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SOC 503
Margaret Buckby

Chapter 1: The Role Of Accounting Information In Ethical Management Dec1sion Making Chapter 1 The Role ofAccounting Information in Ethical Management Decision Making SOLUTIONS LEARNING OBJECTIVES Chapter 1 addresses the following learning objectives: LO1 Describe the process of strategic management and decision making LO2 Identify the types of control systems that managers use LO3 Explain the role of accounting information in strategic management LO4 Explain the information systems and information that is relevant for decision making LO5 Describe how business risk affects management decision making LO6 Appreciate how biases affect management decision making LO7 Determine how managers make higher quality decisions LO8 Explain the importance of ethical decision making These learning objectives (LO1 through LO8) are cross-referenced in the textbook to individual exercises and problems. © 2012 John Wiley and Sons Canada, Ltd. 2 Cost Management QUESTIONS 1.1 Organizational vision is the core purpose of the organization and shapes the current organization and its future. Decisions about the organizational vision are important because they communicate to employees and other stakeholders the overall direction of operations. Core competencies are the strengths of the organization relative to competitors. The choice of core competencies that an organization focuses upon is important to the success of the organization because value is added by these competencies. To be successful, the vision should be guided by the basic strengths of the organization. Organizational strategies are developed around core competencies. These tactics are important because they guide the long-term decisions, such as product lines that will be offered. Operating plans put into action the organizational strategies in the short term. These plans guide employees in their day to day operations. 1.2 Once operating plans are in place, organizations need to know whether the plans are being met or need to be changed to take advantage of new opportunities. To do this, actual performance needs to be measured and compared to the plans (monitored). To help managers move toward the organizational goals, incentives such as performance-based bonuses are offered (motivating). 1.3 See Exhibit 1.9 for a list of possible internal and external reports. Students may have thought of other reports as well. Following are examples of internal reports. Capital budgets support organizational strategies, the master budget supports operating plans, and variance reports (actual versus planned performance) help organizations monitor and motivate performance if they are tied to compensation contracts. Financial statements are external reports that provide creditors and shareholders information about current and past operations. Tax returns are reports prepared for the government that also determine the amount of taxes due. Suppliers need reports about inventory levels to keep an organization’s inventory levels up to date. 1.4 The type of information needed depends on the type of decision. For product-related decisions, managers may need information about competitors’ prices and quality of products. For employee-related decisions, they may need to know the amount of experience employees have had or estimate costs to lay them off using information about length of service from human resources. If managers are developing a new good or service, they need information from suppliers about the cost of resources. Students may have thought of other types of decisions and information needed for them. 1.5 Cash flows that vary with the available alternatives for a decision are relevant because they relate directly to each separate decision that could be made. Summing these relevant cash flows provides quantitative information about the relevant costs and benefits for each alternative. However, some cash flows will not change, regardless of the decision made. These are irrelevant cash flows because they remain the same under all courses of action and have no influence on the decision. © 2012 John Wiley and Sons Canada, Ltd. Chapter 1: The Role Of Accounting Information In Ethical Management Decision Making 3 1.6 Business risk is the possibility that an event could occur and interfere with an organization’s ability to meet strategic goals or operating plans. Examples of business risks are shown in Exhibit 1.11. Some events, such as a hurricane or tsunami, may occur infrequently but have devastating effects. Other events, such as product returns under warranty, occur regularly but could escalate if production processes become out of control. The degree of business risk varies across organizations, industries, geographic regions, and time periods. Top managers are responsible for addressing business risks, taking calculated risks across the enterprise, and appropriately managing and mitigating the risks for the benefit of the stakeholders (i.e., quality of decision). 