MANAGEMENT ACCOUNTING Information for Decision-Making and Strategy Execution
MANAGEMENT ACCOUNTING Information for Decision-Making and Strategy Execution
S I X T H E D I T I O N
Anthony A. Atkinson University of Waterloo
Robert S. Kaplan Harvard University
Ella Mae Matsumura University of Wisconsin–Madison
S. Mark Young University of Southern California
Boston Columbus Indianapolis New York San Francisco Upper Saddle River Amsterdam Cape Town Dubai London Madrid Milan Munich Paris Montreal Toronto
Delhi Mexico City S~ao Paulo Sydney Hong Kong Seoul Singapore Taipei Tokyo
AVP/Executive Editor: Stephanie Wall Editorial Director: Sally Yagan Editor in Chief: Donna Battista Director of Editorial Services: Ashley Santora Editorial Project Manager: Christina Rumbaugh Editorial Assistant: Brian Reilly Director of Marketing: Patrice Jones Marketing Assistant: Ian Gold Senior Managing Editor, Production: Cynthia Zonneveld Production Editor: Carol O’Rourke Text Permissions Coordinator: Tracy Metivier Senior Operations Specialist: Diane Peirano Art Director: Anthony Gemellaro Cover Design: Anthony Gemmellaro Cover Illustration/Photo: © Image Source/Corbis Composition/Full-Service Project Management: S4Carlisle Publishing Services/Lynn Steines Printer/Binder: Edwards Brothers Cover printer: Lehigh-Phoenix Color/Hagerstown Typeface: 10/12 Palatino
Credits and acknowledgments borrowed from other sources and reproduced, with permission, in this textbook appear on appropriate page within text.
Copyright © 2012, 2007, 2004, 2001, 1997 by Pearson Education, Inc., Upper Saddle River, New Jersey, 07458. Pearson Prentice Hall. All rights reserved. Printed in the United States of America. This publication is protected by Copyright and permission should be obtained from the publisher prior to any prohibited reproduction, storage in a retrieval system, or transmission in any form or by any means, electronic, mechanical, photocopying, recording, or likewise. For information regarding permission(s), write to: Rights and Permissions Department.
Library of Congress Cataloging-in-Publication Data Management accounting / Anthony A. Atkinson . . . [et al.].—6th ed.
p. cm. Includes index. ISBN-13: 978-0-13-702497-1 ISBN-10: 0-13-702497-5
1. Managerial accounting. I. Atkinson, Anthony A. II. Title. HF5657.4.M328 2012 658.15�11—dc22
2011003287
10 9 8 7 6 5 4 3 2
ISBN-10: 0-13-702497-5 ISBN-13: 978-0-13-702497-1
This book is dedicated to our parents and families.
This page intentionally left blank
Preface xvii
Acknowledgments xxi
About the Authors xxiii
CHAPTER 1 How Management Accounting Information Supports Decision Making 1
CHAPTER 2 The Balanced Scorecard and Strategy Map 15
CHAPTER 3 Using Costs in Decision Making 62
CHAPTER 4 Accumulating and Assigning Costs to Products 121
CHAPTER 5 Activity-Based Cost Systems 165
CHAPTER 6 Measuring and Managing Customer Relationships 218
CHAPTER 7 Measuring and Managing Process Performance 252
CHAPTER 8 Measuring and Managing Life-Cycle Costs 301
CHAPTER 9 Behavioral and Organizational Issues in Management Accounting and Control Systems 340
CHAPTER 10 Using Budgets for Planning and Coordination 393
CHAPTER 11 Financial Control 462
Glossary 510
Subject Index 518
Name and Company Index 524
v
BRIEF CONTENTS
This page intentionally left blank
Preface xvii
Acknowledgments xxi
About the Authors xxiii
CHAPTER 1 How Management Accounting Information Supports Decision Making 1
What Is Management Accounting? 2 Management Accounting and Financial Accounting 2 A Brief History of Management Accounting 3
IN PRACTICE: Definition of Management Accounting (2008), Issued by the Institute of Management Accountants 4
Strategy 5 The Plan-Do-Check-Act (PDCA) Cycle 6
IN PRACTICE: Company Mission Statements 7 Behavioral Implications of Management Accounting Information 9 Summary 10 Key Terms 10 Assignment Materials 10
CHAPTER 2 The Balanced Scorecard and Strategy Map 15
The Balanced Scorecard 19 Strategy 23
IN PRACTICE: Infosys Develops a Balanced Scorecard to Describe and Implement Its Strategy 24
Balanced Scorecard Objectives, Measures, and Targets 24 Creating a Strategy Map 25
Financial Perspective 26 Customer Perspective 27 Process Perspective 31 Learning and Growth Perspective 35
Strategy Map and Balanced Scorecard at Pioneer Petroleum 36 Financial Perspective 36 Customer Perspective 37 Process Perspective 39 Learning and Growth Perspective 40
Applying the Balanced Scorecard to Nonprofit and Government Organizations 43 IN PRACTICE: A Balanced Scorecard for a Nonprofit Organization 44
Managing with the Balanced Scorecard 45 Barriers to Effective Use of the Balanced Scorecard 46 Epilogue to Pioneer Petroleum 48
vii
CONTENTS
Summary 49 Key Terms 49 Assignment Materials 50
CHAPTER 3 Using Costs in Decision Making 62
How Management Accounting Supports Internal Decision Making 63
Pricing 63 Product Planning 63 Budgeting 64 Performance Evaluation 64 Contracting 64
Variable and Fixed Costs 64 Variable Costs 64 Fixed Costs 66
Cost-Volume-Profit Analysis 66 Developing and Using the CVP Equation 67
IN PRACTICE: Introducing Uncertainty into Cost Volume Profit Analysis 68 Variations on the Theme 68
IN PRACTICE: Breakeven on a Development Project 69 Financial Modeling and What-If Analysis 69
IN PRACTICE: Cost-Volume-Profit Analysis 69 The Multiproduct Firm 70
IN PRACTICE: Estimating the Effect of Unit Sales on Share Price 70 The Assumptions Underlying CVP Analysis 72
Other Useful Cost Definitions 72 Mixed Costs 72 Step Variable Costs 73 Incremental Costs 73 Sunk Costs 74
IN PRACTICE: Sunk Costs 74 IN PRACTICE: Overcoming the Sunk Cost Effect 75 IN PRACTICE: Human Behavior and Sunk Costs 75 Relevant Cost 76 Opportunity Cost 76 Avoidable Cost 77
Make-or-Buy—The Outsourcing Decision 78 IN PRACTICE: Contracting Out 79 Manufacturing Costs 79
The Decision to Drop a Product 82 IN PRACTICE: Be Wary When Labeling Departments Losers 83
Costing Orders 85 Costing Orders and Opportunity Cost Considerations 86
Relevant Cost and Short-Term Product Mix Decisions 87 Multiple Resource Constraints 89
IN PRACTICE: Choosing the Least Cost Materials Mix 90 Building the Linear Program 90 The Graphical Approach to Solving Linear Programs 91
viii Contents
Epilogue to Nolan Industries 93 IN PRACTICE: Excel’s Goal Seek and Solver 96
Summary 96 Key Terms 97 Assignment Materials 97
CHAPTER 4 Accumulating and Assigning Costs to Products 121
IN PRACTICE: On the Importance of Understanding Costs in the Restaurant Business 122
Cost Management Systems 123 Cost Flows in Organizations 123
Manufacturing Organizations 123 Retail Organizations 124 Service Organizations 124
Some Important Cost Terms 125 Cost Object 125 Consumable Resources 125 Capacity-Related Resources 125 Direct and Indirect Costs 125
IN PRACTICE: Cost Objects 125 IN PRACTICE: Indirect Costs 126 Cost Classification and Context 127 Going Forward 127
Handling Indirect Costs in a Manufacturing Environment 128 Multiple Indirect Cost Pools 130 Cost Pool Homogeneity 132
Overhead Allocation: Further Issues 134 Using Planned Capacity Cost 134
IN PRACTICE: Why Costing Matters 135 Reconciling Actual and Applied Capacity Costs 135 Estimating Practical Capacity 138
Job Order and Process Systems 138 Job Order Costing 138 Process Costing 139 Some Process Costing Wrinkles 141 Final Comments on Process Costing 142
Epilogue to Strict’s Custom Framing 144 Summary 145 Appendix 4-1 Allocating Service Department Costs 146 Key Terms 150 Assignment Materials 150
CHAPTER 5 Activity-Based Cost Systems 165
Traditional Manufacturing Costing Systems 167 Limitations of Madison’s Existing Standard Cost System 170 Vanilla Factory and Multiflavor Factory 170 Activity-Based Costing 172
Calculating Resource Capacity Cost Rates 173 Calculating Resource Time Usage per Product 174
Contents ix
x Contents
Calculating Product Cost and Profitability 175 Possible Actions as a Result of the More Accurate Costing 177
IN PRACTICE: Using Activity-Based Costing to Increase Bank Profitability 178 Measuring the Cost of Unused Resource Capacity 179 Fixed Costs and Variable Costs in Activity-Based Cost Systems 179 Using the ABC Model to Forecast Resource Capacity 181 Updating the ABC Model 184
IN PRACTICE: W.S. Industries Uses ABC Information for Continuous Improvement 185
Service Companies 187 Capacity Cost Rate 188 Calculating the Time Equation for the Consumption of Broker’s Capacity 189
Implementation Issues 189 Lack of Clear Business Purpose 190 Lack of Senior Management Commitment 190 Delegating the Project to Consultants 190 Poor ABC Model Design 191 Individual and Organizational Resistance to Change 191 People Feel Threatened 192
Epilogue to Madison Dairy 192 Summary 193 Appendix 5-1 Historical Origins of Activity-Based Costing 194 Key Terms 196 Assignment Materials 196
CHAPTER 6 Measuring and Managing Customer Relationships 218
Measuring Customer Profitability: Extending the Madison Dairy Case 220
Reporting and Displaying Customer Profitability 222
IN PRACTICE: Building a Whale Curve of Customer Profitability 224 Customer Costs in Service Companies 224
Increasing Customer Profitability 226 Process Improvements 226 Activity-Based Pricing 226 Managing Relationships 226 The Pricing Waterfall 227
Salesperson Incentives 232 Life-Cycle Profitability 233 Measuring Customer Performance with Nonfinancial Metrics 235
Customer Satisfaction 235 Customer Loyalty 236 The Net Promoter Score 238
Epilogue to Madison Dairy 239 Summary 240 Key Terms 240 Assignment Materials 241
CHAPTER 7 Measuring and Managing Process Performance 252
Process Perspective and the Balanced Scorecard 255 Facility Layout Systems 255
Process Layouts 256 Product Layouts 257
IN PRACTICE: Manufacturing a CD 258 Group Technology 259
Inventory Costs and Processing Time 259 Inventory and Processing Time 259 Inventory-Related Costs 260 Costs and Benefits of Changing to a New Layout: An Example Using Group Technology 260 Summary of Costs and Benefits 266
IN PRACTICE: History of Lean Manufacturing 267 Cost of Nonconformance and Quality Issues 268
Quality Standards 268 Costs of Quality Control 269
Just-in-Time Manufacturing 270 Implications of JIT Manufacturing 270 JIT Manufacturing and Management Accounting 271
IN PRACTICE: Using Lean Manufacturing in a Hospital Setting 272
Kaizen Costing 273 Comparing Traditional Cost Reduction to Kaizen Costing 273 Concerns about Kaizen Costing 274
Benchmarking 275 Stage 1: Internal Study and Preliminary Competitive Analyses 276 Stage 2: Developing Long-Term Commitment to the Benchmarking Project and Coalescing the Benchmarking Team 277 Stage 3: Identifying Benchmarking Partners 277 Stage 4: Information Gathering and Sharing Methods 278 Stage 5: Taking Action to Meet or Exceed the Benchmark 279
IN PRACTICE: Benchmarking Mobile Web Experiences 279 Epilogue to Blast from the Past Robot Company 280
Production Flows 280 Effects on Work-in-Process Inventory 281 Effect on Production Costs 281 Cost of Rework 282 Cost of Carrying Work-in-Process Inventory 283 Benefits from Increased Sales 283 Summary of Costs and Benefits 284
Summary 285 Key Terms 285 Assignment Materials 285
CHAPTER 8 Measuring and Managing Life-Cycle Costs 301
Managing Products over Their Life Cycle 302 Research, Development, and Engineering Stage 303 Manufacturing Stage 303 Postsale Service and Disposal Stage 304
Contents xi
Target Costing 305 A Target Costing Example 308 Concerns about Target Costing 314
IN PRACTICE: Target Costing and the Mercedes-Benz M-Class 315
Breakeven Time: A Comprehensive Metric for New Product Development 316 Innovation Measures on the Balanced Scorecard 320
Market Research and Generation of New Product Ideas 320 Design, Development, and Launch of New Products 321
IN PRACTICE: Life-Cycle Revenues: The Case of Motion Pictures 321
Environmental Costing 324 Controlling Environmental Costs 324
IN PRACTICE: The Cisco Take-Back and Recycle Program 328 IN PRACTICE: Scientific Progress and the Reduction of Environmental Costs: The Case of Chromium in Groundwater 328
Summary 329 Key Terms 329 Assignment Materials 329
CHAPTER 9 Behavioral and Organizational Issues in Management Accounting and Control Systems 340
What Are Management Accounting and Control Systems? 342 The Meaning of “Control” 342
Characteristics of a Well-Designed MACS 342 Technical Considerations 342 Behavioral Considerations 343
The Human Resource Management Model of Motivation 344 The Organization’s Ethical Code of Conduct and MACS Design 345
Avoiding Ethical Dilemmas 345 Dealing with Ethical Conflicts 346
IN PRACTICE: Does Cheating at Golf Lead to Cheating in Business? 347 The Elements of an Effective Ethical Control System 349 Steps in Making an Ethical Decision 349 Motivation and Congruence 349 Task and Results Control Methods 351
IN PRACTICE: Monitoring in the Workplace 351 Using a Mix of Performance Measures: A Balanced Scorecard Approach 353
The Need for Multiple Measures of Performance: Non–Goal-Congruent Behavior 353 Dysfunctional Behavior 353 Using the Balanced Scorecard to Align Employees to Corporate Goals and Business Unit Objectives 354 Change Management 355
Empowering Employees to Be Involved in MACS Design 355 Participation in Decision Making 355 Education to Understand Information 356
xii Contents
Behavioral Aspects of MACS Design: An Example from Budgeting 357 Designing the Budget Process 357 Influencing the Budget Process 359
Developing Appropriate Incentive Systems to Reward Performance 360
Choosing between Intrinsic and Extrinsic Rewards 361 Extrinsic Rewards Based on Performance 362 Effective Performance Measurement and Reward Systems 362 Conditions Favoring Incentive Compensation 364 Incentive Compensation and Employee Responsibility 364 Rewarding Outcomes 364 Managing Incentive Compensation Plans 365 Types of Incentive Compensation Plans 366
IN PRACTICE: UNIBANCO—Tying the Balanced Scorecard to Compensation 367
Epilogue to Advanced Cellular International and Chapter Summary 371 Key Terms 372 Assignment Materials 373
CHAPTER 10 Using Budgets for Planning and Coordination 393
Determining the Levels of Capacity-Related and Flexible Resources 394 The Budgeting Process 395
The Role of Budgets and Budgeting 395 The Elements of Budgeting 397 Behavioral Considerations in Budgeting 398 Budget Components 398 Operating Budgets 400 Financial Budgets 400
The Budgeting Process Illustrated 400 Oxford Tole Art, Buoy Division 400 Demand Forecast 403 The Production Plan 403 Developing the Spending Plans 405 Choosing the Capacity Levels 406 Handling Infeasible Production Plans 408
Interpreting the Production Plan 408 The Financial Plans 409 Understanding the Cash Flow Statement 409 Using the Financial Plans 413 Using the Projected Results 414
What-If Analysis 415 Evaluating Decision-Making Alternatives 415 Sensitivity Analysis 415
Comparing Actual and Planned Results 417 Variance Analysis 417 Basic Variance Analysis 418 Canning Cellular Services 418 First-Level Variances 420 Decomposing the Variances 420 Planning and Flexible Budget Variances 421
Contents xiii
Quantity and Price Variances for Material and Labor 422 Sales Variances 428
The Role of Budgeting in Service and Not-For-Profit Organizations 431 Periodic and Continuous Budgeting 431 Controlling Discretionary Expenditures 432
Incremental Budgeting 432 Zero-Based Budgeting 433 Project Funding 433
Managing the Budgeting Process 434 Criticisms of the Traditional Budgeting Model and the “Beyond Budgeting” Approach 434
Epilogue to the California Budget Crisis 435 Summary 436 Key Terms 437 Assignment Materials 437
CHAPTER 11 Financial Control 462
The Environment of Financial Control 463 Financial Control 464 The Motivation for Decentralization 464
IN PRACTICE: Standard Operating Precedures at Mercedes-Benz USA 465 IN PRACTICE: Evaluating Performance at McDonald’s Corporation Restaurants 466
Responsibility Centers and Evaluating Unit Performance 467 Coordinating Responsibility Centers 467
IN PRACTICE: The High Cost of Coordination 468 Responsibility Centers and Financial Control 469
IN PRACTICE: Nonfinancial Performance Measures at Federal Express: The Service Quality Indicator 469 Responsibility Center Types 470
IN PRACTICE: Investment Centers at General Electric in 2010 472 Evaluating Responsibility Centers 474
IN PRACTICE: Financial Statement Business Segment Reporting 477
Transfer Pricing 481 Approaches to Transfer Pricing 481
IN PRACTICE: International Transfer Pricing 482 Transfer Prices Based on Equity Considerations 485
Assigning and Valuing Assets in Investment Centers 486 The Efficiency and Productivity Elements of Return on Investment 487
Assessing Productivity Using Financial Control 489 Questioning the Return on Investment Approach 489
xiv Contents
IN PRACTICE: Labor Productivity in a Consultancy 489 IN PRACTICE: Managing Productivity in Airlines 490 Using Residual Income 490
IN PRACTICE: Organization Adopt Economic Value Added for Different Reasons 492
The Efficacy of Financial Control 493 Epilogue to Adrian’s Home Services 494 Summary 496 Key Terms 497 Assignment Materials 497
Glossary 510
Subject Index 518
Name and Company Index 524
Contents xv
This page intentionally left blank
Intended Audience
The sixth edition of Management Accounting targets undergraduate and MBA courses in managerial accounting with a major redesign and several new topics. It integrates state-of-the-art thinking on recent innovations in management accounting including:
• the Balanced Scorecard, • strategy maps, • time-driven activity-based costing for product and customer profitability
analysis, • target costing, • environmental costing, and • the design of management control systems.
