Managerial Accounting

Topic 1. Job-order costing

Glossary
No Terms Meaning
1 Allocation base A measure of activity such as direct labor-hours or machine-hours
that is used to assign costs to cost objects
3 Bill of materials A document that shows the quantity of each type of direct material
required to make a product
4 Cost driver A factor, such as machine-hours, beds occupied, computer time,
or flight-hours, that causes overhead costs
5 Cost of goods The manufacturing costs associated with the goods that were
manufactured finished during the period
6 Finished goods Units of product that have been completed but not yet sold to
customers
7 Job cost sheet A form that records the materials, labor, and manufacturing
overhead costs charged to a job
8 Job-order costing A costing system used in situations where many different
products, jobs, or services are produced each period
9 Materials requisition A document that specifies the type and quantity of materials to be
form drawn from the storeroom and that identifies the job that will be
charged for the cost of those materials
10 Multiple A costing system with multiple overhead cost pools and a
predetermined different predetermined overhead rate for each cost pool, rather
overhead rates than a single predetermined overhead rate for the entire company.
Each production department may be treated as a separate overhead
cost pool.
11 Normal cost system A costing system in which overhead costs are applied to a job by
multiplying a predetermined overhead rate by the actual amount
of the allocation base incurred by the job
12 Over-applied A credit balance in the Manufacturing Overhead account
overhead that occurs when the amount of overhead cost applied to Work in
Process exceeds the amount of overhead cost actually incurred
during a period
13 Overhead The process of charging manufacturing overhead cost to job cost
application sheets and to the Work in Process account
14 Predetermined A rate used to charge manufacturing overhead cost to jobs that is
overhead rate established in advance for each period. It is computed by dividing
the estimated total manufacturing overhead cost for the period by
the estimated total amount of the allocation base for the period
15 Raw materials Any materials that go into the final product
16 A schedule that contains three elements of product

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 Schedule of cost costs—direct materials, direct labor, and manufacturing
of goods overhead—and that summarizes the portions of those costs that
manufactured remain in ending Work in Process inventory and that are
transferred out of Work in Process into Finished Goods
17 Schedule of cost of A schedule that contains three elements of product costs—direct
goods sold materials, direct labor, and manufacturing overhead — and that
summarize the portions of those costs that remain in ending
Finished Goods inventory and that are transferred out of Finished
Goods into Cost of Goods Sold
18 Time ticket A document that is used to record the amount of time an employee
spends on various activities
19 Under-applied A debit balance in the Manufacturing Overhead account
overhead that occurs when the amount of overhead cost actually incurred
exceeds the amount of overhead cost applied to Work in Process
during a period
20 Work in process Units of product that are only partially complete and will require
further work before they are ready for sale to the customer

Concepts in Action
1. Read and fill in the blanks with the following words: costing data, project variances,
unique, last-minute, profitable, identified, leverage, budgeted, cost, individually, pricing decisions,
direct labor-hours, completed, success, experience, grand opening, stages, estimated overhead costs,
allocation bases, the percentage
Job Costing on Cowboys Stadium
Over the years, fans of the National Football League have (1) the Dallas
Cowboys as “America’s Team.” Since 2009, however, the team known for winning five Super
Bowls has become just as recognized for its futuristic new home, Stadium in Arlington, Texas.
When the Cowboys take the field, understanding each week’s game plan is critical for
(2) But for Manhattan Construction, the company that managed the development
of the $1.2 billion Cowboys Stadium project, understanding costs is just as critical for making
successful (3) , winning contracts, and ensuring that each project is
(4) . Each job is estimated (5) because the (6) end-
products, whether a new stadium or an office building, demand different quantities of
Manhattan Construction’s resources.
In 2006, the Dallas Cowboys selected Manhattan Construction to lead the construction
of its 73,000 seat, 3 million- square-foot stadium. To be (7) in three years, the
stadium design featured two monumental arches spanning about a quarter-mile in length over
the dome, a retractable roof, the largest retractable glass doors in the world (in each end zone),
canted glass exterior walls, 325 private suites, and a 600-ton JumboTron hovering 90 feet
above the field.
With only 7% of football fans ever setting foot in a professional stadium, “Our main
competition is the home media center,” Cowboys owner Jerry Jones said in unveiling the
stadium design in 2006. “We wanted to offer a real (8) that you can’t have at
home, but to see it with the technology that you do have at home.”

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 Generally speaking, the Cowboys Stadium project had five (9) : (1)
conceptualization, (2) design and planning, (3) preconstruction, (4) construction, and (5)
finalization and delivery. During this 40-month process, Manhattan Construction hired
architects and subcontractors, created blueprints, purchased and cleared land, developed the
stadium—ranging from excavation to materials testing to construction—built out and finished
interiors, and completed (10) changes before the stadium’s
(11) in mid-2009.
While most construction projects have distinct stages, compressed timeframes and
scope changes required diligent management by Manhattan Construction. Before the first game
was played, Manhattan Construction successfully navigated nearly 3,000 change requests and a
constantly evolving budget.
To ensure proper allocation and accounting of resources, Manhattan Construction
project managers used (12) . The system first calculated the (13) of
more than 500 line items of direct materials and labor costs. It then allocated (14)
(supervisor salaries, rent, materials handling, and so on) to the job using
direct material costs and (15) as (16) .
Manhattan Construction’s job-costing system allowed managers to track (17) on
a weekly basis. Manhattan Construction continually estimated the profitability of the Cowboys
Stadium project based on (18) of work completed, insight gleaned from
previous stadium projects, and revenue earned. Managers used the job-costing system to
actively manage costs, while the Dallas Cowboys had access to clear, concise, and transparent
(19) .
Just like quarterback Tony Romo navigating opposing defenses, Manhattan
Construction was able to (20) its job-costing system to ensure the successful
construction of a stadium as iconic as the blue star on the Cowboys’ helmets.
2. Listen and fill in the blanks

Making movie

Big Hollywood movies are fraught with costs of story writers, camera, equipment,
studio space, actors, even the right to shoot in a specific location like a famous restaurant has a
cost. (1) is critical to the studio’s success because it helps them to (2)

such as what type of films to produce in the future? How much to charge for
DVD? and even figure out if the director is keeping to a film’s budget while it is being made.

(3) involves the (4) , (5) and (6) of

(7) . From these data, companies can determine both (8) and
(9) of each product. There are two basic types of (10) :
a job-order cost system and a process cost system. Under (11) ,a
company like a movie studio or an independent self – financed film maker assigns costs to
each job or in this case each movie produced. And an (12) of job
order costing is that each job or batch has its own (13) , it
measures costs for (14) rather than for set time periods.
Heidi van Leer knows a lot about film costs. She ‘s not only a programmer for the
annual Slamdance Film Festival in Park City Ulta but in independent film maker herself. Heidi

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van Leer:” production costs, especially the studio production they’re really used to spending a
lot of money on everything. In an independent film, I usually just try and feed my crew, pay for
my equipment, pay for stock and that’s about it”

Companies that manufacture large volumes of (15) use a

(16) which accumulates product related costs for (17) such
as a quarter or year and assigns them to (18) or processes. Job order
costing is more precise in assignment of costs to projects than process costing. However
recording the information is (19) . Just the same, it isn’t unusual for a
company to use both systems . For example Jones Soda practices process costing when
manufacturing soda but uses job order costing when producing small custom orders for its my
Jones program.

Studios today must be more budget – conscious than ever that means maintaining a
good job order (20) . The flow of costs (21) , (22) and
(23) in job order cost accounting parallels the physical flow of
the materials as they are converted into finished goods. While a film is produced, the studio
accumulates (24) through accurate record keeping and assigns those costs
to the account for each film as a (25) . When the film is finished, they
transfer the cost to the film to finished good inventory. Later, when the film is sold or
distributed, they transfer the costs for that film to (26) . So that they can
compare costs to the final revenues of the film to determine their profit.

Not all cost can be easily attributed to one section as the flow of material. Overhead
costs like studio executive office space cannot be assigned to specific jobs on the basis of
(27) incurred. Instead companies assign costs to a work - in process into
specific jobs on an estimated basis to the use (28)______________________

In general, company across industries established a predetermined overhead rate

(29)____________________of the year. Small companies often use a single company – wide
predetermined overhead rate. Large companies often use rates that vary from department to
department. The formula for a predetermined overhead rate is as follows:
(30)______________ divided by (31) equals
Predetermined overhead rate. Overhead relates to production operations as a whole. To know
what the whole is, the logical thing is to wait until the end of the years operation. At that time,
the studio know all of its costs for the period. As a practical matter though, managers cannot
wait until (32) . To price product accurately they need information
about product costs of (33) completed during the year. Using a predetermined
overhead rate enables the cost to be determined for the job immediately.

Job order costing can be fairly (34) and (35) manufacturing

situations. But how costs are assigned to a movie is often (36) and may be
subjected to (37) . For example in Hollywood studios often negotiate
producer, director and actors payment based on a percentage of a films (38) .
As a movie has gone to larger box office grosses it is not uncommon to see the various players
fighting over what they perceive to be their fair share.
Filmmaking has changed greatly in the last half century. Before 1917 it was nearly
impossible to do a film outside of a major studio. Technology has changed all that. But even
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 with new distribution channels like cable networks and the internet the overwhelming supply
of material has reduced the price, studio can pay for any individual film.
The (39) of film both great and small is dependent upon the practices of a
careful (40) .

Summary
Read and fill in the blanks with the following words: predetermined overhead rate,
labor time tickets, job-order costing, over-applied overhead, manufacturing overhead costs,
the actual overhead cost, materials requisition forms, the estimated total manufacturing
overhead cost, finished goods, the estimated total amount of the allocation base direct labor-
hours machine-hours, under-applied, cost of goods sold, work- in process

(1) is used in situations where the organization offers

many different products or services, such as in furniture manufacturing, hospitals, and legal
firms. (2) and (3) are used to assign direct
materials and direct labor costs to jobs in a job- order costing system. (4)
are assigned to jobs using a (5) . All of the costs
are recorded on a job cost sheet. The predetermined overhead rate is determined before the
period begins by dividing (6) for the period by
(7) for the period. The most frequently
used allocation bases are (8) and (9) .
Overhead is applied to jobs by multiplying the predetermined overhead rate by the actual
amount of the allocation base recorded for the job. Because the predetermined overhead rate is
based on estimates, (10 ) incurred during a period may be more or
less than the amount of overhead cost applied to production. Such a difference is referred to as
(11) or (12) . The under-applied or over-applied
overhead for a period can be either closed out to (13) or allocated
between (14) , (15) , and Cost of Goods Sold.
When overhead is under-applied, manufacturing overhead costs have been understated and
therefore inventories and/or expenses must be adjusted upwards. When overhead is over-
applied, manufacturing overhead costs have been overstated and therefore inventories
and/or expenses must be adjusted downwards.
Questions
1. Why aren’t actual manufacturing overhead costs traced to jobs just as direct materials
and direct labor costs are traced to jobs?
2. Explain the four-step process used to compute a predetermined overhead rate.
3. What is the purpose of the job cost sheet in a job-order costing system?
4. Explain how a sales order, a production order, a materials requisition form, and a labor
time ticket are involved in producing and costing products.
5. Explain why some production costs must be assigned to products through an allocation
process.
6. Why do companies use predetermined overhead rates rather than actual manufacturing
overhead costs to apply overhead to jobs?