1.7 Biases are preconceived notions adopted without careful thought. This chapter’s box introduces non-rational escalation of commitment. Also, the Snow-Blade Snowboards example demonstrated a type of information bias: the average cost per unit overestimated relevant cost for the manager’s decision to accept or reject a customer order. Predisposition bias was probably a major issue in the RIM case. Poorer quality decisions result when managers fail to recognize and control for biases because important information is often overlooked. 1.8 Higher quality decisions are made by using higher quality information, that is, information that has few uncertainties and is relevant, complete, as certain as possible, and timely. This information needs to be prepared in reports that are easy to understand, readily available, relevant and timely. Then a high quality decision-making process is used. This is a process that is thorough, as unbiased as possible, focused, creative, and visionary as it relates to strategies. 1.9 There are many reasons for behaving ethically. From an economic perspective, if everyone behaved ethically, less investment would be needed in police and security protection. In addition, written contracts would be less important, and a court system would not be needed to determine whether people are acting unethically and then penalize wrongdoers. More business would probably be transacted because people could trust each other. From a personal perspective, people would feel their world was more certain if they knew others would always treat them ethically. Even in a world where many people are unethical, organizations and individuals who act ethically develop better long term reputations and self-respect and improve social welfare. 1.10 Ethical behavior takes into consideration the wellbeing of others and society in making decisions and choosing courses of action. Because many different kinds of stakeholders rely on accounting information, unethical behavior can be very costly through poor decisions that are based on bad information. When accountants are not ethical, investors no longer believe information produced by firms and are unwilling to invest. The market collapses and firms lose their value and society suffers from the losses. 1.11 In business situations, non-rational escalation of commitment occurs when managers inappropriately use more resources based on the value of an original investment. This often occurs when a poor decision is made in the first place and more money is spent because managers hope the project will succeed and make up for past losses, or they may want to save face and not admit the original decision did not lead to a successful outcome. © 2012 John Wiley and Sons Canada, Ltd. 4 Cost Management People exhibit non-rational escalation of commitment in many ways. For example, people may continue repairing a vehicle or household appliance because of money previously spent. 1.12 Belief systems provide guidance and motivation that encourages employees to act in ways that are consistent with the organization’s goals and vision. Boundary systems provide limits on what employees can do. Boundary systems include things like codes of conduct and budgets. The two systems are similar in that they both provide information that helps employees determine the best courses of action for the organization. They are different in that belief systems provide encouragement and motivation while boundary systems provide limits and a way to monitor employee behavior so that it does not exceed the limits. 1.13 Interactive control systems are sets of information that are discussed by managers from many different levels in an organization. These discussions occur regularly. The managers focus on interpreting the information and determining what it means and what opportunities and challenges have arisen. These systems help managers determine whether organizational strategies and operating plans are appropriate or need to be changed. They may also lead to reanalysis of organizational vision or core competencies. 1.14 Diagnostic control systems measure and monitor progress toward managers’ pre-set goals. In addition, these systems motivate employees to reach these goals. Diagnostic control systems provide information about actions taken and allow managers to determine whether the actions are moving the organization toward its goals. These include budgets and variances, balanced scorecards, among others. 