial decision making. It is to provide information, perhaps indirectly through financial reports, to the owners of the organization about the performance of the organization and the manager.Cost Data for Managerial Decisions This book covers many topics on the use of cost data for managers. The following sections provide examples of these topics.cost driver Costs for Decision MakingFactor that causes, or\"drives,\" costs. One of the most difficult tasks in calculating the financial consequences of alterna- tives is estimating how costs (or revenues or assets) among the alternatives will differ.differential costs For example, Carmen's Cookies has been making and selling a variety of cookiesWith two or more alternatives, through a small store downtown. One of Carmen's customers, the manager of thecosts that differ among or local coffee shop, suggests to Carmen that she expand her operation and sell some ofbetween alternatives. her cookies wholesale to coffee shops, grocery stores, and the local university fooddifferential revenues service. The key is to determine which would be more profitable: remain the same sizeRevenues that change in or expand operations.response to a particularcourse of action. Now Carmen has the difficult task of estimating how revenues and costs will change if she expands into this new distribution channel. She uses her work experience and knowledge of the company's costs to estimate cost changes. She identifies cost drivers, which are factors that cause costs. For example, to make cookies requires labor. There- fore, the number of cookies made is a cost driver that causes, or drives, labor costs. To estimate the effect of adding a wholesale channel, Carmen estimates how many addi- tional cookies she would have to make. Based on that estimate, she determines the addi- tional costs and revenues to the company that selling additional cookies will generate. Do we \"know\" how this decision will affect the firm? We do not, of course. These are estimates that require making many assumptions and forecasts, some of which may not be realized. This is what makes this type of analysis both fun and challeng- ing. In business, nobody knows for certain what will happen in the future. In making decisions, however, managers constantly must try to predict future events. Cost accounting has more to do with estimating future costs than recording past costs. For decision making, information about the past is a means to an end; it helps you predict what will happen in the future. To complete the example, assume that Carmen estimates that her revenues would increase by 35 percent; food costs, labor, and utilities would increase 50 percent; rent per month would not change; and other costs would increase by 20 percent if she starts to sell through other outlets. Carmen enters the data into a spreadsheet to esti- mate how profits would change if she were to add the new channel. See Columns 1 and 2 of Exhibit 1.3 for her present and estimated costs, revenues, and profits. The costs shown in Column 3 are the differences between those in Columns 1 and 2. We refer to the costs and revenues that appear in Column 3 as differential costs and differential revenues. These are the costs and revenues, respectively, that change in response to a particular course of action. The costs in Column 3 of Exhibit 1.3 are differential costs because they differ if Carmen decides to sell cookies through the wholesale channel.

Chapter 1 Cost Accounting: Information for Decision Making 11 A B C DE F G H I JK Exhibit 1.31 CARMEN'S COOKIES Differential Costs, Revenues, and Profits2 Projected Income Statement3 For One Week .----i-· (3) T- - ·-·T-4 - (1) (2) Status Quo: Alternative: Original Shop Wholesale and5 Sales Only Retail Distribution Difference $ 2.2056 Sales revenue -- $6,300 - $ 8.50587 Costs8 Food 1,800 2,700b 900 5009 Labor 1,000 1,500b 200 -0-10 Utilities 400 600b 200 $1,80011 Rent 1,250 1,250 $__1QQ12 Other 1,000 1,200° -··13 Total costs $5,450 $ 7.25014 Operating profits ~ $1,2551516 8 35 percent higher than status quo.17 b50 percent higher than status quo.18 0 20 percent higher than status quo. The analysis shows a $405 increase in operating profits if Carmen sells to theother stores. Based on this analysis, Carmen decides to expand her distribution chan-nels. Note that only differential costs and revenues affect the decision. For example,rent does not change, so it is irrelevant to the decision. In Chapters 2 through 11, we discuss methods to estimate and analyze costs, aswell as how accounting systems record and report cost information. Fast-Food Chain Menu Items and Costs Business ApplicationIt is not just small businesses that think about costs . With chain is testing a smaller Whopper Jr. hamburger as itan increase in food and energy prices, fast-food chains , tries to overcome high ingredient costs.such as Burger King and McDonald 's, are consideringalternative ways to prepare some of their basic items. For In these examples , increases in costs that are outside ofexample , the firm's control (food and energy, for example) , com- bined with a reluctance to raise prices, mean that other This month, McDonald's Corp . said it's testing less costs must be closely monitored so that profits will not be expensive ways to make its $1 double cheeseburger; eroded . already, some restaurants are selling the burger with one slice of cheese instead of two . And in an interview, Source: J . Jargon , \"Food Makers Scrimp on Ingredients in an Effort Burger King Holdings Inc. CEO John Chidsey said the to Fatten The ir Profits,\" The Wall Street Journal, August 23 , 2008.Costs for Control and EvaluationAn organization of any but the smallest size divides responsibility for specific func- responsibility centertions among its employees. These functions are grouped into organizational units. Spec ific un it of anThe units, which may be called departments, divisions, segments, or subsidiaries, spec- organization assigned toify the reporting relations within the firm. These relations are often shown on an a manager w ho is heldorganization chart. The organizational units can be based on products, geography, or ac countable for its operationsbusiness function. We use the general term responsibility center to refer to these units. and resources .The manager assigned to lead the unit is accountable for, that is, has responsibilityfor, the unit's operations and resources. For example, the chief of internal medicine is responsible for the operations of aparticular part of a hospital. The president of General Motors Europe is responsiblefor most of the company's operations in Europe. The president of a company isresponsible for the entire company.

12 Part I Introduction and OverviewExhibit 1.4 Carmen Diaz PresidentResponsibility Centers,Revenues, and Costs I I Ray Adams Cathy Peterson Vice President Vice President Retail Operations Wholesale Operations - ~ - - - - - - -A· , ____B___~_ _C____~__D____,___ 1 CARMEN'S COOKIES ~ - - --------- For !-~~;;;;h+-\"~-j -~-:n-:~-~l~-!!_-~-()- W-h--: -1-;--s~=-le==.:~=:~=:-~-:-:-=-=----·.._----<· 4 I Operations Operations Total 5 Sales revenue _ ~ =40=0~+--=$ =23=·=60=0c.+--=$=5=2,=00=0~1--< 6 Department costs 7 Food 13.500 9,800 23 ,300 8 Labora 4,500 3 ,200 7,700 9 , Utilities 2,100 3,900 , 1,800 11 Total department costs [~ _______lli,.§QQ · ~ .L. $ 3,600 12 Center m_~rginb I --------- · $ 6,000 ~ -__ 13 General and administrative costs __ 14 General manager's salary (Carmen) tI 5,000 15 1-ooer(administrative) . . $8.3220000 ·- 16 Total general and administrative costs t·-----f-·--------- 17 Operating profit I i $.....J.AQQ 18 alncludes department managers' salaries but excludes Carmen's salar~y·- - ~ - - - · - + - -• 19 bThe difference between revenues and costs attributable to a responsibility center. Consider Carmen's Cookies. When she first opened the store, Carmen managed the entire operation herself. As the enterprise became more successful, she added a new location exclusively to serve the wholesale distribution network. She then hired two managers: Ray Adams to manage the original retail store and Cathy Peterson to manage the wholesale network. Carmen, as president, oversaw the entire operation. See the top part of Exhibit 1.4 for the company's organization chart. Exhibit 1.4 also includes the company income statement, along with the state- ments for the two centers. Each manager is responsible for the revenues and costs of his or her center. The Total column is for the entire company. Note that the costs at the bottom of the income statement are not assigned to the centers; they are the costs of running the company. These costs are not the particular responsibility of either Ray or Cathy. Consider the other (administrative) costs. Carmen, not Ray or Cathy, is responsible for designing the administrative systems (e.g., accounting and payroll), so she manages this cost as part of her responsibility to run the entire organization. Ray and Cathy, on the other hand, focus on managing food and labor costs (other than their own salaries) and responsibility center revenues.budget Budgeting You have probably had to budget-for college, a vacation, or livingFinancial plan of the revenues expenses. Even the wealthiest people should budget to make the best use of theirand resources needed to resources. (For some, budgeting could be one reason for their wealth.) Budgeting iscarry out activities and meet very important to the financial success of individuals and organizations.financ ial goals. Each responsibility center in an organization typically has a budget that is its financial plan for the revenues and resources needed to carry out its tasks and meet its financial goals. Budgeting helps managers decide whether their goals can be achieved and, if not, what modifications are necessary.

Chapter 1 Cost Accounting: Information for Decision Making 131 A BC D EF Exhibit 1.52- · CARMEN'S COOKIES3 _,_ Budget versus Actual4 Retail Responsibility Center ~- Data Budgeted versus Actual Costs For the Month Ending April 30 5 Actual Budget Difference 6 Food 7 Flour $ 2,100 $ 2,200 $ (100) - 8 Eggs 5 ,200 4,700 · 500 9 Chocolate 2,000 1,900 100 10 Nuts 2,000 1,900 100 11 Other 2,200 2,200 -0- 12 Total food 13 Labor $13,500 $12,900 $ 600- -- · 3 ,0 0 0 3 ,000 ~ -- - - - · - · 1,500 ---1.2QQ -0- 14 Manager $ 4,500 $ 4,500 -0- 15 Other 1,800 $ -0- 16 Total labor 5,000 1,800 I -0- 17 Utilities $24,800 -0- 18 Rent 32 ,000 5,000 $ 600 19 Total cookie costs $24,200 -0-20 Number of cookies sold21 32 ,0 0 0 I Managers are responsible for achieving the targets set in the budget. The resourcesthat a manager actually uses are compared with the amount budgeted to assess theresponsibility center's and the manager's performance. For example, managers in anautomobile dealership compare the daily sales to a budget every day. (Sometimesthat budget is the sales achieved on a comparable day in the previous year.) Everyday, managers of United Airlines compare the percentage of their airplanes' seatsfilled (the loadfactor) to a budget. Every day, managers of hotels and hospitals com-pare their occupancy rates to their budgets. By comparing actual results with bud-gets, managers can do things to change their activities or revise their goals and plans. As part of the planning and control process, managers prepare budgets containingexpectations about revenues and costs for the coming period. At the end of the period,they compare actual results with the budget. This allows them to see whether changescan be made to improve future operations. See Exhibit 1.5 for the type of statementused to compare actual results with the planning budget for Carmen's Cookies. For instance, Ray observes that the retail responsibility center sold 32,000 cook-ies as budgeted but that actual costs were higher than budgeted. Costs that appear toneed follow-up are those for eggs, chocolate, and nuts. Should Ray inquire whetherthere was waste in using eggs? Did the cost of nuts per pound rise unexpectedly? Wasthe company buying chocolate from the best source? Was there theft of the choco-late? As we will see, even costs that are lower than expected (like flour) should beevaluated. For example, is lower quality flour being purchased? These are just a fewquestions that the information in Exhibit 1.5 would prompt. We discuss developing budgets and measuring the performance of managers andresponsibility centers in Chapters 12 through 18.Different Data for Different DecisionsOne principle of cost accounting is that different decisions often require differentcost data. \"One size fits all\" does not apply to cost accounting. Each time you face acost information problem in your career, you should first learn how the data will beused. Are the data needed to value inventories in financial reports to shareholders?Are they for managers' use in evaluating performance? Are the data to be used fordecision making? The answers to these questions will guide your selection of themost appropriate accounting data.

