CHAPTER 1 INTRODUCTION

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Everyday Planning and Control

(a) Plans for taking a course in college include the amount of time to devote to it and to other courses. These plans follow the lines indicated in the chapter. Students formulate objectives for grades, for the knowledge to be gained for its own sake, for future courses, and so on. They evaluate their personal strengths and weaknesses to determine how much work to do. Examinations provide feedback on the sufficiency of work being done; test results might indicate that more, less, or the same amount of work should be devoted to the course. Such evaluations can be made whether the major objective is to gain knowledge or just to obtain a particular grade. (b) Planning for a long automobile trip involves such matters as the amount of time to be spent on the road, the desired time of arrival, the cost of various services along the way (gas and oil, lodging, food, tolls, etc.), the value of taking various routes, and so on. Each of these factors can be affected by the objectives of the trip. A trip home from college is usually made because the student would rather be at home than at school, so time in route is more critical than if one were simply touring the country between school and home. The costs involved in various alternative routes and schedules are important whatever the purpose of the trip, and influence decisions regarding route, lodgings, and food. During a long trip, you would examine results to see if you were meeting your objectives. If the trip were taking too long, some actions might be indicated, such as taking a shorter but less scenic route, or more costly but faster toll roads. Again, evaluations of strengths and weaknesses are important; financial resources, the quality of the car, one's ability to drive under different conditions, and the possibility of emergencies developing are a few concerns that you need to consider in selecting a route. (c) Decorating one's own apartment is very much goal-directed; the apartment or room must satisfy several demands. It must be pleasant to live and entertain in, yet it must be within one's means. Once the tenant has set objectives, the remaining steps include formulating plans to meet them, such as examining colors, types of furniture, lighting, floor covering, pictures and other wall decorations to see if they fit the objectives. Provided that the selected elements meet price requirements, the work can proceed; but as it does, evaluations will be made regarding the effects being created. A picture or rug that looked perfect in the store might look terrible in the room and modifications will be needed. Some decisions made during the planning process may be irrevocable; the cost of installing wallto-wall carpeting is committed, while a piece of furniture might be exchanged. Furniture and pictures can be moved once they are obtained, but a new doorway broken through a wall cannot easily be shifted a few feet to the left. 1-1

(d) The lines of reasoning are about the same as with the other items. The coach must evaluate the available resources (players), plan how to gain the best results from them, ensure that the players follow the plans, evaluate the results of using particular plans, and modify plans. For example, a coach of a football team may stress a running game or a passing game, depending on the talents of the players. If the players tend to be fast but small, one defensive arrangement may be better than others. It is also necessary to examine the environmentin this case, the other teams that will be played. The plan for a particular game will depend largely on the team being played and on weather conditions. If the opponent rarely passes, the coach might bring defenders closer to the line of scrimmage to stop the runners. As play progresses (interim evaluations), the coach might see weaknesses in the other team and develop a different strategy. Note to the Instructor: When studying a new subject, students benefit from seeing that they already have a basic framework from which to proceed. Though this question is not about businesses or other organized economic entities, it focuses attention on the universality of processes described in the chapter. Each activity has objectives and goals, requires formulating plans, entails the evaluation of available resources and consideration of alternatives, goes on over time during which interim results will become known, can be evaluated in reference to plans, and may require modifications of planned actions. You might want to interject questions or comments relating more specifically to organized economic activities. Several parts of the question deal specifically with economic problems, at least to the extent that financial considerations are important. 1-2 Ethics

(a) Wright has violated both the confidentiality and integrity standards. He has disclosed confidential information and has used it to profit, or at least as a repayment for his sister's favors. He has also acted in a way that discredits the profession and has accepted gifts (tips from his sister) that influenced his actions. (b) Roberts has violated the competence, integrity, and objectivity standards. He failed the competence standard by not preparing a report that used all relevant information. He failed to communicate unfavorable information, actively subverted the organization's objectives by trying to influence it to accept a project it should reject, and probably did so in the hope of a quid pro quo from his superior. These acts violate the integrity standard. He did not disclose all relevant information, nor communicate it fairly and objectively. The objectivity and competence standards appear to overlap in the area of reporting and disclosure, but Roberts seems to have hit a trifecta. 1-3 Who Needs Financial Accounting?