1.15 The four levers of control are used together to guide and control business strategy, to insure that employees are complying with the organization’s plans and policies, and to empower employees to identify opportunities and challenges and to develop strategies for success. © 2012 John Wiley and Sons Canada, Ltd. Chapter 1: The Role Of Accounting Information In Ethical Management Decision Making 5 MULTIPLE-CHOICE QUESTIONS 1.16 Which of the following statements is true? a) Management accounting is guided by IFRS or Canadian ASPE. b) Management accounting information is mainly for external users. c) Management accounting is future oriented. d) Management accounting information is mainly quantitative. Ans: C 1.17 Which of the following statements is not true? a) Unavoidable cost is relevant in decision-making. b) Avoidable cost is relevant in decision-making. c) Additional investment is relevant in decision-making d) Cost saving is relevant in decision-making Ans: A 1.18 Which of the following is not one of the components of ethical decision making? a) Identify ethical problems as they arise. b) Objectively consider the well-being of others and society when exploring alternatives. c) Clarify and apply ethical values, and choose a course of action which avoids the exposure of wrongdoing. d) Work toward ongoing improvement of personal and organizational ethics. Ans: C 1.19 Which of the following statements is not true? a) Monitoring and motivating is part of an implementation function. b) Budgeting is a part of a control function. c) Performance measure is a part of a control function. d) Budget is a quantitative expression of a plan. Ans: B 1.20 Which of the following characteristics is not high-quality information? a) Timely b) Relevant c) Complete d) Circumventing Ans: D © 2012 John Wiley and Sons Canada, Ltd. 6 Cost Management EXERCISES 1.21 Types of Manager Decisions - Microsoft Corporation A. (4) Measuring, monitoring & motivating (specifically monitoring) because it is comparing actual versus expectations B. (2) Operating plans because it involves looking at short-term plans C. (3) Actual operations because this is part of normal operations (developing new products) D. (3) Actual operations because this is part of normal operations (customer support for existing products) E. (2) Operating plans because it involves developing short-term plans F. (4) Measuring, monitoring & motivating because it involves comparing actual to expectations and discussing variances from budget with managers (and measuring their performance as managers). Presumably the managers know in advance that their performance is measured based (or at least partially based) on these variances from budget, which should motivate their performance. G. (1) Organizational strategies because it involves a long-term decision to expand facilities 1.22 Types of Personal Decisions A. A student’s vision might be a particular type of career, or job they would like to have after graduation. B. A student’s core competencies include his or her knowledge, leadership skills, and abilities to communicate, to analyze and solve problems, to sell ideas to colleagues, to develop spreadsheets, any skill or talent that is well developed. C. A student’s long-term strategies include completing a particular degree in college, acquiring certain licenses (such as CA) and other qualifications, selecting a group of organizations within which to work, and determining means of financing an education. D. Short term planning includes the particular schedule of classes over the next year, determining whether it is necessary to work during the school year, finding a place to live. E. Actual results are scores on exams and projects, and grades for the semester or quarter. Financial results are the monthly and quarter or semester costs incurred. F. Students might prepare a financial budget and a time management budget and compare their actual results to the plans they have made. Some students might set up rewards for © 2012 John Wiley and Sons Canada, Ltd. Chapter 1: The Role Of Accounting Information In Ethical Management Decision Making 7 themselves if they achieve certain goals, such as a good grade for an exam or class, or for meeting planned study goals (set in hours). 1.23 Relevant Costs - Avery Car Rental The question calls for a computation to determine the number of kilometres driven over four days so that the rental cost would be the same under the two options. The easiest way to solve this is to first write the total cost for each option using number of kilometres as an unknown variable. Then set the two costs equal to each other and solve for the number of kilometres. Let x be the number of kilometres driven: ($26 per day*4 days) + ($0.20 per km*x) = ($35 per day*4 days) + ($0.08 per km* x) $104 + $0.20*x = $140 + $0.08*x $0.20 *x -$0.08 *x = $140 - $104 $0.12 *x = $36 x = $36 / $0.12 x= 300 kilometres 1.24 Relevant Costs - Driving A. The current average cost per kilometre most likely includes depreciation and insurance. These would be irrelevant because they would not change depending on the option that Susan chooses for driving to this client’s office. B. Susan has no cost and receives no reimbursement if she uses a company car. If she uses her own car, her incremental cost will be $0.25 per kilometre times 100 kilometres, or $25. She will receive a reimbursement of $0.30 per kilometre times 100 kilometres, or $30. So, she will be $5 ($30 - $25) better off if she drives her own car. (Note: It is not clear which option would make Susan’s company better off because the incremental cost of operating the company car is unknown.) © 2012 John Wiley and Sons Canada, Ltd. 8 Cost Management 