page i

introduction TO
MANAGERIAL ACCOUNTING

9TH EDITION

PETER C. BREWER, Ph.D.

Wake Forest University

RAY H. GARRISON, D.B.A., CPA

Professor Emeritus
Brigham Young University

ERIC W. NOREEN, Ph.D., CMA

Professor Emeritus
University of Washington
Accounting Circle Professor of Accounting
Temple University
 page xxiii

BRIEF CONTENTS

PROLOGUE Managerial Accounting: An Overview 1

CHAPTER ONE Managerial Accounting and Cost Concepts 26

CHAPTER TWO Job-Order Costing: Calculating Unit Product Costs 66

CHAPTER THREE Job-Order Costing: Cost Flows and External Reporting 102

CHAPTER FOUR Activity-Based Costing 152

CHAPTER FIVE Process Costing 190

CHAPTER SIX Cost-Volume-Profit Relationships 222

Variable Costing and Segment Reporting: Tools for

CHAPTER SEVEN
Management 286

CHAPTER EIGHT Master Budgeting 336

CHAPTER NINE Flexible Budgets, Standard Costs, and Variance Analysis 392

Performance Measurement in Decentralized Organizations

CHAPTER TEN
468

CHAPTER ELEVEN Differential Analysis: The Key to Decision Making 508

CHAPTER TWELVE Capital Budgeting Decisions 564

CHAPTER THIRTEEN Statement of Cash Flows 616

CHAPTER FOURTEEN Financial Statement Analysis 660

Integration Exercises: An Overview 700

Index 714
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TABLE OF CONTENTS
PROLOGUE

Managerial Accounting: An Overview 1

WHAT IS MANAGERIAL ACCOUNTING? 2
Planning 3
Controlling 4
Decision Making 4
WHY DOES MANAGERIAL ACCOUNTING MATTER TO YOUR
CAREER? 5
Business Majors 5
Accounting Majors 7
Professional Certification—A Smart Investment 7
MANAGERIAL ACCOUNTING: UNDERSTANDING THE BROADER
CONTEXT 9
Big Data 9
Ethics 10
Code of Conduct for Management Accountants 10
Strategy 11
Enterprise Risk Management 13
Corporate Social Responsibility 16
Process Management Perspective 17
Leadership 18
Intrinsic Motivation 18
Extrinsic Incentives 18
Cognitive Bias 19
Summary 20
Glossary 20
Questions 20
Exercises 21

CHAPTER ONE 1
Managerial Accounting and Cost Concepts
26
COST CLASSIFICATIONS FOR ASSIGNING COSTS TO COST
OBJECTS 28
Direct Cost 29
Indirect Cost 29
COST CLASSIFICATIONS FOR MANUFACTURING COMPANIES
29
Manufacturing Costs 29
Direct Materials 29
Direct Labor 30
Manufacturing Overhead 30
Nonmanufacturing Costs 30
COST CLASSIFICATIONS FOR PREPARING FINANCIAL
STATEMENTS 31
Product Costs 31
Period Costs 32
COST CLASSIFICATIONS FOR PREDICTING COST BEHAVIOR
33
Variable Cost 33
Fixed Cost 35
The Linearity Assumption and the Relevant Range 36
Mixed Costs 38
Cost Terminology—A Closer Look 40
COST CLASSIFICATIONS FOR DECISION MAKING 40
Differential Cost and Revenue 41
Opportunity Cost and Sunk Cost 42
USING DIFFERENT COST CLASSIFICATIONS FOR DIFFERENT
PURPOSES 43
The Traditional Format Income Statement 43
The Contribution Format Income Statement 44
Summary 45
Guidance Answers to Decision Point 46
Guidance Answers to Concept Checks 46
Review Problem 1: Cost Terms 47
Review Problem 2: Income Statement Formats 48
Glossary 49
Questions 50
Applying Excel 50
The Foundational 15 52
Exercises 52
Problems 59
Building Your Skills 63