14 Part I Introduction and OverviewSelf-Study Questions1. Suppose that all of the costs for Carmen 's Cookies 2. For what decisions wou ld estimated cost information be(Exhibit 1.3) were differential and increased proportion- useful if you were a hospital admin istrator? The directorately with sales revenue. What would have been the of a museum? The marketing vice president of a bank?impact on profits of adding the new distri bution The solutions to these questions are at the end of the chapter.channel?Trends in Cost Accounting throughout the Value Chain LO 1-4 Cost accounting continues to experience dramatic changes. Developments in infor-Identify current trends mation technology (IT) have nearly eliminated manual bookkeeping. Emphasis on cost control is increasing in banks, hospitals, manufacturing industries (from com- in cost accounting. puters to automobiles), airlines, school districts, and many other organizations that have traditionally not focused on it. Cost accounting has become a necessity in virtu- ally every organization, including fast-food outlets, professional organizations, and government agencies. One reason for this rapid change is that managers at each stage of the value chain require information on the performance of products, services, suppliers, customers, and employees. Managers of the activities and cost accountants must work together at each stage to make decisions that increase firm value. Because these processes themselves have undergone great change in recent years, cost accountants and cost accounting methods must continuously adapt to changes in all business areas. Cost Accounting in Research and Development (R&DJ Lean manufacturing techniques, in which Toyota Motor Company is considered a leader, are not simply about production. Companies partner with suppliers in the development stage to ensure cost-effective designs for products. Product engineers need cost accounting information to make decisions about alternative materials. For example, Johnson Controls, a manufacturer of automobile seats, needs to make trade-offs between the cost and weight of materials, which is an important factor in fuel economy and the cost of recycling the materials at the end of the car's life.activity-based costing Cost Accounting in Design(ABC)Costing method that first An important activity in product development is design. Product designers mustassi gns costs to activities write detailed specifications on a product's design and manufacture. The design of aand then assigns them to product can have a significant impact on the cost to manufacture it. Designs that areprod ucts based on the complex might add additional functions, which, while making a product more desir-products' consumption able, may also require complex and expensive manufacturing processes. Design forof activities. manufacturing (DFM) is the concept that manufacturing cost and complexity need to be considered in the design of the product. Cost accountants help designers under- stand the trade-off by using methods such as activity-based costing, which considers the activities or processes that will be required to bring a product to market. Hewlett- Packard, for example, uses activity-based costing methods to communicate to design- ers the costs of alternative designs of testing equipment. Activity-based costing is a product costing method that has received a great deal of attention since the 1990s. This costing method is more detailed and complicated than conventional costing methods, but it can provide more accurate cost numbers. ABC assigns costs to products based on several different activities, depending on how they drive costs, whereas traditional costing methods assign costs to products based on only one or two factors, generally based on volume. In general, ABC provides more detailed cost information, enabling managers to make more informed decisions.

Chapter 1 Cost Accounting: Information for Decision Making 15Cost Accounting in PurchasingCompanies now partner with suppliers to increase the efficiency in the supply chain. Part- performance measurenering requires information on the performance of partners to ensure the relationship Metric that indicates how welladds value. Performance measures are being used to evaluate the performance of key sup- an individual , business unit,pliers and business partners. For example, United Technologies and Sun Microsystems product, firm , and so on , isboth maintain extensive supplier metrics systems. Sun Microsystems also includes an working.effort to \"value\" nonperformance in understanding the effect of suppliers on Sun's value. benchmarking The use of cost accounting methods such as target costing, activity-based costing, Continuous process ofperformance measures, and incentive systems that support teamwork, helps firms such as measuring a company'sFedEx and Dell Inc. manage their partnerships to keep the supply chain \"lean\" and add own products, services, orvalue throughout the chain. Some firms, for example, Sainsbury, a supermarket chain in activities against competitors'the United Kingdom, maintain a Web portal for their suppliers that allows them to see performance.their own performance over time and compare it to the average performance of othercomparable suppliers. In the United States, Boeing Aircraft and United Technologiesalso use the Internet to provide comparative performance data to suppliers. These approaches to managing suppliers allow firms to support continualimprovement throughout the supply chain by facilitating benchmarking. Using bench-marking methods, managers measure a company's own products, services, and activi-ties against the best levels of performance that can be found either inside or outsidethe manager's own organization. Because managers seek continual improvement, theydo not treat benchmarking as a one-time event but as an ongoing process.Cost Accounting in ProductionOperations managers and financial accountants use cost information in the produc- just-in-time (JIT) methodtion stage to understand and report the costs of the multiple products produced. One In production or purchasing,of the most important developments in production, associated with lean manufac- eac h un it is purchased orturing, is the use of just-in-time (JIT) methods. Using just-in-time methods, compa- produced just in time for itsnies produce or purchase units just in time for use, keeping inventories at a minimum. use .If inventories are low, accountants can spend less time on inventory valuation forexternal reporting and more time on managerial activities. lean accounting A cost accounting system that The economic justification for JIT comes from the trade-off between the costs of provides measures at thesetup and stock-outs as compared with the costs of holding inventory (obsolescence, work cell or process levelstorage space and associated tax and insurance, and costs associated with organizing and minimizes wasteful orand keeping track of inventory). Modern cost accounting systems have helped man- unnecessary transactionagers better understand the relative costs so that appropriate inventory policies can processes.be set and targeted improvements sought. Firms that use lean manufacturing techniques look to the cost accounting sys-tem to support these techniques by providing useful measurements at the work cell orprocess level. Lean accounting systems provide these measures. In addition, thesesystems are designed to avoid unnecessary transactions, in effect eliminating \"waste\"from the accounting processes, just as lean manufacturing is designed to eliminatewaste from the manufacturing process. The production process is not limited to manufacturing. Service firms, such asbanks, insurance companies, and theme parks, produce or provide services demandedby customers. Efficient use of capacity (employees) in providing services is critical inincreasing value. Managers look to cost accounting information to help them under-stand and plan capacity. For example, the brokerage firm Charles Schwab uses ABCinformation to allocate costs and thus determine the costs of capacity in variousoperational processes. The firm then builds up the product cost according to its useof time in regard to the key processes.Cost Accounting in MarketingMarketing managers require cost accounting information to understand the profit-ability of different customer groups. Advances in accounting information systems

16 Part I Introduction and Overviewcustomer relationship that capture data at various levels of detail have made possible customer relationshipmanagement (CRM) management (CRM), which allows firms to target more precisely those customersSystem that al lows firms to who are profitable by assessing the costs to serve a customer along with the revenuestarget profitable customers by a customer generates. For example, Harrah's Entertainment is able to compete on theassessing customer revenues basis of providing complimentary services to customers (typically called \"comping\")and costs. based on their expected personal profitability.outsourcing Cost Accounting in DistributionHaving one or more of thefirm's activities performed Earlier, we said that managers use accounting information to determine where in theby another firm or ind ividual supply chain value-added activities will take place. Cost accountants work with man-in the supply or distributi on agers to estimate whether it is more efficient (less costly) to perform an activity in thechain. firm or to have another firm produce the product or perform the service. This is referred to as outsourcing. Firms frequently consider activities in the distribution stage for outsourcing. As business becomes more global, specialized information on markets, regulations, and customs is critical to the speed of delivery. As a result, cost information often identifies specialized companies as being more efficient in distrib- uting products, as opposed to handling distribution internally. The Japanese camera manufacturer Nikon, for example, now relies on UPS for distribution where it used to handle this activity internally. Many distribution compa- nies such as UPS and FedEx, in fact, have developed entirely new businesses consult- ing with firms in regard to distribution solutions. These consulting services rely heavily on cost information to identify cost-effective distribution systems. Cost Accounting in Customer Servicetotal quality Many companies have adopted the concept of total quality management (TQM),management (TQM) which means that the organization is managed to excel on all dimensions and theManagement method by customer ultimately defines quality. The customers determine the company's perfor-which the organization seeks mance standards according to what is important to them (which is not necessarilyto excel on all dimensions, what is important to product engineers, accountants, or marketers). Companies canwi th the customer ultimately indicate the high quality to consumers through the product warranty. Cost accoun-defining quality. tants help managers make decisions about quality in two ways. First, cost of quality (COQ) systems identify the costs associated with producing defective units as well ascost of quality (COQ) the lost sales associated with poor-quality products. Second, they provide informa-System that identifies the tion on the projected warranty claims, which can be compared to the increase incosts of producing low-quality revenues estimated from offering a longer or more comprehensive warranty.items , including rework,returns , and lost sales. For example, Korean manufacturer Hyundai Motors determined that its quality improvements justified offering a 10-year warranty, something unique in the auto- mobile industry. This decision was based on estimates of warranty costs and studies concerning the sales impact of the longer warranty.enterprise resource Enterprise Resource Planningplanning (ERP)Information tech nology that We have seen how cost accounting is used throughout the value chain. It is importantlinks the various systems of that the information be consistent in all components of the chain.the enterprise into a singlecomprehensive information As the cost of information technology falls and the value of information increases,system . managers have adopted enterprise resource planning (ERP) systems. ERP systems are integrated information systems that link various activities in an organization. Typical systems include modules for production, purchasing, human resources, and finance. By integrating these systems, managers hope to avoid lost orders, duplication of effort, and costly studies to determine what is the current state of the enterprise. Because all of the company's systems are integrated, the potential for ERP to provide information on costs of products and services is large. Implementation prob- lems and the scale of the task in large firms (enterprises) have kept many companies from realizing that potential so far. However, with the increased emphasis on internal control from the Sarbanes-Oxley Act (discussed later in the chapter), ERP systems will become even more valuable.

