Managerial Accounting – BUS 5110

-Schedule & Topics:

Preparation Resources
An Introduction to Business, K. Collins, (2012) Available
for reading online
at https://2012books.lardbucket.org/pdfs/an-introduction-
to-business-v1.0.pdf
Managerial and Cost Accounting, L. M. Walther & C. J.
Skousen (2009).� Available for reading online at
http://www.bookboon.com/

Week 1: Unit 1 –Review of Basic Accounting

Week 2: Unit 2– Cost Flows: Job Order, Process Costing, and

Activity-Based Costing (ABC)

Week 3: Unit 3 –Cost Analysis Models: Unit Costs, Break-even

Analysis, and Cost-Volume-Profit

Week 4: Unit 4– Differential Analysis

Week 5: Unit 5– Statement of Cash Flows (SOCF)

Week 6: Unit 6– Budgets: Operations, Flexible, and Cash Flow

Budgets

Week 7: Unit 7– Capital Budgets and Interpreting Financial

Statements

Week 8: Unit 8– Financial Ratios, Trend Analysis & Course

Wrap-up
Collins: The Role of Accounting in Business

Financially Speaking
Accounting is often called “the language of business” because it provides much of the information that
owners, managers, and investors need to evaluate a company’s financial performance.
In this chapter, we’ll start by explaining what accounting is and by identifying the various uses of
accounting information. Then, we’ll learn how to prepare a set of financial statements, how to interpret
them, and how to analyze a company’s performance using a technique called ratio analysis. Finally,
we’ll discuss career opportunities and the future of the accounting profession.

12.1 The Role of Accounting

LEARNING OBJECTIVE

1. Define accounting and identify the different uses of accounting information.

KEY TAKEAWAYS

• Accounting is a system for measuring and summarizing business activities, interpreting financial
information, and communicating the results to management and other stakeholders to help them make
better business decisions.

• Accounting can be divided into two major fields:

1. Management accounting provides information and analyses to decision makers inside the
organization (such as owners and managers) to help them operate the business.

2. Financial accounting provides information to people outside the organization (such as

investors, creditors, government agencies, suppliers, employees, and labor unions) as well as to
internal managers to assist them in assessing the financial performance of the business.

EXERCISE

Who uses accounting information? What do they use it for, and why do they find it helpful? What
problems would arise if they weren’t provided with accounting information?
12.2 Understanding Financial Statements
LEARNING OBJECTIVE

1. Understand the functions of the three basic financial statements: income statement, balance sheet,
and statement of cash flows.

KEY TAKEAWAYS

 The three financial statements prepared by accountants are the income statement, the balance
sheet, and the statement of cash flows.

 In preparing financial statements, accountants adhere to a uniform set of rules called generally
accepted accounting principles (GAAP): principles for financial reporting that are established
by an independent agency called the Financial Accounting Standards Board (FASB).

 The income statement shows what the firm’s revenues and expenses are and whether it made a
profit.

 The balance sheet indicates what assets and liabilities the business has and the amount that its
owners have invested in it (owner’s equity).

 The statement of cash flows shows how much cash the business has

coming in and going out.

 It furnishes information about three categories of activities that cause

cash either to come in or to go out: operating activities, investing

activities, and financing activities.

 Breakeven analysis is a technique used to determine the level of sales

needed to break even—to operate at a sales level at which you have

neither profit nor loss.

 To break even, total sales revenue must exactly equal all your expenses

(both variable and fixed costs).

 To calculate the breakeven point in units to be sold, you divide fixed

 costs by contribution margin per unit (selling price per unit minus

variable cost per unit).

 This technique can also be used to determine the level of sales needed to

obtain a specified profit.

EXERCISES

1. (AACSB) Analysis

Describe the information provided by each of these financial statements: income statement,
balance sheet, statement of cash flows. Identify ten business questions that can be answered by
using financial accounting information. For each question, indicate which financial statement
(or statements) would be most helpful in answering the question, and why.