The author team consists of top scholars who have served as advisers to small, medium-sized, and large enterprises in the private, nonprofit, and public sectors. They present a conceptually sound and practically relevant perspective on the role of management accounting information in informing important decisions made by business managers, aligning employees and organizational units with strategic objectives, driving continuous process improvements, and influencing the design of products and services. The sixth edition provides problems and cases drawn from the authors’ practical experience including cases from Harvard Business School and the Institute of Management Accountants (IMA) that engage students in strategic and organizational analyses. This action orientation makes the text an excellent fit for management accounting courses taught from a managerial perspective. Although this text is primarily intended for business and accounting students, it will also be useful to practicing managers who would benefit from understanding how to mobi- lize management accounting to drive value in their organizations.
All Enterprises Need Management Accounting
Management accounting information creates value for all types of organizations: private sector companies attempting to deliver superior and sustainable returns to shareholders, nonprofit and nongovernmental organizations (NGOs) striving to deliver positive social impact to targeted constituents, and public-sector agencies that are empowered to improve the lives of citizens. The common thread across all of these diverse enterprises is how to implement a strategy that delivers long-term value to their stakeholders. Strategy implementation requires decision making that is aligned with strategic goals, continuous improvement of critical processes, motiva- tion and alignment of employees with organizational objectives, and innovation that develops new products and services. This book is the only management accounting book that explains in detail how to use measurement and management systems for sustainable value creation.
xvii
PREFACE
New to This Edition
• Chapter 1 introduces the plan–do–check–act cycle as an organizing framework for embedding multiple management accounting processes.
• Chapter 2 is an updated and repositioned chapter on the Balanced Scorecard and strategy maps. It uses an extended example, drawn from an actual company’s experience, to illustrate how to develop a Balanced Scorecard and strategy map for a company’s new strategy. Placing this chapter at the front of the book helps students to understand the strategic context for the measure- ment, decision-making, and control topics discussed in subsequent chapters.
• Chapter 3 is an entirely rewritten chapter for introducing students to funda- mental cost concepts. Variable, fixed, incremental, relevant, sunk, avoidable, and opportunity costs are explained and illustrated. Students’ understanding of the concepts is highlighted through decision-making examples on make versus buy, product abandonment, financial modeling for what-if analyses, and product mix optimization with constrained resources. The chapter ends with several numerical examples that enable students to test their ability to apply fundamental cost concepts in diverse settings. In addition, the chapter contains a new case on product costing and decision analysis in the wine industry.
• Chapter 4, also a major update for the sixth edition, provides the foundation for understanding how cost systems can be designed to assign direct and indirect costs to cost objects, such as products, services, and operating depart- ments. It features an explicit and extensive treatment of capacity measurement and costing that sets the stage for the activity-based costing material that follows in subsequent chapters.
• Chapter 5 covers the measurement and management of product costs through the framework of time-driven activity-based costing. This recent innovation helps product costing to be done in a simple, transparent, accurate, and flexible manner. The chapter features the many ways managers can eliminate losses and improve product profitability once they understand the fundamental economics of their products and services.
• Chapter 6, measuring and managing customer relationships, is an entirely new chapter for the sixth edition. The chapter is new not only to the text but also to most management accounting courses. It features the strategic importance of understanding and transforming customer profitability through decisions on product features, product mix, order pricing, and customer relationships. Entirely new material in this chapter includes the pricing waterfall for measur- ing customer discounts, promotions, and allowances, and an extended treat- ment of how to derive customer satisfaction and loyalty metrics for a business unit’s Balanced Scorecard.
• Chapter 7 features the role for management accounting information to drive strategy execution through enhanced continuous improvement activities, includ- ing lean management, kaizen costing, theory of constraints, cost of quality, six sigma, just-in-time, and benchmarking techniques. As in Chapter 6, new mater- ial illustrates how to derive process improvement performance measures for the organization’s Balanced Scorecard.
• Chapter 8 introduces students to the total life-cycle costing concept. At the front end, the chapter shows how target costing can inform decisions made dur- ing the product design and development stages. Target costing helps companies to develop products that meet customers’ functionality requirements at a cost that yields targeted profit margins. New material in the chapter introduces the breakeven time concept for measuring the performance of the product
xviii Preface
development process, and the selection of other innovation metrics that compa- nies can incorporate into their Balanced Scorecards. The chapter concludes by examining processes and metrics at the back end of the product life cycle, when consumers dispose of or return their used products.
• The sixth edition drops two topics, capital budgeting and financial ratio analysis, that our research shows are now usually covered in other courses. It retains and updates chapters from the fifth edition on the behavioral and organizational aspects of management accounting, budgeting, and financial and managerial control of decentralized operations.
• Also retained are the valuable HBS cases, first introduced in the fifth edition: * Sippican (A) and (B) (integrating time-driven activity-based costing,
budgeting, and the Balanced Scorecard), * Midwest Office Products (time-driven ABC in a service setting), * Chadwick, Inc. (designing a Balanced Scorecard for a pharmaceutical
company), and * Domestic Auto Parts (building a Balanced Scorecard).
• An additional HBS case is new to the sixth edition: * Citibank: Performance Evaluation (the costs and benefits of using multiple
performance measures to evaluate performance).
All of these cases are brief for preparation ease and are accompanied by Instructor Case Notes found in the instructor resources.
• The sixth edition also retains the following Institute of Management Accountants cases: * How Mercedes-Benz used target costing to develop its new SUV and * Precision Systems, Inc.: Improving processes in order entry, with linkages to
value-chain ideas (effects on customers, sales representatives, manufacturing, and other internal uses of the order entry information).
• Readings in Management Accounting, Sixth Edition, by S. Mark Young This supplement contains 53 recent and classic business press and academic articles that correlate with the chapter coverage in Management Accounting, Sixth Edition. Ideal for additional content reinforcement and for any case-based course, this supplement includes articles from a variety of sources to show the application of management accounting in diverse organizational settings.
Instructor Materials
The following supplements are available to adopting instructors. For detailed descriptions, please visit www.pearsonhighered.com.
• Instructor’s Manual—teaching tips and additional resources for each chapter. • Test Bank—over 1,200 test questions. • Solutions Manual—solutions for every question, exercise, problem,
and HBS case study. • PowerPoint slides—presentations for every chapter.
Preface xix
This page intentionally left blank
We would like to acknowledge, with thanks, the individuals who made this text possible.
We appreciate and benefited from the reviews and suggestions of Professors:
Signe Cahn, Webster University Alan Czyzewski, Indiana State University Fara Elikai, University of North Carolina–Wilmington Judith Harris, Nova Southeastern University Kay Poston, South University Barbara Pughsley, South University P. K. Sen, University of Cincinnati
For the sixth edition, we also thank the following individuals:
Carol O’Rourke, Production Project Manager Christina Rumbaugh, Editorial Project Manager Lynn Steines, Project Manager, S4Carlisle Publishing Services Stephanie Wall, Acquisitions Vice President
We also gratefully acknowledge Professors Shahid Ansari, Jan Bell, Thomas Klammer, and Carol Lawrence for allowing us to use some of their material on target costing; Professor Priscilla Wisner for permitting us to use her case on the wine industry; Carolyn Streuly for her valuable contributions; and Professor Michael D. Shields and Professor Thomas Lin for their continuing support of the book.
The authors and product team would appreciate hearing from you! Let us know what you think about this book by writing to [email protected]. Please include “Feedback about AKMY 6e” in the subject line.
xxi
ACKNOWLEDGMENTS
This page intentionally left blank
Anthony A. Atkinson
A professor in the School of Accountancy at the University of Waterloo, Anthony A. Atkinson received a bachelor of commerce and M.B.A. degrees from Queen’s University in Kingston, Ontario, and M.S. and Ph.D. degrees in industrial administra- tion from Carnegie-Mellon University in Pittsburgh. He is a fellow of the Society of Management Accountants of Canada and has written or coauthored two texts, vari- ous monographs, and more than 35 articles on performance measurement and cost- ing. In 1989, the Canadian Academic Accounting Association awarded Atkinson the Haim Falk Prize for Distinguished Contribution to Accounting Thought for his mono- graph that studied transfer pricing practice in six Canadian companies. He has served on the editorial boards of two professional and five academic journals and is a past editor of the Journal of Management Accounting Research. Atkinson also served as a member of the Canadian government’s Cost Standards Advisory Committee, for which he developed the costing principles it now requires of government contractors.
Robert S. Kaplan
Robert S. Kaplan is Baker Foundation Professor at the Harvard Business School, where he has taught for 27 years. Previously, he served on the faculty and as Dean of the Tepper Business School at Carnegie-Mellon University. Kaplan received a B.S. and M.S. in electrical engineering from M.I.T., and a Ph.D. in operations research from Cornell University.
Kaplan has done extensive writing, teaching, and consulting on linking cost and performance management systems to strategy implementation. He has helped to develop both activity-based costing and the Balanced Scorecard. His 14 books have been translated into 28 languages. Kaplan’s most recent books are The Execution Premium with David Norton and Time-Driven Activity-Based Costing with Steven Anderson. He has also authored or coauthored 21 Harvard Business Review articles and more than 100 others in academic and professional journals.
Kaplan was inducted into the Accounting Hall of Fame in 2006 and received the Lifetime Contribution Award from the Management Accounting Section of the American Accounting Association in January 2006. In 2008, his coauthored book, Relevance Lost: The Rise and Fall of Management Accounting, received the AAA Seminal Contribution to Accounting Literature Award. His articles and books have also been recognized with several Wildman Medal and AAA Notable Contributions to Accounting Literature Awards.
Kaplan received the Outstanding Accounting Educator Award in 1988 from the American Accounting Association (AAA), the 1994 CIMA Award from the Chartered Institute of Management Accountants (UK) for “Outstanding Contributions to the Accountancy Profession,” and the 2001 Distinguished Service Award from the Institute of Management Accountants (IMA) for contributions to the practice and academic community.
xxiii
ABOUT THE AUTHORS
Ella Mae Matsumura
Ella Mae Matsumura is an associate professor in the Department of Accounting and Information Systems in the School of Business at the University of Wisconsin–Madison, and is affiliated with the university’s Center for Quick Response Manufacturing. She received an A.B. in mathematics from the University of California, Berkeley, and M.Sc. and Ph.D. degrees from the University of British Columbia. Matsumura has won two teaching excellence awards at the University of Wisconsin–Madison and was elected as a lifetime fellow of the university’s Teaching Academy, formed to promote effective teaching. She is a member of the university team awarded an IBM Total Quality Management Partnership grant to develop curriculum for total quality management education.
Professor Matsumura was a co-winner of the 2010 Notable Contributions to Management Accounting Literature Award. She has served in numerous leadership positions in the American Accounting Association (AAA). She was coeditor of Accounting Horizons and has chaired and served on numerous AAA committees. She has been secretary–treasurer and president of the AAA’s Management Accounting Section. Her past and current research articles focus on decision making, perfor- mance evaluation, compensation, supply chain relationships, and sustainability. She coauthored a monograph on customer profitability analysis in credit unions.
S. Mark Young
S. Mark Young holds the George Bozanic and Holman G. Hurt Chair in Sports and Entertainment Business and is also professor of accounting and professor of manage- ment and organization at the Marshall School of Business, University of Southern California (USC), and professor of communication and journalism at the Annenberg School for Communication at USC. Professor Young received an A.B. from Oberlin College (economics) and a Ph.D. from the University of Pittsburgh.
Professor Young has published research in a variety of journals including The Accounting Review, Accounting, Organizations and Society, the Journal of Accounting Research, the Journal of Marketing Research, and Contemporary Accounting Research. Currently, he is on the editorial board of several major journals and was past associ- ate editor for The Accounting Review. In 2006, he was a co-winner of the Notable Contribution to the Accounting Literature (with Shannon Anderson) and has won the Notable Contributions to the Management Accounting Literature Award twice— with Frank Selto (1994) and Shannon Anderson (2003). He also received the Jim Bulloch Award for Innovations in Management Accounting Education in 2005. Dr. Young has extensive executive teaching and consulting experience. He has won several outstanding teaching awards including the Golden Apple Teaching Award and is a distinguished fellow of the Center for Excellence in Teaching at USC.
Professor Young also studies the entertainment industry and his book, The Mirror Effect: How Celebrity Narcissism Is Seducing America (with Dr. Drew Pinsky) is a New York Times bestseller. He also comments regularly in the media and has appeared on The View, Howard Stern, Fox & Friends, and CNN’s Situation Room and has been quoted in the New York Times, Newsweek, China Daily, Psychology Today, Scientific American Mind, and the London Times.
xxiv About the Authors
Chapter 11Chapter
1
How Management Accounting Information Supports Decision Making
After completing this chapter, you will be able to: 1. Understand the major differences between financial
and management accounting.
2. Appreciate the historical evolution of management accounting to its present set of practices.
3. Understand how management accounting information is used for strategic and operational decision making.
4. Understand the steps of the plan–do–check–act cycle and how each step defines a unique purpose and role for management accounting information.
5. Be sensitive to the behavioral consequences that result from the introduction of new measurement and management systems.
Research in Motion In September 2010 Research in Motion (RIM), the producer of the BlackBerry smart phone, announced that PlayBook, its entry into the hot tablet market, would be introduced in the first quarter of 2011. This announcement caused a 3% decline in the value of RIM’s shares, which analysts attributed to disappointment that the PlayBook would not be available for the December holiday season as previously expected.
RIM, once a smart phone market leader, was experiencing intense com- petition. Despite the extraordinary success of its BlackBerry products in the business market segment, new competitors such as Apple’s iPhone, which had been developed originally for the consumer market segment, had eroded RIM’s market leadership position. Apple’s latest hot product, the iPad tablet, had achieved extraordinary success since its launch in March 2010 and RIM was under huge market pressure to respond with its own tablet.
2 Chapter 1 How Management Accounting Information Supports Decision Making
Management accounting is the process of supplying the managers and employees in an organization with relevant information, both financial and nonfinancial, for making decisions, allocating resources, and monitoring, evaluating, and rewarding perfor- mance. The reported expense of an operating department, such as the assembly depart- ment of an automobile plant or an electronics company, is one example of management accounting information. Other examples are the cost of producing a product, the cost of delivering a service, and the cost of performing an activity or business process, such as creating a customer invoice or serving a customer. Nonfinancial management account- ing information includes measures related to customer satisfaction and loyalty, process quality and timeliness, innovation, and employee motivation.
Management Accounting and Financial Accounting
Most students study management accounting after taking an initial course in financial accounting. These two subjects share important similarities since both are based on financial information and other quantitative information about business operations. But they differ in important ways.
WHAT IS MANAGEMENT ACCOUNTING?
The situation RIM faced in 2010 vividly illustrates the nature of both corporate strategy (choosing the markets in which it will compete) and business unit strategy (choosing how to compete in a given market segment). The strategic decisions that RIM faced required relevant and timely information, much of which is supplied by management accounting information.
Alamy Images
Chapter 1 How Management Accounting Information Supports Decision Making 3
Financial accounting has the following attributes:
1. It is retrospective, reporting and summarizing in financial terms the results of past decisions and transactions.
2. It is primarily oriented to external stakeholders, such as investors, creditors, regulators, and tax authorities.
3. It must be consistent with rules formulated by standard setters such as the Financial Accounting Standards Board (FASB) in the United States and the International Accounting Standards Board (IASB) for much of the rest of the world, and local country regulatory authorities, such as the U.S. Securities and Exchange Commission (SEC). These standard setters and regulatory authorities specify the content of the reports, the rules for how the content gets developed, and how the content will be presented.
In contrast, management accounting information has the following attributes:
1. It is both retrospective, providing feedback about past operations, and also prospective, incorporating forecasts and estimates about future events. For both retrospective reporting and prospective planning, management accounting uses both financial and nonfinancial measures.
2. It is oriented to meeting the decision-making needs of employees and managers inside the organization. Ideally, a good management accounting system can become a source of competitive advantage for a company.
3. It has no prescribed form or rules about its content, how the content is to be developed, and how the content is to be presented. All of these get determined by managers’ judgments and decisions about what best meets their needs for actionable information and is defined entirely by the needs of managers using the information. No standard setter or regulator specifically influences the design of management accounting information and systems.
Management accounting information must be relevant and helpful to managers, and customized to serve multiple purposes.
A Brief History of Management Accounting
In the early 19th century, management accounting consisted of systems to measure the cost of producing individual products, such as a piece of clothing or a weapon. As enterprises grew in scale and scope, the demands for accurate costing information increased. By the middle of the 19th century, railroad managers had implemented large, complex costing systems that allowed them to compute the costs of carrying different types of freight, such as coal and steel, along multiple routes. This information supported efficiency improvements and pricing decisions. The railroads were the first modern industry to develop and use large quantities of financial statistics to assess and monitor organizational performance. Later in the century, Andrew Carnegie, in his steel company, developed detailed systems to record the cost of materials and labor used in his various mills. Carnegie intensively studied and acted on the information from his systems to continually reduce costs in his mills, and to close mills that he felt were irretrievably inefficient. Carnegie exploited his cost advantage by lowering his prices to levels that competitors could not match if they wanted to stay in business. Thus, Carnegie’s excellent costing systems gave him a sustainable competitive advantage in the marketplace and promoted the growth and success of his company.
In the early 20th century, companies, such as DuPont and General Motors, expanded the focus of management accounting beyond cost accounting to manage- ment planning and control. These large companies replaced market mechanisms with
4 Chapter 1 How Management Accounting Information Supports Decision Making
internal resource allocation to multiple lines of business. Executives needed informa- tion, such as return-on-investment by business unit, for coordination and control among these multiple businesses. They used management accounting information to empower and inform the visible hand of management to replace what Adam Smith called the invisible hand of market forces.1
These organizations sought to improve efficiency and therefore profitability by internalizing what were previously open market transactions and eliminating the costs of transacting with external agents. The rise of these integrated companies created a demand for measuring the performance of individual organizational units to evaluate their performance through comparisons with stand-alone organizations that performed the same task. For example, an automobile company might want to compare the cost performance of a division that makes transmissions with that of an independent supplier, an application that we discuss in Chapter 3. Managers devel- oped ways to measure the profitability and the performance of their units and continue to use them today, as discussed in Chapter 11 of the book.
After these innovations, the evolution of management accounting practice slowed as senior management interest focused on developing and preparing external financial statements that complied with the new reporting and auditing requirements imposed by regulatory authorities in the 1930s. Only in the 1970s, when American and European companies were under intense pressure from Japanese manufacturers, did interest revive in developing new management accounting tools. These tools included systems that reported on quality, service, and customer and employee performance rather than simple financial summaries of organizational unit perfor- mance. Also, major advances were made in measuring the cost of products and ser- vices to reflect the increasing importance of indirect and support costs required to design and produce a product, deliver a service, and meet a customer’s demands. This text features, and in fact is organized around, many recent innovations in cost, profit, and performance measurement systems.
In summary, the history of management accounting illustrates that innovations in management accounting practice were—and continue to be—driven by the information needs of new strategies as companies became more complex, technologies changed, and new competitors appeared. When controlling and reducing costs were important, inno- vations in costing systems occurred. When organizations gained advantage from scale and diversification, innovative executives developed new management control systems to monitor and manage their complex enterprises. When competitive advantage shifted to how well a company deployed and managed its intangible assets—customer relationships, process quality, innovation, and, especially, employees, new systems for cost and performance management emerged.