Chapter 1 Cost Accounting: Information for Decision Making 17Creating Value in the OrganizationThese trends in the way organizations do business create exciting times in costaccounting and excellent future opportunities for you to make important contribu-tions to organizations. Keep in mind that these new methods are not ends in them-selves. They are tools to help you add value to organizations and their employees,customers, shareholders, and communities. Self-Study Question3. What are the major causes of changes in cost account- The solution to this question is at the end of the chapter. ing systems in recent years? Key Financial Players in the OrganizationAll managers in the organization, not just financial professionals, use cost account-ing information. Because our focus is on cost accounting and decision making, wewill often be viewing a decision from an operational manager's perspective. Forexample, we might look at a pricing decision or a sourcing decision that a marketingor production manager has to make. As a financial or operational manager in an organization, you will work closelywith many financial professionals. See Exhibit 1.6 for a list of the typical financialtitles in organizations and examples of their activities. If you work in the accountingor finance function in an organization, you are likely to have one of these jobs. If youare an auditor or consultant, you will work with many of these financial managers.If you work in marketing, operations, or management, these financial managers willbe on one of many teams working with you.Exhibit 1.6 Key Financial Managers in an Organization Major Responsibilities and Example ActivitiesTitle Primary Duties • Signs off on financial statements• Chief financial • Manages entire finance and • Determines policy on debt versus equity officer (CFO) accounting function financing• Treasurer • Manages liquid assets • Determines where to invest cash • Conducts business with banks• Controller balances• Internal auditor and other financial institutions • Obtains lines of credit • Oversees public issues of stock• Cost accountant • Determines cost accounting policies and debt • Maintains the accounting records • Ensures that procurement rules are • Plans and designs information and incentive systems followed • Recommends policies and procedures • Ensures compliance with laws, regulations, and company policies to reduce inventory losses and procedures • Evaluates costs of products and • Provides consulting and auditing processes services within the firm • Recommends cost-effective methods to • Records, measures, estimates, and distribute products analyzes costs • Works with financial and operational manager to provide relevant informa- tion for decisions

18 Part I Introduction and Overview Whatever your job, you will work in cross-functional teams of people from many areas such as engineering, production, marketing, finance, and accounting. Consider a project designed to identify a new design for an airplane. Cross-functional teams add value to decision making by: • Bringing a variety of expertise and perspectives to the problem. • Ensuring that the product is appropriate for its customer base (requiring interac- tion between engineering and marketing). • Giving production a chance to formulate an efficient production process (requir- ing interaction between engineering and production). Obtaining financing for the project (requiring interaction among all groups, including finance and accounting). • Determining whether the project is economically feasible (requiring interaction among all functions).Choices: Ethical Issues for Accountants LO 1-5 We have discussed decisions that you will make in using or preparing cost accounting Understand ethical information. Now, we alert you to ethical issues that you will have to face. The sooner you are aware of these issues, the better you will be able to deal with them in your issues faced by career. The design of cost systems is ultimately about the assignment of costs to vari-accountants and ways ous activities, products, projects, corporate units, and people. How that is done affects prices, reimbursement, and pay. As you know from current events, the design of the to deal with ethical cost accounting system has the potential to be misused to defraud customers, employ-problems that you face ees, or shareholders. As a user or preparer of cost information, you need to be aware of the implications of the way in which information is used. Most important, you in you r career. need to be aware of when the system has the potential for abuse. What Makes Ethics So Important? Accountants report information that can have a substantial impact on the careers of managers. Managers are generally held accountable for achieving financial performance targets. Failure to achieve them can have serious negative consequences for the managers, including losing their jobs. If a division or company is hav- ing trouble achieving financial performance targets, accountants may find themselves under pressure by management to make accounting choices that will improve performance reports. As a professional accountant, manager, or business owner, you will face ethical situations on an everyday basis. Your personal ethical choices can affect not only your own self-image but also others' perception of you. Ulti- mately, the ethical decisions you make directly influence the type of life you are likely to lead. You should confront ethical dilemmas bearing in mind the type of life that you want to lead. Many students think that businesspeople who are unethical are sleazy characters. In fact, most are hard-working people who are surprised that they have gotten caught up in unethical activities. Even people who com- mit organizational crimes are often surprised by their own behavior. A for- mer federal prosecutor told us, \"Most businesspeople who commit crimes are very surprised that they did what they did.\" For example, a few years ago, numerous executives of companies in the DRAM market, such asUnethical behavior often leads to illegal Samsung and Infineon, were charged with price-fixing. (DRAM stands foractivities as managers attempt to improve \"dynamic random access memory,\" which is the type of memory used inreported results. See the Business most personal computers.) Many of these executives did jail time for anApplication item on options backdatingfor an example and the text in this section activity that was intended to benefit their companies, not themselves. Mostfor some approaches to handling ethical of them did not realize that exchanging information with competitors wasproblems. © Photod isc/Getty Images, RF illegal.

Chapter 1 Cost Accounting: Information for Decision Making 19 In an attempt to influence the accounting profession, many of its professional organizations such as the Institute of Management Accountants (IMA), Institute of Internal Auditors (IIA), and the American Institute of Certified Public Accountants (AICPA) have developed codes of ethics to which their members are expected to adhere. Similarly, businesses such as Johnson & Johnson generally use these codes as a public statement of their commitment to certain business practices with respect to their customers and as a guide for their employees. Throughout this book, we include discussions of ethical issues. Our aim is to make you aware of potential problems that you and your colleagues will face in your careers. Many accountants, managers, and business owners have found themselves in serious trouble because they did many small things, none of which appeared seriously wrong, only to find that these small things added up to big trouble. If you know the warning signs of potential ethical problems, you will have a chance to protect yourself and set the proper moral tone for your company and your profession at the same time. The IMA code of conduct appears in the Appendix to this chapter. In its \"State-ment of Ethical Professional Practice,\" the IMA states that management (and cost) accountants have a responsibility to maintain the highest levels of ethical conduct.They also have a responsibility to maintain professional competency, refrain fromdisclosing confidential information, and maintain integrity and objectivity in theirwork. These standards recommend that accountants faced with ethical conflicts fol-low the established policies that deal with them. If the policies do not resolve theconflict, accountants should consider discussing the matter with superiors, poten-tially as high as the audit committee of the board of directors. In extreme cases, theaccountant could have no alternative but to resign. Many people believe that the appropriate way to deal with ethical issues is not byrequiring employees to read and sign codes of ethics but to rely on more fundamentalconcepts of right and wrong. Codes of conduct look good on paper, but ultimatelymuch of ethical behavior comes from an individual's personal beliefs. We are certainthat you will be faced with important ethical choices during your career, and we wishyou well in making the right choices.EthicsThe IMA Code of Ethics discusses the steps cost accountants should take whenfaced with an ethical conflict. Essentially, these steps are:• DISCUSS the conflict with your immediate superior or, if the conflict involves your superior, the next level in authority. This might require contacting the board of directors or an appropriate committee of the board, such as the audit commit- tee or the executive committee;• CLARIFY the relevant issues and concepts by discussions with a disinterested party or by contacting an appropriate and confidential ethics \"hotline\";• CONSULT your attorney about your rights and obligations. During the wave of corporate scandals after the tum of the century, two accountantsdistinguished themselves for their courage in bringing unethical behavior to light. Thesetwo accountants, Cynthia Cooper at WorldCom and Sherron Watkins at Enron, alongwith an FBI agent, were named Persons of the Year by Time magazine. Although theseaccountants have been publicly applauded for their courage and integrity, they wereheavily criticized for not being team players when they brought their concerns to topmanagement. But they held their ground and would not back down. You, too, might becalled upon by circumstances to blow the whistle on unethical practices where you work.The Sarbanes-Oxley Act of 2002 and EthicsWhen the public perception of widespread ethical problems in business exists, theresult is often legislation making certain conduct not only unethical but also illegal.In the late 1990s and early 2000s, the investing and consuming public became awareof several practices, including manipulation of accounting results, designed to