Because bankers, suppliers, stockholders, and other external parties use financial accounting information to help make decisions that affect the company, the company's managers should understand what that information is, how it is used, and how management decisions will affect it. That understanding is particularly important to the topmost managers, whose responsibilities encompass the entire entity. But lower-level managers also need such an understanding, not only because they may aspire to the higher1-2

level positions, but also because the decisions made by managers at all levels are the source of the economic events that are reported in the typical financial accounting statements made available to outsiders. Note to the Instructor: You might wish to use this question to review the types of external parties whose decisions affect the future of the entity and how those decisions relate to decisions made by management. For example, you might discuss, in general terms of course, how a decision to bring out a new product might require not only additional funding (a decision of a banker or potential stockholder) but also dealing with new suppliers (who are concerned with the company's credit rating and liquidity) and new customers (who are concerned about the company's stability). It may not be too early to point out that many large companies operate sub-units as near- independent entities, and that the managers of those sub-entities might report to the larger entity as if it were "the outside world." Finally, some instructors might wish to point out that since, as the chapter states, some of the reports used in managerial accounting (income statement, balance sheet, cash flow statement) are similar to reports studied in financial accounting, a manager must learn the basic elements of such reports during the study of one subject or another. 1-4 Conventional versus World-Class Manufacturing

(a) Product warranty costs should be lower because a WCM will make fewer defective products. (b) Salaries of quality control inspectors should be lower because a WCM will have its workers inspect as they go, rather than having separate inspections. Nor will a WCM inspect incoming materials and components because it will deal only with vendors whose quality has been demonstrated. (c) Amounts paid to vendors for parts and components should be higher because a WCM will not search out the lowest prices, but will seek highquality components delivered when needed. (d) Wage rates for direct laborers should be higher because a WCM's workers will be multiskilled and should therefore command premium wages. (e) Total supervisory salaries should be lower because a WCM's workers will not need as much supervision. (f) Warehousing costs should be lower because a WCM will produce as needed and so will not require storage space for materials or finished product. 1-5 Value Chain

(a) Acme Motors quality costs should decrease. Acme will need to spend less on inspecting incoming goods for quality. There should be less waste on the production line due to poor quality parts. (b) Quality costs for the suppliers will increase. Eventually the prices being charged Acme will increase as well to cover the increased costs by the suppliers. The net result to Acme Motors is decreased internal quality costs somewhat offset by the increased prices charged by the suppliers. 1-6 Review of Financial Statement Preparation (40 minutes) 1-3

1.

Freeport Company Income Statement for the Year 20X2 $225,000 145,000 $ 80,000 $ 20,000 3,500 35,000 58,500 $ 21,500 8,600 $ 12,900

Sales Cost of goods sold Gross margin Operating expenses: Depreciation Interest Other Total operating expenses Income before taxes Income taxes (@ 40%) Net income 2.

Freeport Company Balance Sheet as of December 31, 20X2

Assets Current assets: Cash (a) Accounts receivable (b) Inventory (c) Total current assets Property, plant, and equipment: (d) Cost Less accumulated depreciation Net property, plant, and equipment Total assets Equities Current liabilities: Accounts payable (e) Taxes payable Total current liabilities Long-term debt: Bonds payable, 7%, due 20X5 Total liabilities Stockholders' equity: Common stock, no par value, 5,000 shares authorized, issued, and outstanding Retained earnings Total stockholders' equity Total liabilities and stockholders equity

$ 13,500 30,000 30,000 $ 73,500 290,000 124,000 166,000 $239,500

$ 18,000 8,600 26,600 50,000 $ 76,600 100,000 62,900 162,900 $239,500

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(a)

Computation of cash Balance, beginning of year Collections on account Total available Disbursements: For accounts payable Expenses Taxes Fixed assets Interest ($50,000 x .07) Dividends Balance, end of year $ 10,000 220,000 230,000 $132,000 35,000 11,000 30,000 3,500 5,000 (216,500) $ 13,500

(b) Computation of accounts receivable Balance, beginning of year Sales Collections Balance, end of year (c) Computation of inventory Beginning inventory Purchases Cost of goods available Cost of goods sold Ending inventory (d) Computation of property, plant, and equipment Cost Balance, beginning of year New equipment 20X2 depreciation Balance, end of year (e) Computation of accounts payable Balance, beginning of year Purchases Payments to suppliers Balance, end of year (f) Computation of retained earnings Balance, beginning of year Net income Dividends declared Balance, end of year $ 55,000 12,900 (5,000) $ 62,900 $ 10,000 140,000 150,000 (132,000) $ 18,000 $260,000 30,000 $290,000 Accumulated Depreciation $104,000 20,000 $124,000 $ 35,000 140,000 175,000 (145,000) $ 30,000 $ 25,000 225,000 250,000 (220,000) $ 30,000

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Note to the Instructor: The time spent to cover this assignment might be used in the following ways. 1. Reviewing basic material on financial reporting, such as the following: (a) The single-step and multiple-step income statement formats.