1 Alfred DuPont Chandler, The Visible Hand: The Managerial Revolution in American Business (Cambridge, Mass.: Belknap Press, 1977).
Management accounting is a profession that involves partnering in management decision making, devis- ing planning and performance management systems,
and providing expertise in financial reporting and control to assist management in the formulation and implementation of an organization’s strategy.
IN PRACTICE Definition of Management Accounting (2008), Issued by the Institute of Management Accountants
Source: “Definition of Management Accounting,” one of a series of Statements on Management Accounting, published by the Institute of Management Accountants, 2008, accessed from http://www.imanet.org/PDFs/Secure/Member/SMA/SMA_ DefinManAcct_0408_2.pdf, which may be limited to IMA members.)
Chapter 1 How Management Accounting Information Supports Decision Making 5
STRATEGY
This book frames management accounting as a discipline that helps an enterprise to develop and implement its strategy. Of course, this also requires that strategic objectives be linked to reporting on and improving operations.
Strategy is about an organization making choices about what it will do and, equally important, about what it will not do. At the highest level strategic planning involves choosing a strategy that provides the best fit between the organization’s environment and its internal resources in order to achieve the organization’s objectives. Selecting a strategy forces managers to make choices about what mar- kets the organization should target and how the organization will compete in those markets. The details about how to do strategic planning and the type of informa- tion and analysis that strategists use to select a particular strategy are covered in strategy courses. But once a strategy has been selected, the organization needs management accounting information to help implement the strategy, allocate resources for the strategy, communicate the strategy, and link employees and operational processes to achieve the strategy. As the strategy gets executed, management accounting information provides feedback about where it is working and where it is not, and guides actions to improve the performance from the strat- egy. We can view the iterative strategy execution process through the lens of the plan–do–check–act cycle, originally developed for improving the quality of prod- ucts and processes (see Exhibit 1-1).
The Gap operates retail outlets, such as Banana Republic, Gap, and Old Navy, that target different market segments. Each market segment addresses different customers so the managers in each of the Gap’s operating units need different management accounting information to evaluate their performance. Getty Images, Inc.—Getty News
6 Chapter 1 How Management Accounting Information Supports Decision Making
The Plan–Do–Check–Act (PDCA) Cycle
Quality expert W. Edwards Deming helped develop and disseminate the plan–do–check–act (PDCA) cycle, and it is often called the Deming cycle. Deming proposed it as a systematic and recursive way to develop, implement, monitor, evaluate, and, when necessary, change a course of action. Although Deming’s focus was on improving product and process quality, his idea can be applied to any decision-making activity. We will illustrate how the PDCA cycle can frame the strategic and operational roles for management accounting information.
Plan The first PDCA step defines the organization’s purpose and selects the focus and scope of its strategy. Many organizations start the planning stage by reaffirming or updating their mission statement, which should be a powerful message to people inside and outside the organization about the organization’s purpose and the value it intends to create in society. The enterprise’s planners then accumulate information about the organization’s external environment (political, economic, social, technolog- ical, environmental, and legal), its industry situation, and its internal strengths and weaknesses, relative to competitors. Executives use this information to decide on a strategy (a course of action) to achieve the organization’s objectives. The planning step uses management accounting information in several ways.
Plan
• Identify objectives. • Choose a course of action to achieve the desired objectives.
Do
• Implement the chosen course of action.
Act
• Maintain the current direction if results are acceptable. Otherwise return to the plan stage to develop and implement an alternative course of action.
Check
• Monitor (measure) the results of the implemented course of action. • Evaluate the results by comparing them with results expected when the plan was developed.
Exhibit 1-1 The Plan–Do–Check–Act (PDCA) Cycle
Chapter 1 How Management Accounting Information Supports Decision Making 7
Virtually every company has a mission statement that expresses its fundamental purpose and how it intends to add value to society through its relation- ships with customers, shareholders, employees, suppliers, and communities. You can find the mission statements for all Fortune 500 companies at the
website http://www.missionstatements.com/fortune_ 500_mission_statements.html. As one example, FedEx, a Fortune 500 company, provides its mission state- ment and other aspects of its system of corporate governance at http://ir.fedex.com/governance.cfm
IN PRACTICE A Mission Statement
Chapter 2 introduces the strategy map and Balanced Scorecard, two important management accounting tools for planning, deploying, and communicating the strategy. The strategy map and Balanced Scorecard capture management’s beliefs about the drivers or causes of success in achieving an organization’s objectives. They also provide a systematic way of identifying the management accounting informa- tion needed to communicate, monitor, and evaluate the chosen strategy.
Another essential component for the strategy planning stage is to estimate the cost and profit consequences from a course of action. Managers use cost– volume–profit (CVP) analysis, a widely used financial management tool that is introduced in Chapter 3, for profit planning and financial modeling. The chapter starts with the fundamental cost concepts and cost behavior that are the foundation for CVP analysis. Chapter 3 also discusses relevant cost analysis, which is used to help managers make ongoing business decisions such as whether to make or buy a product component, drop or add a product or department, and add or subtract resource capacity. Chapter 3 provides insight into the critical role management accounting information plays in the support of many of the important planning decisions that arise regularly in organizations.
The financial consequences of a strategy are often translated into a budget, per- haps the most widely used short-term financial planning and control tool. To develop
FedEx has crafted a strong mission statement to express its fundamental purpose to shareholders, employees, customers, and suppliers. Alamy Images
8 Chapter 1 How Management Accounting Information Supports Decision Making
a budget, the organization’s financial planners develop a forecast that summarizes the revenue, cost, and profit consequences from the organization’s planned activities. Chapter 10 discusses the scope and components of budgeting—an activity you will inevitably confront no matter where your professional career takes you.
Organizations also need to plan for the development of entirely new products and services. Chapter 8 discusses the role of management accounting for designing new products, monitoring the efficiency of the product development process, and assessing the total life-cycle cost consequences from using and disposing of products. End-of-cycle salvage and reclamation costs can be enormous, and information about these future costs for any project are now considered part of any new product development process.
Do The “do” step of the PDCA cycle involves the implementation of a chosen course of action. In this setting, management accounting information is communicated to front-line and support employees to inform their daily decisions and work activi- ties. Employees use cost, profit, and nonfinancial information to operate and improve processes; market, sell, and deliver products and services to customers; and respond to customer requests. Management accounting information is often used by internal auditing to ensure that the planned strategy and decisions are being faithfully executed. This enforcement role, which is an element of the wider role of corporate governance, has become an important component of the contribu- tion that management accounting information makes in organizations.
Check The check step in the PDCA cycle includes two components: measuring and monitoring ongoing performance and taking short-term actions based on the measured performance. Management accounting’s traditional focus has been on measuring, evaluating, and reporting the costs of ongoing operations. Chapters 4 and 5 develop the nature and ele- ments of systems designed to calculate the cost and profitability of products. Chapter 6 introduces an expanded role for management accounting information by measuring the cost of serving customers and customer profitability. Understanding the profit or loss of a company’s multiple products and customers is essential feedback on how well the company’s product-line and market strategy is working. Chapter 7 contributes to the check step in the PDCA cycle with its coverage of analyzing and improving operational processes. Chapter 10 describes the traditional financial control tool of variance analysis and Chapter 11 illustrates how management accounting information is used to evaluate overall departmental and business unit performance.
One of this book’s innovations is to complement the normal financial focus of man- agement accounting information with extensive treatment of the role of nonfinancial measures of performance. Chapter 2’s introduction of the Balanced Scorecard frames the importance and role for nonfinancial information in managers’ planning and control decisions. Nonfinancial information reports on the critical drivers of long-term financial performance: customers, processes, innovation, employees, systems, and culture. The particular nonfinancial measures most useful for an organization will vary based on its industry and strategy, but generally will include measures of customer loyalty, process quality, and employee capabilities and motivation.
Act In the final PDCA step, managers take actions to lower costs, change resource alloca- tions, improve the quality, cycle time, and flexibility of processes, modify the product mix, change customer relationships, and redesign and introduce new products. They reward (and occasionally punish) employees based on performance. Rather than a
Chapter 1 How Management Accounting Information Supports Decision Making 9
separate chapter or two on the act step of the PDCA cycle, we have embedded such decision making throughout the book. This emphasizes the fact that management accounting should always be informative and actionable for helping the organization implement its plan. As these new actions get implemented, the management team will eventually return to the planning step to assess whether its previous plan is still valid and worth continuing, or whether it has become time to adapt the plan or perhaps introduce a new strategic plan. This launches the enterprise on another trip around its PDCA cycle.
BEHAVIORAL IMPLICATIONS OF MANAGEMENT ACCOUNTING INFORMATION
Thus far we have emphasized the analytic role played by management accounting information for planning, resource allocation, decision making, acting, monitoring, and improving. Although the role of management accounting information is essen- tial for supporting decisions and solving problems, information is never neutral. The mere act of measuring and informing affects the individuals involved. A famous study conducted in the 1920s at the Hawthorne Plant of the Western Electric Company concluded that individuals and groups alter their behavior when they know they are being studied and their performance is being measured. People react when they are being measured. They focus on the variables and behavior being meas- ured and pay less attention to those not being measured. Some people have over- stated this effect by declaring, “What gets measured gets done.” More accurately, the expression should be “If you don’t measure it, you can’t manage and improve it,” which can be taken as one of the fundamental rationales for studying and imple- menting management accounting systems.
It is normal, however, as managers introduce or redesign cost and performance measurement systems, for people familiar and comfortable with the previous systems to resist change. These people have acquired expertise in the use (and occasional misuse) of the old system and are concerned about whether their expe- rience and expertise will be transferable to the new system. People also may feel committed to the decisions and actions taken on the basis of information an old system has produced. These actions may no longer seem valid based on the information produced by a newly installed management accounting system. Thus, a new management system can lead to embarrassment and threat, a trigger for reactions against change. The design and introduction of new measurements and systems must be accompanied by an analysis of the behavioral and organizational reactions to the measurements, a topic we discuss extensively in Chapter 9. Even more important, when the measurements are used not only for information, planning, and decision making but also for control, evaluation, and reward, employees and managers place great emphasis on the measurements themselves. Managers and employees may take unexpected and undesirable actions to influence their score on the performance measure. For example, managers seeking to improve current bonuses based on reported profits may skip discretionary expenditures such as preventive maintenance, research and development, and advertising that may improve performance in future periods.
Thus we must be ever vigilant to not only see the analytic, or left-brain, proper- ties of management accounting information but also appreciate the emotional, or right-brain, reactions by individuals to the information used to monitor and evaluate their performance.
10 Chapter 1 How Management Accounting Information Supports Decision Making
SUMMARY
This chapter introduced the role and nature of man- agement accounting within the PDCA planning and control cycle. Management accounting must inform the actions and decisions made by managers and employees. This is why the generation and use of management accounting information must be driven by the organization’s strategic choices. Management accounting information also monitors and evaluates the results from implemented decisions. It leads to
KEY TERMS
financial accounting, 3 management accounting, 2
nonfinancial information, 8 plan–do–check–act cycle, 5
strategy, 5
ASSIGNMENT MATERIALS
Questions 1-1 What is management accounting? (LO 1) 1-2 Why do a company’s operators/workers,
managers, and executives have different informational needs than shareholders and external suppliers of capital? (LO 1, 3)
1-3 Why may financial information alone be insufficient for the ongoing informational needs of operators/workers, managers, and executives? (LO 1, 3)
1-4 Why might senior executives need measures besides financial ones to assess how well their business performed in the most recent period? (LO 1, 3)
1-5 Provide examples of how management ac- counting systems have changed in response to information needs as companies have become more complex, technologies have changed, or new competitors have appeared. (LO 1, 2)
1-6 Given a selected strategy, how do organiza- tions use management accounting informa- tion to implement the strategy? (LO 3)
1-7 Briefly explain each of the four steps of the plan–do–check–act cycle. (LO 4)
1-8 How can management accounting informa- tion produce behavioral and organizational reactions? (LO 5)
Exercises
LO 1, 3, 4, 5 1-9 The role of management accounting Consider the descriptions of management accounting provided in the chapter. Discuss why the associated responsibilities are viewed as “accounting” and how people handling those responsibilities interface with other functional areas in fulfilling the stated responsibilities. What skills and knowledge does one need to fulfill the responsibilities?
LO 1, 3 1-10 The plan–do–check–act cycle For each of the four steps of the plan–do–check–act cycle, describe examples of possible uses of management accounting information.
LO 1, 3 1-11 Different information needs Consider the operation of a fast-food company with hundreds of retail outlets scattered about the country. Consider the descriptions of management accounting provided in the chapter to identify management accounting information needs for the following: a. The manager of a local fast-food outlet that prepares food and serves it
to customers who walk in or pick it up at a drive-through window b. The regional manager who supervises the operations of all the retail
outlets in a three-state region
new actions to improve the implementation of the intended strategy through operational enhance- ments, decisions about products, processes, and customers, new product introductions, and, perhaps most important, better motivated and empowered managers and employees. But all new measurement and management systems must be introduced with sensitivity to the reactions of employees and man- agers to the act of measurement.
Chapter 1 How Management Accounting Information Supports Decision Making 11
c. Senior management located at the company’s corporate headquarters. Consider specifically the information needs of the president and the vice presidents of operations and marketing.
Be sure to address the content, frequency, and level of aggregation of information needed by these different managers.
LO 1, 3 1-12 Different information needs Consider the descriptions of management accounting provided in the chapter to identify management accounting information needs for the following: a. The managers of (1) a patient unit, where patients stay while being treated
for illness or while recuperating from an operation, and (2) the radiology department, where patients obtain X-rays and receive radiological treatment
b. The manager of a nursing service who hires and assigns nurses to all patient units and to specialty services, such as the operating room, emergency room, recovery room, and radiology room
c. The chief executive officer of the hospital. Be sure to address the content, frequency, and level of aggregation of information needed by these different managers.
LO 3 1-13 The elements of quality For each of the following products, suggest three measures of quality: a. Television set b. University course c. Meal in an exclusive restaurant d. Carryout meal from a restaurant e. Container of milk f. Visit to the doctor g. Trip on an airplane h. Pair of jeans i. Novel j. University textbook.
Problems
LO 1, 3 1-14 Differences between financial and managerial accounting Many German companies have their management accounting department as part of the manufacturing operations group rather than as part of the corporate finance department. These German companies operate two separate accounting departments. One performs financial accounting functions for shareholders and tax authorities, and the other maintains and operates the costing system for manufacturing operations.
Required
What are the advantages and disadvantages of having separate departments for financial account- ing and management accounting?
LO 1 1-15 Differences between financial and managerial accounting The controller of a German machine tool company believed that historical cost depreciation was inadequate for assigning the cost of using expensive machinery to individual parts and products. Each year, he estimated the replacement cost of each machine and included depreciation based on the machine’s replacement cost in the machine-hour rate used to assign machine expenses to the parts produced on that machine. Additionally, the controller included an interest charge, based on 50% of the machine’s replacement value, into the machine-hour rate. The interest rate was an average of the three- to five-year interest rate on government and high-grade corporate securities.
12 Chapter 1 How Management Accounting Information Supports Decision Making
As a consequence of these two decisions (charging replacement cost rather than historical cost and imputing a capital charge for the use of capital equipment), the product cost figures used internally by company managers were inconsistent with the numbers that were needed for inventory valuation for financial and tax reporting. The accounting staff had to perform a tedious reconciliation process at the end of each year to back out the interest and replacement value costs from the cost of goods sold and inventory values before they could prepare the financial statements.
Required
(a) Why would the controller introduce additional complications into the company’s costing sys- tem by assigning replacement value depreciation costs and imputed interest costs to the com- pany’s parts and products?
(b) Why should management accountants create extra work for the organization by deliberately adopting policies for internal costing that violate the generally accepted accounting princi- ples that must be used for external reporting?
LO 1, 3, 4 1-16 Role of financial information for continuous improvement Consider an organization that has empowered its employees, asking them to improve the quality, productivity, and responsiveness of their processes that involve repetitive work. This work could arise in a manufacturing setting, such as assembling cars or producing chemicals, or in a service setting, such as processing invoices or responding to customer orders and requests. Clearly the workers would benefit from feedback on the quality (defects, yields) and process times of the work they were doing to suggest where they could make improvements. Identify the role, if any, for sharing financial information with these employees to help them in their efforts to improve quality, productivity, and process times. Be specific about the types of financial information that would be helpful and the specific decisions or actions that could be made better by supplementing physical and operational information with financial information.
Cases
LO 1, 3, 4 1-17 Different information needs Julie Martinez, manager of the new retail outlet of Super Printing, is pondering the management challenges in her new position. Super Printing is a long-established printing company in a major metropolitan area. The new Super outlet, located at the edge of the parking lot for Western Business School, represents Super’s attempt to break into the rapidly growing business for retail digital imaging.
The Super retail store provides a range of copying and digital imaging services for the business school’s students, faculty, and administrators, plus other retail customers. Super’s primary prod- ucts are black-and-white copies of documents. Variation exists even in this basic product, however, as consumers can choose from a variety of paper colors, sizes, and quality. Super recently purchased a machine that prints color copies from digital input. Color copies also can be produced in a vari- ety of sizes, paper quality, and paper types, including transparencies for overhead projection and photographic-quality reproductions. Other printing products include business cards, laminated luggage tags, and name badges for conferences, executive programs, and students.
In addition to physical printing, the Super center provides fax services by which individuals can both receive and transmit documents. When incoming faxes are received, a store employee calls the recipient, who stops at the outlet to pick up the document. The center also has several personal computers, both Windows-based and Macintosh, that students rent by the hour for basic computer processing, Internet access, e-mail, and preparing presentations and résumés. Each computer is
Chapter 1 How Management Accounting Information Supports Decision Making 13
connected to Super’s black-and-white and color printers, enabling students to produce paper copies of their presentations and résumés.
Super has other machines that assemble printed pages into bound documents. Two different binding types are available. The store also sells a limited selection of office supplies, including paper, envelopes, paper clips, glue, binders, tabs, pens, pencils, and marking pens.
Currently, about five employees (including Julie) work at the retail outlet during prime hours (8:00 A.M. to 5:00 P.M.) with two to four people working the evening shift (5:00 P.M. to midnight) when walk-in business is much slower. The number of people working during the evening hours is determined by the anticipated backlog of reproduction work that will be performed during these hours.
Prices for the various products and services have been set based on those of competitors, such as FedEx Kinko’s and Staples. Julie receives a daily report on total sales, broken down by cash sales, credit card sales, and credit sales to various programs at the business school; however, she currently does not have a report on expenses such as labor, materials, and equipment for each line of business (black-and-white and color printing, computer services, document preparation, fax services, and sales of office supplies). Thus, Julie is unsure whether each line of business is profitable. Julie is also unsure how efficiently the business is run.