2. (AACSB) Analysis

You’re the president of a student organization, and to raise funds for a local women’s shelter
you want to sell single long-stem red roses to students on Valentine’s Day. Each prewrapped
rose will cost $3. An ad for the college newspaper will cost $100, and supplies for posters will
cost $60. If you sell the roses for $5, how many roses must you sell to break even? Because
breaking even won’t leave you any money to donate to the shelter, you also want to know how
many roses you’d have to sell to raise $500. Does this seem like a realistic goal? If the number of
roses you need to sell in order to raise $500 is unrealistic, what could you do to reach this goal?

12.3 Accrual Accounting

LEARNING OBJECTIVE

1. Understand the difference between cash-basis and accrual accounting.

KEY TAKEAWAYS

 Companies using cash-basis accounting recognize revenue as earned only when cash is received
and recognize expenses as incurred only when cash is paid out.

 The cash-basis method of accounting ignores accounts receivables, accounts payables,

inventories, and depreciation.

 In contrast, companies using accrual accounting recognize revenues when they’re earned
(regardless of when the cash is received) and expenses when they’re incurred (regardless of
when the cash is paid out).

 Most companies use accrual accounting.

EXERCISES

1. (AACSB) Analysis

To earn money to pay some college expenses, you ran a lawn- mowing business during the
summer. Before heading to college at the end of August, you wanted to find out how much
money you earned for the summer. Fortunately, you kept good accounting records. During the
summer, you charged customers a total of $5,000 for cutting lawns (which includes $500 still
owed to you by one of your biggest customers). You paid out $1,000 for gasoline, lawn mower
repairs, and other expenses, including $100 for a lawn mower tune-up that you haven’t paid for
yet. You decided to prepare an income statement to see how you did. Because you couldn’t
decide whether you should prepare a cash- basis statement or an accrual statement, you
prepared both. What was your income under each approach? Which method (cash-basis or
accrual) more accurately reflects the income that you earned during the summer? Why?

2. (AACSB) Analysis

Identify the categories used on a classified balance sheet to report assets and liabilities. How do
you determine what goes into each category? Why would a banker considering a loan to your
company want to know whether an asset or liability is current or long-term?

3. (AACSB) Analysis

You review a company’s statement of cash flows and find that cash inflows from operations are
$150,000, net outflows from investing are $80,000, and net inflows from financing are $60,000.
Did the company’s cash balance increase or decrease for the year? By what amount? What types
of activities would you find under the category investing activities? Under financing activities?
If you had access to the company’s income statement and balance sheet, why would you be
interested in reviewing its statement of cash flows? What additional information can you
gather from the statement of cash flows?

12.4 Financial Statement Analysis

LEARNING OBJECTIVE

1. Evaluate a company’s performance using financial statements and ratio analysis.

KEY TAKEAWAYS

 Two common techniques for evaluating a company’s financial performance are vertical
percentage analysis and ratio analysis.

 Vertical percentage analysis reveals the relationship of each item on the income statement to a
specified base—generally sales—by expressing each item as a percentage of that base.

 The percentages help you to analyze changes in the income statement items over time.

 Ratios show the relationship of one number to another number—for example, gross profit to
sales or net profit to total assets.
  Ratio analysis is used to assess a company’s performance and financial condition over time and
to compare one company to similar companies or to an overall industry.

 Ratios can be divided into four categories: profit margin ratios, management efficiency ratios,
management effectiveness ratios, and debt-to-equity ratios.

• Profit margin ratios show how much of each sales dollar is left after certain costs are covered.

◦ Two common profitability ratios are the gross profit margin (which shows how much of each sales
dollar remains after paying for the goods sold) and net profit margin (which shows how much of each
sales dollar remains after all costs are covered).

• Management efficiency ratios tell you how efficiently your assets are being managed.

◦ One of the ratios in this category—inventory turnover—measures a firm’s efficiency in selling its
inventory by looking at the relationship between sales and inventory.

• Management effectiveness ratios tell you how effective management is at running the business and
measure overall company performance by comparing net profit to some measure of the amount of
capital used in the business.