(b) The combined statement of income and retained earnings that reports activity on a single statement, leaving the balance sheet for "positions." (c) Disclosure details, such as classes of fixed assets, depreciation, and inventory methods, etc. (d) 2. The distinction between the accrual and cash bases of accounting. Leading the students into questions of managerial accounting, such as:

(a) Does the income statement you have prepared help you determine what income would be in 20X2 if sales had been higher (lower) than expected? (b) (c) 1-7 Was there a need for short-term borrowing during 20X2? Were the purchases of fixed assets wise? Review of the Statement of Cash Flows (25 minutes)

Freeport Company Statement of Cash Flows for the Year 20X2 Net cash flow from operating activities: Net income Adjustments for noncash items included in income: Depreciation Increase in accounts receivable Decrease in inventory Increase in accounts payable Decrease in taxes payable Net cash provided by operations Cash flow for investing activities - purchase of new plant and equipment Cash flow for financing activities - payment of dividends Net increase in cash Beginning cash balance Ending cash balance $12,900 20,000 (5,000) 5,000 8,000 ( 2,400) 38,500 (30,000) (5,000) $ 3,500 10,000 $13,500

One profitable area for class discussion is the relationship of profit and cash flow. The company earned $12,900, but its cash increased by only $3,500. You might point out that the company's cash flow from operations was considerable ($38,500), but that purchases of plant and equipment and the payment of dividends were the principal reasons for the lesser increase in cash.

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1-8 1.

Review of Financial Statement Preparation

(40 minutes)

St. Francis Company Income Statement For the Year 20X2 $960,000 480,000 480,000 $80,000 24,000 180,000 146,000

Sales Cost of goods sold Gross margin Operating expenses: Depreciation Interest Salaries and wages (f) Other (g) Income before taxes Income taxes (40%) Net income 2.

430,000 50,000 20,000 $ 30,000

St. Francis Company Balance Sheet As of December 31, 20X2

Assets Current assets: Cash (a) Accounts receivable (b) Inventory (c) Prepaid expenses Total current assets Property, plant, and equipment: Cost (d) Less accumulated depreciation (d) Total assets Equities Current liabilities: Accounts payable (e) Taxes payable Accrued expenses Total current liabilities Long-term liabilities: Bonds payable, 6%, due 20X4 Total liabilities Stockholders' equity: Common stock, $10 par value, 24,000 shares authorized, issued and outstanding Retained earnings: Balance at beginning of year $182,000 Net income 30,000 212,000 Dividends 10,000 Balance at end of year Total stockholders' equity Total liabilities and stockholders equity

$ 84,000 260,000 200,000 12,000 $556,000 $760,000 340,000 420,000 $976,000

$100,000 20,000 14,000 134,000 400,000 $534,000 $240,000

202,000 442,000 $976,000

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(a)

Computation of cash Balance, beginning of year Collections on account Issuance of common stock Total available Disbursements: Accounts payable Other expenses Prepaid expenses Salaries and wages Taxes Plant and equipment Interest ($50,000 x .07) Dividends Balance, end of year $ 40,000 $860,000 80,000 $940,000 980,000 $420,000 130,000 12,000 190,000 50,000 60,000 24,000 10,000 (896,000) $ 84,000

(b) Computation of accounts receivable Balance, beginning of year Sales Collections Balance, end of year (c) Computation of inventory Beginning inventory Purchases Cost of goods available Cost of goods sold Ending inventory (d) Computation of property, plant, and equipment Cost Balance, beginning of year New equipment Depreciation expense Balance, end of year (e) Computation of accounts payable Balance, beginning of year Purchases Payments to suppliers Balance, end of year $ 80,000 440,000 520,000 (420,000) $100,000 $700,000 60,000 $760,000 Accumulated Depreciation $260,000 80,000 $340,000 $240,000 440,000 680,000 (480,000) $200,000 $160,000 960,000 1,120,000 (860,000) $260,000

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(f)

Computation of salaries and wages Balance, beginning of year Payments Balance, end of year Salaries and wages expense for the year $ 24,000 (190,000) (166,000) ( 14,000) $180,000

(g)

Computation of other expense Prepaid expenses, beginning of year Other expenses, paid in cash Total, other expenses $ 16,000 130,000 $146,000 (20 minutes)

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Review of the Cash Flow Statement

St. Francis Company Statement of Cash Flows for the Year 20X2 Net cash flow from operating activities: Net income Adjustments for noncash expenses and revenues included in income: Depreciation Increase in accounts receivable Decrease in inventory Decrease in prepaid expenses Increase in accounts payable Decrease in taxes payable Decrease in accrued payables Net cash provided by operations Cash flow for investing activities: Purchase of new plant and equipment Cash flow from financing activities: Issuance of common stock Payment of dividends Net cash inflow from financing activities Net increase in cash Beginning cash balance Ending cash balance $30,000 80,000 (100,000) 40,000 4,000 20,000 (30,000) (10,000) 34,000 (60,000) $80,000 (10,000) 70,000 $44,000 40,000 $84,000