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 7. What factors should be considered in selecting a base to be used in computing the
predetermined overhead rate?
8. If a company fully allocates all of its overhead costs to jobs, does this guarantee that a
profit will be earned for the period?
9. What account is credited when overhead cost is applied to Work in Process? Would
you expect the amount applied for a period to equal the actual overhead costs of the period?
Why or why not?
10. What is under-applied overhead? Over-applied overhead? What disposition is made of
these amounts at the end of the period?
11. Provide two reasons why overhead might be under-applied in a given year.
12. What adjustment is made for under-applied overhead on the schedule of cost of goods
sold? What adjustment is made for over-applied overhead?
13. What is a plant-wide overhead rate? Why are multiple overhead rates, rather than a
plant - wide overhead rate, used in some companies?
14. What happens to overhead rates based on direct labor when automated equipment
replaces direct labor?

Topic 2. Process costing

Glossary
No Terms Meaning
1 Conversion cost Direct labor cost plus manufacturing overhead cost
2 Equivalent units The product of the number of partially completed units and their
percentage of completion with respect to a particular cost. Equivalent
units are the number of complete whole units that could be obtained
from the materials and effort contained in partially completed units
3 Equivalent units of The units transferred to the next department (or to finished goods)
production during the period plus the equivalent units in the department’s ending
(weighted-average work in process inventory
method)
4 FIFO method A process costing method in which equivalent units and unit costs
relate only to work done during the current period
5 Operation costing A hybrid costing system used when products have some common
characteristics and some individual characteristics
6 Process costing A costing method used when essentially homogeneous products are
produced on a continuous basis
7 Processing An organizational unit where work is performed on a product and
department where materials, labor, or overhead costs are added to the product
8 Weighted-average A process costing method that blends together units and costs from
method both the current and prior periods

Concepts in Action

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 1. Read and fill in the blanks with the following words: combination, customer profile,
production costs, opportunity, job costing, retail stores, a mass-production, hybrid-costing
system, the conversion cost, customized ,three-step, process costing, digitize

Hybrid Costing for Customized Shoes at Adidas

Adidas has been designing and manufacturing athletic footwear for nearly 90 years.
Although shoemakers have long individually crafted shoes for professional athletes like Reggie
Bush of the New Orleans Saints, Adidas took this concept a step further when it initiated the
mi adidas program. Mi adidas gives customers the (1) to create shoes to their
exact personal specifications for function, fit, and aesthetics. Mi adidas is available in
(2 around the world, and in special mi adidas “Performance Stores” in cities
such as New York, Chicago, and San Francisco.
The process works as follows: The customer goes to a mi adidas station, where a
salesperson develops an in-depth (3) , a 3-D computer scanner develops
a scan of the customer’s feet, and the customer selects from among 90 to 100 different styles
and colors for his or her modularly designed shoe. During the (4) , 30-minute
high-tech process, mi adidas experts take customers through the “mi fit,” “mi performance,”
and “mi design” phases, resulting in a customized shoe (5) their needs. The
resulting data are transferred to an Adidas plant, where small, multiskilled teams produce the
(6) shoe. The measuring and fitting process is (7) , but purchasing
your own specially made shoes costs between $40 and $65 on top of the normal retail price,
depending on the style.
Historically, costs associated with individually customized products have fallen into the
domain of job costing. Adidas, however, uses a (8) — (9) for
the material and customizable components that customers choose and (10) to
account for the conversion costs of production. The cost of making each pair of shoes is
calculated by accumulating all (11) and dividing by the number of shoes
made. In other words, even though each pair of shoes is different, (12) of
each pair is assumed to be the same.
The (13) of customization with certain features of mass production is
called mass customization. It is the consequence of being able to (14) information
that individual customers indicate is important to them. Various products that companies are
now able to customize within (15) setting (for example,
personal computers, blue jeans, bicycles) still require job costing of materials and considerable
human intervention. However, as manufacturing systems become flexible, companies are also
using process costing to account for the standardized conversion costs.
____________________________________________________________________________
2. Listen and fill in the blanks
Jones Soda
In a world where soda brands and flavors can be found almost anywhere and often fill
entire aisle supermarkets , John Soda manages (1) from the competition. This
is partly due to quirky label photos which are submitted by customer as well as their fund yet
eccentric line of soda flavors.

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 Mike Spear “ it’s kind of a modern terms but I would say that Jones is an
(2) , today we had 1,2 million photos in our gallery,
online photo gallery, so we really let consumers participate in the brand. You know that and
our flavors and colors of our flavors are very unique. There is not a lot of green apples sodas
out there, not a lot of fruits sodas out there”
Fans of Jones Soda are so well fanatic that many create video tributes to their favorite
flavors or feel themselves trying some of the more challenging flavor. There are many
companies today that manufacture sodas, so competition is understandably fears for both
market share and sell space.
(3) is a cost accounting method that works ideally for the soda
industry or any industry where costs are assigned to (4) that are
(5) in a continuous fashion. (6) on the other
hand is better suited for organizations looking to assign costs to (7) such as
advertising agencies, motion picture companies and law firms. (8) between
the two include: both (9) track three manufacturing (10) , the
accumulation of the costs of materials, labor and overhead and (11) is the
same. The (12) between a job order cost and a process cost system are : the
number of (13) accounts used, the documents used (14) costs,
the point at which costs are (15) and unit cost computations
As a general rule, manufacturing of soda normally consists of two processes: blending
and bottling. As the flow of costs indicates companies can add materials labor and
manufacturing overhead in both departments. When the blending Department finishes its work
, they transfer the (16) to the bottling department. The bottling
department finishes the goods and then transfers (17) . Within each
department (18) is performed on (19) .
Since Jones Soda uses a wide variety of labels particularly within the my Jones personal
customization program, they have three major processes: blending, bottling and labeling. The
use of custom labels has a bit of a story history of Jones Soda .When they first incorporated
custom labels ten years ago, the process was quite humble. They used an intern and inkjet
printer
Mike Spear:” Literally it was sort of a (20) as business grew we
decided that we had to outsource it and then the process actually goes through a machine
now where the labels are glued in, the liquid goes through a process of applying to the bottles
so it’s not hands on anymore
Vendors such as this can give Jones a (21) because as suppliers
they have expertise in specialized areas. Alternatively, large (22) like
Coke and Pepsi have the resources and economy of scale to do almost everything internally.
Now let’s look at an example where we’ve generalized to the assignment of cost at
Jones for the previous month. For purposes of this exercise let’s assume Jones does everything
in-house, so there would be three processes. First ,we have a work - in process for raw
materials. Raw materials used were blending 16,000; bottling 3,000 and labeling 7,000 .
Factory labor costs were blending 10,000; bottling 4,000 and labeling 6,000 and
manufacturing overhead costs were blending 5,000; bottling 2,000 and labeling 2500. The
company transfers units completed at a cost of $19,000 in the blending department to the
bottling department . The bottling department transfers units completed at a cost of $10,000 to

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 the labeling department and the labeling department transfers units completed at a cost of
$8,000 to finished goods .
Companies often use a combination of a process cost and a job order cost system
called (23) . This (24) is similar to process costing in
its assumption that (25) are used to manufacture the product. The my
Jones program for example with its highly customized small quantity order is a good example
of a manufactured product more suited to a job order cost system.
Jones Soda has a model run with the little guy create some changes. Cost accounting
helps Jones to compete in a cutthroat business against industry mega corporations along the
way they’ve inspired a great loyalty among fans and organizations including NASA who
ordered soda during their space shuttle program.
Mike Spear: ” and I find out that was just neat. They put it in their VIP areas so I would
imagine senators and vice president senior drinking Jones as they watch the space shuttle
launched into space. I think in a model of some other soda brands if another CBG brand that
we make this emotional connection with consumers, and it just makes me feel good that we can
make people feel good so”

Summary
Read and fill in the blanks with the following words: transferred out, the cost reconciliation report,
percentage of completion, equivalent units, process costing, a job-order costing system, specific
cost category, partially completed units, costs flow, completed units, weighted-average method ,
work–in process

(1) is used in situations where homogeneous products or services are

produced on a continuous basis. (2) through the manufacturing accounts in
basically the same way in a process costing system as in (3) .
However, costs are accumulated by department rather than by job in process costing..
In process costing, the (4) of production must be determined for each
cost category in each department. Under the (5) , the equivalent
units of production equals the number of units transferred out to the next department or to
finished goods plus the equivalent units in ending work in process inventory. The
equivalent units in ending inventory equals the product of the number of
(6) in ending work in process inventory and their (7) with respect to
the specific cost category.
Under the weighted-average method, the cost per equivalent unit for a (8) is
computed by adding the cost of beginning work in process inventory and the cost added during
the period and then dividing the result by the equivalent units of production. The cost per
equivalent unit is then used to value the ending (9) inventory and the units
(10) to the next department or to finished goods.
(11) reconciles the cost of beginning inventory and the costs
added to production during the period to the cost of ending inventory and the cost of units
transferred out. Costs are transferred from one department to the next until the last processing
department. At that point, the cost of (12) is transferred to finished goods.

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Questions
1. Under what conditions would it be appropriate to use a process costing system?
2. In what ways are job-order and process costing similar?
3. Why is cost accumulation simpler in a process costing system than it is in a job-order
costing system?
4. How many Work in Process accounts are maintained in a company that uses process
costing?
5. Assume that a company has two processing departments—Mixing followed by Firing.
Prepare a journal entry to show a transfer of work in process from the Mixing Department
to the Firing Department.
6. Assume that a company has two processing departments—Mixing followed by Firing.
Explain what costs might be added to the Firing Department’s Work in Process account
during a period.
7. What is meant by the term equivalent units of production when the weighted-average
method is used?
8. Watkins Trophies, Inc., produces thousands of medallions made of bronze, silver, and
gold. The medallions are identical except for the materials used in their manufacture. What
costing system would you advise the company to use?