Further, the different business lines require different quantities and types of capital: equipment such as copying and printing machines, computers, and facsimile machines; physical capital such as office space; and the different inventories of paper types, colors, grades and sizes, and office supplies.
If the pilot store that Julie is operating is successful, then the parent company will likely try to open many similar outlets near schools and universities throughout the metropolitan area. For this purpose, the parent company wants to know which business lines are the most profitable, includ- ing the cost of capital and space required, so that these lines can be featured at each retail outlet. If some business lines are not profitable, then Super probably will not offer those services at newly opened stores unless they are necessary to build retail traffic.
Required
Identify the management accounting information needs for the following:
(a) An employee desiring to help serve customers more efficiently and effectively (b) Julie Martinez, the manager of the pilot retail outlet (c) The president of Super Printing
Be sure to address the content, frequency, and level of aggregation of information needed by these different individuals.
LO 1, 3 1-18 Information for employee empowerment A U.S. automobile components plant had recently been reorganized so that quality and employee teamwork were to be the guiding princi- ples for all managers and workers. One production worker described the difference:
In the old production environment, we were not paid to think. The foreman told us what to do, and we did it even if we knew he was wrong. Now, the team decides what to do. Our voices are heard. All middle management has been cut out, including foremen and superintendents. Management relies on us, the team members, to make decisions. Salary people help us make these decisions; the production and manufacturing engineers work for us. They are always saying, “We work for you. What do you need?” And they listen to us.
The plant controller commented as follows:
In traditional factories, the financial system viewed people as variable costs. If you had a production problem, you sent people home to reduce your variable costs. Here, we do not send people home. Our production people are viewed as problem solvers, not as variable costs.
14 Chapter 1 How Management Accounting Information Supports Decision Making
Required
(a) What information needs did the production workers have in the old environment? (b) What information do you recommend be supplied to the production workers in the new
environment that emphasizes quality, defect reduction, problem solving, and teamwork?
LO 1, 3, 4 1-19 Financial information for continuous improvement The manager of a large semiconductor production department expressed his disdain for the cost information he was presently given:
Cost variances are useless to me.2 I don’t want to ever have to look at a cost variance, monthly or weekly. Daily, I look at sales dollars, bookings, and on-time delivery (OTD)—the percent of orders on time. Weekly, I look at a variety of quality reports including the outgoing quality control report on items passing the final test before shipment to the customer, in-process quality, and yields. Yield is a good surrogate for cost and quality. Monthly, I do look at the financial reports. I look closely at my fixed expenses and compare these to the budgets, especially on discretionary items like travel and maintenance. I also watch headcount.
But the financial systems still don’t tell me where I am wasting money. I expect that if I make operating improvements, costs should go down, but I don’t worry about the linkage too much. The organizational dynamics make it difficult to link cause and effect precisely.
Required
Comment on this production manager’s assessment of his limited use for financial and cost summaries of performance. For what purposes, if any, are cost and financial information helpful to operating people? How should the management accountant determine the appropriate blend between financial and nonfinancial information for operating people?
LO 1, 2, 3, 4, 5 1-20 Comprehensive performance measurement in public and nonprofit organizations Organizations in the public and nonprofit sector, such as government agencies and charitable social service entities, have financial systems that budget expenses and monitor and control actual spending. Explain why these organizations should consider developing a compre- hensive set of performance measurements (including nonfinancial measures) to monitor and report on their performance. Provide examples of financial and nonfinancial measures that should be included in such a comprehensive set of measurements.
2 We will study cost variances in later chapters. For the purposes of this case, it is sufficient to recognize that a cost variance represents the difference between the cost actually assigned to a production department and the cost that was expected or budgeted for that department.
Chapter 22Chapter
15
The Balanced Scorecard and Strategy Map
After completing this chapter, you will be able to: 1. Explain why both financial and nonfinancial measures are
required to evaluate and manage a company’s strategy.
2. Understand how a Balanced Scorecard can represent cause-and- effect hypotheses of a company’s strategy across financial, customer, process, and learning and growth perspectives.
3. Explain why a clear strategy is vital for a company.
4. Appreciate the role for a strategy map to translate a strategy into financial, customer, process, and learning and growth objectives.
5. Select measures for the strategic objectives in the four perspectives of a company’s Balanced Scorecard and strategy map.
6. Extend the Balanced Scorecard framework to nonprofit and public-sector organizations.
7. Recognize problems that companies may experience when implementing the Balanced Scorecard and suggest ways to overcome them.
Pioneer Petroleum Pioneer Petroleum was the U.S. marketing and refining division of a large global petroleum company. It operated five refineries and had more than 7,000 branded gasoline stations around the United States, which sold about 25 million gallons of gasoline per day. Historically, Pioneer mar- keted a full range of products and services. It did, however, match the prices of discount stations operating near a Pioneer station so that it would not lose market share. Pioneer’s CEO Brian Roberts had recently learned that Pioneer was the least profitable marketing and refining com- pany in the United States. He decided to turn around the company by im- plementing a strategy based on a marketing study that had revealed five
16 Chapter 2 The Balanced Scorecard and Strategy Map
distinct consumer segments among the gasoline-buying public (see Exhibit 2-1).
Pioneer’s executives saw that price-sensitive consumers constituted only 20% of all U.S. gasoline purchasers. Another segment, Homebodies, had little loyalty to any brand or station. But three segments wanted more than a commodity purchase. After considerable discussion, Pioneer de- cided on a strategy to offer a superior buying experience to the three top- tier segments: Road Warriors, True Blues, and Generation F3. Also, it would no longer seek to attract price-sensitive consumers by lowering prices to compete with discount gasoline stations.
Road Warriors (16%) Generally higher-income middle-aged men who drive 25,000 to 50,000 miles a year, buy premium gasoline with a credit card, purchase sandwiches and drinks from the convenience store, will sometimes wash their cars at the carwash.
True Blues (16%) Usually men and women with moderate to high incomes who are loyal to a brand and sometimes to a particular station; frequently buy premium gasoline and pay in cash.
Generation F3 (27%) (F3—fuel, food, and fast) Upwardly mobile men and women— half under 25 years of age—who are constantly on the go; drive a lot and snack heavily from the convenience store.
Homebodies (21%) Usually homemakers who shuttle their children around during the day and use whatever gasoline station is based in town or along their route of travel.
Price Shoppers (20%) Generally aren’t loyal to either a brand or a particular station, and rarely buy the premium line; frequently on tight budgets; the focus of attention of marketing efforts of gasoline companies for years.
Exhibit 2-1 Pioneer’s Five Gasoline-Buyer Segments
Time-sensitive customers prefer self-service gasoline stations. Alamy Images
Chapter 2 The Balanced Scorecard and Strategy Map 17
Roberts faced the challenge of realigning Pioneer to the new customer-focused strategy. The realignment could not be done just at the top. It had to take place at the grass roots. For its strategy to suc- ceed, Pioneer would have to make everyone aware of the strategy and accountable for its success. A survey had revealed that employees felt internal reporting requirements, administrative processes, and top-down policies were stifling creativity and innovation. Relationships with cus- tomers were adversarial, and people were working narrowly to enhance the reported results of their individual, functional units. Roberts expressed the problem as follows:
I am accountable for a large organization, spread over a large geographic area. At the end of the day, success comes from individ- uals at the frontline of operations. You’ve got an operator at a refin- ery, sitting in front of a computer screen controlling a process unit at 3 A.M. on Sunday morning when management is not around. My fate is determined by that person’s attitude, whether that person is paying attention. Thirty seconds of inattention at the wrong time can shut down that refinery, stopping production. If you’re going to drive the business you have to drive it down to that individual who is at the frontline, making the decision.
Pioneer had operated for decades with a centralized structure, organized by functions, such as purchasing, supply chain, manufactur- ing (refining), distribution, and marketing. Only two people, Roberts and his executive vice president, among Pioneer’s 7,000 employees had accountability for a profit and loss statement. Managers of a refinery, pipeline, or distribution facility were responsible for achieving cost targets, while managers of sales districts had to meet revenue targets. To create a more agile organization, Roberts decentralized Pioneer into 17 strategic business units (including regional gasoline sales districts and specialized product units, such as for jet fuels and lubricants) that would be closer to customers. Each business unit would have its own profit and loss accountability. Roberts now faced the problem of how to upgrade the skills of the newly appointed business unit heads who had all grown up within a structured, top-down functional organization:
We were taking people who had spent their whole professional lives as managers in a big functional organization, and we were ask- ing them to become the leaders of entrepreneurial profit-making busi- nesses, some with up to $1 billion in assets. How were we going to get them out of their historic area of functional expertise to think strategically, as general managers of profit-oriented businesses?
Roberts believed that a major impediment to change was the com- pany’s historic focus on achieving short-term financial performance:
The financial metrics gave us a controller’s mentality, reviewing the past, not guiding the future. I wanted metrics that could communicate what we wanted to be so that everyone in the organization could un- derstand and implement our strategy. We needed metrics that could link our planning process to actions, to encourage people to do the things that the organization was now committed to accomplishing.
Roberts struggled with how he could change the performance mea- surement framework at Pioneer into one that would be better aligned with its new strategy and organizational structure.
18 Chapter 2 The Balanced Scorecard and Strategy Map
Companies use performance measurement systems to perform multiple roles:
• Communicate the company’s strategic objectives. • Motivate employees to help the company achieve its strategic objectives. • Evaluate the performance of managers, employees, and operating units. • Help managers allocate resources to the most productive and profitable
opportunities. • Provide feedback on whether the company is making progress in improving
processes and meeting the expectations of customers and shareholders.
The challenge is to find the right mix of financial and nonfinancial measures to perform these multiple tasks. Throughout the 19th and 20th centuries, companies like Pioneer Petroleum used only financial metrics to measure their performance. Finan- cial control systems, which we will describe later in the book (Chapter 11), relied on metrics such as operating income and return on investment (ROI) to motivate and evaluate performance. These financial metrics were adequate when the primary as- sets that generated a company’s income and value were physical assets, such as prop- erty, plant, equipment, and inventory, and financial assets, including cash, marketable securities, and investments. By the end of the 20th century, however, firms could no longer create value only through their physical and financial assets. They needed to create value through their intangible assets—customer loyalty and rela- tionships, efficient and high-quality operating processes, new products and services, employee skills and motivation, databases and information systems, and, most in- tangible of all, organizational culture.
With these changes in the factors driving competitive success, financial measures become insufficient for measuring and managing company performance. Consider a company that spends money in the current period to enhance its intangible assets through the following actions:
• Upgrading the skills and motivation of employees. • Expanding the data captured and shared about processes, customers,
and suppliers. • Accelerating new products through the research and development pipeline. • Improving the quality and speed of production, distribution, and service
processes. • Enhancing trusted relationships with profitable customers and low-cost suppliers.
All of these actions help to create value for the company. But the financial system treats the spending on such actions as expenses of the current period. Thus the com- pany’s reported profitability and financial performance decrease during a period when it has actually increased the value of its intangible assets. Or consider the con- verse situation in which a company cuts back drastically on its spending to train em- ployees, enhance information systems, improve operating processes, develop new products, and build customer loyalty. As such spending declines, reported income and ROI increases, at just the time when the company has likely become less valuable because of the depreciation of its competitive capabilities. Clearly, the financial re- ports fail to reflect the changes in value that occur when a company either enhances or destroys the value of its intangible assets.
A fundamental principle underlying management accounting is that measurement must support the company’s strategy and operations. Some claim “if you don’t mea- sure it, you can’t manage and improve it.” If companies are to get better at managing and improving the value created from their intangible assets, they need a measurement system designed for these types of assets. Several frameworks have been proposed for
Chapter 2 The Balanced Scorecard and Strategy Map 19
1 References on organizational performance measurement include Richard L. Lynch and Kelvin F. Cross, Measure Up! How to Measure Corporate Performance (Cambridge, Mass.: Blackwell Business, 1995); Robert S. Kaplan and David P. Norton, The Balanced Scorecard: Translating Strategy into Action (Cambridge, Mass.: Harvard Business School Press, 1996); and Andy Neely, Business Performance Measurement: Theory and Practice (Cambridge, UK: Cambridge University Press, 2002).
2 NIST: Malcolm Baldrige Excellence Program home page, retrieved November 20, 2010 from http:// www.nist.gov/baldrige/
3 The EFQM Excellence Model home page, retrieved November 20, 2010 from http://www.efqm.org
% of organizations using this framework
Framework
• The Balanced Scorecard
• None (customized)
• Total quality management
• Shareholder value (EVATM)
• Other —Value dynamics / Accenture (1)
—PWC (1)
—Etc.
62%
0 10
15%
13%
3%
7%
• Baldrige (7) • Six sigma (5) • EFQM (1)
20 30 40 50 60 70
Exhibit 2-2 Performance Measurement Frameworks
expanded performance measurement,1 including those introduced by national and in- ternational quality management programs such as the Malcolm Baldrige National Quality Program for performance excellence2 and the EFQM Excellence model.3
Among all of the various proposals for improving companies’ performance measure- ment systems, the management accounting system based on the Balanced Scorecard (BSC) has become the most widely adopted around the world (see data presented in Exhibit 2-2). The Balanced Scorecard provides a framework that continues to measure financial outcomes but supplements these with nonfinancial measures derived from the company’s strategy. And, the BSC is not restricted to private-sector companies; many nonprofits and public sector entities have also adopted this framework to manage their creation of social value (as we will describe later in this chapter).
THE BALANCED SCORECARD
The Balanced Scorecard (see Exhibit 2-3) measures organizational performance across four different but linked perspectives that are derived from the organization’s mis- sion, vision, and strategy. The four perspectives address the following fundamental questions:
• Financial—How is success measured by our shareholders? • Customer—How do we create value for our customers?
Source: R. Lawson, D. Desroches, and T. Hatch, Scorecard Best Practices: Design, Implementation, and Evaluation (New York: Wiley, 2008).
20 Chapter 2 The Balanced Scorecard and Strategy Map
Learning and growth perspective
“How do we align and enhance our intangible assets to improve the critical processes?”
“To meet our financial and customer objectives, at which processes must we excel?”
Process perspective
“To achieve our vision and financial objectives, how must we deliver value to our customers?”
Customer perspective
Mission, vision, and strategy
Financial perspective
“What financial performance should we deliver for our shareholders?”
Exhibit 2-3 The Four Perspectives of the Balanced Scorecard
• Process—At which processes must we excel to meet our customer and share- holder expectations?
• Learning and growth—What employee capabilities, information systems, and organizational capabilities do we need to continually improve our processes and customer relationships?4
With the Balanced Scorecard measurement system, companies continue to track financial results but they also monitor, with nonfinancial measures, whether they are building or destroying their capabilities—with customers, processes, employees, and systems—for future growth and profitability. Financial measures tend to be lagging indicators of the strategy; they report the financial impact of decisions made in the current and prior periods. The nonfinancial measures in the three other BSC perspec- tives are leading indicators. Improvements in these indicators should lead to better financial performance in the future, while decreases in the nonfinancial indicators (such as customer satisfaction and loyalty, process quality, and employee motivation) generally predict decreased future financial performance.
As a simple example of the cause-and-effect linkages across Balanced Scorecard measures, consider the partial scorecard produced by a small manufacturing company. This company’s strategy is to win business by producing low-cost, high- quality products, and delivering them on time to its customers (see Exhibit 2-4). The company’s financial objective, shown in the financial perspective, is to increase its return on equity (ROE; net income divided by book value). The company expects to generate increased revenues for improving its ROE financial measure by retaining and expanding sales to existing customers. Therefore, it has a customer loyalty objec- tive in its customer perspective, which it measures by (1) percentage of repeat
4 Most organizations implementing the BSC have found four to be the right number for describing their strategy. Some organizations have added a fifth perspective to highlight particularly important aspects of their strategy, such as suppliers, employees, community involvement, or, for nonprofit organiza- tions, social impact. Using fewer than four typically sacrifices metrics that are critical for the strategy.
Chapter 2 The Balanced Scorecard and Strategy Map 21
Strategy map of objectives Objectives
• Increase shareholder value
• Return on equity
• % employees trained and certified in process improvement capabilities
• Percentage of repeat customers • Growth in customers’ sales • % deliveries made on time • Prices compared to competitors
• % improvement in cycle times • Product defect rates • Process yield improvement
Financial Increase shareholder
value
• Retain customers • Deliver products on time • Offer competitive prices
• Reduce process cycle times • Improve process quality
• Develop employees’ process improvement skills
Customer Retain customers
Deliver products on time
Offer competitive
prices
Reduce process
cycle time
Process
Learning and growth Develop
employees’ process
improvement skills
Measures
Improve process quality
Exhibit 2-4 A Simple Balanced Scorecard of Linked Objectives and Measures
customers and (2) the growth in year-to-year sales with existing customers. The com- pany’s strategy is based on its belief that customers value on-time delivery of orders and low prices. Thus, improved on-time delivery performance and competitive prices are expected to lead to increased customer loyalty, which in turn will lead to higher financial performance. So the predictive metrics of customer loyalty and on-time de- livery appear in the scorecard’s customer perspective.
The financial and customer measures represent the “what” of strategy, that is, what the company wants to accomplish with its two most important external con- stituents: shareholders and customers. The process perspective describes “how” the strategy will be executed; it identifies the processes that are most important to meet the expectations of shareholders and customers. For example, short cycle times and high-quality production processes are necessary to achieve exceptional on-time de- livery and low prices. Therefore, measures of quality, such as defect rates and yields, and of process cycle time—the time required to convert raw materials into finished products—are used as important process metrics. These are leading indicators for customer loyalty. Measures for the fourth perspective, learning and growth, arise from asking another “how” question: How will employees obtain the skills and knowledge to be able to improve the quality and cycle times of the company’s pro- duction processes? The company recognizes that its production workers must be well trained in process improvement techniques. Therefore, the learning and growth per- spective uses a measure of employees’ capabilities to predict improvements in process quality and cycle times.
This simple example shows how an entire chain of cause-and-effect relationships among performance measures in the four Balanced Scorecard perspectives tells the story of the business unit’s strategy. The scorecard’s objectives and measures identify and make explicit the hypotheses about the cause-and-effect relationships between outcome measures (e.g., ROE and customer loyalty) in the financial and customer perspectives and the performance drivers (i.e., lead indicators) of those outcomes— such as zero defect processes, short cycle-time processes, and skilled, motivated employees—that are measured in the process and learning and growth perspectives.