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Different Costs for Different Purposes

(15 minutes)

1. Virtually zero; to be precise, the cost of gas to go the extra mile to the friend's house and back to your own house. 2. $7.50 for gas (150 miles/30 miles per gallon = 5 gallons at $1.50 = $7.50). Note to the Instructor: The concepts of allocated costs and differential costs are introduced in Chapters 3-5, but students should have little difficulty understanding the points raised here. To concentrate on the main points, we did not list other costs that would vary with miles driven, such as oil and tires. Some students will see that some other costs would be incurred in making the trip as opposed to not making it. A few might think of opportunity costs in the form of lost income from a job, or of the alternative value of time spent driving instead of doing something more 1-9

pleasant. 1-11 JIT (15 minutes)

Manager A said that the company could not time production just right, so buffer stocks are needed to prevent workers from falling idle. JIT principles do not permit extra inventory because it hides defects and is wasteful. The company now pushes goods through, rather than pulling them through. Eliminating inventories at work stations will force the company to maintain high quality and "do it right the first time." Manager B said that some current problems were caused by poor product design. JIT requires close cooperation between design and manufacturing, so that products will be relatively easy to make and will not fail because of design or manufacturing flaws. Customers might be persuaded to buy standard products if they can benefit. JIT does not permit any one area (design, production) to impose its perceived requirements on another area. The quality control manager discussed the sophistication of the company's inspections. JIT manufacturers do not use vendors whose shipments include defects, eliminating the non-value-adding activity of inspecting incoming shipments. Workers inspect products as they proceed through the factory, so that no defectives go from one station to another. This practice eliminates the need for final inspections. The company now finds 10%-15% defectives at the end of the process, which greatly increases its costs. The production manager spoke about the functional arrangement of machinery. JIT manufacturers use cells that perform all of the work on a product. This reduces the need to move product from one station to another, allows workers more flexibility in job assignments, and saves space. Workers should do better under the JIT system because they learn more skills and become more valuable to the company. 1-12 Ethics (5 minutes)

Much as you might like to, you cannot tell your father to sell (and then to sell short) without violating the Standards and becoming liable for criminal prosecution under insider trading rules. (Most students will not know about insider trading.) The situation is a moral dilemma. And it is doubtful that your father will understand your failure to tell him when he loses most of his investment. The confidentiality standards explicitly prohibit "disclosing confidential information acquired in the course of their work . . . " and "using or appearing to use confidential information . . . for unethical or illegal advantage either personally or through third parties." The latter provision probably applies even if the management accountant does not gain from the disclosure. (The person in the current situation could gain through inheritance if the father's estate benefits from selling the stock.)

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Ethics

(10 minutes)

1. The issue here is not that the lunch is an unacceptable gift that compromises Taylor's integrity. Many students will say Taylor committed no breach because the gift of a lunch is negligible. Rather, Taylor might have violated the Standards because she did not disclose her interest. She did not, as required by the objectivity standard, "disclose fully all relevant information that could reasonably be expected to influence an intended user's understanding of the reports, comments, and recommendations presented." Taylor might not have done anything culpable, but she should have known better. Whether the final decision would have changed had Taylor revealed her friendship is debatable, but the point is whether the managers making the decision might have thought differently had they known about the friendship. 2. Taylor is now clearly in violation of the integrity standard that prohibits accepting ". . . any gift, favor, or hospitality that would influence or would appear to influence their actions." The amount of the gift is now relevant, as, of course, is the failure to disclose the friendship. 1-14 Conventional and JIT Manufacturing (15 minutes)

The memorandum might cover the following points. Updating designs to meet customer suggestions without considering manufacturability, effects on cycle time, cost, and effect on operations is unwise. A JIT manufacturer ensures that design and manufacturing coordinate activities. Jason warehouses materials and components. A JIT manufacturer orders stock as needed, eliminating the handling and storage. Jason goes to great lengths to get the best prices on materials and components. A JIT manufacturer is more concerned about quality and meeting delivery schedules. Jason deals with many suppliers, while a JIT manufacturer deals with relatively few. Jason inspects all incoming shipments, while a JIT manufacturer stops inspecting once it determines that a vendor delivers defect-free components. Jason also inspects for deterioration before it puts components into process, which a JIT manufacturer would not tolerate. Jason maintains inventories at work stations, has long setup times, and considerable moving of goods during production. A JIT manufacturer keeps no inventories at stations, strives for short setup times, and manufactures in cells, which minimizes handling, among other advantages. Jason inspects at the end of production, while workers in a JIT environment inspect continually. Continual inspection makes possible keeping little inventory and eliminating separate inspection. Moreover, Jason cannot always identify the source of a defect, while a JIT manufacturer can do so. Jason's cycle times are much higher than those of a JIT manufacturer.

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