CHAPTER TWO 2
Job-Order Costing: Calculating Unit Product
Costs 66
JOB-ORDER COSTING—AN OVERVIEW 68
JOB-ORDER COSTING—AN EXAMPLE 69
Measuring Direct Materials Cost 70
Job Cost Sheet 70
Measuring Direct Labor Cost 71
Computing Predetermined Overhead Rates 72
Applying Manufacturing Overhead 73
Manufacturing Overhead—A Closer Look 74
The Need for a Predetermined Rate 75
Computation of Total Job Costs and Unit Product Costs 76
JOB-ORDER COSTING—A MANAGERIAL PERSPECTIVE 77

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Choosing an Allocation Base—A Key to Job Cost Accuracy 77

JOB-ORDER COSTING USING MULTIPLE PREDETERMINED
OVERHEAD RATES 78
Multiple Predetermined Overhead Rates—A Departmental Approach 79
Multiple Predetermined Overhead Rates—An Activity-Based Approach 81
JOB-ORDER COSTING—AN EXTERNAL REPORTING
PERSPECTIVE 82
Overhead Application and the Income Statement 82
Job Cost Sheets: A Subsidiary Ledger 82
JOB-ORDER COSTING IN SERVICE COMPANIES 83
Summary 84
Guidance Answer to Decision Point 84
Guidance Answers to Concept Checks 85
Review Problem: Calculating Unit Product Costs 85
Glossary 87
Questions 87
Applying Excel 88
The Foundational 15 89
Exercises 90
Problems 95
Building Your Skills 99

CHAPTER THREE 3
Job-Order Costing: Cost Flows and External
Reporting 102
JOB-ORDER COSTING—THE FLOW OF COSTS 104
The Purchase and Issue of Materials 106
Issue of Direct and Indirect Materials 106
Labor Cost 107
Manufacturing Overhead Costs 108
Applying Manufacturing Overhead 108
The Concept of a Clearing Account 109
 Nonmanufacturing Costs 110
Cost of Goods Manufactured 111
Cost of Goods Sold 111
SCHEDULES OF COST OF GOODS MANUFACTURED AND COST
OF GOODS SOLD 114
Schedule of Cost of Goods Manufactured 115
Schedule of Cost of Goods Sold 116
Income Statement 117
UNDERAPPLIED AND OVERAPPLIED OVERHEAD—A CLOSER
LOOK 118
Computing Underapplied and Overapplied Overhead 118
Disposition of Underapplied or Overapplied Overhead Balances 120
Closed to Cost of Goods Sold 121
Closed Proportionally to Work in Process, Finished Goods, and Cost of Goods
Sold 121
Comparing the Two Methods for Disposing of Underapplied or Overapplied
Overhead 123
A General Model of Product Cost Flows 124
Summary 124
Guidance Answers to Decision Point 125
Guidance Answers to Concept Checks 125
Review Problem: The Flow of Costs in a Job-Order Costing
System 126
Glossary 128
Questions 129
Applying Excel 129
The Foundational 15 130
Exercises 131
Problems 135
Building Your Skills 140
Appendix 3A: Job-Order Costing: A Microsoft Excel-Based
Approach 141
Appendix 3A: Exercises and Problems 146
CHAPTER FOUR 4
Activity-Based Costing 152
ASSIGNING OVERHEAD COSTS TO PRODUCTS 154
Plantwide Overhead Rate 154
Departmental Overhead Rates 155
Activity-Based Costing (ABC) 155
DESIGNING AN ACTIVITY-BASED COSTING SYSTEM 157
Hierarchy of Activities 157
An Example of an Activity-Based Costing System Design 159
USING ACTIVITY-BASED COSTING 160
Comtek Inc.’s Basic Data 161
Direct Labor-Hours as a Base 162
Computing Activity Rates 162
Computing Product Costs 163
Shifting of Overhead Cost 164
TARGETING PROCESS IMPROVEMENTS 166
EVALUATION OF ACTIVITY-BASED COSTING 166
The Benefits of Activity-Based Costing 166
Limitations of Activity-Based Costing 166
The Cost of Implementing Activity-Based Costing 167
Limitations of the ABC Model 167
Modifying the ABC Model 167
Activity-Based Costing and Service Industries 168
Summary 168
Guidance Answers to Decision Point 169
Guidance Answers to Concept Checks 169
Review Problem: Activity-Based Costing 170
Glossary 172
Questions 172
Applying Excel 172
The Foundational 15 175
Exercises 176
Problems 181
Building Your Skills 186