22 Chapter 2 The Balanced Scorecard and Strategy Map
• Increase profits and ROI • Grow revenues • Operate with fewer planes
• Reduce ground turnaround times
• Attract and retain more customers • Arrive on time • Offer lowest prices
• Improve training and motivation of ground crew
• # repeat customers
• FAA on-time arrival rating
• Prices compared to competitors
• Average time plane spends at gate • % on-time departures
• % ground crew who are stockholders • # hours of training per ground crew member • % ground crew aware of company’s strategy
Strategy map (partial) Objectives
• Operating income • ROI • % increase in revenues per mile flown • Revenues-to-asset ratio
Financia
MANAGEMENT ACCOUNTING Information for Decision-Making and Strategy Execution
S I X T H E D I T I O N
Anthony A. Atkinson University of Waterloo
Robert S. Kaplan Harvard University
Ella Mae Matsumura University of Wisconsin–Madison
S. Mark Young University of Southern California
Boston Columbus Indianapolis New York San Francisco Upper Saddle River Amsterdam Cape Town Dubai London Madrid Milan Munich Paris Montreal Toronto
Delhi Mexico City S~ao Paulo Sydney Hong Kong Seoul Singapore Taipei Tokyo
AVP/Executive Editor: Stephanie Wall Editorial Director: Sally Yagan Editor in Chief: Donna Battista Director of Editorial Services: Ashley Santora Editorial Project Manager: Christina Rumbaugh Editorial Assistant: Brian Reilly Director of Marketing: Patrice Jones Marketing Assistant: Ian Gold Senior Managing Editor, Production: Cynthia Zonneveld Production Editor: Carol O’Rourke Text Permissions Coordinator: Tracy Metivier Senior Operations Specialist: Diane Peirano Art Director: Anthony Gemellaro Cover Design: Anthony Gemmellaro Cover Illustration/Photo: © Image Source/Corbis Composition/Full-Service Project Management: S4Carlisle Publishing Services/Lynn Steines Printer/Binder: Edwards Brothers Cover printer: Lehigh-Phoenix Color/Hagerstown Typeface: 10/12 Palatino
Credits and acknowledgments borrowed from other sources and reproduced, with permission, in this textbook appear on appropriate page within text.
Copyright © 2012, 2007, 2004, 2001, 1997 by Pearson Education, Inc., Upper Saddle River, New Jersey, 07458. Pearson Prentice Hall. All rights reserved. Printed in the United States of America. This publication is protected by Copyright and permission should be obtained from the publisher prior to any prohibited reproduction, storage in a retrieval system, or transmission in any form or by any means, electronic, mechanical, photocopying, recording, or likewise. For information regarding permission(s), write to: Rights and Permissions Department.
Library of Congress Cataloging-in-Publication Data Management accounting / Anthony A. Atkinson . . . [et al.].—6th ed.
p. cm. Includes index. ISBN-13: 978-0-13-702497-1 ISBN-10: 0-13-702497-5
1. Managerial accounting. I. Atkinson, Anthony A. II. Title. HF5657.4.M328 2012 658.15�11—dc22
2011003287
10 9 8 7 6 5 4 3 2
ISBN-10: 0-13-702497-5 ISBN-13: 978-0-13-702497-1
This book is dedicated to our parents and families.
This page intentionally left blank
Preface xvii
Acknowledgments xxi
About the Authors xxiii
CHAPTER 1 How Management Accounting Information Supports Decision Making 1
CHAPTER 2 The Balanced Scorecard and Strategy Map 15
CHAPTER 3 Using Costs in Decision Making 62
CHAPTER 4 Accumulating and Assigning Costs to Products 121
CHAPTER 5 Activity-Based Cost Systems 165
CHAPTER 6 Measuring and Managing Customer Relationships 218
CHAPTER 7 Measuring and Managing Process Performance 252
CHAPTER 8 Measuring and Managing Life-Cycle Costs 301
CHAPTER 9 Behavioral and Organizational Issues in Management Accounting and Control Systems 340
CHAPTER 10 Using Budgets for Planning and Coordination 393
CHAPTER 11 Financial Control 462
Glossary 510
Subject Index 518
Name and Company Index 524
v
BRIEF CONTENTS
This page intentionally left blank
Preface xvii
Acknowledgments xxi
About the Authors xxiii
CHAPTER 1 How Management Accounting Information Supports Decision Making 1
What Is Management Accounting? 2 Management Accounting and Financial Accounting 2 A Brief History of Management Accounting 3
IN PRACTICE: Definition of Management Accounting (2008), Issued by the Institute of Management Accountants 4
Strategy 5 The Plan-Do-Check-Act (PDCA) Cycle 6
IN PRACTICE: Company Mission Statements 7 Behavioral Implications of Management Accounting Information 9 Summary 10 Key Terms 10 Assignment Materials 10
CHAPTER 2 The Balanced Scorecard and Strategy Map 15
The Balanced Scorecard 19 Strategy 23
IN PRACTICE: Infosys Develops a Balanced Scorecard to Describe and Implement Its Strategy 24
Balanced Scorecard Objectives, Measures, and Targets 24 Creating a Strategy Map 25
Financial Perspective 26 Customer Perspective 27 Process Perspective 31 Learning and Growth Perspective 35
Strategy Map and Balanced Scorecard at Pioneer Petroleum 36 Financial Perspective 36 Customer Perspective 37 Process Perspective 39 Learning and Growth Perspective 40
Applying the Balanced Scorecard to Nonprofit and Government Organizations 43 IN PRACTICE: A Balanced Scorecard for a Nonprofit Organization 44
Managing with the Balanced Scorecard 45 Barriers to Effective Use of the Balanced Scorecard 46 Epilogue to Pioneer Petroleum 48
vii
CONTENTS
Summary 49 Key Terms 49 Assignment Materials 50
CHAPTER 3 Using Costs in Decision Making 62
How Management Accounting Supports Internal Decision Making 63
Pricing 63 Product Planning 63 Budgeting 64 Performance Evaluation 64 Contracting 64
Variable and Fixed Costs 64 Variable Costs 64 Fixed Costs 66
Cost-Volume-Profit Analysis 66 Developing and Using the CVP Equation 67
IN PRACTICE: Introducing Uncertainty into Cost Volume Profit Analysis 68 Variations on the Theme 68
IN PRACTICE: Breakeven on a Development Project 69 Financial Modeling and What-If Analysis 69
IN PRACTICE: Cost-Volume-Profit Analysis 69 The Multiproduct Firm 70
IN PRACTICE: Estimating the Effect of Unit Sales on Share Price 70 The Assumptions Underlying CVP Analysis 72
Other Useful Cost Definitions 72 Mixed Costs 72 Step Variable Costs 73 Incremental Costs 73 Sunk Costs 74
IN PRACTICE: Sunk Costs 74 IN PRACTICE: Overcoming the Sunk Cost Effect 75 IN PRACTICE: Human Behavior and Sunk Costs 75 Relevant Cost 76 Opportunity Cost 76 Avoidable Cost 77
Make-or-Buy—The Outsourcing Decision 78 IN PRACTICE: Contracting Out 79 Manufacturing Costs 79
The Decision to Drop a Product 82 IN PRACTICE: Be Wary When Labeling Departments Losers 83
Costing Orders 85 Costing Orders and Opportunity Cost Considerations 86
Relevant Cost and Short-Term Product Mix Decisions 87 Multiple Resource Constraints 89
IN PRACTICE: Choosing the Least Cost Materials Mix 90 Building the Linear Program 90 The Graphical Approach to Solving Linear Programs 91
viii Contents
Epilogue to Nolan Industries 93 IN PRACTICE: Excel’s Goal Seek and Solver 96
Summary 96 Key Terms 97 Assignment Materials 97
CHAPTER 4 Accumulating and Assigning Costs to Products 121
IN PRACTICE: On the Importance of Understanding Costs in the Restaurant Business 122
Cost Management Systems 123 Cost Flows in Organizations 123
Manufacturing Organizations 123 Retail Organizations 124 Service Organizations 124
Some Important Cost Terms 125 Cost Object 125 Consumable Resources 125 Capacity-Related Resources 125 Direct and Indirect Costs 125
IN PRACTICE: Cost Objects 125 IN PRACTICE: Indirect Costs 126 Cost Classification and Context 127 Going Forward 127
Handling Indirect Costs in a Manufacturing Environment 128 Multiple Indirect Cost Pools 130 Cost Pool Homogeneity 132
Overhead Allocation: Further Issues 134 Using Planned Capacity Cost 134
IN PRACTICE: Why Costing Matters 135 Reconciling Actual and Applied Capacity Costs 135 Estimating Practical Capacity 138
Job Order and Process Systems 138 Job Order Costing 138 Process Costing 139 Some Process Costing Wrinkles 141 Final Comments on Process Costing 142
Epilogue to Strict’s Custom Framing 144 Summary 145 Appendix 4-1 Allocating Service Department Costs 146 Key Terms 150 Assignment Materials 150
CHAPTER 5 Activity-Based Cost Systems 165
Traditional Manufacturing Costing Systems 167 Limitations of Madison’s Existing Standard Cost System 170 Vanilla Factory and Multiflavor Factory 170 Activity-Based Costing 172
Calculating Resource Capacity Cost Rates 173 Calculating Resource Time Usage per Product 174
Contents ix
x Contents
Calculating Product Cost and Profitability 175 Possible Actions as a Result of the More Accurate Costing 177
IN PRACTICE: Using Activity-Based Costing to Increase Bank Profitability 178 Measuring the Cost of Unused Resource Capacity 179 Fixed Costs and Variable Costs in Activity-Based Cost Systems 179 Using the ABC Model to Forecast Resource Capacity 181 Updating the ABC Model 184
IN PRACTICE: W.S. Industries Uses ABC Information for Continuous Improvement 185
Service Companies 187 Capacity Cost Rate 188 Calculating the Time Equation for the Consumption of Broker’s Capacity 189
Implementation Issues 189 Lack of Clear Business Purpose 190 Lack of Senior Management Commitment 190 Delegating the Project to Consultants 190 Poor ABC Model Design 191 Individual and Organizational Resistance to Change 191 People Feel Threatened 192
Epilogue to Madison Dairy 192 Summary 193 Appendix 5-1 Historical Origins of Activity-Based Costing 194 Key Terms 196 Assignment Materials 196
CHAPTER 6 Measuring and Managing Customer Relationships 218
Measuring Customer Profitability: Extending the Madison Dairy Case 220
Reporting and Displaying Customer Profitability 222
IN PRACTICE: Building a Whale Curve of Customer Profitability 224 Customer Costs in Service Companies 224
Increasing Customer Profitability 226 Process Improvements 226 Activity-Based Pricing 226 Managing Relationships 226 The Pricing Waterfall 227
Salesperson Incentives 232 Life-Cycle Profitability 233 Measuring Customer Performance with Nonfinancial Metrics 235
Customer Satisfaction 235 Customer Loyalty 236 The Net Promoter Score 238
Epilogue to Madison Dairy 239 Summary 240 Key Terms 240 Assignment Materials 241
CHAPTER 7 Measuring and Managing Process Performance 252
Process Perspective and the Balanced Scorecard 255 Facility Layout Systems 255
Process Layouts 256 Product Layouts 257
IN PRACTICE: Manufacturing a CD 258 Group Technology 259
Inventory Costs and Processing Time 259 Inventory and Processing Time 259 Inventory-Related Costs 260 Costs and Benefits of Changing to a New Layout: An Example Using Group Technology 260 Summary of Costs and Benefits 266
IN PRACTICE: History of Lean Manufacturing 267 Cost of Nonconformance and Quality Issues 268
Quality Standards 268 Costs of Quality Control 269
Just-in-Time Manufacturing 270 Implications of JIT Manufacturing 270 JIT Manufacturing and Management Accounting 271
IN PRACTICE: Using Lean Manufacturing in a Hospital Setting 272
Kaizen Costing 273 Comparing Traditional Cost Reduction to Kaizen Costing 273 Concerns about Kaizen Costing 274
Benchmarking 275 Stage 1: Internal Study and Preliminary Competitive Analyses 276 Stage 2: Developing Long-Term Commitment to the Benchmarking Project and Coalescing the Benchmarking Team 277 Stage 3: Identifying Benchmarking Partners 277 Stage 4: Information Gathering and Sharing Methods 278 Stage 5: Taking Action to Meet or Exceed the Benchmark 279
IN PRACTICE: Benchmarking Mobile Web Experiences 279 Epilogue to Blast from the Past Robot Company 280
Production Flows 280 Effects on Work-in-Process Inventory 281 Effect on Production Costs 281 Cost of Rework 282 Cost of Carrying Work-in-Process Inventory 283 Benefits from Increased Sales 283 Summary of Costs and Benefits 284
Summary 285 Key Terms 285 Assignment Materials 285
CHAPTER 8 Measuring and Managing Life-Cycle Costs 301
Managing Products over Their Life Cycle 302 Research, Development, and Engineering Stage 303 Manufacturing Stage 303 Postsale Service and Disposal Stage 304
Contents xi
Target Costing 305 A Target Costing Example 308 Concerns about Target Costing 314
IN PRACTICE: Target Costing and the Mercedes-Benz M-Class 315
Breakeven Time: A Comprehensive Metric for New Product Development 316 Innovation Measures on the Balanced Scorecard 320
Market Research and Generation of New Product Ideas 320 Design, Development, and Launch of New Products 321
IN PRACTICE: Life-Cycle Revenues: The Case of Motion Pictures 321
Environmental Costing 324 Controlling Environmental Costs 324
IN PRACTICE: The Cisco Take-Back and Recycle Program 328 IN PRACTICE: Scientific Progress and the Reduction of Environmental Costs: The Case of Chromium in Groundwater 328
Summary 329 Key Terms 329 Assignment Materials 329
CHAPTER 9 Behavioral and Organizational Issues in Management Accounting and Control Systems 340
What Are Management Accounting and Control Systems? 342 The Meaning of “Control” 342
Characteristics of a Well-Designed MACS 342 Technical Considerations 342 Behavioral Considerations 343
The Human Resource Management Model of Motivation 344 The Organization’s Ethical Code of Conduct and MACS Design 345
Avoiding Ethical Dilemmas 345 Dealing with Ethical Conflicts 346
IN PRACTICE: Does Cheating at Golf Lead to Cheating in Business? 347 The Elements of an Effective Ethical Control System 349 Steps in Making an Ethical Decision 349 Motivation and Congruence 349 Task and Results Control Methods 351
IN PRACTICE: Monitoring in the Workplace 351 Using a Mix of Performance Measures: A Balanced Scorecard Approach 353
The Need for Multiple Measures of Performance: Non–Goal-Congruent Behavior 353 Dysfunctional Behavior 353 Using the Balanced Scorecard to Align Employees to Corporate Goals and Business Unit Objectives 354 Change Management 355
Empowering Employees to Be Involved in MACS Design 355 Participation in Decision Making 355 Education to Understand Information 356
xii Contents
Behavioral Aspects of MACS Design: An Example from Budgeting 357 Designing the Budget Process 357 Influencing the Budget Process 359
Developing Appropriate Incentive Systems to Reward Performance 360
Choosing between Intrinsic and Extrinsic Rewards 361 Extrinsic Rewards Based on Performance 362 Effective Performance Measurement and Reward Systems 362 Conditions Favoring Incentive Compensation 364 Incentive Compensation and Employee Responsibility 364 Rewarding Outcomes 364 Managing Incentive Compensation Plans 365 Types of Incentive Compensation Plans 366
IN PRACTICE: UNIBANCO—Tying the Balanced Scorecard to Compensation 367
Epilogue to Advanced Cellular International and Chapter Summary 371 Key Terms 372 Assignment Materials 373
CHAPTER 10 Using Budgets for Planning and Coordination 393
Determining the Levels of Capacity-Related and Flexible Resources 394 The Budgeting Process 395
The Role of Budgets and Budgeting 395 The Elements of Budgeting 397 Behavioral Considerations in Budgeting 398 Budget Components 398 Operating Budgets 400 Financial Budgets 400
The Budgeting Process Illustrated 400 Oxford Tole Art, Buoy Division 400 Demand Forecast 403 The Production Plan 403 Developing the Spending Plans 405 Choosing the Capacity Levels 406 Handling Infeasible Production Plans 408
Interpreting the Production Plan 408 The Financial Plans 409 Understanding the Cash Flow Statement 409 Using the Financial Plans 413 Using the Projected Results 414
What-If Analysis 415 Evaluating Decision-Making Alternatives 415 Sensitivity Analysis 415
Comparing Actual and Planned Results 417 Variance Analysis 417 Basic Variance Analysis 418 Canning Cellular Services 418 First-Level Variances 420 Decomposing the Variances 420 Planning and Flexible Budget Variances 421
Contents xiii
Quantity and Price Variances for Material and Labor 422 Sales Variances 428
The Role of Budgeting in Service and Not-For-Profit Organizations 431 Periodic and Continuous Budgeting 431 Controlling Discretionary Expenditures 432
Incremental Budgeting 432 Zero-Based Budgeting 433 Project Funding 433
Managing the Budgeting Process 434 Criticisms of the Traditional Budgeting Model and the “Beyond Budgeting” Approach 434
Epilogue to the California Budget Crisis 435 Summary 436 Key Terms 437 Assignment Materials 437
CHAPTER 11 Financial Control 462
The Environment of Financial Control 463 Financial Control 464 The Motivation for Decentralization 464
IN PRACTICE: Standard Operating Precedures at Mercedes-Benz USA 465 IN PRACTICE: Evaluating Performance at McDonald’s Corporation Restaurants 466
Responsibility Centers and Evaluating Unit Performance 467 Coordinating Responsibility Centers 467
IN PRACTICE: The High Cost of Coordination 468 Responsibility Centers and Financial Control 469
IN PRACTICE: Nonfinancial Performance Measures at Federal Express: The Service Quality Indicator 469 Responsibility Center Types 470
IN PRACTICE: Investment Centers at General Electric in 2010 472 Evaluating Responsibility Centers 474
IN PRACTICE: Financial Statement Business Segment Reporting 477
Transfer Pricing 481 Approaches to Transfer Pricing 481
IN PRACTICE: International Transfer Pricing 482 Transfer Prices Based on Equity Considerations 485
Assigning and Valuing Assets in Investment Centers 486 The Efficiency and Productivity Elements of Return on Investment 487
Assessing Productivity Using Financial Control 489 Questioning the Return on Investment Approach 489
xiv Contents
IN PRACTICE: Labor Productivity in a Consultancy 489 IN PRACTICE: Managing Productivity in Airlines 490 Using Residual Income 490
IN PRACTICE: Organization Adopt Economic Value Added for Different Reasons 492
The Efficacy of Financial Control 493 Epilogue to Adrian’s Home Services 494 Summary 496 Key Terms 497 Assignment Materials 497
Glossary 510
Subject Index 518
Name and Company Index 524
Contents xv
This page intentionally left blank
Intended Audience
The sixth edition of Management Accounting targets undergraduate and MBA courses in managerial accounting with a major redesign and several new topics. It integrates state-of-the-art thinking on recent innovations in management accounting including:
• the Balanced Scorecard, • strategy maps, • time-driven activity-based costing for product and customer profitability
analysis, • target costing, • environmental costing, and • the design of management control systems.
The author team consists of top scholars who have served as advisers to small, medium-sized, and large enterprises in the private, nonprofit, and public sectors. They present a conceptually sound and practically relevant perspective on the role of management accounting information in informing important decisions made by business managers, aligning employees and organizational units with strategic objectives, driving continuous process improvements, and influencing the design of products and services. The sixth edition provides problems and cases drawn from the authors’ practical experience including cases from Harvard Business School and the Institute of Management Accountants (IMA) that engage students in strategic and organizational analyses. This action orientation makes the text an excellent fit for management accounting courses taught from a managerial perspective. Although this text is primarily intended for business and accounting students, it will also be useful to practicing managers who would benefit from understanding how to mobi- lize management accounting to drive value in their organizations.