 The return on assets ratio, for instance, compares net profit to total assets to determine whether
the company generated a reasonable profit on the assets invested in it.
 Financial condition ratios are used to assess a firm’s financial strength.
 The current ratio (which compares current assets to current liabilities) provides a measure of a
company’s ability to meet current liabilities.
 The debt-to-equity ratio examines the riskiness of a company’s capital structure by looking at
the amount of debt that it has relative to total equity.
 Finally, the interest coverage ratio (which measures the number of times a firm’s operating
income can cover its interest expense) assesses a company’s ability to make interest
payments on outstanding debt.
EXERCISES

1. (AACSB) Analysis

The accountant for my company just ran into my office and told me that our gross profit margin
increased while our net profit margin decreased. She also reported that while our debt-to- equity ratio
increased, our interest coverage ratio decreased. She was puzzled by the apparent inconsistencies. Help
her out by providing possible explanations for the behavior of these ratios.

2. Which company is more likely to have the higher inventory turnover ratio: a grocery store or an
automobile manufacturer? Give an explanation for your answer.

12.5 Challenges Facing the Accounting Profession

LEARNING OBJECTIVES

1. Discuss the future of the profession.

 2. Learn about career opportunities in accounting.

KEY TAKEAWAYS

 Recently, the accounting profession has suffered through a number of public embarrassments.

 In response, Congress passed the Sarbanes-Oxley Act, which severely restricts the ability of
accountants to serve the same clients as both auditors and consultants.

 The Public Accounting Oversight Board was set up to take over from its members the task of
regulating the profession, and new regulations require CFOs and CEOs to sign statements
attesting to the accuracy of their financial statements.

 Finally, auditors have to be more vigorous in detecting and reporting fraudulent activities.

 Those beginning careers in accounting have two career options: work as a public accountant or
work as a private accountant.

 Public accounting firms provide clients with external audits in which they examine a company’s
financial statements and submit an opinion on whether they have been prepared in accordance
with GAAP. They also provide other accounting and tax services.

 Most members of such firms are certified public accountants (CPAs) who have met required
education and work requirements.

 Private accountants, often called management or corporate accountants, work for individual
companies, not-for-profit organizations, or government agencies.

 Most private accountants record and analyze financial information and provide support to
other members of the organization.

 Private accountants also conduct internal audits as well as a variety of specialized services.

 Those who pass a special exam and meet other professional requirements in the field of
management accounting are designated as certified management accountants (CMAs).

EXERCISES

1. What is accounting and what purpose does it serve? What do accountants do? What career choices do
they have? Which career choice seems most interesting to you? Why?

2. (AACSB) Analysis

What actions have been taken to help restore the trust that the public once had in the accounting
profession? Do you believe these actions will help? Why, or why not? What other suggestions do you
have to help the accounting profession and corporate America regain the public trust?

12.6 Cases and Problems

LEARNING ON THE WEB (AACSB)

Discounting Retailers

There was a time when Kmart was America’s number-one discount retailer and Sears, Roebuck & Co.
was the seventh largest corporation in the world. Things have changed since Wal-Mart came on the
scene. In the forty-five years since Sam Walton opened the first Wal-Mart store in Rogers, Arkansas, the
company has propelled itself to the number-one spot in discount retailing, and (even more impressive)
has higher sales than any other company in the world. Over this same forty-five-year period, Target
emerged as a major player in the retail industry. The forty-five-year period wasn’t kind to Kmart and
Sears, and both stores watched their dominance in the retail market slip away. In an effort to reverse
the downward spiral of both retailers, in November 2004, Sears and Kmart merged into a new company
called Sears Holdings. To learn more about how Wal-Mart, Target, and Sears Holdings are doing today,
go to the National Retail Federation’s Web site (http://www.nrf.com/modules.php?
name=News&op=viewlive&sp_id=112) and click on STORES Top 100 Retailers to access a report that
ranks the 2006 top 100 retailers. After reading the introduction and reviewing the list of top retailers,
prepare a report comparing the three retailers on the following:

 Sales and percentage increase or decrease in sales

 Net income (or loss) and percentage increase or decrease in net income

 Number of stores and percentage increase or decrease in number of

stores

 Net income as a percentage of sales

Based on your analysis and reading, answer the following questions:

1. Do you believe that Target will be able to compete against Wal-Mart in the future? If so, how?

2. What about Sears Holdings? Will the company survive?

3. Some people criticize Wal-Mart for forcing other retailers out of

business and for lowering the average wage for retail workers. Is this a legitimate criticism? In
your opinion, has Wal-Mart helped the American people or hurt them?