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CHAPTER FIVE 5
Process Costing 190
COMPARISON OF JOB-ORDER AND PROCESS COSTING 192
Similarities between Job-Order and Process Costing 192
Differences between Job-Order and Process Costing 192
COST FLOWS IN PROCESS COSTING 193
Processing Departments 193
The Flow of Materials, Labor, and Overhead Costs 193
Materials, Labor, and Overhead Cost Entries 195
Materials Costs 195
Labor Costs 195
Overhead Costs 195
Completing the Cost Flows 196
PROCESS COSTING COMPUTATIONS: THREE KEY
CONCEPTS 197
Key Concept #1 197
Key Concept #2 197
Key Concept #3 197
THE WEIGHTED-AVERAGE METHOD: AN EXAMPLE 198
Step 1: Compute the Equivalent Units of Production 198
Step 2: Compute the Cost per Equivalent Unit 201
Step 3: Assign Costs to Units 202
Step 4: Prepare a Cost Reconciliation Report 203
OPERATION COSTING 204
Summary 205
Guidance Answer to Decision Point 206
Guidance Answers to Concept Checks 206
Review Problem: Process Cost Flows and Costing Units 206
Glossary 209
Questions 209
Applying Excel 209
The Foundational 15 211
Exercises 212
Problems 216
Building Your Skills 220

CHAPTER SIX 6
Cost-Volume-Profit Relationships 222
THE BASICS OF COST-VOLUME-PROFIT (CVP) ANALYSIS 225
Contribution Margin 225
CVP Relationships in Equation Form 228
CVP Relationships in Graphic Form 229
Preparing the CVP Graph 229
Contribution Margin Ratio (CM Ratio) and the Variable Expense Ratio 231
Applications of the Contribution Margin Ratio 232
Additional Applications of CVP Concepts 234
Example 1: Change in Fixed Cost and Sales Volume 235
Alternative Solution 1 235
Alternative Solution 2 235
Example 2: Change in Variable Costs and Sales Volume 236
Solution 236
Example 3: Change in Fixed Cost, Selling Price, and Sales Volume 236
Solution 236
Example 4: Change in Variable Cost, Fixed Cost, and Sales Volume 237
Solution 237
Example 5: Change in Selling Price 237
Solution 237
BREAK-EVEN AND TARGET PROFIT ANALYSIS 238
Break-Even Analysis 238
The Equation Method 238
The Formula Method 238
Break-Even in Dollar Sales 239
 Target Profit Analysis 240
The Equation Method 240
The Formula Method 240
Target Profit Analysis in Terms of Dollar Sales 240
The Margin of Safety 241
CVP CONSIDERATIONS IN CHOOSING A COST STRUCTURE
243
Cost Structure and Profit Stability 243
Operating Leverage 245
SALES MIX 246
The Definition of Sales Mix 247
Sales Mix and Break-Even Analysis 247
Summary 249
Guidance Answers to Decision Point 250
Guidance Answers to Concept Checks 251
Review Problem: CVP Relationships 251
Glossary 254
Questions 254
Applying Excel 255
The Foundational 15 256
Exercises 256
Problems 261
Building Your Skills 269
Appendix 6A: Analyzing Mixed Costs 271
Glossary (Appendix 6A) 278
Appendix 6A: Exercises and Problems 279

CHAPTER SEVEN 7
Variable Costing and Segment Reporting:
Tools for Management 286
OVERVIEW OF VARIABLE AND ABSORPTION COSTING 288
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Variable Costing 288