20 Part I Introduction and Overview increase the compensation of managers at several firms. These practices came to light with the failure of many of these businesses when the \"tech bubble\" burst in early 2000. The United States Congress passed legislation in 2002 that was intended to address some of the more serious problems of corporate governance. The legislation, termed the Sarbanes-Oxley Act of 2002, has many provisions and affects both com- panies and accounting firms. For our purposes, some of the important provisions concern those in Title III and Title IV that deal with corporate responsibility and enhanced financial disclosure, respectively. The CEO and CFO are responsible for signing financial statements and stipulating that the financial statements do not omit material information. The requirement that these officers sign the company's finan- cial statements makes it clear that the \"buck stops\" with the CEO and CFO and that they are personally responsible for the financial statements. They cannot legitimately claim that lower-level managers or employees misled them about the financial state- ments, as was stated by defendant executives in many fraud trials in the past. We have learned that top executives are taking this sign-off very seriously, especially knowing that misrepresentation of their company's financial reports could mean substantial prison time. They must further disclose that they have evaluated the company's inter- nal controls and that they have notified the company's auditors and the audit com- mittee of the board of any fraud that involves management. Section 404 of Title IV requires managers to attest to the adequacy of their inter- nal controls. Good internal controls assure that financial records accurately and fairly reflect transactions and that expenditures are in accordance with the authoriza- tion of company management and directors. Further, good internal controls help protect against the unauthorized purchase, use, or sale of company assets. An example of an internal control is the requirement that two people, not just one, sign checks. Requiring two people to sign checks reduces the probability that someone will divert the company's cash to personal use. Sarbanes-Oxley is important for managers who design cost information systems. Whether the cost information is used for pricing decisions or performance evalua- tion, the manager must be aware of the potential that the resulting information could be misleading or support fraudulent activity. Compliance with Sarbanes-Oxley does not, however, mean that the manager has met all of his or her ethical responsibilities.Options Backdating at AppleStock options are a popu lar compensation tool used to moti- imp lications' of backdating. \" (Because the backdating tookvate senior executives. Recently, executives at several com- place in 2001, the CEO was not requi red to attest topan ies have been accused of setting an earlier date for an the financial statements , indicati ng his knowledge of theoption grant than the day the option actually is awarded. (If accounting implications of transactions .) Part IV2 of thethe stock price had been rising, this would increase the Code of Ethics of the Institute of Management Accountingvalue of the option to the executive.) Such a decision (see Appendix) requires members to:requires the firm to recognize as cost of compensation thedifference between the stock price on the date of the grant Disclose al l relevant information that could reasonablyand the stock price on the earlier date indicated. Failure to be expected to influence an intended user's understand-do so is potentially fraudulent. ing of the reports , analyses, or recommendations. One company accused of backdating is Apple, Inc. The former CFO claims that he \"warned Jobs at the timeTwo senior executives, the general counsel and the chief that Apple would likely need to take an accounting charge iffinancial officer, settled charges with the Securities and it issued options on any day other than January 2.\"Exchange Commission (SEC) over the matter. After an inter-nal investigation, Apple's Board of Directors, \"admitted to Sources: P. Burrows, \"Parting Shots at Apple's Jobs ,\" Business-frequent backdating but exonerated [CEO Steven P.J Jobs- Week, Apri l 27 , 2007 ; IMA, http://www. imanetorg/docs/default-in part because Jobs 'did not app reciate the accou nting source/press_re leases/statement-of-ethical-p rofessio nal- practice_2-2-12. pdf?sfvrsn=2.

Chapter 1 Cost Accounting: Information for Decision Making 21Sarbanes-Oxley is a law; ethics is based on behavior. The IMA guidelines suggest youanswer the following questions when faced with an ethical dilemma:• Will my actions be fair and just to all parties affected?• Would I be pleased to have my closest friends learn of my actions? Consider the Business Application discussion of options backdating. You as themanager or cost accountant need to be aware of the powerful incentives created byperformance measurement and compensation systems and how those incentivescould lead to unethical (or even illegal) conduct. For example, imagine the pressureyou would feel to remain silent about unfavorable accounting implications of actionsthat your boss (the CEO) wanted to take. You would probably find it difficult to tellyour boss about these implications, especially when he or she would stand to benefitpersonally from the actions. Self-Study Question4. What are the three essential steps a cost accountant The solution to this question is at the end of the chapter. should take when faced with an ethical conflict? Cost Accounting and Other Business DisciplinesFinally, keep in mind that cost accounting does not exist in a vacuum. The boundarybetween what is cost accounting and what belongs in another discipline is oftenblurred. This is natural because in the \"real world,\" problems are generally multidis-ciplinary. Production managers use cost accounting data to make scheduling andinventory decisions requiring concepts from operations. We will look to some con-cepts from organizational behavior because changes in the cost accounting systemmust be implemented by individuals in the organization who will react in differentways. Marketing issues arise when we use cost accounting data to evaluate pricingdecisions. Throughout the book, we will venture into these other disciplines as a mat-ter of course. ~ The DebriefCarmen takes a break from her classes and talks about what cost accounting with what I will learn in marketing,she has learned : operations, finance, and management. ,,, , Before taking this class, I wondered whether I Carmen identified three important things she picked up fromshould quit the cookie business and take a job with the introduction :another firm. What I learned just from the introductionto my cost accounting class is that there are tools that I 1. Her cookie store is made up of a series of activitiescan learn to use to identify areas for improvement and (the value chain) that combine to add value to thethat can help me analyze some of the decisions I have business.to make. 2. She can use cost information to help her make deci- The example of finding other activities that can sions to increase value , but this information needs to beadd value made me think of something I can add to my tailored to the decision she is trying to make.business-party planning' I sell a lot of cookies to par-ents for birthday parties; it would not be difficult to sup- 3. Business decisions, including the development and useply other food, party favors, and so on. of accounting information , often require us to ask not just what is best in terms of increasing value , but also I've decided to stick with the store. I am especially what is ethical. Accountants , like all managers, need toexcited that I will !earn how to combine what I learn in understand the ethical implications of their actions.

22 Part I Introduction and OverviewSUMMARY This chapter discusses the use of cost accounting in its two primary managerial uses: decision making and perfo rmance evaluation. The following summarizes key ideas tied to the chapter's learning objectives. For example, LO 1-1 refers to the first learning objective in the chapter. LO 1-1 Describe the way managers use accounting information to create value in orga- nizations. Managers make decisions to increase the value of the organization using information from the accounting system. Cost information helps identify value- increasing alternatives and activities that do not add value to the product or service. LO 1-2 Distinguish between the uses and users of cost accounting and financial accounting information. Financial accounting information provides information to users (decision makers) who are not involved in the operations and strategy of the firm. These users are often external to the firm. While cost accounting information is often used in the financial accounting system, its primary role is to aid managers inside the firm in making operational and strategic decisions. LO 1-3 Explain how cost accounting information is used for decision making and per- formance evaluation in organizations. Cost accounting information can be used for decision making by assessing differential costs associated with alternative courses of action. Accounting information also can be used to evaluate performance by comparing budget amounts to actual results. LO 1-4 Identify current trends in cost accounting. Cost accounting changes with changes in information technology and the adoption of new operational techniques. LO 1-5 Understand ethical issues faced by accountants and ways to deal with ethical problems that you face in your career. Ethical standards exist for management accountants. These standards are related to competence, confidentiality, integrity, and objectivity.KEY TERMS activity-based costing (ABC), 14 generally accepted accounting principles benchmarking, 15 (GAAP), 7 budget, 12 cost accounting, 6 international financial reporting standards cost-benefit analysis, 9 (IFRS), 7 cost driver, I0 cost of quality (COQ), 16 just-in-time (JIT) method, 15 customer relationship management lean accounting, 15 nonvalue-added activities, 9 (CRM), 16 outsourcing, 16 differential costs, JO performance measure, 15 differential revenues, JO responsibility center, 11 distribution chain, 5 supply chain, 5 enterprise resource planning (ERP), 16 total quality management (TQM), 16 financial accounting, 6 value-added activities, 4 value chain, 4APPENDIX: INSTITUTE OF MANAGEMENT ACCOUNTANTSCODE OF ETHICS In today's modern world of business, individuals in management accounting and finan- cial management constantly face ethical dilemmas. For example, if the accountant's immediate superior instructs the accountant to record the physical inventory at its origi- nal cost when it is obvious that the inventory has a reduced value due to obsolescence, what should the accountant do? To help make such a decision, here is a brief general discussion of ethics and the \"Statement of Ethical Professional Practice\" by the Insti- tute of Management Accountants (IMA). Ethics, in its broader sense, deals with human conduct in relation to what is morally good and bad, right and wrong. To determine

Chapter 1 Cost Accounting: Information for Decision Making 23 whether a decision is good or bad, the decision maker must compare his/her options with some standard of perfection. This standard of perfection is not a statement of static position but requires the decision maker to assess the situation and the values of the parties affected by the decision. The decision maker must then estimate the outcome of the decision and be responsible for its results. Two good questions to ask when faced with an ethical dilemma are, \"Will my actions be fair and just to all parties affected?\" and \"Would I be pleased to have my closest friends learn of my actions?\" Individuals in management accounting and financial management have a unique set of circumstances relating to their employment. To help them assess their situa- tion, the IMA has developed the following \"Statement of Ethical Professional Prac- tice,\" which is available on their Web site.Statement of Ethical Professional Practice Members of the IMA shall behave ethically. A commitment to ethical professional practice includes overarching principles that express our values, and standards thatguide our conduct.PrinciplesIMA's overarching ethical principles include: Honesty, Fairness, Objectivity, andResponsibility. Members shall act in accordance with these principles and shallencourage others within their organizations to adhere to them.StandardsA member's failure to comply with the following standards may result in disciplinaryaction.I. CompetenceEach member has a responsibility to:1. Maintain an appropriate level of professional expertise by continually developing knowledge and skills.2. Perform professional duties in accordance with relevant laws, regulations, and technical standards.3. Provide decision support information and recommendations that are accurate, clear, concise, and timely.4. Recognize and communicate professional limitations or other constraints that would preclude responsible judgment or successful performance of an activity.II. ConfidentialityEach member has a responsibility to:1. Keep information confidential except when disclosure is authorized or legally required.2. Inform all relevant parties regarding appropriate use of confidential information. Monitor subordinates' activities to ensure compliance.3. Refrain from using confidential information for unethical or illegal advantage.III. IntegrityEach member has a responsibility to:1. Mitigate actual conflicts of interest, regularly communicate with business associates to avoid apparent conflicts of interest. Advise all parties of any potential conflicts.2. Refrain from engaging in any conduct that would prejudice carrying out duties ethically.3. Abstain from engaging in or supporting any activity that might discredit the profession.