All Enterprises Need Management Accounting
Management accounting information creates value for all types of organizations: private sector companies attempting to deliver superior and sustainable returns to shareholders, nonprofit and nongovernmental organizations (NGOs) striving to deliver positive social impact to targeted constituents, and public-sector agencies that are empowered to improve the lives of citizens. The common thread across all of these diverse enterprises is how to implement a strategy that delivers long-term value to their stakeholders. Strategy implementation requires decision making that is aligned with strategic goals, continuous improvement of critical processes, motiva- tion and alignment of employees with organizational objectives, and innovation that develops new products and services. This book is the only management accounting book that explains in detail how to use measurement and management systems for sustainable value creation.
xvii
PREFACE
New to This Edition
• Chapter 1 introduces the plan–do–check–act cycle as an organizing framework for embedding multiple management accounting processes.
• Chapter 2 is an updated and repositioned chapter on the Balanced Scorecard and strategy maps. It uses an extended example, drawn from an actual company’s experience, to illustrate how to develop a Balanced Scorecard and strategy map for a company’s new strategy. Placing this chapter at the front of the book helps students to understand the strategic context for the measure- ment, decision-making, and control topics discussed in subsequent chapters.
• Chapter 3 is an entirely rewritten chapter for introducing students to funda- mental cost concepts. Variable, fixed, incremental, relevant, sunk, avoidable, and opportunity costs are explained and illustrated. Students’ understanding of the concepts is highlighted through decision-making examples on make versus buy, product abandonment, financial modeling for what-if analyses, and product mix optimization with constrained resources. The chapter ends with several numerical examples that enable students to test their ability to apply fundamental cost concepts in diverse settings. In addition, the chapter contains a new case on product costing and decision analysis in the wine industry.
• Chapter 4, also a major update for the sixth edition, provides the foundation for understanding how cost systems can be designed to assign direct and indirect costs to cost objects, such as products, services, and operating depart- ments. It features an explicit and extensive treatment of capacity measurement and costing that sets the stage for the activity-based costing material that follows in subsequent chapters.
• Chapter 5 covers the measurement and management of product costs through the framework of time-driven activity-based costing. This recent innovation helps product costing to be done in a simple, transparent, accurate, and flexible manner. The chapter features the many ways managers can eliminate losses and improve product profitability once they understand the fundamental economics of their products and services.
• Chapter 6, measuring and managing customer relationships, is an entirely new chapter for the sixth edition. The chapter is new not only to the text but also to most management accounting courses. It features the strategic importance of understanding and transforming customer profitability through decisions on product features, product mix, order pricing, and customer relationships. Entirely new material in this chapter includes the pricing waterfall for measur- ing customer discounts, promotions, and allowances, and an extended treat- ment of how to derive customer satisfaction and loyalty metrics for a business unit’s Balanced Scorecard.
• Chapter 7 features the role for management accounting information to drive strategy execution through enhanced continuous improvement activities, includ- ing lean management, kaizen costing, theory of constraints, cost of quality, six sigma, just-in-time, and benchmarking techniques. As in Chapter 6, new mater- ial illustrates how to derive process improvement performance measures for the organization’s Balanced Scorecard.
• Chapter 8 introduces students to the total life-cycle costing concept. At the front end, the chapter shows how target costing can inform decisions made dur- ing the product design and development stages. Target costing helps companies to develop products that meet customers’ functionality requirements at a cost that yields targeted profit margins. New material in the chapter introduces the breakeven time concept for measuring the performance of the product
xviii Preface
development process, and the selection of other innovation metrics that compa- nies can incorporate into their Balanced Scorecards. The chapter concludes by examining processes and metrics at the back end of the product life cycle, when consumers dispose of or return their used products.
• The sixth edition drops two topics, capital budgeting and financial ratio analysis, that our research shows are now usually covered in other courses. It retains and updates chapters from the fifth edition on the behavioral and organizational aspects of management accounting, budgeting, and financial and managerial control of decentralized operations.
• Also retained are the valuable HBS cases, first introduced in the fifth edition: * Sippican (A) and (B) (integrating time-driven activity-based costing,
budgeting, and the Balanced Scorecard), * Midwest Office Products (time-driven ABC in a service setting), * Chadwick, Inc. (designing a Balanced Scorecard for a pharmaceutical
company), and * Domestic Auto Parts (building a Balanced Scorecard).
• An additional HBS case is new to the sixth edition: * Citibank: Performance Evaluation (the costs and benefits of using multiple
performance measures to evaluate performance).
All of these cases are brief for preparation ease and are accompanied by Instructor Case Notes found in the instructor resources.
• The sixth edition also retains the following Institute of Management Accountants cases: * How Mercedes-Benz used target costing to develop its new SUV and * Precision Systems, Inc.: Improving processes in order entry, with linkages to
value-chain ideas (effects on customers, sales representatives, manufacturing, and other internal uses of the order entry information).
• Readings in Management Accounting, Sixth Edition, by S. Mark Young This supplement contains 53 recent and classic business press and academic articles that correlate with the chapter coverage in Management Accounting, Sixth Edition. Ideal for additional content reinforcement and for any case-based course, this supplement includes articles from a variety of sources to show the application of management accounting in diverse organizational settings.
Instructor Materials
The following supplements are available to adopting instructors. For detailed descriptions, please visit www.pearsonhighered.com.
• Instructor’s Manual—teaching tips and additional resources for each chapter. • Test Bank—over 1,200 test questions. • Solutions Manual—solutions for every question, exercise, problem,
and HBS case study. • PowerPoint slides—presentations for every chapter.
Preface xix
This page intentionally left blank
We would like to acknowledge, with thanks, the individuals who made this text possible.
We appreciate and benefited from the reviews and suggestions of Professors:
Signe Cahn, Webster University Alan Czyzewski, Indiana State University Fara Elikai, University of North Carolina–Wilmington Judith Harris, Nova Southeastern University Kay Poston, South University Barbara Pughsley, South University P. K. Sen, University of Cincinnati
For the sixth edition, we also thank the following individuals:
Carol O’Rourke, Production Project Manager Christina Rumbaugh, Editorial Project Manager Lynn Steines, Project Manager, S4Carlisle Publishing Services Stephanie Wall, Acquisitions Vice President
We also gratefully acknowledge Professors Shahid Ansari, Jan Bell, Thomas Klammer, and Carol Lawrence for allowing us to use some of their material on target costing; Professor Priscilla Wisner for permitting us to use her case on the wine industry; Carolyn Streuly for her valuable contributions; and Professor Michael D. Shields and Professor Thomas Lin for their continuing support of the book.
The authors and product team would appreciate hearing from you! Let us know what you think about this book by writing to [email protected]. Please include “Feedback about AKMY 6e” in the subject line.
xxi
ACKNOWLEDGMENTS
This page intentionally left blank
Anthony A. Atkinson
A professor in the School of Accountancy at the University of Waterloo, Anthony A. Atkinson received a bachelor of commerce and M.B.A. degrees from Queen’s University in Kingston, Ontario, and M.S. and Ph.D. degrees in industrial administra- tion from Carnegie-Mellon University in Pittsburgh. He is a fellow of the Society of Management Accountants of Canada and has written or coauthored two texts, vari- ous monographs, and more than 35 articles on performance measurement and cost- ing. In 1989, the Canadian Academic Accounting Association awarded Atkinson the Haim Falk Prize for Distinguished Contribution to Accounting Thought for his mono- graph that studied transfer pricing practice in six Canadian companies. He has served on the editorial boards of two professional and five academic journals and is a past editor of the Journal of Management Accounting Research. Atkinson also served as a member of the Canadian government’s Cost Standards Advisory Committee, for which he developed the costing principles it now requires of government contractors.
Robert S. Kaplan
Robert S. Kaplan is Baker Foundation Professor at the Harvard Business School, where he has taught for 27 years. Previously, he served on the faculty and as Dean of the Tepper Business School at Carnegie-Mellon University. Kaplan received a B.S. and M.S. in electrical engineering from M.I.T., and a Ph.D. in operations research from Cornell University.
Kaplan has done extensive writing, teaching, and consulting on linking cost and performance management systems to strategy implementation. He has helped to develop both activity-based costing and the Balanced Scorecard. His 14 books have been translated into 28 languages. Kaplan’s most recent books are The Execution Premium with David Norton and Time-Driven Activity-Based Costing with Steven Anderson. He has also authored or coauthored 21 Harvard Business Review articles and more than 100 others in academic and professional journals.
Kaplan was inducted into the Accounting Hall of Fame in 2006 and received the Lifetime Contribution Award from the Management Accounting Section of the American Accounting Association in January 2006. In 2008, his coauthored book, Relevance Lost: The Rise and Fall of Management Accounting, received the AAA Seminal Contribution to Accounting Literature Award. His articles and books have also been recognized with several Wildman Medal and AAA Notable Contributions to Accounting Literature Awards.
Kaplan received the Outstanding Accounting Educator Award in 1988 from the American Accounting Association (AAA), the 1994 CIMA Award from the Chartered Institute of Management Accountants (UK) for “Outstanding Contributions to the Accountancy Profession,” and the 2001 Distinguished Service Award from the Institute of Management Accountants (IMA) for contributions to the practice and academic community.
xxiii
ABOUT THE AUTHORS
Ella Mae Matsumura
Ella Mae Matsumura is an associate professor in the Department of Accounting and Information Systems in the School of Business at the University of Wisconsin–Madison, and is affiliated with the university’s Center for Quick Response Manufacturing. She received an A.B. in mathematics from the University of California, Berkeley, and M.Sc. and Ph.D. degrees from the University of British Columbia. Matsumura has won two teaching excellence awards at the University of Wisconsin–Madison and was elected as a lifetime fellow of the university’s Teaching Academy, formed to promote effective teaching. She is a member of the university team awarded an IBM Total Quality Management Partnership grant to develop curriculum for total quality management education.
Professor Matsumura was a co-winner of the 2010 Notable Contributions to Management Accounting Literature Award. She has served in numerous leadership positions in the American Accounting Association (AAA). She was coeditor of Accounting Horizons and has chaired and served on numerous AAA committees. She has been secretary–treasurer and president of the AAA’s Management Accounting Section. Her past and current research articles focus on decision making, perfor- mance evaluation, compensation, supply chain relationships, and sustainability. She coauthored a monograph on customer profitability analysis in credit unions.
S. Mark Young
S. Mark Young holds the George Bozanic and Holman G. Hurt Chair in Sports and Entertainment Business and is also professor of accounting and professor of manage- ment and organization at the Marshall School of Business, University of Southern California (USC), and professor of communication and journalism at the Annenberg School for Communication at USC. Professor Young received an A.B. from Oberlin College (economics) and a Ph.D. from the University of Pittsburgh.
Professor Young has published research in a variety of journals including The Accounting Review, Accounting, Organizations and Society, the Journal of Accounting Research, the Journal of Marketing Research, and Contemporary Accounting Research. Currently, he is on the editorial board of several major journals and was past associ- ate editor for The Accounting Review. In 2006, he was a co-winner of the Notable Contribution to the Accounting Literature (with Shannon Anderson) and has won the Notable Contributions to the Management Accounting Literature Award twice— with Frank Selto (1994) and Shannon Anderson (2003). He also received the Jim Bulloch Award for Innovations in Management Accounting Education in 2005. Dr. Young has extensive executive teaching and consulting experience. He has won several outstanding teaching awards including the Golden Apple Teaching Award and is a distinguished fellow of the Center for Excellence in Teaching at USC.
Professor Young also studies the entertainment industry and his book, The Mirror Effect: How Celebrity Narcissism Is Seducing America (with Dr. Drew Pinsky) is a New York Times bestseller. He also comments regularly in the media and has appeared on The View, Howard Stern, Fox & Friends, and CNN’s Situation Room and has been quoted in the New York Times, Newsweek, China Daily, Psychology Today, Scientific American Mind, and the London Times.
xxiv About the Authors
Chapter 11Chapter
1
How Management Accounting Information Supports Decision Making
After completing this chapter, you will be able to: 1. Understand the major differences between financial
and management accounting.
2. Appreciate the historical evolution of management accounting to its present set of practices.
3. Understand how management accounting information is used for strategic and operational decision making.
4. Understand the steps of the plan–do–check–act cycle and how each step defines a unique purpose and role for management accounting information.
5. Be sensitive to the behavioral consequences that result from the introduction of new measurement and management systems.
Research in Motion In September 2010 Research in Motion (RIM), the producer of the BlackBerry smart phone, announced that PlayBook, its entry into the hot tablet market, would be introduced in the first quarter of 2011. This announcement caused a 3% decline in the value of RIM’s shares, which analysts attributed to disappointment that the PlayBook would not be available for the December holiday season as previously expected.
RIM, once a smart phone market leader, was experiencing intense com- petition. Despite the extraordinary success of its BlackBerry products in the business market segment, new competitors such as Apple’s iPhone, which had been developed originally for the consumer market segment, had eroded RIM’s market leadership position. Apple’s latest hot product, the iPad tablet, had achieved extraordinary success since its launch in March 2010 and RIM was under huge market pressure to respond with its own tablet.
2 Chapter 1 How Management Accounting Information Supports Decision Making
Management accounting is the process of supplying the managers and employees in an organization with relevant information, both financial and nonfinancial, for making decisions, allocating resources, and monitoring, evaluating, and rewarding perfor- mance. The reported expense of an operating department, such as the assembly depart- ment of an automobile plant or an electronics company, is one example of management accounting information. Other examples are the cost of producing a product, the cost of delivering a service, and the cost of performing an activity or business process, such as creating a customer invoice or serving a customer. Nonfinancial management account- ing information includes measures related to customer satisfaction and loyalty, process quality and timeliness, innovation, and employee motivation.
Management Accounting and Financial Accounting
Most students study management accounting after taking an initial course in financial accounting. These two subjects share important similarities since both are based on financial information and other quantitative information about business operations. But they differ in important ways.
WHAT IS MANAGEMENT ACCOUNTING?
The situation RIM faced in 2010 vividly illustrates the nature of both corporate strategy (choosing the markets in which it will compete) and business unit strategy (choosing how to compete in a given market segment). The strategic decisions that RIM faced required relevant and timely information, much of which is supplied by management accounting information.
Alamy Images
Chapter 1 How Management Accounting Information Supports Decision Making 3
Financial accounting has the following attributes:
1. It is retrospective, reporting and summarizing in financial terms the results of past decisions and transactions.
2. It is primarily oriented to external stakeholders, such as investors, creditors, regulators, and tax authorities.
3. It must be consistent with rules formulated by standard setters such as the Financial Accounting Standards Board (FASB) in the United States and the International Accounting Standards Board (IASB) for much of the rest of the world, and local country regulatory authorities, such as the U.S. Securities and Exchange Commission (SEC). These standard setters and regulatory authorities specify the content of the reports, the rules for how the content gets developed, and how the content will be presented.
In contrast, management accounting information has the following attributes:
1. It is both retrospective, providing feedback about past operations, and also prospective, incorporating forecasts and estimates about future events. For both retrospective reporting and prospective planning, management accounting uses both financial and nonfinancial measures.
2. It is oriented to meeting the decision-making needs of employees and managers inside the organization. Ideally, a good management accounting system can become a source of competitive advantage for a company.
3. It has no prescribed form or rules about its content, how the content is to be developed, and how the content is to be presented. All of these get determined by managers’ judgments and decisions about what best meets their needs for actionable information and is defined entirely by the needs of managers using the information. No standard setter or regulator specifically influences the design of management accounting information and systems.
Management accounting information must be relevant and helpful to managers, and customized to serve multiple purposes.
A Brief History of Management Accounting
In the early 19th century, management accounting consisted of systems to measure the cost of producing individual products, such as a piece of clothing or a weapon. As enterprises grew in scale and scope, the demands for accurate costing information increased. By the middle of the 19th century, railroad managers had implemented large, complex costing systems that allowed them to compute the costs of carrying different types of freight, such as coal and steel, along multiple routes. This information supported efficiency improvements and pricing decisions. The railroads were the first modern industry to develop and use large quantities of financial statistics to assess and monitor organizational performance. Later in the century, Andrew Carnegie, in his steel company, developed detailed systems to record the cost of materials and labor used in his various mills. Carnegie intensively studied and acted on the information from his systems to continually reduce costs in his mills, and to close mills that he felt were irretrievably inefficient. Carnegie exploited his cost advantage by lowering his prices to levels that competitors could not match if they wanted to stay in business. Thus, Carnegie’s excellent costing systems gave him a sustainable competitive advantage in the marketplace and promoted the growth and success of his company.
In the early 20th century, companies, such as DuPont and General Motors, expanded the focus of management accounting beyond cost accounting to manage- ment planning and control. These large companies replaced market mechanisms with
4 Chapter 1 How Management Accounting Information Supports Decision Making
internal resource allocation to multiple lines of business. Executives needed informa- tion, such as return-on-investment by business unit, for coordination and control among these multiple businesses. They used management accounting information to empower and inform the visible hand of management to replace what Adam Smith called the invisible hand of market forces.1
These organizations sought to improve efficiency and therefore profitability by internalizing what were previously open market transactions and eliminating the costs of transacting with external agents. The rise of these integrated companies created a demand for measuring the performance of individual organizational units to evaluate their performance through comparisons with stand-alone organizations that performed the same task. For example, an automobile company might want to compare the cost performance of a division that makes transmissions with that of an independent supplier, an application that we discuss in Chapter 3. Managers devel- oped ways to measure the profitability and the performance of their units and continue to use them today, as discussed in Chapter 11 of the book.
After these innovations, the evolution of management accounting practice slowed as senior management interest focused on developing and preparing external financial statements that complied with the new reporting and auditing requirements imposed by regulatory authorities in the 1930s. Only in the 1970s, when American and European companies were under intense pressure from Japanese manufacturers, did interest revive in developing new management accounting tools. These tools included systems that reported on quality, service, and customer and employee performance rather than simple financial summaries of organizational unit perfor- mance. Also, major advances were made in measuring the cost of products and ser- vices to reflect the increasing importance of indirect and support costs required to design and produce a product, deliver a service, and meet a customer’s demands. This text features, and in fact is organized around, many recent innovations in cost, profit, and performance measurement systems.
In summary, the history of management accounting illustrates that innovations in management accounting practice were—and continue to be—driven by the information needs of new strategies as companies became more complex, technologies changed, and new competitors appeared. When controlling and reducing costs were important, inno- vations in costing systems occurred. When organizations gained advantage from scale and diversification, innovative executives developed new management control systems to monitor and manage their complex enterprises. When competitive advantage shifted to how well a company deployed and managed its intangible assets—customer relationships, process quality, innovation, and, especially, employees, new systems for cost and performance management emerged.