Absorption Costing 288
Selling and Administrative Expenses 288
Summary of Differences 289
VARIABLE AND ABSORPTION COSTING—AN EXAMPLE 290
Variable Costing Contribution Format Income Statement 291
Absorption Costing Income Statement 293
RECONCILIATION OF VARIABLE COSTING WITH ABSORPTION
COSTING INCOME 295
ADVANTAGES OF VARIABLE COSTING AND THE
CONTRIBUTION APPROACH 298
Enabling CVP Analysis 298
Explaining Changes in Net Operating Income 298
Supporting Decision Making 299
SEGMENTED INCOME STATEMENTS AND THE CONTRIBUTION
APPROACH 299
Traceable and Common Fixed Costs and the Segment Margin 299
Identifying Traceable Fixed Costs 300
Traceable Fixed Costs Can Become Common Fixed Costs 301
SEGMENTED INCOME STATEMENTS—AN EXAMPLE 302
Levels of Segmented Income Statements 302
SEGMENTED INCOME STATEMENTS—DECISION MAKING AND
BREAK-EVEN ANALYSIS 305
Decision Making 305
Break-Even Analysis 305
SEGMENTED INCOME STATEMENTS—COMMON MISTAKES
307
Omission of Costs 307
Inappropriate Methods for Assigning Traceable Costs among Segments 308
Failure to Trace Costs Directly 308
Inappropriate Allocation Base 308
Arbitrarily Dividing Common Costs among Segments 308
INCOME STATEMENTS—AN EXTERNAL REPORTING
PERSPECTIVE 309
Companywide Income Statements 309
 Segmented Financial Information 310
Summary 310
Guidance Answers to Decision Point 311
Guidance Answers to Concept Checks 311
Review Problem 1: Contrasting Variable and Absorption
Costing 312
Review Problem 2: Segmented Income Statements 314
Glossary 316
Questions 316
Applying Excel 316
The Foundational 15 318
Exercises 319
Problems 326
Building Your Skills 332

CHAPTER EIGHT 8
Master Budgeting 336
WHY AND HOW DO ORGANIZATIONS CREATE BUDGETS? 338
Why Do Organizations Create Budgets? 338
How Do Organizations Create Budgets? 338
THE MASTER BUDGET: AN OVERVIEW 339
Seeing the Big Picture 341
PREPARING THE MASTER BUDGET 342
The Beginning Balance Sheet 343
The Budgeting Assumptions 343
The Sales Budget 346
The Production Budget 347
Inventory Purchases—Merchandising Company 348
The Direct Materials Budget 349
The Direct Labor Budget 351
The Manufacturing Overhead Budget 352
The Ending Finished Goods Inventory Budget 353
 The Selling and Administrative Expense Budget 353
The Cash Budget 355
The Budgeted Income Statement 360
The Budgeted Balance Sheet 360
Summary 362
Guidance Answer to Decision Point 363
Guidance Answers to Concept Checks 364
Review Problem: Budget Schedules 364
Glossary 366
Questions 366
Applying Excel 367
The Foundational 15 368
Exercises 369
Problems 377
Building Your Skills 387

CHAPTER NINE 9
Flexible Budgets, Standard Costs, and
Variance Analysis 392
THE VARIANCE ANALYSIS CYCLE 394
PREPARING PLANNING BUDGETS AND FLEXIBLE BUDGETS
WITH ONE COST DRIVER 395
Characteristics of a Flexible Budget 395
Deficiencies of the Static Planning Budget 395
How a Flexible Budget Works 398
FLEXIBLE BUDGET VARIANCES 399
Revenue Variances 399
Spending Variances 400
PREPARING PLANNING BUDGETS AND FLEXIBLE BUDGETS
WITH MULTIPLE COST DRIVERS 401
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STANDARD COSTS—SETTING THE STAGE 403

Setting Direct Materials Standards 404
Setting Direct Labor Standards 405
Setting Variable Manufacturing Overhead Standards 406
Using Standards in Flexible Budgets 406
A GENERAL MODEL FOR STANDARD COST VARIANCE
ANALYSIS 407
USING STANDARD COSTS—DIRECT MATERIALS VARIANCES
409
The Materials Price Variance 410
The Materials Quantity Variance 411
USING STANDARD COSTS—DIRECT LABOR VARIANCES 413
The Labor Rate Variance 413
The Labor Efficiency Variance 414
USING STANDARD COSTS—VARIABLE MANUFACTURING
OVERHEAD VARIANCES 415
The Variable Manufacturing Overhead Rate and Efficiency Variances 416
AN IMPORTANT SUBTLETY IN THE MATERIALS VARIANCES
418
Summary 420
Guidance Answers to Decision Point 421
Guidance Answers to Concept Checks 421
Review Problem 1: Variance Analysis Using a Flexible Budget
421
Review Problem 2: Standard Costs 423
Glossary 425
Questions 425
Applying Excel 426
The Foundational 15 427
Exercises 428
Problems 434
Building Your Skills 440
Appendix 9A: Predetermined Overhead Rates and Overhead
Analysis in a Standard Costing System 443
Glossary 450
Appendix 9A: Exercises and Problems 450
Appendix 9B: Standard Cost Systems: A Financial Reporting
Perspective Using Microsoft Excel 456
Appendix 9B: Exercises and Problems 462