1.25 Relevant Costs, Other Relevant Factors - NetFlix A. The question calls for a computation to determine the number of DVDs rented per month so that the total cost would be the same under the two options. The total cost for the Netflix option is $21.95. The total cost of the video store option is $3.95 times the number of DVDs rented. These costs will be the same when: $21.95 per month = $3.95 per DVD * x number of DVDs per month $21.95 / $3.95 = x x = 5.56 DVDs per month (students should actually round this to 6 since they cannot rent 0.56 of a DVD) The cost of the Netflix option will be higher if studentsrent fewer than 6 DVDs per month, and it will be lower if students rent more than 6 DVDs per month. B. If students often pay extra charges because they fail to return DVDs to a video store in a timely manner, they might prefer NetFlix. If they prefer to order from home, they may prefer NetFlix. If NetFlix carries movies that students cannot get at a video store, they may prefer NetFlix. If they like to rent movies spontaneously and do not want to plan their rentals in advance, then they would prefer the video store. If students like to rent newly-released movies, they might be able to get them more quickly at a video store than through Netflix. 1.26 Levers of Control, Ethics A. An organization’s culture may be influenced significantly by beliefs systems, which define core values. Two specific beliefs system controls that might discourage managers from overlooking unethical behavior are core values statements and ethics statements that include descriptions of the values and ethical practices that managers and other employees are expected to follow. Students might think of other relevant beliefs systems controls. B. Boundary systems establish limits on individual behavior in response to risk that should be avoided. Specific types of boundary systems that relate to ethics include codes of conduct and budgets, which limit specific behaviors. Students might think of other relevant boundary systems controls. © 2012 John Wiley and Sons Canada, Ltd. Chapter 1: The Role Of Accounting Information In Ethical Management Decision Making 9 1.27 Effects of Biases A. When the quality of information is poor, resulting in data that misestimates or misrepresents a situation, poor decisions are likely to be made. This is called information bias. When people’s minds do not appropriately process information, cognitive biases occur. A predisposition bias occurs when people do not control their preferences, attitudes, or emotions in making a decision and they are therefore unable to make an objective analysis of the situation or problem. B. The manager’s forecasts do not seem to appropriately describe potential changes in revenues and costs, but do make operations appear to be improving, which may be important to the manager’s self-image. Changes in sales and costs are driven by many different factors that cannot easily be predicted. Historical data is often useful, and the fast-food store had not been doing that well. Small improvements may be possible, but large improvements are unlikely to occur without significant changes in operations. C. The revenues and costs can be benchmarked with other locations of the same chain or other fast-food stores with similar products. Also historical data and economic data including changes in demographics, disposable income, etc., could assist in checking reliability. 1.28 Master Data Management, Control Systems, Quality of Information A. An enterprise-wide database could be used to develop information for budgets and balanced scorecards at the levels of both sub-units and the entire organization. These would be used as part of a diagnostic control system. If this information is then shared among managers on a periodic basis, along with data about the market and any changes in the business environment, it couldbe used for interactive control systems. B. Common rules insure a consistency of data so that when managers are using the data to measure, monitor and motivate performance they can reach agreement more quickly when interpreting results of analyses using the data. The practice of using a data governance function helps managers improve the consistency and accuracy of data used in the diagnostic and interactive control systems. While managers may have different viewpoints, the underlying data is the same, so that all managers understand that differences are related to viewpoints rather than data differences. © 2012 John Wiley and Sons Canada, Ltd. 10 Cost Management 1.29 Ethics, Culture, Belief, and Boundary Systems A. Corporate culture sets the tone for employees. If the culture sets a high bar regarding ethics, the top management will act in ways that provide models and will adopt policies that strengthen the overall ethics used in the firm. If top management puts more weight on objectives other than on ethics, they will expect their employees to do so as well. This could easily weaken ethical behavior among all employees. B. Ethical values are part of both the belief systems and boundary systems within organizations. In vision, mission, and values statements, organizations often address and promote their ethical values. These are part of belief systems. In addition, firms develop checks and balances to ensure that breaches of ethical conduct (e.g., bribery or conflicts of interest) will be avoided. These are part of boundary systems. 