Topic 3. CVP analysis

Glossary
No Terms Meaning
1 Break-even point The level of sales at which profit is zero
2 Contribution margin ratio A ratio computed by dividing contribution margin by
(CM ratio) dollar sales
3 Cost-volume-profit (CVP) A graphical representation of the relationships
graph between an organization’s revenues, costs, and
profits on the one hand and its sales volume on the
other hand
4 Degree of operating A measure, at a given level of sales, of how a
leverage percentage change in sales will affect profits. The
degree of operating leverage is computed by dividing
contribution margin by net operating income
5 Incremental analysis An analytical approach that focuses only on those
costs and revenues that change as a result of a decision
6 Margin of safety The excess of budgeted or actual dollar sales over the
break-even dollar sales
7 Operating leverage A measure of how sensitive net operating income is to
a given percentage change in dollar sales
8 Sales mix The relative proportions in which a company’s
products are sold. Sales mix is computed by

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9 Target profit analysis
10 Variable expense ratio
expressing the sales of each product as a percentage of
total sales.
Estimating what sales volume is needed to achieve a
specific target profit.
A ratio computed by dividing variable expenses by
dollar sales

Concepts in action
1. Read and fill in the blanks with the following words: low, competitive disadvantage,
in contrast, loyal listeners, fixed costs, cost structure , revenue, bankruptcy, the weight of,
lost, variable costs decrease, high operating leverage, profitability, in debt, opposite, cut,
high , renegotiating, fee

Fixed Costs, Variable Costs, and the Future of Radio

Building up too much (1) can be hazardous to a company’s health.
Because fixed costs, unlike (2) , do not automatically (3) as
volume declines, companies with too much fixed costs can lose a considerable amount of
money during lean times. Sirius XM, the satellite radio broadcaster, learned this lesson the
hard way.
To begin broadcasting in 2001, both Sirius Satellite Radio and
XM Satellite Radio—the two companies now comprising Sirius XM—spent billions of dollars
on broadcasting licenses, space satellites, and other technology infrastructure. Once
operational, the companies also spent billions on other fixed items such as programming and
content (including Howard Stern and Major League Baseball), satellite transmission, and
R&D. (4) , variable costs were minimal, consisting mainly of artist-royalty
fees and customer service and billing. In effect, this created a business model with a
(5) —that is, the companies’ (6) had a very
significant proportion of fixed costs. As such, (7) could only be
achieved by amassing millions of paid subscribers and selling advertising.
The (8) of this highly-leveraged business model was nearly
disastrous. Despite amassing more than 14 million subscribers, over the years Sirius and XM
rang up $3 billion (9) and tallied cumulative operating losses in excess of $10 billion.
Operating leverage, and the threat of bankruptcy, forced the merger of Sirius and XM in
2007, and since then the combined entity has struggled to (10) costs, refinance its
sizable debt, and reap the profits from over 18 million monthly subscribers.
While satellite radio has struggled under (11) too much fixed cost,
Internet radio had the (12) problem—too much variable costs. But “How?”
you ask. Don’t variable costs only increase as revenues increase?
Yes, but if the revenue earned is less than the variable cost, an increase in revenue can lead
to (13) This is almost what happened to Pandora, the Internet radio
service.
Pandora launched in 2005 with only $9.3 million in venture capital. Available free over
the Internet, Pandora earned revenue in three ways: advertising on its Web site, subscription
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 fees from users who wanted to opt-out of advertising, and affiliate fees from iTunes and
Amazon.com. Pandora had (14) fixed costs but (15) variable costs for
streaming and performance royalties. Over time, as Pandora’s popular service attracted
millions of (16) , its costs for performance royalties––set by the Copyright
Royalty Board on a per song basis––far exceeded its revenues from advertising and
subscriptions. As a result, even though royalty rates were only a fraction of a cent, Pandora
(17) more and more money each time it played another song!
In 2009, Pandora avoided bankruptcy by (18) a lower per-song
royalty rate in exchange for at least 25% of its U.S. revenue annually. Further, Pandora began
charging its most frequent users a small (19) and also started increasing its
advertising (20)__________________
__________________________________________________________________________________
2. Listen and fill in the blanks

Southwest Airlines
Brad Hawkins:” Southwest Airlines is simply the most legendary and successful
company in modern aviation history. Almost everyone has a Southwest story whether you are
an employee working for the company or you are a devoted customer to the product the
Southwest offered for nearly 40 years”
Back then in 1971 southwest was just a scrappy upstart with a cheeky sense of humor.
Today they ‘re still cheeky but they carry more passengers within the US than any other
airlines and they’ve been (1) every single year of their existence even during
(2) when some competitors were losing 10 to 15 million a day.
Managing any business requires an understanding of how costs respond to changes in
(3 and the effective changes in (4) in (5) on (6) .
Within (7) companies classify costs in a (8) of ways.
(9) are costs that vary in total (10) with changes
in the (11) . so for example if an airline paid 10cents a bag for peanuts and a
flight had one passenger the cost for peanuts would be 10cents. If there were 50 passengers the
cost would be $5 and if there were 100 passengers it would be $10. Variables costs may also
be defined as costs that (12) at every level of activity within
(13) . So the per unit cost up a bag of peanut would be the same
regardless of the number of passengers on the plane. (14) are cost that
(15) regardless of changes in the activity level. the salary of the
pilot on that flight for example would be the same regardless if he or she flew 50 passengers or
100. Because total fixed costs (16) as (17) , fixed
costs per unit is very (18) with activity, as volume increases unit costs decrease
and (19) . Thus if we were to calculate the pilot salary per passenger for one
passenger the fixed cost per unit would be $200, for 2 passengers it would be $100 and for
100 passengers it would be just $2.
Today airlines like Southwest are thought of largely as variable cost companies
because fuel often their largest cost can (20) in price. how significant is
this particular variable cost to their (21) , they consume 1,4 billion gallons
of fuel a year so just a 1 cent per gallon increase equals $14 million. it follows then that
(22) would play a key role in their (23) .

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 The most significant relationship in cost volume profit analysis is the
(24) at which total revenues equal total costs or the (25) .
A great way for a company to determine a break – even point is to prepare
(26 also known not surprisingly as (27) .
Let’s examine a typically airline round trip flight. to keep things simple, we assume that
every ticket costs $100 and that the plane has 150 seats. Okay, looking at our graph we’ve got
the unit of sales along the (28) which in this case is seats. The
(29) is labeled $ because we will use it to record both total revenues and
total costs (fixed plus variable). First, we plot our total sales line starting at zero going up to
(30) . So total revenue for a full plane would be $100 x 150 seats or $1500.
The revenue line here is (31) throughout, sets all tickets cost the same.
Next, we plot our total fixed cost which in this case happens to be $4000 and it is the
same at every level of activity. This represents things like the pilot salary overhead in
(32) . A total cost line starts at the fixed cost line at zero activity. For
this flight we assume a variable cost of $ 60 per seat so if the plane were
(33) the variable cost would be$60 x 150 seats or $9,000 and the
total cost would be $9,000 in variable costs plus $4,000 in fixed costs or $13,000.
(34) that total costs from total revenue we get a $2,000 profit round – trip and
where do they break-even? that would be here, at the (35) of the total cost
line and the total sales line where at 100 seats or $10,000 in sales. Southwest covers the costs
but has not yet earn a profit.
Okay, now the interesting part, Southwest flights are not always full, of course , in fact
the average last year was 75% occupancy. On our graph, that translates to just $480 in profit
round-trip or $240 each way. $240 in profit cannot be true. well yes in fact the
(36) for a one-way flight on Southwest last year was just slightly
higher at $290 and if your divide that by the average one-way ticket price of $58 you can see
that just 5 passengers per flight kept the most successful airline in the USA
Why are airline margin so razor thin mostly because ticket prices adjusted for inflation
or half of what they were 25 years ago. Fuel costs have (37) and that explains
why most airlines now charge for checked baggage, most but not Southwest
Brad Hawkins :” the leadership really made a courageous decision. early on this
process the wall street analysts saying “what are you doing ? you’ve leaving hundreds of
millions of dollars in (38) on the table” but people don’t
want feel nickel-and-dime they don’t want to come back to that”
How did Southwest make this decision by analyzing (39) and
(40) . Southwest flights’ re just one type of aircraft and the
resulting efficiencies give them the lowest baggage handling costs in the industry. crunching
the numbers they predicted that the bags fly free program would lead to higher occupancy
rates and more revenue and the profits would outweigh incremental revenue gain from
baggage fees and as Brad’s explain, their prediction was correct.
Brad Hawkins :” our leadership noted a significant share shift more than a 1% which is
about a billion dollars’ worth of customer business shifting over to us for no reason other the
bags fly free strategy”

13
 The airline business is complex in few companies today seem to properly manage all
their fixed and variable costs from personnel to fuel contracts to flight schedules. Southwest
does it well, manages customer loyalty and seems to have an awful lot of fun in the process
____________________________________________________________________________
3. Listen and fill in the blanks

Whole foods
Michael Besancon has worked for Whole Foods for most of his adult life. He loves his
job and that has a lot to do with the fact that he feels good about the Whole foods mission.
Michael Besancon:” the number one (1) of Whole Foods market is to
sell the highest quality natural organic foods possible. Every store of Whole Foods market is
different and every store has a feel. You could blindfold me and take me into a Whole Foods
Market anywhere in the country and I would know I was in a Whole Foods. If I didn’t see any
signs because I would know it by the feel”
Whole Foods sells mostly organic groceries with an emphasis on fresh produces. Their
commitment to sustainable agriculture collaboration with suppliers in community wellness
makes them a premium brand that costs a little more than their big box competitors but
maintaining high quality and great value for the customers without compromising their core
values is the true secret to their success.
(2) (CVP) is the study of the effects of changes in
(3) and (4) on the (5) . Is it important to (6) ?
determining (7) ? Maximizing use of (8) ?
setting (9) ? and often reported in a (10) for
(11) . The income statement classifies costs as variable or fixed and compute
a (12) - the amount of revenue remaining after deducting variable
costs.
Let’s start by reviewing some basics about CVP analysis, specifically break-even
analysis, target net income and margin of safety. For sake of simplicity, let’s assume you’re
selling just one product tomatoes at a farmers market. (13) can be
computed by taking fixed costs and dividing by the contribution margin
((14) ). Contribution margin can also be expressed in the form of
the (15) , contribution margin divided by sales providing the
break-even point in dollars versus units. When a company is in its early stages of operation, the
(16) is break even. Failure to do so will lead to (17) .
Once you’ve determined the break-even point, you want to set a sale goal that will
generate a (18) . This will provide you with (19 in
either units or dollars depending on whether you use a contribution margin per unit or
contribution margin ratio. Finally, (20) indicates how much sales
can decline before you’re operating at a loss and again can be expressed in dollar terms or as a
percentage
Ok, that seems easy enough. Now let’s get back to the Whole foods where things are
slightly more complicated because Whole Foods doesn’t just sell tomatoes, they sell thousands
of different products with different costs that fluctuate constantly under a variety of
(21) such as the weather, competition and transportation costs.