CHAPTER TEN 10
Performance Measurement in Decentralized
Organizations 468
DECENTRALIZATION IN ORGANIZATIONS 470
Advantages and Disadvantages of Decentralization 470
RESPONSIBILITY ACCOUNTING 471
Cost, Profit, and Investment Centers 471
Cost Center 471
Profit Center 471
Investment Center 471
EVALUATING INVESTMENT CENTER PERFORMANCE—RETURN
ON INVESTMENT 472
The Return on Investment (ROI) Formula 472
Net Operating Income and Operating Assets Defined 472
Understanding ROI 473
Criticisms of ROI 476
RESIDUAL INCOME 477
Motivation and Residual Income 478
Divisional Comparison and Residual Income 479
OPERATING PERFORMANCE MEASURES 481
Throughput (Manufacturing Cycle) Time 481
Delivery Cycle Time 481
Manufacturing Cycle Efficiency (MCE) 482
 Example 483
Solution 483
BALANCED SCORECARD 484
Common Characteristics of Balanced Scorecards 484
A Company’s Strategy and the Balanced Scorecard 487
Tying Compensation to the Balanced Scorecard 488
Summary 489
Guidance Answer to Decision Point 490
Guidance Answers to Concept Checks 490
Review Problem: Return on Investment (ROI) And Residual
Income 490
Glossary 491
Questions 492
Chapter 10: Applying Excel 492
The Foundational 15 493
Exercises 494
Problems 498
Building Your Skills 505

CHAPTER ELEVEN 11
Differential Analysis: The Key to Decision
Making 508
DECISION MAKING: SIX KEY CONCEPTS 510
Key Concept #1 510
Key Concept #2 510
Key Concept #3 510
Key Concept #4 511
Key Concept #5 511
Key Concept #6 511
IDENTIFYING RELEVANT COSTS AND BENEFITS: AN
EXAMPLE 512
DECISION ANALYSIS: THE TOTAL COST AND DIFFERENTIAL
COST APPROACHES 514
Why Isolate Relevant Costs? 516
ADDING AND DROPPING PRODUCT LINES AND OTHER
SEGMENTS 517
An Illustration of Cost Analysis 517
A Comparative Format 519
Beware of Allocated Fixed Costs 520

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MAKE OR BUY DECISIONS 522

Strategic Aspects of the Make or Buy Decision 522
An Example of a Make or Buy Decision 522
Opportunity Cost 525
SPECIAL ORDER DECISIONS 526
VOLUME TRADE-OFF DECISIONS 527
What Is a Constraint? 527
Utilizing a Constrained Resource to Maximize Profits 528
Managing Constraints 531
JOINT PRODUCT COSTS AND SELL OR PROCESS FURTHER
DECISIONS 533
Santa Maria Wool Cooperative: An Example 534
ACTIVITY-BASED COSTING AND RELEVANT COSTS 536
Summary 537
Guidance Answers to Decision Point 537
Guidance Answers to Concept Checks 538
Review Problem: Differential Analysis 538
Glossary 539
Questions 540
Applying Excel 540
The Foundational 15 542
Exercises 543
Problems 551
Building Your Skills 559