CAREER OPPORTUNITIES
Is a Career in Accounting for You?

Do you want to learn what opportunities are available for people graduating with degrees in
accounting? Go to the Web site of the American Institute of Certified Public Accountants
(http://www.startheregoplaces.com) and click on the “Today’s CPA” icon (top, left). Scroll down to the
bottom of the page and click on “Video” to watch the video clip featuring a CPA. Then click on “CPAs
Exclusives” (left sidebar) and read about other featured accountants. Select a job that interests you and
answer each of the following questions:

 What is the job like?

 Why does the accountant enjoy the job?

 Why does the job seem interesting to you?

Explore career options in public accounting and business and industry. Learn about earning
potential in these fields. Select the career path you find most appealing and answer these
questions:

1. What opportunities would be available to you if you followed this career path?

2. How much should you expect to earn at the beginning of your career? After five years? After
fifteen years?

ETHICS ANGLE (AACSB)

Counting Earnings before They Hatch

You recently ran into one of your former high school teachers. You were surprised to learn that he’d
left teaching, gone back to school, and, a little more than a year ago, started a business that creates
Web sites for small companies. It so happens that he needs a loan to expand his business, and the bank
wants financial statements. When he found out that you were studying accounting, he asked whether
you’d look over a set of statements that he’d just prepared for his first year in business. Because you’re
anxious to show off your accounting aptitude, you agreed.

First, he showed you his income statement. It looked fine: revenues (from designing Web sites) were
$94,000, expenses were $86,000, and net income was $8,000. When you observed how unusual it was
that he’d earned a profit in his first year, he seemed a little uneasy.

“Well,” he confessed, “I fudged a little when I prepared the statements. Otherwise, I’d never get the
loan.”

He admitted that $10,000 of the fees shown on the income statement was for work he’d recently started
doing for a client (who happened to be in big trouble with the IRS). “It isn’t like I won’t be earning the
money,” he explained. “I’m just counting it a little early. It was easy to do. I just added $10,000 to my
revenues and recorded an accounts receivable for the same amount.”

You quickly did the math: without the $10,000 payment for the client in question, his profit of $8,000
would become a loss of $2,000 (revenues of $84,000 less expenses of $86,000).

As your former teacher turned to get his balance sheet, you realized that, as his accountant, you had to
decide what you’d advise him to do. The decision is troublesome because you agree that if he changes
the income statement to reflect the real situation, he won’t get the bank loan.

1. What did you decide to do, and why?

2. Assuming that he doesn’t change the income statement, will his balance

sheet be incorrect? How about his statement of cash flows? What will happen to next year’s
income: will it be higher or lower than it should be?

3. What would happen to your former teacher if he gave the bank the fraudulent financial statements
and the bank discovered the truth? How could the bank learn the truth?

TEAM-BUILDING SKILLS (AACSB)

Taking Stock of Ratios

Your class has been told that each group of three students will receive a share of stock in one of three
companies in the same industry. But there’s a catch: each group has to decide which of the companies it
wants to own stock in. To reach this decision, your team will use ratio analysis to compare the three
companies. Each team member will analyze one of the companies using the ratios presented in this
chapter. Then, you’ll get together, compare your results, and choose a company. Here are the details of
the project:

1. The team selects a group of three companies in the same industry. Here are just a few examples:

 Auto manufacturers. Ford, General Motors, Toyota

 Airlines. Southwest, Continental, American Airlines

 Drug companies. GlaxoSmithKline, Eli Lilly & Co., Bristol-

Myers Squibb

 Specialty retailers. Bed Bath & Beyond, Pottery Barn, Pier 1

Imports

 Computers. Hewlett Packard, Gateway, Apple Computer

2. Every team member gets a copy of one company’s most recent annual report (which includes its
financial statements) from the company’s Web site (investor section).