1 Alfred DuPont Chandler, The Visible Hand: The Managerial Revolution in American Business (Cambridge, Mass.: Belknap Press, 1977).
Management accounting is a profession that involves partnering in management decision making, devis- ing planning and performance management systems,
and providing expertise in financial reporting and control to assist management in the formulation and implementation of an organization’s strategy.
IN PRACTICE Definition of Management Accounting (2008), Issued by the Institute of Management Accountants
Source: “Definition of Management Accounting,” one of a series of Statements on Management Accounting, published by the Institute of Management Accountants, 2008, accessed from http://www.imanet.org/PDFs/Secure/Member/SMA/SMA_ DefinManAcct_0408_2.pdf, which may be limited to IMA members.)
Chapter 1 How Management Accounting Information Supports Decision Making 5
STRATEGY
This book frames management accounting as a discipline that helps an enterprise to develop and implement its strategy. Of course, this also requires that strategic objectives be linked to reporting on and improving operations.
Strategy is about an organization making choices about what it will do and, equally important, about what it will not do. At the highest level strategic planning involves choosing a strategy that provides the best fit between the organization’s environment and its internal resources in order to achieve the organization’s objectives. Selecting a strategy forces managers to make choices about what mar- kets the organization should target and how the organization will compete in those markets. The details about how to do strategic planning and the type of informa- tion and analysis that strategists use to select a particular strategy are covered in strategy courses. But once a strategy has been selected, the organization needs management accounting information to help implement the strategy, allocate resources for the strategy, communicate the strategy, and link employees and operational processes to achieve the strategy. As the strategy gets executed, management accounting information provides feedback about where it is working and where it is not, and guides actions to improve the performance from the strat- egy. We can view the iterative strategy execution process through the lens of the plan–do–check–act cycle, originally developed for improving the quality of prod- ucts and processes (see Exhibit 1-1).
The Gap operates retail outlets, such as Banana Republic, Gap, and Old Navy, that target different market segments. Each market segment addresses different customers so the managers in each of the Gap’s operating units need different management accounting information to evaluate their performance. Getty Images, Inc.—Getty News
6 Chapter 1 How Management Accounting Information Supports Decision Making
The Plan–Do–Check–Act (PDCA) Cycle
Quality expert W. Edwards Deming helped develop and disseminate the plan–do–check–act (PDCA) cycle, and it is often called the Deming cycle. Deming proposed it as a systematic and recursive way to develop, implement, monitor, evaluate, and, when necessary, change a course of action. Although Deming’s focus was on improving product and process quality, his idea can be applied to any decision-making activity. We will illustrate how the PDCA cycle can frame the strategic and operational roles for management accounting information.
Plan The first PDCA step defines the organization’s purpose and selects the focus and scope of its strategy. Many organizations start the planning stage by reaffirming or updating their mission statement, which should be a powerful message to people inside and outside the organization about the organization’s purpose and the value it intends to create in society. The enterprise’s planners then accumulate information about the organization’s external environment (political, economic, social, technolog- ical, environmental, and legal), its industry situation, and its internal strengths and weaknesses, relative to competitors. Executives use this information to decide on a strategy (a course of action) to achieve the organization’s objectives. The planning step uses management accounting information in several ways.
Plan
• Identify objectives. • Choose a course of action to achieve the desired objectives.
Do
• Implement the chosen course of action.
Act
• Maintain the current direction if results are acceptable. Otherwise return to the plan stage to develop and implement an alternative course of action.
Check
• Monitor (measure) the results of the implemented course of action. • Evaluate the results by comparing them with results expected when the plan was developed.
Exhibit 1-1 The Plan–Do–Check–Act (PDCA) Cycle
Chapter 1 How Management Accounting Information Supports Decision Making 7
Virtually every company has a mission statement that expresses its fundamental purpose and how it intends to add value to society through its relation- ships with customers, shareholders, employees, suppliers, and communities. You can find the mission statements for all Fortune 500 companies at the
website http://www.missionstatements.com/fortune_ 500_mission_statements.html. As one example, FedEx, a Fortune 500 company, provides its mission state- ment and other aspects of its system of corporate governance at http://ir.fedex.com/governance.cfm
IN PRACTICE A Mission Statement
Chapter 2 introduces the strategy map and Balanced Scorecard, two important management accounting tools for planning, deploying, and communicating the strategy. The strategy map and Balanced Scorecard capture management’s beliefs about the drivers or causes of success in achieving an organization’s objectives. They also provide a systematic way of identifying the management accounting informa- tion needed to communicate, monitor, and evaluate the chosen strategy.
Another essential component for the strategy planning stage is to estimate the cost and profit consequences from a course of action. Managers use cost– volume–profit (CVP) analysis, a widely used financial management tool that is introduced in Chapter 3, for profit planning and financial modeling. The chapter starts with the fundamental cost concepts and cost behavior that are the foundation for CVP analysis. Chapter 3 also discusses relevant cost analysis, which is used to help managers make ongoing business decisions such as whether to make or buy a product component, drop or add a product or department, and add or subtract resource capacity. Chapter 3 provides insight into the critical role management accounting information plays in the support of many of the important planning decisions that arise regularly in organizations.
The financial consequences of a strategy are often translated into a budget, per- haps the most widely used short-term financial planning and control tool. To develop
FedEx has crafted a strong mission statement to express its fundamental purpose to shareholders, employees, customers, and suppliers. Alamy Images
8 Chapter 1 How Management Accounting Information Supports Decision Making
a budget, the organization’s financial planners develop a forecast that summarizes the revenue, cost, and profit consequences from the organization’s planned activities. Chapter 10 discusses the scope and components of budgeting—an activity you will inevitably confront no matter where your professional career takes you.
Organizations also need to plan for the development of entirely new products and services. Chapter 8 discusses the role of management accounting for designing new products, monitoring the efficiency of the product development process, and assessing the total life-cycle cost consequences from using and disposing of products. End-of-cycle salvage and reclamation costs can be enormous, and information about these future costs for any project are now considered part of any new product development process.
Do The “do” step of the PDCA cycle involves the implementation of a chosen course of action. In this setting, management accounting information is communicated to front-line and support employees to inform their daily decisions and work activi- ties. Employees use cost, profit, and nonfinancial information to operate and improve processes; market, sell, and deliver products and services to customers; and respond to customer requests. Management accounting information is often used by internal auditing to ensure that the planned strategy and decisions are being faithfully executed. This enforcement role, which is an element of the wider role of corporate governance, has become an important component of the contribu- tion that management accounting information makes in organizations.
Check The check step in the PDCA cycle includes two components: measuring and monitoring ongoing performance and taking short-term actions based on the measured performance. Management accounting’s traditional focus has been on measuring, evaluating, and reporting the costs of ongoing operations. Chapters 4 and 5 develop the nature and ele- ments of systems designed to calculate the cost and profitability of products. Chapter 6 introduces an expanded role for management accounting information by measuring the cost of serving customers and customer profitability. Understanding the profit or loss of a company’s multiple products and customers is essential feedback on how well the company’s product-line and market strategy is working. Chapter 7 contributes to the check step in the PDCA cycle with its coverage of analyzing and improving operational processes. Chapter 10 describes the traditional financial control tool of variance analysis and Chapter 11 illustrates how management accounting information is used to evaluate overall departmental and business unit performance.
One of this book’s innovations is to complement the normal financial focus of man- agement accounting information with extensive treatment of the role of nonfinancial measures of performance. Chapter 2’s introduction of the Balanced Scorecard frames the importance and role for nonfinancial information in managers’ planning and control decisions. Nonfinancial information reports on the critical drivers of long-term financial performance: customers, processes, innovation, employees, systems, and culture. The particular nonfinancial measures most useful for an organization will vary based on its industry and strategy, but generally will include measures of customer loyalty, process quality, and employee capabilities and motivation.
Act In the final PDCA step, managers take actions to lower costs, change resource alloca- tions, improve the quality, cycle time, and flexibility of processes, modify the product mix, change customer relationships, and redesign and introduce new products. They reward (and occasionally punish) employees based on performance. Rather than a
Chapter 1 How Management Accounting Information Supports Decision Making 9
separate chapter or two on the act step of the PDCA cycle, we have embedded such decision making throughout the book. This emphasizes the fact that management accounting should always be informative and actionable for helping the organization implement its plan. As these new actions get implemented, the management team will eventually return to the planning step to assess whether its previous plan is still valid and worth continuing, or whether it has become time to adapt the plan or perhaps introduce a new strategic plan. This launches the enterprise on another trip around its PDCA cycle.
BEHAVIORAL IMPLICATIONS OF MANAGEMENT ACCOUNTING INFORMATION
Thus far we have emphasized the analytic role played by management accounting information for planning, resource allocation, decision making, acting, monitoring, and improving. Although the role of management accounting information is essen- tial for supporting decisions and solving problems, information is never neutral. The mere act of measuring and informing affects the individuals involved. A famous study conducted in the 1920s at the Hawthorne Plant of the Western Electric Company concluded that individuals and groups alter their behavior when they know they are being studied and their performance is being measured. People react when they are being measured. They focus on the variables and behavior being meas- ured and pay less attention to those not being measured. Some people have over- stated this effect by declaring, “What gets measured gets done.” More accurately, the expression should be “If you don’t measure it, you can’t manage and improve it,” which can be taken as one of the fundamental rationales for studying and imple- menting management accounting systems.
It is normal, however, as managers introduce or redesign cost and performance measurement systems, for people familiar and comfortable with the previous systems to resist change. These people have acquired expertise in the use (and occasional misuse) of the old system and are concerned about whether their expe- rience and expertise will be transferable to the new system. People also may feel committed to the decisions and actions taken on the basis of information an old system has produced. These actions may no longer seem valid based on the information produced by a newly installed management accounting system. Thus, a new management system can lead to embarrassment and threat, a trigger for reactions against change. The design and introduction of new measurements and systems must be accompanied by an analysis of the behavioral and organizational reactions to the measurements, a topic we discuss extensively in Chapter 9. Even more important, when the measurements are used not only for information, planning, and decision making but also for control, evaluation, and reward, employees and managers place great emphasis on the measurements themselves. Managers and employees may take unexpected and undesirable actions to influence their score on the performance measure. For example, managers seeking to improve current bonuses based on reported profits may skip discretionary expenditures such as preventive maintenance, research and development, and advertising that may improve performance in future periods.
Thus we must be ever vigilant to not only see the analytic, or left-brain, proper- ties of management accounting information but also appreciate the emotional, or right-brain, reactions by individuals to the information used to monitor and evaluate their performance.
10 Chapter 1 How Management Accounting Information Supports Decision Making
SUMMARY
This chapter introduced the role and nature of man- agement accounting within the PDCA planning and control cycle. Management accounting must inform the actions and decisions made by managers and employees. This is why the generation and use of management accounting information must be driven by the organization’s strategic choices. Management accounting information also monitors and evaluates the results from implemented decisions. It leads to
KEY TERMS
financial accounting, 3 management accounting, 2
nonfinancial information, 8 plan–do–check–act cycle, 5
strategy, 5
ASSIGNMENT MATERIALS
Questions 1-1 What is management accounting? (LO 1) 1-2 Why do a company’s operators/workers,
managers, and executives have different informational needs than shareholders and external suppliers of capital? (LO 1, 3)
1-3 Why may financial information alone be insufficient for the ongoing informational needs of operators/workers, managers, and executives? (LO 1, 3)
1-4 Why might senior executives need measures besides financial ones to assess how well their business performed in the most recent period? (LO 1, 3)
1-5 Provide examples of how management ac- counting systems have changed in response to information needs as companies have become more complex, technologies have changed, or new competitors have appeared. (LO 1, 2)
1-6 Given a selected strategy, how do organiza- tions use management accounting informa- tion to implement the strategy? (LO 3)
1-7 Briefly explain each of the four steps of the plan–do–check–act cycle. (LO 4)
1-8 How can management accounting informa- tion produce behavioral and organizational reactions? (LO 5)
Exercises
LO 1, 3, 4, 5 1-9 The role of management accounting Consider the descriptions of management accounting provided in the chapter. Discuss why the associated responsibilities are viewed as “accounting” and how people handling those responsibilities interface with other functional areas in fulfilling the stated responsibilities. What skills and knowledge does one need to fulfill the responsibilities?
LO 1, 3 1-10 The plan–do–check–act cycle For each of the four steps of the plan–do–check–act cycle, describe examples of possible uses of management accounting information.
LO 1, 3 1-11 Different information needs Consider the operation of a fast-food company with hundreds of retail outlets scattered about the country. Consider the descriptions of management accounting provided in the chapter to identify management accounting information needs for the following: a. The manager of a local fast-food outlet that prepares food and serves it
to customers who walk in or pick it up at a drive-through window b. The regional manager who supervises the operations of all the retail
outlets in a three-state region
new actions to improve the implementation of the intended strategy through operational enhance- ments, decisions about products, processes, and customers, new product introductions, and, perhaps most important, better motivated and empowered managers and employees. But all new measurement and management systems must be introduced with sensitivity to the reactions of employees and man- agers to the act of measurement.
Chapter 1 How Management Accounting Information Supports Decision Making 11
c. Senior management located at the company’s corporate headquarters. Consider specifically the information needs of the president and the vice presidents of operations and marketing.
Be sure to address the content, frequency, and level of aggregation of information needed by these different managers.
LO 1, 3 1-12 Different information needs Consider the descriptions of management accounting provided in the chapter to identify management accounting information needs for the following: a. The managers of (1) a patient unit, where patients stay while being treated
for illness or while recuperating from an operation, and (2) the radiology department, where patients obtain X-rays and receive radiological treatment
b. The manager of a nursing service who hires and assigns nurses to all patient units and to specialty services, such as the operating room, emergency room, recovery room, and radiology room
c. The chief executive officer of the hospital. Be sure to address the content, frequency, and level of aggregation of information needed by these different managers.
LO 3 1-13 The elements of quality For each of the following products, suggest three measures of quality: a. Television set b. University course c. Meal in an exclusive restaurant d. Carryout meal from a restaurant e. Container of milk f. Visit to the doctor g. Trip on an airplane h. Pair of jeans i. Novel j. University textbook.
Problems
LO 1, 3 1-14 Differences between financial and managerial accounting Many German companies have their management accounting department as part of the manufacturing operations group rather than as part of the corporate finance department. These German companies operate two separate accounting departments. One performs financial accounting functions for shareholders and tax authorities, and the other maintains and operates the costing system for manufacturing operations.
Required
What are the advantages and disadvantages of having separate departments for financial account- ing and management accounting?
LO 1 1-15 Differences between financial and managerial accounting The controller of a German machine tool company believed that historical cost depreciation was inadequate for assigning the cost of using expensive machinery to individual parts and products. Each year, he estimated the replacement cost of each machine and included depreciation based on the machine’s replacement cost in the machine-hour rate used to assign machine expenses to the parts produced on that machine. Additionally, the controller included an interest charge, based on 50% of the machine’s replacement value, into the machine-hour rate. The interest rate was an average of the three- to five-year interest rate on government and high-grade corporate securities.
12 Chapter 1 How Management Accounting Information Supports Decision Making
As a consequence of these two decisions (charging replacement cost rather than historical cost and imputing a capital charge for the use of capital equipment), the product cost figures used internally by company managers were inconsistent with the numbers that were needed for inventory valuation for financial and tax reporting. The accounting staff had to perform a tedious reconciliation process at the end of each year to back out the interest and replacement value costs from the cost of goods sold and inventory values before they could prepare the financial statements.
Required
(a) Why would the controller introduce additional complications into the company’s costing sys- tem by assigning replacement value depreciation costs and imputed interest costs to the com- pany’s parts and products?
(b) Why should management accountants create extra work for the organization by deliberately adopting policies for internal costing that violate the generally accepted accounting princi- ples that must be used for external reporting?
LO 1, 3, 4 1-16 Role of financial information for continuous improvement Consider an organization that has empowered its employees, asking them to improve the quality, productivity, and responsiveness of their processes that involve repetitive work. This work could arise in a manufacturing setting, such as assembling cars or producing chemicals, or in a service setting, such as processing invoices or responding to customer orders and requests. Clearly the workers would benefit from feedback on the quality (defects, yields) and process times of the work they were doing to suggest where they could make improvements. Identify the role, if any, for sharing financial information with these employees to help them in their efforts to improve quality, productivity, and process times. Be specific about the types of financial information that would be helpful and the specific decisions or actions that could be made better by supplementing physical and operational information with financial information.
Cases
LO 1, 3, 4 1-17 Different information needs Julie Martinez, manager of the new retail outlet of Super Printing, is pondering the management challenges in her new position. Super Printing is a long-established printing company in a major metropolitan area. The new Super outlet, located at the edge of the parking lot for Western Business School, represents Super’s attempt to break into the rapidly growing business for retail digital imaging.
The Super retail store provides a range of copying and digital imaging services for the business school’s students, faculty, and administrators, plus other retail customers. Super’s primary prod- ucts are black-and-white copies of documents. Variation exists even in this basic product, however, as consumers can choose from a variety of paper colors, sizes, and quality. Super recently purchased a machine that prints color copies from digital input. Color copies also can be produced in a vari- ety of sizes, paper quality, and paper types, including transparencies for overhead projection and photographic-quality reproductions. Other printing products include business cards, laminated luggage tags, and name badges for conferences, executive programs, and students.
In addition to physical printing, the Super center provides fax services by which individuals can both receive and transmit documents. When incoming faxes are received, a store employee calls the recipient, who stops at the outlet to pick up the document. The center also has several personal computers, both Windows-based and Macintosh, that students rent by the hour for basic computer processing, Internet access, e-mail, and preparing presentations and résumés. Each computer is
Chapter 1 How Management Accounting Information Supports Decision Making 13
connected to Super’s black-and-white and color printers, enabling students to produce paper copies of their presentations and résumés.
Super has other machines that assemble printed pages into bound documents. Two different binding types are available. The store also sells a limited selection of office supplies, including paper, envelopes, paper clips, glue, binders, tabs, pens, pencils, and marking pens.
Currently, about five employees (including Julie) work at the retail outlet during prime hours (8:00 A.M. to 5:00 P.M.) with two to four people working the evening shift (5:00 P.M. to midnight) when walk-in business is much slower. The number of people working during the evening hours is determined by the anticipated backlog of reproduction work that will be performed during these hours.
Prices for the various products and services have been set based on those of competitors, such as FedEx Kinko’s and Staples. Julie receives a daily report on total sales, broken down by cash sales, credit card sales, and credit sales to various programs at the business school; however, she currently does not have a report on expenses such as labor, materials, and equipment for each line of business (black-and-white and color printing, computer services, document preparation, fax services, and sales of office supplies). Thus, Julie is unsure whether each line of business is profitable. Julie is also unsure how efficiently the business is run.
Further, the different business lines require different quantities and types of capital: equipment such as copying and printing machines, computers, and facsimile machines; physical capital such as office space; and the different inventories of paper types, colors, grades and sizes, and office supplies.