24 Part I Introduction and Overview IV. Credibility Each member has a responsibility to : 1. Communicate information fairly and objectively. 2. Disclose all relevant information that could reasonably be expected to influence an intended user's understanding of the reports, analyses, or recommendations. 3. Disclose delays or deficiencies in information, timeliness, processing, or internal controls in conformance with organization policy and/or applicable law. Resolution of Ethical Conflict In applying the Standards of Ethical Profes- sional Practice, you may encounter problems identifying unethical behavior or resolv- ing an ethical conflict. When faced with ethical issues, you should follow your organization's established policies on the resolution of such conflict. If these policies do not resolve the ethical conflict, you should consider the following courses of action: 1. Discuss the issue with your immediate supervisor except when it appears that the supervisor is involved. In that case, present the issue to the next level. If you can- not achieve a satisfactory resolution, submit the issue to the next management level. If your immediate superior is the chief executive officer or equivalent, the acceptable reviewing authority may be a group such as the audit committee, exec- utive committee, board of directors, board of trustees, or owners. Contact with levels above the immediate superior should be initiated only with your superior's knowledge, assuming he or she is not involved. Communication of such problems to authorities or individuals not employed or engaged by the organization is not considered appropriate, unless you believe there is a clear violation of the law. 2. Clarify relevant ethical issues by initiating a confidential discussion with an IMA Ethics Counselor or other impartial advisor to obtain a better understanding of possible courses of action. 3. Consult your own attorney as to legal obligations and rights concerning the ethi- cal conflict. Source: IMA, http://www.imanet.org/docs/default-source/ press_releases/statement-of-ethical-professional-practice_2-2-12. pdf?sfvrsn=2REVIEW QUESTIONS 1-1. Explain why it is important to consider the concepts of value and value creation in a textbook about cost accounting. 1-2. Explain the differences between financial accounting and cost accounting. Why are these differences important? 1-3. Place the letter of the appropriate accounting cost in Column 2 in the blank next to each decision category in Column 1.Column 1 Column 2_ Providing cost information for financial reporting A. Costs for performance evaluation_ Identifying the best store in a chain B. Costs for inventory valuation_ Determining which plant to use for production C. Costs for decision making1-4. Distinguish among the value chain, the supply chain, and the distribution chain.1-5. Who are the customers of cost accounting?1-6. How can cost accounting information together with a classification of activities into those that are value-added and those that are nonvalue-added help managers improve an organization's performance?1-7. Identify three key financial managers in an organization and their major responsibilities.1-8. Does the passage of Sarbanes-Oxley mean that codes of ethics are no longer necessary?

Chapter 1 Cost Accounting: Information for Decision Making 25CRITICAL ANALYSIS AND DISCUSSION QUESTIONS1-9. After the first day of cost accounting, your friend says, \"The role of accountants is to report what happened. Why do we care about value creation. That's not my responsi- bility.\" Do you agree? Explain.1-10. An airline executive asks you, \"How would you calculate the cost of a passenger?\" What will be your first question to the manager?1-11. You are considering lending a car to a friend so she can drive to Aspen . What costs would you ask her to reimburse? How would your answer change, if at all , if you decided to go along? Identify the possible options and explain your choices.1-12. \"It's not the job of accounting to determine strategy. It is only used to measure results. \" Discuss.1-13. Would you support a proposal to develop a set of \"generally accepted\" accounting standards for measuring executive performance that would be used to determine com- pensation? Why or why not?1-14. How would cost accounting information help managers in a not-for-profit organiza- tion? Is it as important as in a publicly traded, for-profit firm?1-15. Airlines are well known for using complex pricing structures. For example, it is often (but not always) less expensive to buy a ticket in advance than it is on the day of the flight. However, if the airline offered this lower (\"discount\") fare for all seats, it could not remain in business. Why offer fares with different prices? What, if any, costs are different?1-16. Nabisco (a unit of Kraft Foods) makes a variety of cookies (Oreos™, for example) just like Carmen's Cookies. In what ways are the cost accounting issues the same? In what ways are they different?1-17. What potential conflicts might arise between marketing managers and the controller's staff? How might these potential conflicts be resolved with a minimum of interference from the chief executive officer?1-18. Refer to the Business Application discussion of supply chain costs. A colleague says, \"We don't have to worry about other firms in the supply chain. If every firm in the chain minimizes its own cost, we can minimize the total cost and give the customer the best value.\" Do you agree?1-19. Refer to the Business Application discussion of options backdating. If stock options and other forms of performance-based compensation result in some managers engag- ing in unethical or illegal behavior, why do firms still use them?1-20. Why does a cost accountant need to be familiar with new developments in information technology?1-21. Will studying cost accounting increase the chances that Carmen's Cookies will suc- ceed? How? Will it guarantee success? Explain.1-22. Many companies, especially in the travel industry (airlines, hotels, and so on) have so- called loyalty programs offering members benefits that depend on the frequency of pur- chase, miles traveled, or amount of money spent among other measures. One example is upgrades to a better seat or to a better room, for the same price as a regular seat or regu- lar room. Such upgrades are generally based on availability, meaning the hotel or airline does not believe it will sell the room or seat. What, if anything, does such an upgrade cost the hotel or airline? Would these costs show up in the accounting records? Explain.All applicable Exercises are included in Connect. 11 comect EXERCISES1-23. Value Chain and Classification of Costs (LO 1-1)Apple Inc., incurs many types of costs in its operations.RequiredFor each cost in the following table, identify the stage in the value chain where this cost is incurred:Cost Stage In the Value Chain_ Programmer costs for a new operating system 1. Marketing_ Costs to ship computers to customers 2. Production_ Call center costs for support calls 3. Customer Service__ Salaries for employees working on new product designs 4. Research and development__ Costs to purchase advertising at university stores 5. Design_ Costs of memory chips to make computers 6. Distribution

26 Part I Introduction and Overview(LO 1-1) 1-24. Supply Chain and Supply Chain Costs Coastal Cabinets produces cabinets for new home builders. You have been called in to settle a~ dispute between Coastal Cabinets and Executive Homes, a builder of custom homes. Executive Homes buys 20,000 units of a particular cabinet from Coastal Cabinets every year. It insists that Coastal keep a one-month inventory to accommodate fluctuations in Exec- utive's demand. Coastal does not want to keep any inventory and says that Executive Homes should buy components in advance and store them. You determine that the inventory storage costs per unit are $50 at Coastal and $125 at Executive Homes. Required How do you suggest the two companies settle their dispute?(LO 1-2) 1-25. Accounting Systems McDonald's is a major company in the restaurant business. Required For each of the decisions below, indicate whether the decision maker would be more likely to get information from the financial (F) or cost (C) accounting system of McDonald's (in addi- tion, perhaps, to other information). a. An investor is deciding whether to purchase stock in McDonald's. b. A marketing manager at McDonald's is trying to determine whether to offer breakfast items all day long. c. A fast-food competitor wants to compare her company's financial performance to McDon ald 's. d. A labor organization representing workers at McDonald 's outlets is deciding whether McDonald's is profitable enough to negotiate for pay raises. e. An advertising manager at McDonald's is deciding what media to use for commercials based on the profitability of different demographic groups.(LO 1-2) 1-26. Accounting Systems Ford Motor Company manufactures cars and trucks. Managers at assembly plants must make many decisions, and for this they use cost accounting information. Required For each of the following managers, identify a decision that he or she might make for which cost accounting data would be useful: a. Plant manager b. Purchasing manager c. Quality supervisor d. Personnel manager e. Maintenance supervisor(LO 1-3) 1-27. Cost Data for Managerial Purposes As an analyst at Delta Air Lines, you are asked to help the operations staff. Operations has~ identified a new method of loading baggage that is expected to result in a 30 percent reduction in labor time but no changes in any other costs. The current labor cost to load bags is $2 per bag. Other costs are $1 per bag. Required a. What differential costs should the operations staff consider for the decision to use the new method next year? What would be the cost savings per bag using it? b. Describe how management would use the information in requirement (a) and any other appropriate information to proceed with the contemplated use of the new baggage load- ing method.(LO 1-3) 1-28. Cost Data for Managerial Purposes Betty's Fashions operates retail stores in both downtown and suburban locations. The com- pany has two responsibility centers: the City Division, which contains stores in downtown locations, and the Mall Division, which contains stores in suburban locations. Betty's CEO is concerned about the profitability of the City Division, which has been operating at a loss for the last several years. The most recent City Division income statement follows. The CEO has

Chapter 1 Cost Accounting: Information for Decision Making 27asked for your advice on shutting down the City Division's operations. If the City Division iseliminated, corporate administration is not expected to change, nor are any other changesexpected in the operations or costs of the Mall Division. BETTY'S FASHIONS, CITY DIVISION Divisional Income Statement For the Year Ending January 31Sales revenue. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $8,600,000Costs 350,000 Advertising-City Division . . ......... . .... . . 4,300,000 Cost of goods sold ............... .. ... . . . Divisional administrative salaries ....... .. . .. . 580,000 Selling costs (sales commissions) ..... .. . . . . 1,160,000 Rent. . . ... .. . ..... . . . . .. . .. . . . .. .. ... . · 1,470,000 Share of corporate administration .. .. ....... . 950,000Total costs .. ...... . . ...... .. . ............ . $8,810 ,000Net loss before income tax benefit ... . ....... . . $ (210,000)Tax benefit at 40% rate ..................... . 84,000 fNet loss ... . .. . .... . .. ... . .. . .. ... ...... . . $ (126,000)RequiredWhat revenues and costs are probably differential for the decision to discontinue the CityDivision's operations? What will be the effect on Betty's profits if the division is eliminated? Isthere any other information you would like to have before recommending whether or not toclose the City Division?1-29. Cost Data for Managerial Purposes (LO 1-3)State University Business School (SUBS) offers several degrees, including Bachelor of BusinessAdministration (BBA). The new dean believes in using cost accounting information to makedecisions and is reviewing a staff-developed income statement broken down by the degree offered.The dean is considering closing down the BBA program because the analysis, which follows,shows a loss. Tuition increases are not possible. The dean has asked for your advice. If the BBAdegree program is dropped, school administration costs are not expected to change, but directcosts of the program, such as operating costs, building maintenance, and classroom costs, wouldbe saved. There will be no other changes in the operations or costs of other programs.( STATE UNIVERSITY BUSINESS SCHOOL, BBA DEGREE Degree Income Statement~ For the Academic Year Ending June 30 IRevenue .. .. ... .. .. . . .. . . . .. ............ . $6,000,000j Costs~ Advertising-SBA program .... ... . . .. . ... . . 225,000 3,060,000I Faculty salaries ...... . .. .. .... ...... ... . .I Degree operating costs (part-time staff) .. .. .. . 390,000I Building maintenance .. ... ............... . 555,000 Classroom costs (building depreciation) . .. . . . 1,275,000 Allocated school administration costs .. ... . .. . 645,000Total costs ... . .... . .... . .... . ..... . .... . . . $6,150,000Net loss ... ....... .. ... . .... . ... . .. ... . . . . $ (150,000)RequiredWhat revenues and costs are probably differential for the decision to drop the BBA program?What will be the net effect on the SUBS contribution (profit) if the BBA program is dropped? Isthere any other information you would like to have before recommending whether or not todrop the BBA program?