14
 Michael Besancon:” Produce could be a higher because of lower freight costs in one
area and in another area it could have a lower margin on it. what you have to do is you have to
blend your margin across the full spectrum of products “
Whole foods starts by determining their (22) , the (23) in
which they sell their (24) . Sales mix is important to managers because different
products often have substantially different contribution margin. Managers can compute break-
even sales for a mix of two or more products by determining the (25) unit
contribution margin of all the products. However to avoid having to calculate thousands of
different unique contribution margins they calculate the break-even point in terms of sales
dollars rather than units sold. Using sales information for division of product lines, also they
must compute the (26) rather than contribution margin per unit.
Ultimately, information such as this provided using CVP analysis can help managers better
understand the impact of sales mix on (27) .
Price fluctuation is one thing but what happens when fluctuation strikes whole nations
and industries. during the recent recession, Whole Foods managed to actually maintain
profitability despite opening 16 new stores, they did this by reducing certain premium prices
and reducing the size of each new store allowing for savings in other areas
Michael Besacon “and we have moved into a direction of what we call right – sizing
stores and the savings from that is that the rent obvious utilities and fewer team members
would be needed to start a store”
Companies that have higher fixed costs relative to variable costs have higher
(28) . Operating leverage is calculated as the contribution margin
divided by the (29) . When a company sales revenues are increasing high
operating leverage can mean that profits will increase rapidly. However when sales are
declining too much operating leverage can have quite devastating effects on the company. By
working with suppliers and streamlining store space to control costs lower overhead gives
Whole Foods a way to lower operating leverage. This coupled with an increased
(30) or during trouble times allows Whole Foods to continue as a
competitive alternative for health-conscious grocery shoppers

Summary
Read and fill in the blanks with the following words: the contribution margin ratio,
special case, sales mix, CVP analysis, a CVP graph, net operating income, break-even
analysis, critical questions, fixed expense, exceeds, the degree of operating leverage, constant,
multiproduct, the margin of safety, specified target profit

(1) is based on a simple model of how profits respond to prices,

costs, and volume. This model can be used to answer a variety of (2) such
as what is the company’s breakeven volume, what is its margin of safety, and what is likely to
happen if specific changes are made in prices, costs, and volume.
(3) depicts the relationships between unit sales on the one hand and
fixed expenses, variable expenses, total expenses, total sales, and profits on the other hand. The
profit graph is simpler than the CVP graph and shows how profits depend on sales. The CVP

15
 and profit graphs are useful for developing intuition about how costs and profits respond to
changes in sales.
(4) is the ratio of the total contribution margin to total sales.
This ratio can be used to quickly estimate what impact a change in total sales would have on
(5) . The ratio is also useful in (6) .
Target profit analysis is used to estimate how much sales would have to be to attain a
(7) . The unit sales required to attain the target profit can be estimated by
dividing the sum of the target profit and (8) by the unit contribution
margin. Break-even analysis is a (9) of target profit analysis that is used to
estimate how much sales would have to be to just break even. The unit sales required to break
even can be estimated by dividing the fixed expense by the unit contribution margin.
(10) is the amount by which the company’s current sales
(11) break-even sales. (12) allows
quick estimation of what impact a given percentage change in sales would have on the
company’s net operating income. The higher the degree of operating leverage, the greater is the
impact on the company’s profits. The degree of operating leverage is not (13) —it
depends on the company’s current level of sales. The profits of a (14) company
are affected by its (15) . Changes in the sales mix can affect the break-even point,
margin of safety, and other critical factors.
Questions
1. What is meant by a product’s contribution margin ratio? How is this ratio useful in
planning business operations?
2. Often the most direct route to a business decision is an incremental analysis. What is meant
by an incremental analysis?
3. In all respects, Company A and Company B are identical except that Company A’s costs
are mostly variable, whereas Company B’s costs are mostly fixed. When sales increase,
which company will tend to realize the greatest increase in profits? Explain.
4. What is meant by the term operating leverage?
5. What is meant by the term break-even point?
6. In response to a request from your immediate supervisor, you have prepared a CVP graph
portraying the cost and revenue characteristics of your company’s product and operations.
Explain how the lines on the graph and the break-even point would change if (a ) the
selling price per unit decreased, (b ) fixed cost increased throughout the entire range of
activity portrayed on the graph, and (c) variable cost per unit increased.
7. What is meant by the margin of safety?
8. What is meant by the term sales mix? What assumption is usually made concerning sales
mix in CVP analysis?
9. Explain how a shift in the sales mix could result in both a higher break-even point and a
lower net income.

16
Topic 4. Static Budgets
Glossary
No Terms Meaning
1 Budget A detailed plan for the future that is usually expressed
in formal quantitative terms.
2 Budget committee A group of key managers who are responsible for
overall budgeting policy and for coordinating the
preparation of the budget.
3 Cash budget A detailed plan showing how cash resources will be
acquired and used over a specific time period.
4 Continuous budget A 12-month budget that rolls forward one month as
the current month is completed.
5 Control The process of gathering feedback to ensure that a
plan is being properly executed or modified as
circumstances change.
6 Direct labor budget A detailed plan that shows the direct labor-hours
required to fulfill the production budget.
7 Direct materials budget A detailed plan showing the amount of raw materials
that must be purchased to fulfill the production budget
and to provide for adequate inventories.
8 Ending finished goods A budget showing the dollar amount of unsold
inventory budget finished goods inventory that will appear on the
ending balance sheet.
9 Manufacturing overhead A detailed plan showing the production costs, other
budget than direct materials and direct labor, that will be
incurred over a specified time period.
10 Master budget A number of separate but interdependent budgets that
formally lay out the company’s sales, production, and
financial goals and that culminates in a cash budget,
budgeted income statement, and budgeted balance
sheet.
11 Merchandise purchases A detailed plan used by a merchandising company that
budget shows the amount of goods that must be purchased
from suppliers during the period.
12 Participative budget See Self-imposed budget.
13 Perpetual budget See Continuous budget.
14 Planning Developing goals and preparing budgets to achieve
those goals.
15 Production budget A detailed plan showing the number of units that must
be produced during a period in order to satisfy both
sales and inventory needs.
16 Sales budget A detailed schedule showing expected sales expressed
in both dollars and units.

17
 17 Self-imposed budget A method of preparing budgets in which managers
prepare their own budgets. These budgets are then
reviewed by higher-level managers, and any issues are
resolved by mutual agreement.
18 Selling and administrative A detailed schedule of planned expenses that will be
expense budget incurred in areas other than manufacturing during a
budget period.

Concepts in action
Read and fill in the blanks with the following words: budgeting, value, companies, control, runs,
accounts, managers, experts, expenses, revenue, sensitivity, competitive, users, decision making

Web-Enabled Budgeting and Hendrick Motorsports

In recent years, an increasing number of (1) have implemented
comprehensive software packages that manage budgeting and forecasting functions across the
organization. One such option is Microsoft Forecaster, which was originally designed by FRx
Software for businesses looking to gain (2) over their budgeting and forecasting
process within a fully integrated Web-based environment.
Among the more unique companies implementing Web-enabled budgeting is Hendrick
Motorsports. Featuring champion drivers Jeff Gordon and Jimmie Johnson, Hendrick is the
premier NASCAR Sprint Cup stock car racing organization. According to Forbes magazine,
Hendrick is NASCAR’s most valuable team, with an estimated (3) of $350 million.
Headquartered on a 12 building, 600,000-square-foot campus near Charlotte, North Carolina,
Hendrick operates four full-time teams in the Sprint Cup series, which (4) annually
from February through November and features 36 races at 22 speedways across the United
States. The Hendrick organization has annual (5) of close to $195 million and more
than 500 employees, with tasks ranging from accounting and marketing to engine building and
racecar driving. Such an environment features multiple functional areas and units, varied
worksites, and ever-changing circumstances. Patrick Perkins, director of marketing, noted,
“Racing is a fast business. It’s just as fast off the track as it is on it. With the work that we put
into development of our teams and technologies, and having to respond to change as well as
anticipate change, I like to think of us in this business as change (6) .”
Microsoft Forecaster, Hendrick’s Web-enabled budgeting package, has allowed
Hendrick’s financial managers to seamlessly manage the planning and budgeting process.
Authorized users from each functional area or team sign on to the application through the
corporate intranet. Security on the system is tight: Access is limited to only the (7) that
a manager is authorized to budget. (For example, Jeff Gordon’s crew chief is not able to see
what Jimmie Johnson’s team members are doing.) Forecaster also allows (8) at the
racetrack to access the application remotely, which allows (9) to receive or update real-
time “actuals” from the system. This way, team managers know their allotted (10) for
each race. Forecaster also provides users with additional features, including seamless links
with general ledger accounts and the option to perform what-if ((11) ) analyses. Scott
Lampe, chief financial officer, said, “Forecaster allows us to change our forecasts to respond to
changes, either rule changes [such as changes in the series’ points system] or technology
18
 changes [such as pilot testing NASCAR’s new, safer “Car of Tomorrow”] throughout the
racing season.”
Hendrick’s Web-enabled budgeting system frees the finance department so it can work
on strategy, analysis, and (12) . It also allows Hendrick to complete its annual
(13) process in only six weeks, a 50% reduction in the time spent budgeting and
planning, which is critical given NASCAR’s extremely short off-season. Patrick Pearson from
Hendrick Motorsports believes the system gives the organization a (14) advantage:
“In racing, the team that wins is not only the team with the fastest car, but the team that is the
most disciplined and prepared week in and week out. Forecaster allows us to respond to that
changing landscape.”
Budgetary Planning at BabyCakes
Listen and fill in the blanks