If the pilot store that Julie is operating is successful, then the parent company will likely try to open many similar outlets near schools and universities throughout the metropolitan area. For this purpose, the parent company wants to know which business lines are the most profitable, includ- ing the cost of capital and space required, so that these lines can be featured at each retail outlet. If some business lines are not profitable, then Super probably will not offer those services at newly opened stores unless they are necessary to build retail traffic.
Required
Identify the management accounting information needs for the following:
(a) An employee desiring to help serve customers more efficiently and effectively (b) Julie Martinez, the manager of the pilot retail outlet (c) The president of Super Printing
Be sure to address the content, frequency, and level of aggregation of information needed by these different individuals.
LO 1, 3 1-18 Information for employee empowerment A U.S. automobile components plant had recently been reorganized so that quality and employee teamwork were to be the guiding princi- ples for all managers and workers. One production worker described the difference:
In the old production environment, we were not paid to think. The foreman told us what to do, and we did it even if we knew he was wrong. Now, the team decides what to do. Our voices are heard. All middle management has been cut out, including foremen and superintendents. Management relies on us, the team members, to make decisions. Salary people help us make these decisions; the production and manufacturing engineers work for us. They are always saying, “We work for you. What do you need?” And they listen to us.
The plant controller commented as follows:
In traditional factories, the financial system viewed people as variable costs. If you had a production problem, you sent people home to reduce your variable costs. Here, we do not send people home. Our production people are viewed as problem solvers, not as variable costs.
14 Chapter 1 How Management Accounting Information Supports Decision Making
Required
(a) What information needs did the production workers have in the old environment? (b) What information do you recommend be supplied to the production workers in the new
environment that emphasizes quality, defect reduction, problem solving, and teamwork?
LO 1, 3, 4 1-19 Financial information for continuous improvement The manager of a large semiconductor production department expressed his disdain for the cost information he was presently given:
Cost variances are useless to me.2 I don’t want to ever have to look at a cost variance, monthly or weekly. Daily, I look at sales dollars, bookings, and on-time delivery (OTD)—the percent of orders on time. Weekly, I look at a variety of quality reports including the outgoing quality control report on items passing the final test before shipment to the customer, in-process quality, and yields. Yield is a good surrogate for cost and quality. Monthly, I do look at the financial reports. I look closely at my fixed expenses and compare these to the budgets, especially on discretionary items like travel and maintenance. I also watch headcount.
But the financial systems still don’t tell me where I am wasting money. I expect that if I make operating improvements, costs should go down, but I don’t worry about the linkage too much. The organizational dynamics make it difficult to link cause and effect precisely.
Required
Comment on this production manager’s assessment of his limited use for financial and cost summaries of performance. For what purposes, if any, are cost and financial information helpful to operating people? How should the management accountant determine the appropriate blend between financial and nonfinancial information for operating people?
LO 1, 2, 3, 4, 5 1-20 Comprehensive performance measurement in public and nonprofit organizations Organizations in the public and nonprofit sector, such as government agencies and charitable social service entities, have financial systems that budget expenses and monitor and control actual spending. Explain why these organizations should consider developing a compre- hensive set of performance measurements (including nonfinancial measures) to monitor and report on their performance. Provide examples of financial and nonfinancial measures that should be included in such a comprehensive set of measurements.
2 We will study cost variances in later chapters. For the purposes of this case, it is sufficient to recognize that a cost variance represents the difference between the cost actually assigned to a production department and the cost that was expected or budgeted for that department.
Chapter 22Chapter
15
The Balanced Scorecard and Strategy Map
After completing this chapter, you will be able to: 1. Explain why both financial and nonfinancial measures are
required to evaluate and manage a company’s strategy.
2. Understand how a Balanced Scorecard can represent cause-and- effect hypotheses of a company’s strategy across financial, customer, process, and learning and growth perspectives.
3. Explain why a clear strategy is vital for a company.
4. Appreciate the role for a strategy map to translate a strategy into financial, customer, process, and learning and growth objectives.
5. Select measures for the strategic objectives in the four perspectives of a company’s Balanced Scorecard and strategy map.
6. Extend the Balanced Scorecard framework to nonprofit and public-sector organizations.
7. Recognize problems that companies may experience when implementing the Balanced Scorecard and suggest ways to overcome them.
Pioneer Petroleum Pioneer Petroleum was the U.S. marketing and refining division of a large global petroleum company. It operated five refineries and had more than 7,000 branded gasoline stations around the United States, which sold about 25 million gallons of gasoline per day. Historically, Pioneer mar- keted a full range of products and services. It did, however, match the prices of discount stations operating near a Pioneer station so that it would not lose market share. Pioneer’s CEO Brian Roberts had recently learned that Pioneer was the least profitable marketing and refining com- pany in the United States. He decided to turn around the company by im- plementing a strategy based on a marketing study that had revealed five
16 Chapter 2 The Balanced Scorecard and Strategy Map
distinct consumer segments among the gasoline-buying public (see Exhibit 2-1).
Pioneer’s executives saw that price-sensitive consumers constituted only 20% of all U.S. gasoline purchasers. Another segment, Homebodies, had little loyalty to any brand or station. But three segments wanted more than a commodity purchase. After considerable discussion, Pioneer de- cided on a strategy to offer a superior buying experience to the three top- tier segments: Road Warriors, True Blues, and Generation F3. Also, it would no longer seek to attract price-sensitive consumers by lowering prices to compete with discount gasoline stations.
Road Warriors (16%) Generally higher-income middle-aged men who drive 25,000 to 50,000 miles a year, buy premium gasoline with a credit card, purchase sandwiches and drinks from the convenience store, will sometimes wash their cars at the carwash.
True Blues (16%) Usually men and women with moderate to high incomes who are loyal to a brand and sometimes to a particular station; frequently buy premium gasoline and pay in cash.
Generation F3 (27%) (F3—fuel, food, and fast) Upwardly mobile men and women— half under 25 years of age—who are constantly on the go; drive a lot and snack heavily from the convenience store.
Homebodies (21%) Usually homemakers who shuttle their children around during the day and use whatever gasoline station is based in town or along their route of travel.
Price Shoppers (20%) Generally aren’t loyal to either a brand or a particular station, and rarely buy the premium line; frequently on tight budgets; the focus of attention of marketing efforts of gasoline companies for years.
Exhibit 2-1 Pioneer’s Five Gasoline-Buyer Segments
Time-sensitive customers prefer self-service gasoline stations. Alamy Images
Chapter 2 The Balanced Scorecard and Strategy Map 17
Roberts faced the challenge of realigning Pioneer to the new customer-focused strategy. The realignment could not be done just at the top. It had to take place at the grass roots. For its strategy to suc- ceed, Pioneer would have to make everyone aware of the strategy and accountable for its success. A survey had revealed that employees felt internal reporting requirements, administrative processes, and top-down policies were stifling creativity and innovation. Relationships with cus- tomers were adversarial, and people were working narrowly to enhance the reported results of their individual, functional units. Roberts expressed the problem as follows:
I am accountable for a large organization, spread over a large geographic area. At the end of the day, success comes from individ- uals at the frontline of operations. You’ve got an operator at a refin- ery, sitting in front of a computer screen controlling a process unit at 3 A.M. on Sunday morning when management is not around. My fate is determined by that person’s attitude, whether that person is paying attention. Thirty seconds of inattention at the wrong time can shut down that refinery, stopping production. If you’re going to drive the business you have to drive it down to that individual who is at the frontline, making the decision.
Pioneer had operated for decades with a centralized structure, organized by functions, such as purchasing, supply chain, manufactur- ing (refining), distribution, and marketing. Only two people, Roberts and his executive vice president, among Pioneer’s 7,000 employees had accountability for a profit and loss statement. Managers of a refinery, pipeline, or distribution facility were responsible for achieving cost targets, while managers of sales districts had to meet revenue targets. To create a more agile organization, Roberts decentralized Pioneer into 17 strategic business units (including regional gasoline sales districts and specialized product units, such as for jet fuels and lubricants) that would be closer to customers. Each business unit would have its own profit and loss accountability. Roberts now faced the problem of how to upgrade the skills of the newly appointed business unit heads who had all grown up within a structured, top-down functional organization:
We were taking people who had spent their whole professional lives as managers in a big functional organization, and we were ask- ing them to become the leaders of entrepreneurial profit-making busi- nesses, some with up to $1 billion in assets. How were we going to get them out of their historic area of functional expertise to think strategically, as general managers of profit-oriented businesses?
Roberts believed that a major impediment to change was the com- pany’s historic focus on achieving short-term financial performance:
The financial metrics gave us a controller’s mentality, reviewing the past, not guiding the future. I wanted metrics that could communicate what we wanted to be so that everyone in the organization could un- derstand and implement our strategy. We needed metrics that could link our planning process to actions, to encourage people to do the things that the organization was now committed to accomplishing.
Roberts struggled with how he could change the performance mea- surement framework at Pioneer into one that would be better aligned with its new strategy and organizational structure.
18 Chapter 2 The Balanced Scorecard and Strategy Map
Companies use performance measurement systems to perform multiple roles:
• Communicate the company’s strategic objectives. • Motivate employees to help the company achieve its strategic objectives. • Evaluate the performance of managers, employees, and operating units. • Help managers allocate resources to the most productive and profitable
opportunities. • Provide feedback on whether the company is making progress in improving
processes and meeting the expectations of customers and shareholders.
The challenge is to find the right mix of financial and nonfinancial measures to perform these multiple tasks. Throughout the 19th and 20th centuries, companies like Pioneer Petroleum used only financial metrics to measure their performance. Finan- cial control systems, which we will describe later in the book (Chapter 11), relied on metrics such as operating income and return on investment (ROI) to motivate and evaluate performance. These financial metrics were adequate when the primary as- sets that generated a company’s income and value were physical assets, such as prop- erty, plant, equipment, and inventory, and financial assets, including cash, marketable securities, and investments. By the end of the 20th century, however, firms could no longer create value only through their physical and financial assets. They needed to create value through their intangible assets—customer loyalty and rela- tionships, efficient and high-quality operating processes, new products and services, employee skills and motivation, databases and information systems, and, most in- tangible of all, organizational culture.
With these changes in the factors driving competitive success, financial measures become insufficient for measuring and managing company performance. Consider a company that spends money in the current period to enhance its intangible assets through the following actions:
• Upgrading the skills and motivation of employees. • Expanding the data captured and shared about processes, customers,
and suppliers. • Accelerating new products through the research and development pipeline. • Improving the quality and speed of production, distribution, and service
processes. • Enhancing trusted relationships with profitable customers and low-cost suppliers.
All of these actions help to create value for the company. But the financial system treats the spending on such actions as expenses of the current period. Thus the com- pany’s reported profitability and financial performance decrease during a period when it has actually increased the value of its intangible assets. Or consider the con- verse situation in which a company cuts back drastically on its spending to train em- ployees, enhance information systems, improve operating processes, develop new products, and build customer loyalty. As such spending declines, reported income and ROI increases, at just the time when the company has likely become less valuable because of the depreciation of its competitive capabilities. Clearly, the financial re- ports fail to reflect the changes in value that occur when a company either enhances or destroys the value of its intangible assets.
A fundamental principle underlying management accounting is that measurement must support the company’s strategy and operations. Some claim “if you don’t mea- sure it, you can’t manage and improve it.” If companies are to get better at managing and improving the value created from their intangible assets, they need a measurement system designed for these types of assets. Several frameworks have been proposed for
Chapter 2 The Balanced Scorecard and Strategy Map 19
1 References on organizational performance measurement include Richard L. Lynch and Kelvin F. Cross, Measure Up! How to Measure Corporate Performance (Cambridge, Mass.: Blackwell Business, 1995); Robert S. Kaplan and David P. Norton, The Balanced Scorecard: Translating Strategy into Action (Cambridge, Mass.: Harvard Business School Press, 1996); and Andy Neely, Business Performance Measurement: Theory and Practice (Cambridge, UK: Cambridge University Press, 2002).
2 NIST: Malcolm Baldrige Excellence Program home page, retrieved November 20, 2010 from http:// www.nist.gov/baldrige/
3 The EFQM Excellence Model home page, retrieved November 20, 2010 from http://www.efqm.org
% of organizations using this framework
Framework
• The Balanced Scorecard
• None (customized)
• Total quality management
• Shareholder value (EVATM)
• Other —Value dynamics / Accenture (1)
—PWC (1)
—Etc.
62%
0 10
15%
13%
3%
7%
• Baldrige (7) • Six sigma (5) • EFQM (1)
20 30 40 50 60 70
Exhibit 2-2 Performance Measurement Frameworks
expanded performance measurement,1 including those introduced by national and in- ternational quality management programs such as the Malcolm Baldrige National Quality Program for performance excellence2 and the EFQM Excellence model.3
Among all of the various proposals for improving companies’ performance measure- ment systems, the management accounting system based on the Balanced Scorecard (BSC) has become the most widely adopted around the world (see data presented in Exhibit 2-2). The Balanced Scorecard provides a framework that continues to measure financial outcomes but supplements these with nonfinancial measures derived from the company’s strategy. And, the BSC is not restricted to private-sector companies; many nonprofits and public sector entities have also adopted this framework to manage their creation of social value (as we will describe later in this chapter).
THE BALANCED SCORECARD
The Balanced Scorecard (see Exhibit 2-3) measures organizational performance across four different but linked perspectives that are derived from the organization’s mis- sion, vision, and strategy. The four perspectives address the following fundamental questions:
• Financial—How is success measured by our shareholders? • Customer—How do we create value for our customers?
Source: R. Lawson, D. Desroches, and T. Hatch, Scorecard Best Practices: Design, Implementation, and Evaluation (New York: Wiley, 2008).
20 Chapter 2 The Balanced Scorecard and Strategy Map
Learning and growth perspective
“How do we align and enhance our intangible assets to improve the critical processes?”
“To meet our financial and customer objectives, at which processes must we excel?”
Process perspective
“To achieve our vision and financial objectives, how must we deliver value to our customers?”
Customer perspective
Mission, vision, and strategy
Financial perspective
“What financial performance should we deliver for our shareholders?”
Exhibit 2-3 The Four Perspectives of the Balanced Scorecard
• Process—At which processes must we excel to meet our customer and share- holder expectations?
• Learning and growth—What employee capabilities, information systems, and organizational capabilities do we need to continually improve our processes and customer relationships?4
With the Balanced Scorecard measurement system, companies continue to track financial results but they also monitor, with nonfinancial measures, whether they are building or destroying their capabilities—with customers, processes, employees, and systems—for future growth and profitability. Financial measures tend to be lagging indicators of the strategy; they report the financial impact of decisions made in the current and prior periods. The nonfinancial measures in the three other BSC perspec- tives are leading indicators. Improvements in these indicators should lead to better financial performance in the future, while decreases in the nonfinancial indicators (such as customer satisfaction and loyalty, process quality, and employee motivation) generally predict decreased future financial performance.
As a simple example of the cause-and-effect linkages across Balanced Scorecard measures, consider the partial scorecard produced by a small manufacturing company. This company’s strategy is to win business by producing low-cost, high- quality products, and delivering them on time to its customers (see Exhibit 2-4). The company’s financial objective, shown in the financial perspective, is to increase its return on equity (ROE; net income divided by book value). The company expects to generate increased revenues for improving its ROE financial measure by retaining and expanding sales to existing customers. Therefore, it has a customer loyalty objec- tive in its customer perspective, which it measures by (1) percentage of repeat
4 Most organizations implementing the BSC have found four to be the right number for describing their strategy. Some organizations have added a fifth perspective to highlight particularly important aspects of their strategy, such as suppliers, employees, community involvement, or, for nonprofit organiza- tions, social impact. Using fewer than four typically sacrifices metrics that are critical for the strategy.
Chapter 2 The Balanced Scorecard and Strategy Map 21
Strategy map of objectives Objectives
• Increase shareholder value
• Return on equity
• % employees trained and certified in process improvement capabilities
• Percentage of repeat customers • Growth in customers’ sales • % deliveries made on time • Prices compared to competitors
• % improvement in cycle times • Product defect rates • Process yield improvement
Financial Increase shareholder
value
• Retain customers • Deliver products on time • Offer competitive prices
• Reduce process cycle times • Improve process quality
• Develop employees’ process improvement skills
Customer Retain customers
Deliver products on time
Offer competitive
prices
Reduce process
cycle time
Process
Learning and growth Develop
employees’ process
improvement skills
Measures
Improve process quality
Exhibit 2-4 A Simple Balanced Scorecard of Linked Objectives and Measures
customers and (2) the growth in year-to-year sales with existing customers. The com- pany’s strategy is based on its belief that customers value on-time delivery of orders and low prices. Thus, improved on-time delivery performance and competitive prices are expected to lead to increased customer loyalty, which in turn will lead to higher financial performance. So the predictive metrics of customer loyalty and on-time de- livery appear in the scorecard’s customer perspective.
The financial and customer measures represent the “what” of strategy, that is, what the company wants to accomplish with its two most important external con- stituents: shareholders and customers. The process perspective describes “how” the strategy will be executed; it identifies the processes that are most important to meet the expectations of shareholders and customers. For example, short cycle times and high-quality production processes are necessary to achieve exceptional on-time de- livery and low prices. Therefore, measures of quality, such as defect rates and yields, and of process cycle time—the time required to convert raw materials into finished products—are used as important process metrics. These are leading indicators for customer loyalty. Measures for the fourth perspective, learning and growth, arise from asking another “how” question: How will employees obtain the skills and knowledge to be able to improve the quality and cycle times of the company’s pro- duction processes? The company recognizes that its production workers must be well trained in process improvement techniques. Therefore, the learning and growth per- spective uses a measure of employees’ capabilities to predict improvements in process quality and cycle times.
This simple example shows how an entire chain of cause-and-effect relationships among performance measures in the four Balanced Scorecard perspectives tells the story of the business unit’s strategy. The scorecard’s objectives and measures identify and make explicit the hypotheses about the cause-and-effect relationships between outcome measures (e.g., ROE and customer loyalty) in the financial and customer perspectives and the performance drivers (i.e., lead indicators) of those outcomes— such as zero defect processes, short cycle-time processes, and skilled, motivated employees—that are measured in the process and learning and growth perspectives.
22 Chapter 2 The Balanced Scorecard and Strategy Map
• Increase profits and ROI • Grow revenues • Operate with fewer planes
• Reduce ground turnaround times
• Attract and retain more customers • Arrive on time • Offer lowest prices
• Improve training and motivation of ground crew
• # repeat customers
• FAA on-time arrival rating
• Prices compared to competitors
• Average time plane spends at gate • % on-time departures
• % ground crew who are stockholders • # hours of training per ground crew member • % ground crew aware of company’s strategy
Strategy map (partial) Objectives
• Operating income • ROI • % increase in revenues per mile flown • Revenues-to-asset ratio
Financial
Customer
Process
Learning and growth
Measures
Grow revenues
Customer
Process
Learning and growth
Measures
Grow revenues
"Looking for a Similar Assignment? Get Expert Help at an Amazing Discount!"