3. Every member calculates the following ratios for the company for the last two years: gross
profit margin, net profit margin, inventory turnover (if applicable), return on assets, current
ratio, debt-to-equity, and interest coverage.

4. Get together as a group and compare your results. Decide as a group which company you want
to own stock in.

5. Write a report indicating the company that your team selected and explain your choice. Attach the
following items to your team report:

1. A brief explanation of each ratio (how to calculate it and what it means)

2. Detailed calculations showing how each ratio was determined

c. A chart comparing the ratios for the three companies

THE GLOBAL VIEW (AACSB)

Why Aren’t Shoes Made in the USA?

Having just paid $70 for a pair of athletic shoes that were made in China, you wonder why they had to
be made in that country. Why weren’t they made in the United States, where lots of people need good-
paying jobs? You also figure that the shoe company must be making a huge profit on each pair it sells.
Fortunately, you were able to get a breakdown of the costs for making a pair of $70 athletic shoes:From
Tom Vanderbilt, The Sneaker Book: Anatomy of an Industry and an Icon (New York: The New Press,
1998), 111.

Production labor $2.75

Materials 9.00

Rent, equipment 3.00

Supplier’s operating profit 1.75

Duties 3.00

Shipping 0.50

Cost to the Manufacturer $20.00

Research and development 0.25

Promotion and advertising 4.00

Sales, distribution, administration 5.00

Shoe company’s operating profit 6.25

Cost to the Retailer $35.50

Retailer’s Rent 9.00

Personnel 9.50
Other 7.00

Retailer’s operating profit 9.00

Cost to Consumer $70.00

You’re surprised at a few of these items. First, out of the $70, the profit made by the manufacturer was
only $6.25. Second, at $2.75, labor accounted for only about 4 percent of the price you paid. The
advertising cost ($4.00) was

higher than the labor cost. If labor isn’t a very big factor in the cost of the shoes, why are they made in
China?
Deciding to look further into this puzzle, you discover that the $2.75 labor cost was for two hours of
work. Moreover, that $2.75 includes not only the wages paid to the workers, but also labor-related costs,
such as food, housing, and medical care.
That’s when you begin to wonder. How much would I have to pay for the same shoes if they were made
in the United States? Or what if they were made in Mexico? How about Spain? To answer these
questions, you need to know the hourly wage rates in these countries. Fortunately, you can get this
information by going to the Foreign Labor section of the Bureau of Labor Statistics Web site
(http://www.bls.gov/news.release/ichcc.t02.htm). The table you want is “Hourly Compensation Costs in
U.S. Dollars for Production Workers in Manufacturing.” Use the most recent hourly compensation
figures.
To investigate this issue further, you should do the following:
1. Recalculate the cost of producing the shoes in the United States and two other countries of your
choice. Because operating profit for the supplier, the shoe company, and the retailer will change
as the cost to make the shoe changes, you have decided to determine this profit using the
following percentage rates:
 Supplier’s operating profit: 10 percent of its costs
 Shoe company’s operating profit: 20 percent of its costs
(including the cost paid to the supplier to make the shoes)
 Retailer’s operating profit: 15 percent of its costs (including
the cost paid to the shoe company)
2. Prepare a report that does the following:
 Shows the selling price of the shoe for each manufacturing country (the United States
and the other two countries you selected)
 Lists any costs other than labor that might change if shoe production was moved to the
United States
 Identifies other factors that should be considered when selecting a manufacturing
country

◦ Indicates possible changes to production methods that would make production in the United States
less costly
3. Finally, draw some conclusions: Do you, as a U.S. citizen, benefit from shoe production in foreign
countries? Does the United States benefit overall? Does the world benefit? Should shoe production
return to the United States?