OK. So, you are the owner of BabyCakes NYC, the most popular health-conscious
vegan bakery in the city and you just opened a second store but it’s all the way across country
in Los Angeles, and you’re facing your first big holiday rush, so how you can budget for it?
First, let’s go over some basics. Budgeting which is defined as a written statement that
management’s plans for a specific period expressed in (1) is a cornerstone of
planning for any business, large or small.
Erin McKenna: “Aside from doing the baking, the frosting and designing uniforms, I’m
also in charge of all (2) myself. Budgeting definitely makes us more
efficient and helps us judge (3) of the company and it help us be a little bit
more responsible in (4) .”
Once budgets are established, they become important basis for evaluating future
performance. They can motivate (5) to meet objectives, they serve as a
deterrent waste, to promote efficiency and they can serve as (6) .
Erin McKenna: ‘If I didn’t budget I would definitely overspent because there’s so many
things that I want to do for the bakery. It’s like having a baby, and you want to dress it up, and
you want to take it to Disney World, and you want to make it as fun as possible.”
Sometimes people confuse budgeting with planning. Whereas planning focuses on
(7) , budgeting deals with (8) Budgets can be
prepared for any period of time. In the case of Babycakes, Erin prepares (9) budget
which is supplemented by (10) budgets.
Erin McKenna: “From there we know what we can buy, how much we put into certain
items and that way we can look at an extended period of sales trends or weather, holidays...”
Holidays like Valentine’s Day which brings us back to our starting point. With
Valentine’s Day quickly approaching Erin’s need to be sure that she has allocated
(11) to handle the rush, assuming there will be a rush in the new
location. So how did she proceed?
In business, (12) normally contains two classes of budgets.
(13) , which will discuss in this video, and (14) . There
are many different types of (15) but we’ll focus on the two that Erin uses
predominately. Budget goals of course are based on past performance. In larger companies,
data collected from various organizational units beginning several months before the end of
19
current year. Because it is derived from (16) , every other budget depends on it,
the sales budget is the first budget prepared. Normally companies forecast sales by considering
a variety of factors but Erin doesn’t always have all these at her disposal on the new LA
bakery.
Erin McKenna: “It can be challenging to plan for Valentine’s Day because we don’t
have past years that we’ve been at this location.”
In the absence of (17) she’ll refer to data from her New York store for
guidance. One thing she learned over the year is that Valentine’s Day is not a holiday to be
taken lightly.
Erin McKenna: “Our first Valentine’s Day in New York we baked a little bit more than
usual, but right when we open our door, there is a line, you know, sneaking around the block
and we couldn’t take fast enough. So I leant my lesson very quickly that time.”
In terms of marketing, Erin keeps her holiday costs low in the new location by using
her creativity and by making use of online social network.
Erin McKenna: “We will tweet that we have special sweetheart boxes, two cupcakes
and window box and it looks like a little present. And things like heart shaped cookies and that
would usually get the word out enough for us. ”
Because Babycakes appeals to a very specific demographic, people with food allergies
Erin can’t really look to changes like Sprinkles for industry trends. As a general rule, Erin
tends to over-bake rather than under-bake so as not to disappoint our customers. In the end she
doesn’t move all of her product, she can always sell items the following day at
(18)___________________
The bottom line is that for small businesses (19) can be
somewhat informal at times. Erin takes a very hands-on approach to her business which allows
her to spot trends, minimize waste and trust her instincts.
Erin McKenna: “When I’m here and I see the waste then the ideas come. And when I
see their reactions to certain items, the doughnuts, brings a really big emotional reaction from
people. And if I didn’t see that then I wouldn’t know to put more money into doughnut pans
and I will, for example, say, the corn bread isn’t selling, stop making it. You know, like as you
see all the little details.”
OK. Now let’s look at an example in her LA store, let’s say that Erin normally sell
about 1,000 up the red velvet cupcakes a day at $3.5 each. On a Valentine’s Day she expects to
sell an additional 500 or 1,500 red velvet cupcakes in total. So we multiply (20) by
(21) to obtain total sales which in this case is 5,250 for the red velvet
cupcakes. So she knows that she needs to ensure she has enough supplies to handle the
production. Next, let’s look at the production budget which shows the units must be produced
to meet the anticipated sales. This is derived from the sales budget plus the desired change in
(22) . In an ideal world, a bakery wants to end the day by selling all
of its product. However, it needs to maintain supplies to produce the next day’s product. The
required production in units formula is: budgeted sales units plus desire ending finished goods
units minus (23) equals required production units. So, if
they sell 1,000 red velvet cupcakes each day on average and I have to account for an extra 500
red velvet cupcakes on Valentine’s Day, there are only enough raw materials for the holiday
but for the days that follow. This is obviously a very simplified example but you can imagine it
20
 gets even more complicated when Erin has to take into account different types of cupcakes and
other products and flavors.
Erin worked hard to budget for Valentine’s Day in her new location despite not having
much history to help guide her decisions. She relied on a combination of
(24) and informal budgeting intuition to help her make
decisions and the results or lack of them speak for themselves.
Erin McKenna: “Looks like it’s a big success! Budgeted perfectly.”
She did extremely well in her playing with respect to cupcakes running out just before closing
time. and best of all she knows that she has enough supplies for tomorrow with the entire
process starts all over again at 4 a.m.

Summary
Read and fill in the blanks with the following words: budget, budgeting, budgeted,
production, produce, manufacturing, sold, relate, master, cash
This chapter describes the (1) process and shows how the various operating
budgets (2) to each other. The sales (3) is the foundation for profit
planning. Once the sales budget has been set, the (4) budget and the selling and
administrative expense budget can be prepared because they depend on how many units are to
be (5) . The production budget determines how many units are to be (6) ,
so after it is prepared, the various (7) cost budgets can be prepared. All
of these budgets feed into the (8) budget and the budgeted income statement and
balance sheet. The parts of the (9) budget are connected in many ways. For
example, the schedule of expected cash collections, which is completed in connection with the
sales budget, provides data for both the cash budget and the (10) balance sheet.
Questions
1. What is a budget? What is budgetary control?
2. Discuss some of the major benefits to be gained from budgeting.
3. What is a master budget? Briefly describe its contents.
4. Why is the sales forecast the starting point in budgeting?
5. “As a practical matter, planning and control mean exactly the same thing.” Do you agree?
Explain.
6. Describe the flow of budget data in an organization. Who are the participants in the
budgeting process, and how do they participate?
7. What is a self-imposed budget? What are the major advantages of self-imposed budgets?
What caution must be exercised in their use?
8. How can budgeting assist a company in planning its workforce staffing levels?
9. “The principal purpose of the cash budget is to see how much cash the company will have
in the bank at the end of the year.” Do you agree? Explain.

21
Topic 5. Flexible Budgets
Glossary
No Terms
1 Activity variance
2 Flexible budget
3 Ideal standards
4 Labor efficiency variance
5 Labor rate variance
6 Management by exception
7 Materials price variance
8 Materials quantity variance
9 Planning budget
10 Practical standards
11 Price variance
Meaning
The difference between a revenue or cost item in the
static planning budget and the same item in the
flexible budget. An activity variance is due solely to
the difference between the level of activity assumed in
the planning budget and the actual level of activity
used in the flexible budget.
A report showing estimates of what revenues and costs
should have been, given the actual level of activity for
the period.
Standards that assume peak efficiency at all times.
The difference between the actual hours taken to
complete a task and the standard hours allowed for the
actual output, multiplied by the standard hourly labor
rate.
The difference between the actual hourly labor rate
and the standard rate, multiplied by the number of
hours worked during the period.
A management system in which standards are set for
various activities, with actual results compared to
these standards. Significant deviations from standards
are flagged as exceptions.
The difference between the actual unit price paid for
an item and the standard price, multiplied by the
quantity purchased.
The difference between the actual quantity of
materials used in production and the standard quantity
allowed for the actual output, multiplied by the
standard price per unit of materials.
A budget created at the beginning of the budgeting
period that is valid only for the planned level of
activity.
Standards that allow for normal machine downtime
and other work interruptions and that can be attained
through reasonable, though highly efficient, efforts by
the average worker.
A variance that is computed by taking the difference
between the actual price and the standard price and
multiplying the result by the actual quantity of the
22
 input.
12 Quantity variance A variance that is computed by taking the difference
between the actual quantity of the input used and the
amount of the input that should have been used for the
actual level of output and multiplying the result by the
standard price of the input.
13 Revenue variance The difference between how much the revenue should
have been, given the actual level of activity, and the
actual revenue for the period. A favorable
(unfavorable) revenue variance occurs because the
revenue is higher (lower) than expected, given the
actual level of activity for the period.

14 Spending variance The difference between how much a cost should have
been, given the actual level of activity, and the actual
amount of the cost. A favorable (unfavorable)
spending variance occurs because the cost is lower
(higher) than expected, given the actual level of
activity for the period.
15 Standard cost card A detailed listing of the standard amounts of inputs
and their costs that are required to produce one unit of
a specific product.
16 Standard cost per unit The standard quantity allowed of an input per unit of a
specific product, multiplied by the standard price of
the input.
17 Standard hours allowed The time that should have been taken to complete the
period’s output. It is computed by multiplying the
actual number of units produced by the standard hours
per unit.
18 Standard hours per unit The amount of direct labor time that should be
required to complete a single unit of product,
including allowances for breaks, machine downtime,
cleanup, rejects, and other normal inefficiencies.
19 Standard price per unit The price that should be paid for an input.
20 Standard quantity allowed The amount of an input that should have been used to
complete the period’s actual output. It is computed by
multiplying the actual number of units produced by
the standard quantity per unit.
21 Standard quantity per unit The amount of an input that should be required to
complete a single unit of product, including
allowances for normal waste, spoilage, rejects, and
other normal inefficiencies.
22 Standard rate per hour The labor rate that should be incurred per hour of
labor time, including employment taxes and fringe
23
 benefits.
23 Variable overhead The difference between the actual level of activity
efficiency variance (direct labor-hours, machine-hours, or some other
base) and the standard activity allowed, multiplied
by the variable part of the predetermined overhead
rate.
24 Variable overhead rate The difference between the actual variable overhead
variance cost incurred during a period and the standard cost that
should have been incurred based on the actual activity
of the period.

Concepts in action
Read and fill in the blanks with the following words: direct, labor, materials, waste, spoilage,
increase, reducing, expenses, costs, revenue, profit. variances, analysis.