CHAPTER TWELVE 12
Capital Budgeting Decisions 564
CAPITAL BUDGETING—AN OVERVIEW 566
Typical Capital Budgeting Decisions 566
Cash Flows Versus Net Operating Income 566
Typical Cash Outflows 566
Typical Cash Inflows 567
The Time Value of Money 567
THE PAYBACK METHOD 568
Evaluation of the Payback Method 568
An Extended Example of Payback 569
Payback and Uneven Cash Flows 570
THE NET PRESENT VALUE METHOD 571
The Net Present Value Method Illustrated 571
Recovery of the Original Investment 574
An Extended Example of the Net Present Value Method 575
THE INTERNAL RATE OF RETURN METHOD 577
The Internal Rate of Return Method Illustrated 577
Comparison of the Net Present Value and Internal Rate of Return Methods 578
EXPANDING THE NET PRESENT VALUE METHOD 579
Least-Cost Decisions 579
UNCERTAIN CASH FLOWS 581
An Example 581
PREFERENCE DECISIONS—THE RANKING OF INVESTMENT
PROJECTS 583
Internal Rate of Return Method 583
Net Present Value Method 583
THE SIMPLE RATE OF RETURN METHOD 584
POSTAUDIT OF INVESTMENT PROJECTS 587
Summary 587
Guidance Answer to Decision Point 588
Guidance Answers to Concept Checks 589
Review Problem: Comparison of Capital Budgeting Methods
589
Glossary 591
Questions 591
Applying Excel 592
The Foundational 15 593
Exercises 594
Problems 598
Building Your Skills 605
Appendix 12A: The Concept of Present Value 606
Appendix 12A: Review Problem: Basic Present Value
Computations 610
Appendix 12A: Exercises 611
Appendix 12B: Present Value Tables 613

CHAPTER THIRTEEN 13
Statement of Cash Flows 616
THE STATEMENT OF CASH FLOWS: KEY CONCEPTS 619
Organizing the Statement of Cash Flows 619
Operating Activities: Direct or Indirect Method? 620
The Indirect Method: A Three-Step Process 621
Step 1 621
Step 2 622
Step 3 623
Investing and Financing Activities: Gross Cash Flows 624
Property, Plant, and Equipment 625
Retained Earnings 626
Summary of Key Concepts 627
AN EXAMPLE OF A STATEMENT OF CASH FLOWS 628
Operating Activities 629
Step 1 629
 Step 2 630
Step 3 630
Investing Activities 631
Financing Activities 631
Seeing the Big Picture 633
INTERPRETING THE STATEMENT OF CASH FLOWS 635
Consider a Company’s Specific Circumstances 635
Consider the Relationships among Numbers 635
Free Cash Flow 636
Earnings Quality 636

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Summary 637
Guidance Answers to Decision Point 638
Guidance Answers to Concept Checks 638
Review Problem 639
Glossary 643
Questions 643
The Foundational 15 643
Exercises 645
Problems 648
Building Your Skills 656
Appendix 13A: The Direct Method of Determining the Net Cash
Provided by Operating Activities 656
Appendix 13A: Exercises and Problems 658

CHAPTER FOURTEEN 14
Financial Statement Analysis 660
LIMITATIONS OF FINANCIAL STATEMENT ANALYSIS 662
Comparing Financial Data across Companies 662
Looking beyond Ratios 662
STATEMENTS IN COMPARATIVE AND COMMON-SIZE FORM
662
Dollar and Percentage Changes on Statements 663
Common-Size Statements 665
RATIO ANALYSIS—LIQUIDITY 667
Working Capital 668
Current Ratio 668
Acid-Test (Quick) Ratio 669
RATIO ANALYSIS—ASSET MANAGEMENT 669
Accounts Receivable Turnover 669
Inventory Turnover 670
Operating Cycle 671
Total Asset Turnover 671
RATIO ANALYSIS—DEBT MANAGEMENT 672
Times Interest Earned Ratio 672
Debt-to-Equity Ratio 673
Equity Multiplier 673
RATIO ANALYSIS—PROFITABILITY 674
Gross Margin Percentage 674
Net Profit Margin Percentage 675
Return on Total Assets 675
Return on Equity 676
RATIO ANALYSIS—MARKET PERFORMANCE 677
Earnings per Share 677
Price-Earnings Ratio 678
Dividend Payout and Yield Ratios 678
The Dividend Payout Ratio 678
The Dividend Yield Ratio
Book Value per Share 679
SUMMARY OF RATIOS AND SOURCES OF COMPARATIVE
RATIO DATA 679
Summary 681
Guidance Answer to Decision Point 682
Guidance Answers to Concept Checks 682
Review Problem: Selected Ratios and Financial Leverage 683
Glossary 685
Questions 685
The Foundational 15 685
Exercises 686
Problems 691
Building Your Skills 697

Integration Exercises: An Overview 700

Index 714