28 Part I Introduction and Overview(LO 1-3) 1-30. Cost Data for Managerial Purposes Refer to the information in Exercise 1-29. The dean of the Business School is considering expanding the BBA program by offering an evening program in a nearby city. The new eve- ning program would be the same size (in terms of students). The school 's CFO estimates that the combined BBA revenue (on-campus plus the evening program) will be twice the current revenue, as shown in Exercise 1-29. Because the evening program will be new, advertising expenses for the evening session will be three times their current level. Faculty salaries will double. Degree operating costs will increase by 50 percent. Building maintenance and class- room costs will remain unchanged, but classroom space will be rented at a cost of $300,000 per academic year. School administration costs will increase by $30,000, and allocated school administration costs (for both programs) will be $780,000 per academic year. Required a. What will the contribution of the combined BBA program be, given these estimates? b. Are there other factors the dean should consider before making a decision?(LO 1-3) 1-31. Cost Data for Managerial Purposes-Budgeting Refer to Exhibit 1.5, which shows budgeted versus actual costs. Assume that Carmen's Cook- ies is preparing a budget for the month ending June 30. Management prepares the budget by starting with the actual results for April 30 that appear in Exhibit 1.5. Next, management considers what the differences in costs will be between April and June. Management expects the number of cookies sold to be 20 percent greater in June than in April, and it expects all food costs (e.g. , flour, eggs) to be 20 percent higher in June than in April. Management expects \"other\" labor costs to be 25 percent higher in June than in April , partly because more labor will be required in June and partly because employees will get a pay raise. The manager wi ll get a pay raise that will increase the salary from $3,000 in April to $4,000 in June. Rent and utilities are not expected to change. Required Prepare a budget for Carmen's Cookies for June.(LO 1-4) 1-32. Trends in Cost Accounting Required For each cost accounting development listed below, identify one value chain component where it might be used and describe how it could be used in that component. a. Activity-based costing b. Benchmarking c. Cost of quality d. Customer relationship management e. Lean accounting(LO 1-4) 1-33. Trends in Cost Accounting The chapter identified five financial management titles with responsibilities. Required Match the financial management title in the first column with the major responsibility in the second column of the following table: Title Responsibility CFO 1. Ensures procurement rules are followed Treasurer 2. Evaluates costs of products. Controller 3. Determines where to invest cash balances. Internal auditor 4. Maintains accounting records. Cost accountant 5. Signs off on financial statements.(LO 1-5) 1-34. Ethics and Channel Stuffing Continental Condiments is a large food products firm in Pennsylvania. Its sales staff has a strong incentive plan tied to meeting quarterly budgets. On June 25, Maria Tuzzi, a divisional controller, learns that some of the sales staff asked customers to take delivery of sizable quan- tities of products before June 30. The customers were told they could return the products after

Chapter 1 Cost Accounting: Information for Decision Making 29July 1 if they determined the items were not needed. (This is referred to as \"channel stuffing. \")The sales staff also offered to reimburse the customers for any storage costs incurred.Requireda. From the viewpoint of the IMA's \"Statement of Ethical Professional Practice,\" what are Maria's responsibilities?b. What steps should she take to resolve this problem? (CMA adapted)1-35. Ethics and Cost Analysis (LO 1-5)Refer to the information in Exercise 1-30. Jon Blake, the cost analyst working in the CFO'soffice at the Business School, learns that the building to be rented for the evening program isowned by a company in which the dean is a principal investor. After some research, Jon alsoidentifies another comparable site, which rents for $75,000 per year.Requireda. From the viewpoint of the IMA's \"Statement of Ethical Professional Practice,\" what are Jon's responsibilities?b. What steps should he take to resolve this problem? • comectAll applicable Problems are included in Connect. PROBLEMS1-36. Responsibility for Ethical Action (LO 1-5)Dewi Hartono is an assistant controller at Giant Engineering, which contracts with theDefense Department to build and maintain roads on military bases. Dewi recently determinedthat the company was including the direct costs of work for private clients in overhead costs,some of which are charged to the government. She also discovered that several members ofmanagement appeared to be involved in altering accounting invoices to accomplish this. Shewas unable to determine, however, whether her superior, the controller, was involved. Dewiconsidered three possible courses of action . She could discuss the matter with the controller,anonymously release the information to the local newspaper, or discuss the situation with anoutside member of the board of directors whom she knows personally.Requireda. Does Dewi have an ethical responsibility to take a course of action?b. Of the three possible courses of action, which are appropriate and which are inappropriate? ( CMA adapted)1-37. Cost Data for Managerial Purposes (LO 1-3)Imperial Devices (ID) has offered to supply the state government with one model of its secu-rity screening device at \"cost plus 20 percent.\" ID operates a manufacturing plant that can ex celproduce 66,000 devices per year, but it normally produces 60,000. The costs to produce 60,000devices follow:------------ . --- - -- -·- ··-----Production costs: Total Cost Cost per Materials..... ..... ..... ... ... ..... ...... ... .... ...... ... ..... ... ... .......... ... .. ... . Device Labor .............. ... ... ..... .. ... .... .. ...... ............... ...... .......... .. ..... .. . $ 4,500,000 Supplies and other costs that will vary with production ... .. .. 9,000,000 $ 75 Indirect cost that will not vary with production ... ............ ..... . 2 ,700,000 150 2,700,000Variable marketing costs ...... ..... .. .. .... .. .. ......................... ...... ... 1,800,000 45Administrative costs (will not vary with production) ..... .... ..... ... 5,400,000Totals 45 $26,100,000 30 90 $435 Based on these data, company management expects to receive $522 (= $435 x 120 percent)per monitor for those sold on this contract. After completing 500 monitors, the company senta bill (invoice) to the government for $261 ,000 (= 500 monitors x $522 per monitor).

30 Part I Introduction and Overview The president of the company received a call from a state auditor, who stated that the per monitor cost should be: Materials... ..... ..... ... ...... ...... ... ... ... ..... ............ ..... .......... ........ ... ... ....... $ 75 Labor....... .......... ... .. .. .......... ........ .......... .. .......... .... ...... ..... ....... .. ....... 150 Supplies and other costs that will vary with production ... ............... ----1§. $270 Therefore, the price per monitor should be $324 (= $270 x 120 percent). The state govern- ment ignored marketing costs because the contract bypassed the usual selling channels. Required What price would you recommend? Why? (Note: You need not limit yourself to the costs selected by the company or by the government auditor.)(LO 1-3) 1-38. Cost Data for Managerial Purposes You have been asked by two of your friends, Marco and Jenna, to settle a (friendly) argument they are having about splitting the cost of a road trip during Spring Break. They will take Jenna's car and they have agreed to \"share the cost\" of the drive. Based on current fuel prices and the mileage of Jenna's car, the fuel cost is roughly $0.20 per mile. Marco says he should pay about $0.13 per mile for the fuel , plus a small amount ($0.03) for other variable costs (such as routine maintenance). Jenna says that he should pay 50 percent of $0.56, which is the current rate the Internal Revenue Service (IRS) allows for the use of a personal car. In addi- tion to fuel and routine maintenance, the IRS rate is designed to cover \"wear and tear\" on the car. Marco argues that the wear and tear would occur whether he went on the trip or not. Required a. What would you recommend Marco pay Jenna per mile for sharing the car? Explain briefly. b. Would your answer to Requirement (a) change depending on whether or not Jenna was going to take the trip, whether or not Marco went along? Explain briefly. (LO 1-3) 1-39. Cost Data for Managerial Purposes T-Comm makes a variety of products. It is organized in two divisions, North and South. Theex cel managers for each division are paid, in part, based on the financial performance of their divi- sions. The South Division normally sells to outside customers but, on occasion, also sells to the North Division. When it does, corporate policy states that the price must be cost plus 15 percent to ensure a \"fair\" return to the selling division. South received an order from North for 600 units. South's planned output for the year had been 2,400 units before North's order. South's capacity is 3,000 units per year. The costs for producing those 2,400 units follow: Materials ............ ... ... ....... ..... ... ... ... .. .. ................ .. ... ... ..... ... .. .. Total Per Unit Direct labor .... ........... ... .. ...... .. ..... .... ...... ..... .... ..... ...... ......... ... $ 480,000 $ 200 Other costs varying with output ... .......... ..... ...... ......... ..... ... .. . Fixed costs (do not vary with output) ......................... .. .... ... .. 230,400 96 153,600 64 Total costs 2,016,000 840 $2,880,000 $1 ,200 Required a. If you are the manager of the South Division, what unit cost would you ask the North Division to pay? Show calculations. b. If you are the manager of the North Division, what unit cost would you argue you should pay? Show calculations. c. What unit cost would you recommend for a sale of units from the South Division to the North Division? Explain briefly.(LO 1-3) 1-40. Cost Data for Managerial Purposes Campus Package Delivery (CPD) provides delivery services in and around Paradise. Its profits have been declining, and management is planning to add an express service that is expected to increase revenue by $50,000 per year. The total cost to lease the necessary additional package