Starbucks Reduces Direct-cost Variances to Brew a Turnaround

Along with coffee, Starbucks brewed profitable growth for many years. From Seattle
to Singapore, customers lined up to buy $4 lattes and Frappuccinos. Walking around with a
coffee drink from Starbucks became an affordable-luxury status symbol. But when consumers
tightened their purse strings amid the recession, the company was in serious trouble. With
customers cutting back and lower-priced competition—from Dunkin’ Donuts and McDonald’s
among others—increasing, Starbucks’ (1) margins were under attack.
For Starbucks, profitability depends on making each high-quality beverage at the
lowest possible (2) . As a result, an intricate understanding of direct costs is critical.
Variance (3) helps managers assess and maintain profitability at desired levels. In
each Starbucks store, the two key (4) costs are materials and labor.
(5) costs at Starbucks include coffee beans, milk, flavoring syrups,
pastries, paper cups, and lids. To reduce budgeted costs for materials, Starbucks focused on
two key inputs: coffee and milk. For coffee, Starbucks sought to avoid waste and (6) by
no longer brewing decaffeinated and darker coffee blends in the afternoon and evening, when
store traffic is slower. Instead, baristas were instructed to brew a pot only when a customer
ordered it. With milk prices rising (and making up around 10% of Starbucks’ cost of sales), the
company switched to 2% milk, which is healthier and costs less, and redoubled efforts to
reduce milk-related spoilage.
Labor costs at Starbucks, which cost 24% of company (7) annually, were
another area of variance focus. Many stores employed fewer baristas. In other stores, Starbucks
adopted many “lean” production techniques. With 30% of baristas’ time involved in walking
around behind the counter, reaching for items, and blending drinks, Starbucks sought to make
its drink-making processes more efficient. While the changes seem small—keeping bins of
coffee beans on top of the counter so baristas don’t have to bend over, moving bottles of
flavored syrups closer to where drinks are made, and using colored tape to quickly differentiate

24
 between pitchers of soy, nonfat, and low-fat milk—some stores experienced a 10%
(8) in transactions using the same number of workers or fewer.
The company took additional steps to align (9) costs with its pricing.
Starbucks cut prices on easier-to-make drinks like drip coffee, while lifting prices by as much
as 30 cents for larger and more complex drinks, such as a venti caramel macchiato.
Starbucks’ focus on (10) year-over-year variances paid off. In fiscal year
2009, the company reduced its store operating (11) by $320 million, or 8.5%.
Continued focus on direct-cost (12) will be critical to the company’s future
success in any economic climate.

Summary

Summary 1
Read and fill in the blanks with the following words: favorable, unfavorable, flexible, static,
actual, budgeted, reasons, spending, level, cost, fixed, variable, variances, behavior, activity,
change, compared, adjusted
Directly comparing (1) planning budget revenues and costs to (2) revenues
and costs can easily lead to erroneous conclusions. Actual revenues and costs differ from
budgeted revenues and costs for a variety of (3) , but one of the biggest is a (4) in
the level of activity. One would expect actual revenues and costs to increase or decrease as the
activity level increases or decreases. (5) budgets enable managers to isolate the
various causes of the differences between budgeted and actual costs.
A flexible budget is a budget that is (6) to the actual level of activity. It is the
best estimate of what revenues and costs should have been, given the actual level of activity
during the period. The flexible budget can be (7) to the budget from the beginning
of the period or to the actual results.
When the flexible budget is compared to the budget from the beginning of the period,
(8) variances are the result. An activity variance shows how a revenue or cost should
have changed in response to the difference between (9) and actual activity.

When the flexible budget is compared to actual results, revenue and (10) variances
are the result. A (11) revenue variance indicates that revenue was larger than
should have been expected, given the actual level of activity. An (12) revenue
variance indicates that revenue was less than it should have been, given the actual level of
activity. A favorable spending variance indicates that the cost was less than expected, given the
actual (13)___________ of activity. An unfavorable spending variance indicates that the
(14) was greater than it should have been, given the actual level of activity.
A flexible budget performance report combines the activity variances and the revenue
and spending variances on one report.
Common errors in comparing budgeted costs to actual costs are to assume all costs are
(15) or to assume all costs are (16) . If all costs are assumed to be fixed,
the (17) for variable and mixed costs will be incorrect. If all costs are assumed to be
variable, the variances for fixed and mixed costs will be incorrect. The variance for a cost will

25
 only be correct if the actual (18) of the cost is used to develop the flexible budget
benchmark.

Summary 2
Read and fill in the blanks with the following words and terms: investigated, attained,
emphasized, fixed, quantity standards, cost standards, variance, quantity variances, price
variances, standard cost variances, price, cost, quantity.

A standard is a benchmark, or “norm,” for measuring performance. Standards are set

for both the quantity and the (1)________ of inputs needed to manufacture goods or to provide
services. (2) indicate how much of an input, such as labor time or raw
materials, should be used to make a product or provide a service. (3) indicate
what the cost of the input should be.
Standards are normally set so that they can be (4) by reasonable, though
highly efficient, efforts. Such “practical” standards are believed to positively motivate
employees.
When standards are compared to actual performance, the difference is referred to as a
(5) Variances are computed and reported to management on a regular basis for
both the (6) and the (7) elements of direct materials, direct labor, and
variable overhead. (8) are computed by taking the difference between the
actual amount of the input used and the amount of input that is allowed for the actual output,
and then multiplying the result by the standard price of the input. (9) are
computed by taking the difference between actual and standard prices and multiplying the
result by the amount of input purchased.
Not all variances require management attention. Only unusual or particularly
significant variances should be (10) —otherwise a great deal of time would be spent
investigating unimportant matters. Additionally, it should be (11) that the point
of the investigation should not be to find someone to blame. The point of the investigation is to
pinpoint the problem so that it can be (12) and operations improved.
Traditional standard cost variance reports are often supplemented with other
performance measures. Overemphasis on (13) may lead to problems in
other critical areas such as product quality, inventory levels, and on-time delivery.
Questions
1. What is a static planning budget?
2. What is a flexible budget and how does it differ from a static planning budget?
3. What are some of the possible reasons that actual results may differ from what had been
budgeted at the beginning of a period?
4. Why is it difficult to interpret a difference between how much expense was budgeted and
how much was actually spent?
5. What is an activity variance and what does it mean?
6. What is a revenue variance and what does it mean?
7. What is a spending variance and what does it mean?
8. What does a flexible budget performance report do that a simple comparison of budgeted to
actual results does not do?
26
 9. What assumption is implicitly made about cost behavior when a static planning budget is
directly compared to actual results? Why is this assumption questionable?
10. What assumption is implicitly made about cost behavior when all of the items in a static
planning budget are adjusted in proportion to a change in activity? Why is this assumption
questionable?
11. What is a quantity standard? What is a price standard?
12. What is meant by the term management by exception?
13. Why are separate price and quantity variances computed?
14. Who is generally responsible for the materials price variance? The materials quantity
variance? The labor efficiency variance?
15. The materials price variance can be computed at what two different points in time? Which
point is better? Why?
16. If the materials price variance is favorable but the materials quantity variance is
unfavorable, what might this indicate?
17. Should standards be used to identify who to blame for problems?
18. “Our workers are all under labor contracts; therefore, our labor rate variance is bound to be
zero.” Discuss.
19. What effect, if any, would you expect poor-quality materials to have on direct labor
variances?
20. If variable manufacturing overhead is applied to production on the basis of direct
laborhours and the direct labor efficiency variance is unfavorable, will the variable
overhead efficiency variance be favorable or unfavorable, or could it be either? Explain.
21. What is a statistical control chart, and how is it used?
22. Why can undue emphasis on labor efficiency variances lead to excess work in process
inventories?

Topic 6. Managerial Accounting Information for Shorterm Decisions

Glossary

No Terms Meaning
1 Avoidable cost A cost that can be eliminated by choosing one
alternative over another in a decision.
This term is synonymous with relevant cost.
2 Bottleneck A machine or some other part of a process that limits
the total output of the entire system.
3 Constraint A limitation under which a company must operate,
such as limited available machine time or raw
materials that restricts the company’s ability to satisfy
demand.
4 Joint costs Costs that are incurred up to the split-off point in a
process that produces joint products.
5 Joint products Two or more products that are produced from a
common input.

27
 6 Make or buy decision A decision concerning whether an item should be
produced internally or purchased from an outside
supplier.
7 Relevant benefit A benefit that differs between alternatives in a
decision. Synonyms are differential benefit and
incremental benefit.
8 Relevant cost A cost that differs between alternatives in a decision.
Synonyms are avoidable cost, differential cost, and
incremental cost.
9 Sell or process further A decision as to whether a joint product should be sold
decision at the split-off point or sold after further processing.
10 Special order A one-time order that is not considered part of the
company’s normal ongoing business.
11 Split-off point That point in the manufacturing process where some
or all of the joint products can be recognized as
individual products.
12 Sunk cost Any cost that has already been incurred and that
cannot be changed by any decision made now or in the
future.

Concepts in action
1. Read and fill in the blanks with the following words: solutions, resources, savings, costs,
outsourcing, offshoring, scarce, labor, defined, discovered, invented, development, innovation.

Pringles Prints and the Offshoring of Innovation

According to a recent survey, 67% of U.S. companies are engaged in the rapidly-
evolving process of “offshoring,” which is the (1) of business processes and
jobs to other countries. (2) was initially popular with companies because it
yielded immediate labor-cost (3) for activities such as software development, call
centers, and technical support.
While the practice remains popular today, offshoring has transformed from lowering
(4) on back-office processes to accessing global talent for innovation. With global
markets expanding and domestic talent (5) companies are now hiring qualified
engineers, scientists, inventors, and analysts all over the world for research and development
(R&D), new product development (NPD), engineering, and knowledge services.
Innovation Offshoring Services
R&D NPD Engineering Knowlegde services
 Programming  Prototype design  Testing  Market analysis
 Code  Product  Reengineering  Credit analysis
development development  Drafting/modeling  Data mining
 New technologies  Systems design  Embedded systems  Forecasting
 New  Support services  development  Risk

28
 materials/process management
research
By utilizing offshoring innovation, companies not only continue to reduce
(6) costs, but cut back-office costs as well. Companies also obtain local market
knowledge and access to global best practices in many important areas.
Some companies are leveraging offshore (7) by creating global innovation
networks. Procter & Gamble (P&G), for instance, established “Connect and Develop,” a multi-
national effort to create and leverage innovative ideas for product (8) When the
company wanted to create a new line of Pringles potato chips with pictures and words—trivia
questions, animal facts, and jokes—printed on each chip, the company turned to offshore
(9) .
Rather than trying to invent the technology required to print images on potato chips in-
house, Procter & Gamble created a technology brief that (10) the problems it needed
to solve, and circulated it throughout the company’s global innovation network for possible
(11)________________
As a result, P&G (12) a small bakery in Bologna, Italy, run by a university
professor who also manufactured baking equipment. He had (13)___________ an ink-jet
method for printing edible images on cakes and cookies, which the company quickly adapted
for potato chips. As a result, Pringles Prints were developed in less than a year—as opposed to
a more traditional two year process—and immediately led to double-digit product growth.
______________________________________________________________________________________________
2. Listen and fill in the blanks
Incremental Analysis at Method
When Adam Lowry and Eric Ryan, friends since high school got tired of Monday
looking cleaning products that were (1) . They have a decision to make:
live with them like everyone else or try to create an entirely new line, eco-friendly cleaning
products even if that meant competing against (2) corporations.
Eric Ryan: “We knew when we started this business that we weren’t going up against
one goliath player, we were actually going up against seven goliath players who arguably had
100 years head start on us. So reinventing soap is no easy task because It’s a very basic product
and our only chance of success was to bring a lot of differentiations. So this tiny bottle does 50
loads of laundry which would be the equivalent to a very large jog and essentially it’s not only
the world’s most efficient laundry detergent but it’s also the world’s greenest laundry
detergent.”
Managers make important decisions all the time and some of those decisions require
(3) in unusual ways. For Adam and Eric, their first was to decide whether to
(4) themselves, (5)_____________ or because of their unique needs,
outsource in a way that gave them (6) . Which of these methods would
cost more? Which would be more environmentally friendly?
Like many managers they followed (7) in their decision-making
process. They identified a basic challenge. How would they manufacture Method soap? They
(8) their options: open a factory, completely outsource production or outsource
production and retain some control. (9) all the costs and benefits, they made a
decision. And, after all the number started to roll in, they (10) the results of that

29
decision to make sure they (11) . The process used to identify the financial
data that change under alternative courses of action is called (12) . To make
their decision, Method management analyzed (13) factors,
(14) factors, such as costs that would change depending on which alternative
course of action is chosen. There was a major benefit to opening their own factory. Method
would have (15) but they would have to buy or lease a large
building, purchase tons of equipment and employ a huge staff.
Adam Lowry: “Building a manufacturing infrastructure is really expensive and it
burdens your business with a lot of (16) .”
Eric Ryan: “As I knew as you go up against companies with incredible economies of
scale, it’s really really hard to go into that same cost structure”
By outsourcing they share these costs with all the other clients of vender with whom
they did business.
Adam Lowry: “Contract manufacturers are built for scale and can run them more
efficiently than we would if we scale our online first small business.”
So, from a purely quantitative perspective it made the most sense for Eric and Adam to
outsource production of their soaps to an outside party. But costs aren’t the only consideration
for managers at the company, Method had to also consider (17) . Those
considerations which are (18) but still important in making decisions.
Their main mission to make soap that’s easier to use more attractive to display and better for
the environment sets them apart from other cleaning products. The size of their company also
sets them apart from their competition and to that end, a large expensive factory might hinder
them strategically.
Adam Lowry: “And as the little guy in our category, we need to be very quick to market
and very flexible so that we can be innovative. It’s how we compete.”
Another consideration, of course, was (19) . To stay green, they need
lots of control over their production methods, exactly the kind of control they be giving up
using an outside factory. Ultimately, they chose to outsource manufacturing of their products
but only with vendors that (20) for ecological production methods.
Adam Lowry: “We have a program called Green sourcing and what that program’s
about is working with our contract manufacturers and our suppliers to get greener together and
the reason we do that is the footprint of our manufacturing business is actually the footprint of
our suppliers and venders.”
But executing a plan is not always as simple as it might seem. In the case of one
manufacturer, for example, Method offered to install solar panels on the roof of the factory to
power the forklift.
Adam Lowry: “But because we didn’t own that facility, and actually our vendor didn’t
own that facility, they (21) , we had to get very creative in how we did
the solar installation, so we installed the solar on top of the decommissioned tractor-trailer and
parked it on the side of the building and running the wires in the side door.”
There are many qualitative factors that are important to Adam and Eric, and the loyal
customer base which compete with quantitative factors when making decisions.
Adam Lowry: “They include things like what are the carbon footprint of the products
that we’re using and then on the social side there’s issues of where do we manufacture this
30
 product or people being paid a living wage. There are four primary factors that we use to
choose our contract manufacturers and all of the suppliers we use which are
(22) .”
Even though Method’s environmentally friendly manufacturing choices cost more upfront. In
the long-term they usually save money on day-to-day operating costs associated with using
those technologies.
Adam Lowry: “We have a fleet of 8 semi-trailers, 53 foot-trailers that we run
exclusively off of waste vegetable oil biodiesel but now they are cheapest trucks in our fleet
because they get 30 to 50 percent better mileage than any other truck.”
Adam Lowry and Eric Ryan are on a mission to change the way we clean and by
making great (23) that weight different options based on how they
impact (24) like brand identity. They keep Method soap
cleaning up at the cash register and the environment.

Summary
Read and fill in the blanks with the following words and terms: future costs, sunk costs,
differ, constrained, relevant, irrelevant, applications, decisions
Everything in this chapter consists of applications of one simple but powerful idea.
Only those costs and benefits that (1) between alternatives are (2)________ in a
decision. All other costs and benefits are (3) and should be ignored. In particular,
(4) are irrelevant as are (5) that do not differ between alternatives.
This simple idea was applied in a variety of situations including (6) that
involve adding or dropping a product line, making or buying a component, accepting or
rejecting a special order, using a (7) resource, and processing a joint product
further. This list includes only a small sample of the possible (8) of the relevant
cost concept. Indeed, any decision involving costs hinges on the proper identification and
analysis of the costs that are relevant.
Questions
1. What is a relevant cost?
2. Define the following terms: incremental cost, opportunity cost, and sunk cost.
3. Are variable costs always relevant costs? Explain.
4. “Sunk costs are easy to spot—they’re the fixed costs associated with a decision.” Do you
agree? Explain.
5. “Variable costs and differential costs mean the same thing.” Do you agree? Explain.
6. “All future costs are relevant in decision making.” Do you agree? Why?
7. Prentice Company is considering dropping one of its product lines. What costs of the
product line would be relevant to this decision? What costs would be irrelevant?
8. “If a product is generating a loss, then it should be discontinued.” Do you agree? Explain.
9. What is the danger in allocating common fixed costs among products or other segments of
an organization?
10. How does opportunity cost enter into a make or buy decision?
11. Give at least four examples of possible constraints.

31
 12. How will relating product contribution margins to the amount of the constrained resource
they consume help a company maximize its profits?
13. Define the following terms: joint products, joint costs, and split-off point.
14. From a decision-making point of view, should joint costs be allocated among joint
products?
15. What guideline should be used in determining whether a joint product should be sold at the
split-off point or processed further?
16. Airlines sometimes offer reduced rates during certain times of the week to members of a
businessperson’s family if they accompany him or her on trips. How does the concept of
relevant costs enter into the decision by the airline to offer reduced rates of this type?

Topic 7. Managerial Accounting Information for Long-term Decisions

Glossary

No Terms
1 Capital budgeting
2 Cost of capital
3 Internal rate of return
4 Net present value
5 Out-of-pocket costs
6 Payback period
7 Preference decision
8 Project profitability index
9 Screening decision
10 Simple rate of return
11 Working capital
Meaning
The process of planning significant investments in
projects that have longterm implications such as the
purchase of new equipment or the introduction of a
new product.
The average rate of return a company must pay to its
long-term creditors and shareholders for the use of
their funds.
The discount rate at which the net present value of an
investment project is zero; the rate of return of a
project over its useful life.
The difference between the present value of an
investment project’s cash inflows and the present
value of its cash outflows.
Actual cash outlays for salaries, advertising, repairs,
and similar costs.
The length of time that it takes for a project to fully
recover its initial cost out of the net cash inflows that
it generates.
A decision in which the alternatives must be ranked.
The ratio of the net present value of a project’s cash
flows to the investment required.
A decision as to whether a proposed investment
project is acceptable.
The rate of return computed by dividing a project’s
annual incremental accounting net operating income
by the initial investment required.
Current assets less current liabilities.

32
Concepts in action
Read and fill in the blank with the following words: NPV, AAR, returns, techniques, ratio,
capital, money, entertainment, revenue, budgeting, project, decision, investment, positive,
evaluated, developed, experienced.
International capital budgeting at Disney
The Walt Disney Company, one of the world’s leading (1) producers,
had more than $36 billion in 2009 (2) through movies, television networks, branded
products, and theme parks and resorts. Within its theme park business, Disney spends around
$1 billion annually in (3) investments for new theme parks, rides and attractions,
and other park construction and improvements. This (4) is divided between its
domestic properties and international parks in Paris, Hong Kong, and Tokyo.
Years ago, Disney (5) a robust capital budgeting approval process.
Project approval relied heavily on projected (6) on capital investment as measured by
net present value (NPV) and internal rate of return (IRR) calculations. While this worked well
for Disney’s investments in its domestic theme park business, the company
(7)___________ challenges when it considered building the DisneySea theme park near
Tokyo, Japan.
While capital (8) in the United States relies on discounted cash flow
analysis, Japanese firms frequently use the average accounting return (AAR) method instead.
AAR is analogous to an accrual accounting rate of return (AARR) measure based on average
investment. However, it focuses on the first few years of a (9) (five years, in the case
of DisneySea) and ignores terminal values.
Disney discovered that the difference in capital budgeting (10) between
U.S. and Japanese firms reflected the difference in corporate governance in the two countries.
The use of NPV and IRR in the United States underlined the perspective of shareholder-value
maximization. On the other hand, the preference for the simple accounting based measure in
Japan reflected the importance of achieving complete consensus among all parties affected by
the investment (11)______________
When the DisneySea project was (12) , it was found to have a positive
(13) , but a negative (14) . To account for the differences in philosophies
and capital budgeting techniques, managers at Disney introduced a third calculation method
called average cash flow return (ACFR). This hybrid method measured the average cash flow
over the first five years, with the asset assumed to be sold for book value at the end of that
period as a fraction of the initial (15) in the project. The resulting (16) was
found to exceed the return on Japanese government bonds, and hence to yield a (17)_______
return for DisneySea. As a result, the DisneySea theme park was constructed next to Tokyo
Disneyland and has since become a profitable addition to Disney’s Japanese operations.

Summary
Read and fill in the blanks with the following words and terms: cash inflows, cash
outflows, projects, funds, initial investment, accounting net operating income, time value of
money, net present value, internal rate of return, minimum required rate of return, project
profitability index, required.
33
 Investment decisions should take into account the (1) because
a dollar today is more valuable than a dollar received in the future. The net present value and
(2) methods both reflect this fact. In the net present value method,
future cash flows are discounted to their present value. The difference between the present
value of the (3) and the present value of the cash outflows is called a
project’s net present value. If the (4) of a project is negative, the
project is rejected. The discount rate in the net present value method is usually based on a
minimum required rate of return such as a company’s cost of capital.
The internal rate of return is the rate of return that equates the present value of the cash
inflows and the present value of the (5) , resulting in a zero net present value.
If the internal rate of return is less than a company’s (6) , the
project is rejected.
After rejecting (7) whose net present values are negative or whose
internal rates of return are less than the minimum required rate of return, more projects may
remain than can be supported with available (8) The remaining projects can be
ranked using either the (9) or internal rate of return. The project
profitability index is computed by dividing the net present value of the project by the required
(10)_______________
Some companies prefer to use either the payback method or the simple rate of return to
evaluate investment proposals. The payback period is the number of periods that are
(11) to fully recover the initial investment in a project. The simple rate of return is
determined by dividing a project’s (12) by the initial
investment in the project.
Questions
1. What is the difference between capital budgeting screening decisions and capital budgeting
preference decisions?
2. What is meant by the term time value of money?
3. What is meant by the term discounting?
4. Why isn’t accounting net income used in the net present value and internal rate of return
methods of making capital budgeting decisions?
5. Why are discounted cash flow methods of making capital budgeting decisions superior to
other methods?
6. What is net present value? Can it ever be negative? Explain.
7. Identify two simplifying assumptions associated with discounted cash flow methods of
making capital budgeting decisions.
8. If a company has to pay interest of 14% on long-term debt, then its cost of capital is 14%.
Do you agree? Explain.
9. What is meant by an investment project’s internal rate of return? How is the internal rate of
return computed?
10. Explain how the cost of capital serves as a screening tool when using ( a ) the net present
value method and ( b ) the internal rate of return method.
11. As the discount rate increases, the present value of a given future cash flow also increases.
Do you agree? Explain.
12. How is the project profitability index computed, and what does it measure?
34
 13. What is meant by the term payback period? How is the payback period determined?
14. How can the payback method be useful?
15. What is the major criticism of the payback and simple rate of return methods of making
capital budgeting decisions?