Chapter 1 Cost Accounting: Information for Decision Making 31delivery vehicles from the local dealer is $7,500 per year. The present manager will continue to e\"Vc' e#supervise all services at no increase in salary. Due to expansion, however, the labor costs andutilities would increase by 50 percent. Rent and other costs will increase by 20 percent. ~\" I- - A _J_______ B 1 CAMPUS PACKAGE DELIVERY 2 Annual Income Statement before Expansion I 3 - --- ---- s I i 1s2,ooot 4 Sales revenue 5 Costs -f I 6 Vehicle leases 60,000 I 7 Labor I 48,ooo I 8 Utilities $ s.ooo I 9 Rent I 10 Other costs I 16,000 , 11 Manager's salary 12 Total costs s,ooo I 13 Operating profit (loss) 24,000 I i 164,ooo I i (12,000) I 14 I IRequireda. Prepare a report of the differential costs and revenues if the express service is added. (Hint: Use the format of Exhibit 1.3.)b. Should management start the express service?c. Are there factors beyond the differential costs and revenues that management should consider?1-41. Cost Data for Managerial Purposes (LO 1-3)KC Services provides landscaping services in Edison. Kate Chen, the owner, is concernedabout the recent losses the company has incurred and is considering dropping its lawn ser-vices, which she feels are marginal to the company's business. She estimates that doing so willresult in lost revenues of $150,000 per year (including the lost tree business from customerswho use the company for both services). The present manager will continue to supervise thetree services with no reduction in salary. Without the lawn business, Kate estimates that thecompany will save 15 percent of the equipment leases, labor, and other costs. She also expectsto save 20 percent on rent and utilities.Requireda. Prepare a report of the differential costs and revenues if the lawn service is discontinued. (Hint: Use the format of Exhibit 1.3.) AB C1 KC SERVICES2 - Annual Income Statement I3 (Before Dropping Lawn Services)45 Sales revenue i 912,000 I6 Costs - - - - -·- --- I- -- - -- -- $ 360.0007 Equipment leases8 Labor 288,0009 Utilities 48,00010 Rent 96,000 11 Other costs - -- - - -- - - -- -4-8,-·,000 120,0001 21- - -- -- - -- i 960,000 Manager's salary i (48,000)13 Total costs14 Operating profit (loss)15b. Should Kate discontinue the lawn service?c. Are there factors other than the differential costs and revenues that Kate should consider?1-42. Cost Data for Managerial Purposes (LO 1-3)B-You is a consulting firm that works with managers to improve their interpersonal skills.Recently, a representative of a high-tech research firm approached B-You's owner with anoffer to contract for one year with B-You to improve the interpersonal skills of a newly hiredmanager. B-You reported the following costs and revenues during the past year:

32 Part I Introduction and Overviewex cel B-YOU -2- - + - - - - - -Annual Income S·t--ate· -m-e·-n\"t- · -----1-------- 3 4 Sales reven ue $ 504.000 - - ---- -------f-- ------- ----------- -- - - -----------------------------------t---- 5 Costs 6 Labor 239,400--+-- -------l ___!__ _ Equipment lease _ _ _ _____ ____--_3~280 I 4 30,240 1---- 8 Rent 9 - Supplies _ _______j :f~o_--+J-___-__-____-______-__ 1 10 Officers' salaries 147,000 ~ - - - -- - -·--·---·-· -- - -- - - - - - 1 - - - - - - - - - - - - - - - + - - - - --l 11 Other costs 15,960 ,__1_2-+-l-io-ta_l_c-os_t_s- - - - - - - - - - - - + - - - -$-4-90,56=0-+------1 13 - Operating profit (loss) _______________ ______ $ 13,440 14 If B-You decides to take the contract to help the manager, it will hire a full-time consultant at $85,000. Equipment lease will increase by 5 percent. Supplies will increase by an estimated 10 percent and other costs by 15 percent. The existing building has space for the new consul- tant. No new offices will be necessary for this work. Required a. What are the differential costs that would be incurred as a result of taking the contract? b. If the contract will pay $90,000, should B-You accept it? c. What considerations, other than costs, do you think are necessary before making this decision?(LO 1-3) 1-43. Cost Data for Managerial Purposes Tom's Tax Services is a small accounting firm that offers tax services to small businesses and individuals. A local store owner has approached Tom about doing his taxes but is concerned about the fees Tom normally charges. The costs and revenues at Tom's Tax Services follow. If Tom gets the store's business, he will incur an additional $60,000 in labor costs. Tom also estimates that he will have to increase equipment leases by about 10 percent, supplies by 5 percent, and other costs by 15 percent. _____________________ A ___________________ __l_ ____ B ______ C:::______ TOM'S TAX SERVICES - - - - - ------ - - - - - + -- -- < 2 Annual Income Statement 3 , ~- ~~i_!eiv_e__n_u_e_________ __ _ _ ________ $ 720.0051______ 6 Labor - --f--- 4n .ooof---- - 1----- l---- - - - - - - - - - -- - --+--- 50,400 7 Equipment lease 1--8---+-_R_e_nt_ __ _ __ _ _ _ _--+_ _ _4_3~,2_0_0 1----- -a 9 -~ LJ_pplie~ 32,400 10 ___ Tom's_salary ___________________ ______ ________?_?_,_o_q~ ________ , _1_1__ Other costs 22.800 i -f2 Total costs $ 700.800 I !13 Operating pro._f:_i:t:_c(-:.:lo::s:s:,_)_ _ _ _ _-+---------'='$=1=9=.2=0=0+--- ---l 14 Required a. What are the differential costs that would be incurred as a result of adding this new client? b. Tom would normally charge about $75,000 in fees for the services the store would require. How much could he offer to charge and still not lose money on this client? c. What considerations, other than costs, are necessary before making this decision?(LO 1-3) 1-44. Cost Data for Managerial Purposes-Budgeting Refer to Exhibit 1.5. Assume that Carmen's Cookies is preparing a budget for the month end- ing September 30. Management prepares the budget by starting with the actual results fo r April that appear in Exhibit 1.5. Then, management considers what the differences in costs will be between April and September. Management expects cookie sales to be 20 percent greater in September than in April, and it expects all food costs (e.g., flour, eggs) to be 20 percent higher in September than in

Chapter 1 Cost Accounting: Information for Decision Making 33April because of the increase in cookie sales. Management expects \" other\" labor costs tobe 25 percent higher in September than in April, partly because more labor will be requiredin September and partly because employees will get a pay raise. The manager will get a payraise that will increase the salary from $3,000 in April to $3 ,500 in September. Utilities willbe 5 percent higher in September than in April. Rent will be the same in September as inApril. Now, fast forward to early October and assume the following actual results occurred inSeptember: IA BC1 CARMEN'S COOKIES,._2 - - - · Retail Responsibility Center 3 Actual Costs For the ----- ------- 4 Month Ending September 30_________5 ~----- _ _Actu,.al .6 (September)-n--------' - -· -·--- $ 2,700 -------- 7 I Food 8 Flour9 , Eggs 6,50010 I Chocolate 2,100--11 Nuts 2,300 ·- _LlQQ- - - - - - - ---- $16,300 12 Other 13 Total food14 Labor ' 15 - ~ ~~ager ~ - ------- $ 3,500 ----1.§§Q-·- $ 5,35016 Other17 Total labor18 Utilities 2,200 19 Rent __Q,QQQ $28,850 - -- - - - - - - -·· 38,400- - - - - - ~ 20 Total cookie costs - - - - - ·- 21 Number of cookies sold 22 i IRequireda. Prepare a statement like the one in Exhibit 1.5 that compares the budgeted and actual costs for September.b. Suppose that you have limited time to determine why actual costs are not the same as budgeted costs. Which three cost items would you investigate to see why actual and bud- geted costs are different? Why would you choose those three costs?1-45. Cost Data for Managerial Purposes-Budgeting (LO 1-3)Refer to Exhibit 1.5, which shows budgeted versus actual costs. Assume that Carmen's Cook-ies is preparing a budget for the month ending November 30. Management prepares the bud-get for the month ending November 30 by starting with the actual results for April that appearin Exhibit 1.5. Then, management considers what the differences in costs will be betweenApril and November. Management expects cookie sales to be 100 percent greater in November than in Aprilbecause of the holiday season. Management expects that all food costs (e.g., flour, eggs) willbe 120 percent higher in November than in April because of the increase in cookie sales andbecause prices for ingredients are generally higher in the high demand holiday months. Man-agement expects \"other\" labor costs to be 120 percent higher in November than in April,partly because more labor will be required in November and partly because employees will geta pay raise. (120 percent higher means that the amount in November will be 220 percent of theamount in April.) The manager will get a pay raise that will increase the salary from $3,000 inApril to $3,500 in November. Utilities will be 5 percent higher in November than in April.Rent will be the same in November as in April. Now, move ahead to December and assume the following actual results occurred inNovember:

34 Part I Introduction and Overview --+----------~-'---·-·--·--i---·- B_ _ ___j___C 1----+~u_m_b_e_r o_f c_o_()_~_s_s~~ ---+---- - 64,000 2I ~: ~~1·. j: - F_lo_u_r____. -----1-- I $ 1 :.it\"'' -=:!-==-~± l-+- - --~ H~ ~ ~~~ger_'s_sa_la_ry_ ___ _ I 1~_:;_;,~~boc - - ..-.-..-_-_-_tr:~- Required a. Prepare a statement like the one in Exhibit 1.5 that compares the budgeted and actual costs. b. Suppose that you have limited time to determine why actual costs are not the same as budgeted costs. Which three cost items would you investigate to see why actual and bud- geted costs are different? Why would you choose those three costs?(LO l -3) 1-46. Cost Data for Managerial Purposes-Finding Unknowns Quince Products is a small company in southern California that makes jams and preserves. Recently, a sales rep from one of the company's suppliers suggested that Quince could increase its profitability by 50 percent if it introduced a second line of products, packaged fruit. She offered to do the analysis and show the company her assumptions. When Quince's management opened the spreadsheet sent by the sales rep, they noticed that there were several blank cells. In the meantime, the sales rep had taken a job with a com- petitor and told the managers at Quince that she could no longer advise them. Although they were not sure they should rely on the analysis, they asked you to see if you could reconstruct the sales rep's analysis. They had been considering this new business already and wanted to see if their analysis was close to that of an outside observer. The incomplete spreadsheet follows. •- - + - - -A- - - + - - - - ·-B-· - ······~--- C D E- - - + - -F - -H 1 QUINCE PRODUCTS 2 Projected Income Statem_ e_n_t____+ - - - - - - - - + - -·- -H ~.! For One Month 4, I Status Quo: ' % Increase Alternative: 1-----+-----+-1--+ ---- - -- ----- - _5 I_S!J-~~ revenue___ I Single Product (Decrease) Two Products I Difference -- - - ~-(d)- -- - --- -- - ~- _ __ _ __ 30% $13,000 ~ =\"\"(e=)= ~ - + - - - - - +·I * costs______ -- ------ --·-- · ·-- -- ------- ----- ---------------------~---t ___________ .. . . ~ ; - - · ···--~~i --~ j__fv1at~!~---·-··---··- ···-- _ ~.g_()_~- _________ 40o~/ ~-- 2,800 . ~- I .. 19oJ- ~:~~r ·-j\"·-·--·-- 2~~ 1 ~~~ ---t-- 1_~; t_s- - ~~~h==-1-1+p~~~ec:1at~n·---+---- 400 I ___ 25% 500 ____ J _ ~ _ 25 ±--1- (h) 1_.g~L -(,) - 35at----- oi % · ---- __ (g) - - (f) ~ LTO~()_S~---- __ _j!_,6Clg+------·- -- - ~· ~~j_Op~_a!i_llfJ ~~o_!i_t___ ___J~_._4_(:)Cl f-----_(a)___ ~ (bl $ (cl __ ~161- - - --- - - --- I, Required Fill in the blank cells.INTEGRATIVE CASES(LO 1-5) 1-47. Identifying Unethical Actions (Appendix) The managers of Quince Products (Problem 1-46) decide they will hire a management accoun- tant to help them analyze the decision to expand their product line. They solicit bids from various accountants in the city and receive three proposals. In describing their qualifications for the job, the three state:

Chapter 1 Cost Accounting: Information for Decision Making 35Accountant A: \"I have recently advised the symphony on how to raise money and therefore Iknow the local area well.\"Accountant B: \"I have advised several small firms on expansion plans.\"Accountant C: \"I have advised Pear Company [Quince's main competitor] and can share itsexperiences and insights with you.\"All of the proposals have the same price.Requireda. As the accounting manager of Quince Products, prepare a memo recommending which accountant you would prefer to retain. Be sure to include your reasons.b. Which, if any, of the accountants making a proposal are violating the IMA's code of ethics? What is (are) the violation(s)?1-48. Cost Data for Managerial Purposes-Finding Unknowns (LO 1-3)Miller Cereals is a small milling company that makes a single brand of cereal. Recently, a busi-ness school intern recommended that the company introduce a second cereal in order to\"diversify the product portfolio.\" Currently, the company shows an operating profit that is20 percent of sales. With the single product, other costs were twice the cost of rent. The intern estimated that the incremental profit of the new cereal would only be 2.5 percentof the incremental revenue, but it would still add to total profit. On his last day, the intern toldMiller's marketing manager that his analysis was on the company laptop in a spreadsheet witha file name, NewProduct.xlsx. The intern then left for a 12-month walkabout in the outbackof Australia and cannot be reached. When the marketing manager opened the file, it was corrupted and could not be opened.She then found an early (incomplete) copy on the company's backup server. The incompletespreadsheet is shown following. The marketing manager then called a cost managementaccountant in the controller's office and asked for help in reconstructing the analysis.RequiredAs the management accountant, fill in the blank cells. MILLER CEREALS Projected Income Statement for One Year Status Quo: % Increase Alternative: ~j Single Product (Decrease) Two Products ~Sales revenue i......@l 40% L(Ql Difference $60,000Costs Material ................. . 40,000 U) 60,000 (k) ~ Labor ........... ........ ... (I) 20% 60,000 (m) Rent ... .................... (q) 50% (u) I Depreciation .... ..... .. (n) (s) Utilities ............... ... . 8,000 (p) 8,000 1,000 l Other ..................... . (o) 5,000 (v) (r) (f) .{b.l ~ .{g)_ (t) (c) .$___@ ill @l \"1-49. Identifying Unethical Actions (Appendix) (LO 1-5)Before Miller Cereals can introduce the new cereal, the board of directors has to give theirapproval. The marketing manager really wants to introduce the new product and believes(honestly) that it will be profitable and an important next step in the firm's evolution. How-ever, she knows that with the forecasted profit, the board will not give their approval. She asks the management accountant what she can do. He tells her that he has reviewed thenumbers generated by the intern and he thinks they are reasonable. However, he tells her that

36 Part I Introduction and Overview \"other\" costs consist of many different things, so it would be difficult to question a lower number. He suggests that he lower the estimated other costs by an amount sufficient to get board approval. Required Is the management accountant violating the IMA's code of ethics? If so, what is (are) the violation(s)?(LO 1-5) 1-50. Responsibility for Unethical Action The following story is true except that all names have been changed and the time period has been compressed: Charles Austin graduated from a prestigious business school and took a job in a public accounting firm in Atlanta. A client hired him after five years of normal progress through the ranks of the accounting firm. This client was a rapidly growing, publicly held company that produced software for the health care industry. Charles started as assistant controller. The company promoted him to controller after four years. This was a timely promotion. Charles had learned a lot and was prepared to be controller. Within a few months of his promotion to controller, the company's chief financial officer abruptly quit. Upon submitting her resignation, she walked into Charles's office and said, \"I have given Holmes (the company president) my letter of resignation. I'll be out of my office in less than an hour. You will be the new chief financial officer, and you will report directly to Holmes. Here is my card with my personal cell phone number. Call me if you need any advice or if I can help you in any way.\" Charles was in over his head in his new job. His experience had not prepared him for the range of responsibilities required of the company's chief financial officer. Holmes, the com- pany president, was no help. He gave Charles only one piece of advice: \"You have lots of freedom to run the finance department however you want. There is just one rule: Don't ever cross me. If you do, you'll never work again in this city.\" Charles believed his boss could follow through on that threat because he was so well-connected in the Atlanta business community. The end of the company's fiscal year came shortly after Charles's promotion to chief finan- cial officer. After reviewing some preliminary financial amounts, Holmes stormed into Charles's office and made it clear that the results were not to his liking. He instructed Charles to \"find more sales.\" Charles was shocked, but he did as he was told. He identified some ongoing software installation work that should not have been recorded as revenue until the customer signed off on the job. Charles recorded the work done as of year-end as revenue, even though the customer had not signed off on the job. He sent an invoice to the customer for the amount of the improper revenue, then called her to say that the invoice was an accounting error and she should ignore it. Next year, Charles's work life was better but his personal life was not. He went through a costly divorce that resulted in limited time spent with his two small children. Now he was particularly concerned about not crossing his boss because of the threat that he would never work in Atlanta if he did. He could not bear to look for a new job that would take him away from his children. Further, it would be difficult to find a job anywhere that came close to pay- ing the salary and benefits of his current job. With high alimony and child support payments, Charles would feel a dire financial strain if he had to take a cut in pay. The company struggled financially during the year. Clearly, the company would not gen- erate the level of revenues and income that Holmes wanted. As expected, he again instructed Charles to find some way to dress up the income statement. It did not matter to Holmes whether what Charles did was legal or not. Charles had exhausted all legitimate ways of reducing costs and increasing revenues. He faced an ethical dilemma. He could resign and look for a new job, or he could illegitimately record nonexistent sales. He now understood why the former chief financial officer had resigned so abruptly. He wished that he could talk to her, but she was traveling in Australia and could not be contacted. The board of directors would be no help because they would take the president's side in a dispute. After considering his personal circumstances, Charles decided to record the illegitimate sales as the president had instructed. Charles knew that what he did was wrong. He believed that if the fraud was discovered, Holmes, not he, would be in trouble. After all, Charles ratio- nalized, he was just following orders. Required a. Can you justify what Charles did? b. What could Charles have done to avoid the ethical dilemma that he faced? Assume that the company president would have made it impossible for Charles to work in Atlanta in a comparable job.

Chapter 1 Cost Accounting: Information for Decision Making 37c. What if the Securities and Exchange Commission discovered this fraud? Would Charles's boss get in trouble? Would Charles? (Copyright © Michael W Maher, 2017) SOLUTIONS TO SELF-STUDY QUESTIONS 1. All costs in Exhibit 1.3 would increase 35 percent, as shown in the spreadsheet that follows. Total costs would increase from $5,450 in the status quo to $7,357.50 (= 135% x $5,450). Profits would increase from $850 in the status quo to $1,147.50 (= $8,505.00 revenues - $7,357.50 costs). Carmen's profits increase compared to the status quo but not as much as in Exhibit 1.3 because some of the costs there do not increase proportionately with sales revenue.2. Examples of questions for which cost accounting information would be useful include these: For a hospital administrator: - Where should I purchase supplies? - What services cost more than the reimbursements we receive from insurers? - Should we invest in a new CAT scanner? For a museum director: - What ticket prices should we charge? - Should we expand the hours of the museum cafe? - Are opening galas profitable? For a bank's marketing vice president: - Where should I spend my advertising dollars? - If we lower the rate on checking accounts, how much will we lose when customers switch? - What fees should we set for online banking?3. Causes of changes include (but are not limited to) the following: Accounting has become more computerized, thus reducing manual bookkeeping. Increased competition in many industries, including automobiles and electronic equipment, has increased management's interest in managing costs. Development of more highly technical production processes has reduced emphasis on labor and increased emphasis on overhead cost control. Developments in new management techniques have affected accounting. For example, by reducing inventory levels, JIT methods have reduced the need to compute the costs of inventory.4. The three steps are to discuss, clarify, and consult. Specifically: DISCUSS the conflict with your immediate superior or the person at the next level in authority. CLARIFY the relevant issues and concepts by discussions with a disinterested party. You might need to contact an appropriate and confidential ethics \"hotline.\" CONSULT your attorney about your rights and obligations. A Bl _ __g_ _ _l_i:)J j:_L__ F_ ___j_9_l_H~ I_ _ _ I _ _Ll_ -1 CARMEN'S COOKIES 2 - - - - Projected Income Statement - ---\"---------------\"----------- , --- - - - - - - - - - - - - - - - - - - --------·- For One Week3 (2) ____J__ l __:_ ___ (3) __L_ - 4 l- (1) ___ _j_I--- - - - - - - - I Alternative: Status Quo: IWholesale and Original Shop5 Sales Only Retail Distribution ! Difference6 Sales revenue $6,300.00 $ 8,505.00· $2,205.007 Costs -- - - 1,800.00 - 630 .008 Food 2,430.00•9 Labor 1,000.00 1,350.00• 350 .0010 Utilities -- 400.00 540.00• 140.00 ' - ------11 Rent 1,250.00 1,687.50. -- 437 .5012 Other 1,000.00 1,350.00• 350.0013 Total costs $5,450.00 $ 7 , 3 5 7 .5 0 . I $ 1 , 9 0 7 .5014 Operating profits I ---- ---·- ····-15 $ 850.00 $1,147.50.16 •35 percent higher than status quo. $ 297.50 -- =t I II