Managerial Accounting Today

Listen and fill in the blanks
In 1959 when Pizza Hut began to expand out from its first store in Witchita Kansas, the
idea of pizza chains was still very much a novelty. Half of a century later the competitive
environment for restaurants and fast-food both in the US and worldwide has changed
dramatically. To stay on top, managerial (1) for companies like Pizza Hut and
parent company Yum Brands must be forward-looking. One of the ways managerial
accountants improve productivity and eliminate waste is to analyze the (2) . The
value chain refers to all activities associated with (3) .
Activities include research and development, acquisition of materials, production, sales,
delivery and customer relations. At Pizza Hut, (4) fresh fully cooked pizza for
in-store dining, take-out and delivery requires a team effort. Every link in the chain has to work
together in order to reach the goal of bringing the best value to
(5) Companies focus on (6) through a variety
of techniques. Tools such as these allow companies to respond quicker to make better
decisions and they often provide more insight into (7) . Let’s take a closer
look at Pizza Hut and some of the techniques they use to improve productivity and
(8) in their value chain.
For many companies, often the most difficult part of computing accurate unit costs is
determining the proper (9) , the ongoing operating cost of running a
business to assign to a product. This is especially true with new products. Several years ago,
Pizza Hut introduced its line of Tuscani Pastas which required new ingredients and processes
and a massive marketing campaign directed at the public who previously only associated Pizza
Hut with pizza. (10) helped Pizza Hut to accurately assign overhead
costs during and beyond this transition phase.
When acquiring basic ingredients, Pizza Hut can sometimes find profitability and
workflow constrained by shortages and price fluctuations of basic commodities like flour and
cheese. Using the theory of constraint, they can anticipate such constraints called
(11) and circumvent them through clever strategies and creative hedging.
Chris Fuller: “When dairy costs go up, cheese costs can skyrocket and we can’t
tomorrow charge an additional $5 for a pizza, so we work with our suppliers to hedge against
commodity prices. So a year in advance we may set the price for cheese even though it might
go up on the exchange, we can hedge against to get a lower cost to keep providing a good
value, low cost pizzas to our customers.”
The production of each customer order happens at the store level. Most of which are
franchised out. But even if the supply chain is abundantly supplied, they try to limit space and
budget for inventory or spoilage due to over stocking. Thus Pizza Hut provides
(12) that track the current stock levels of everything

35
 from tomatoes to drinking straws, giving managers easy to use tools to reorder supplies online
from central distribution points around the country.
Many companies now employ (13) software systems
which provide a centralized integrated source of information that companies can use to manage
all (14) , from sales to purchasing, to manufacturing, to human
resources. For Pizza Hut, one benefit is that their customers can order at the place that is the
most convenient for them.
Chris Fuller: “Our goal is really to be wherever our customers are. In addition
to the website and other places, we can order picking up the phone, the whole
traditional way. You can order from our iPhone app which was recognized as one of the
most downloaded apps. It’s really fun and you need an interactive way to order your
pizza.”
All this trouble is wasted if the food doesn’t get where it’s going in a timely fashion or
arrive piping hot and tasty, so Pizza Hut employs (15) protocols that
aim to reduce errors in order fulfillment. Even though most stores are independently owned,
each franchisee must learn and adhere to the core company guidelines like methodologies for
assembling, cooking and transporting pizza and other dishes.
Chris Fuller: “The brand has to be the same whether they’re ordering form Amarillo
Texas or from one of our restaurants in Rhode Island. We want to make sure we are fulfilling
that order and creating them the perfect pizza every time. All the way to a smile on her face
when the delivery driver rise at the door or they come to our restaurant to pick up.”
Finally, Pizza Hut seeks customer feedback in order to gauge how it’s doing in their
eyes. For example, customers can use www.tellpizzahut.com and that information goes back to
the individual store to help it improve. Pizza Hut measures both
(16)________________________evaluating all aspects of the company’s performance in an
integrated way, in a balanced scorecard. This helps Pizza Hut understand not only how
customers vote with their wallets but also how well the brand is perceived via community
participation.
Chris Fuller: “We encourage our franchisees to get involve with their communities and
doing philanthropists in their communities as well, so why we have World Hunger Relief Week
and we have the Book it! program. You also see different programs across the country their
causes that are important to our local operators and their communities.”
It isn’t easy to be the largest pizza company in the world and it is even harder to stay on
top in (17) , but the value chain and the various techniques used to
help manage the value chain, all play a key role in helping companies like Pizza Hut stay
number one.

Discussion 1
Use “think-pair-share” to work on this exercise. First, read the following exercise.
Then, take one to two minutes to think of your answers. Pair with another student to discuss
your answers. Finally, be prepared to share your responses with the rest of the class.

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 Name a product and a service you have purchased that you believe was accounted for
using job-order costing. Explain why you think so. Then, think how that product and service
can be transformed such that process costing would be appropriate.

Discussion 2

No Free Lunch Hardly a week goes by without a company advertising a free product
with the purchase of another. Examples are a free printer with a digital camera purchase or a
free monitor with a computer purchase. Can these companies break even, let alone earn
profits? We are reminded of the nofree-lunch adage, meaning that companies expect profits
from the companion or add-on purchase to make up for the free product.

Discussion 3

A local movie theater owner explains to you that ticket sales on weekends and evenings
are strong, but attendance during the weekdays, Monday through Thursday, is poor. The owner
proposes to offer a contract to the local grade school to show educational materials at the
theater for a set charge per student during school hours. The owner asks your help to prepare a
CVP analysis listing the cost and sales projections for the proposal. The owner must propose to
the school’s administration a charge per child. At a minimum, the charge per child needs to be
sufficient for the theater to break even.
Prepare a list of questions being answered by the owner of the movie theater that enable
you to complete a reliable CVP analysis of this situation.

Discussion 4
Norton Company, a manufacturer of infant furniture and carriages, is in the initial
stages of preparing the annual budget for 2010. Scott Ford has recently joined Norton’s
accounting staff and is interested in learning as much as possible about the company’s
budgeting process. During a recent lunch with Marge Atkins, sales manager, and Pete Granger,
production manager, Scott initiated the following conversation.
Scott: Since I’m new around here and am going to be involved with the preparation of the
annual budget, I’d be interested in learning how the two of you estimate sales and production
numbers.
Marge: We start out very methodically by looking at recent history, discussing what we know
about current accounts, potential customers, and the general state of consumer spending. Then,
we add that usual dose of intuition to come up with the best forecast we can.
Pete: I usually take the sales projections as the basis for my projections. Of course, we have to
make an estimate of what this year’s closing inventories will be, which is sometimes difficult.
Scott: Why does that present a problem? There must have been an estimate of closing
inventories in the budget for the current year.
Pete: Those numbers aren’t always reliable since Marge makes some adjustments to the sales
numbers before passing them on to me.
Scott: What kind of adjustments?

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 Marge: Well, we don’t want to fall short of the sales projections so we generally give
ourselves a little breathing room by lowering the initial sales projection anywhere from 5 to 10
percent.
Pete: So, you can see why this year’s budget is not a very reliable starting point. We always
have to adjust the projected production rates as the year progresses, and of course, this changes
the ending inventory estimates. By the way, we make similar adjustments to expenses by
adding at least 10 percent to the estimates; I think everyone around here does the same thing.
Required:
a. Explain why Marge and Pete behave in this manner, and describe the benefits they expect to
realize from the use of budgetary slack.
b. Explain how the use of budgetary slack can adversely affect Marge and Pete.

Discussion 5
In November 2005, Microsoft introduced its highly anticipated new video game player, the
Xbox 360.
In early July 2007, Microsoft announced it was extending the warranty on its Xbox 360 to
three years for a certain type of malfunction indicated by three flashing red lights on the game
console. The warranty extension would apply to previously sold units; however, the warranty
for any other type of failure would not be extended beyond the original one-year warranty
term. In making this announcement, Microsoft indicated it would take a charge of $1.05–1.15
billion in the quarter ending June 30, 2007, for the costs of the warranty extension. [Source:
Nick Wingfi eld, “Microsoft’s Videogame Eff orts Take a Costly Hit,” Wall Street Journal
(July 6, 2007), p. A3.]
a. What relevant costs were likely considered by Microsoft management in reaching the
decision to extend the warranty on the Xbox 360 and, in so doing, incur in excess of $1 billion
of additional costs?
b. Comment on whether Microsoft was ethically obligated to extend the warranty on the Xbox
360 to three years.

Discussion 6
CXI has formal policies and procedures to screen and approve capital projects. Proposed
capital projects are classified as one of the following types:
1. Expansion requiring new plant and equipment,
2. Expansion by replacement of present equipment with more productive equipment, or
3. Replacement of old equipment with new equipment of similar quality.
All expansion and replacement projects that will cost more than $50,000 must be submitted to
the top management capital investment committee for approval. The investment committee
evaluates proposed projects considering the costs and benefits outlined in the supporting
proposal and the long-range effects on the company. The projected revenue and/or expense
effects of the projects, once operational, are included in the proposal. After a project is
accepted, the committee approves an expenditure budget from the project’s inception until it
becomes operational. The expenditures required each year for the expansions or replacements
are also incorporated into CXI’s annual budget procedure. The budgeted revenue and/or cost

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effects of the projects for the periods in which they become operational are incorporated into
the 5-year forecast.
CXI does not have a procedure for evaluating projects once they have been implemented and
become operational. The vice president of finance has recommended that CXI establish a post-
investment audit program to evaluate its capital expenditure projects.
a. Discuss the benefits a company could derive from a post- investment audit program for
capital expenditure projects.
b. Discuss the practical difficulties in collecting and accumulating information that would be
used to evaluate a capital project once it becomes operational.

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