1.30 Pace of Change, Historical Data, Control Systems A. In a rapidly changing environment, historical data may not reflect future operations. For example, changes in technology can alter manufacturing costs, and changes in customer preferences can change required product features and/or selling prices. When this happens, the historical data is less relevant. While historical data may be used as a base, many adjustments need to be made to reflect changes in the business and economic environment. B. Diagnostic control systems use current and historical data to develop information to compare whether an organization is performing according to established plans. In response to changing conditions, managers may need to continuously modify and adapt operations. Accordingly, comparisons of actual results to planned results in diagnostic control systems such as budgets and balanced scorecards may provide less useful information in a rapidly changing environment than in a more stable economic environment. C. In interactive control systems, managers interactively discuss the meaning of information related to strategic uncertainties. They can focus on changes as they arise and also on how current operations might need to change in response. These systems become much more important in a dynamic business environment so that the organization can respond successfully to external changes. 1.31 Relevant Costs, Uncertainties - Toys for Boys A. Selling the cars as-is would provide $5 per car * 10,000 cars = $50,000. Painting and selling the cars would provide [($8 selling price – $2 painting cost) per car * 10,000 cars] = $60,000. The company would be $10,000 better off if it paints the cars. © 2012 John Wiley and Sons Canada, Ltd. Chapter 1: The Role Of Accounting Information In Ethical Management Decision Making 11 B. The gray cars have not sold well at $8.00, and the managers cannot know whether they will sell at $5.00. The red cars appear to be selling well for $8.00 each, so that alternative is probably more certain in terms of selling the cars. However, the managers might not be sure whether the cost to paint the cars will be $2 each. If the managers are fairly certain that the cost will be $2 each, then the painting option probably has less uncertainty overall. If the managers believe that the painting costs could vary substantially from the $2 estimate, then the painting option might have more uncertainty. 1.32 Relevant Costs, Risks, Other Relevant Factors, Bias A. First, students should note that they will still own the car under all three alternatives. Therefore, the monthly payments of $220 will exist under all three alternatives and are not relevant to this decision. The average maintenance costs of $37 per month may contain some costs that are relevant (assuming that maintenance costs increase with the number of kilometres driven); however, this cost is also likely to include costs that do not depend on whether the car is driven to school. For simplicity, this solution assumes that none of the maintenance costs are relevant. Second, note that the estimated monthly use of the car above the 200 kilometres for commuting to campus will be incurred regardless of which option is chosen. Based on cost only, the one-ride bus ticket (Bus B) is the best alternative as shown below: Relevant Semester Costs of Three Alternatives Drive to School Bus A – Semester pass Bus B – One-ride tickets Parking $150.00 Ticket cost $225.00 Ticket cost Gasoline: 200 $2/trip * 24 km/mo*4 mos trips/mo*4 @ $0.10/km* mos $192.00 *($60/600 km) 80.00 $230.00 $225.00 $192.00 B. Gasoline costs for driving the car might be different than estimated because gasoline prices might rise or fall, and students might achieve higher or lower mileage per litre. In addition, maintenance costs might be lower if one of the bus options is chosen. However, it may be difficult to predict the portion of maintenance costs that are likely to vary with kilometres driven. If students choose either of the bus options, they might find that they drive their car to campus sometimes. If they choose the bus semester pass, they might find that they use the bus more than expected. During times of bad weather, students may need to take the bus even though they chose the option to drive. C. Here is a partial list of things that are not necessarily quantifiable in dollars, but could be relevant to this decision: • Flexibility of the bus schedule (both times and routes) • How students value their time © 2012 John Wiley and Sons Canada, Ltd. 12 Cost Management • The ability to use the bus ride time in a useful manner (for example, by studying or relaxing) • The stress students experience under each alternative (some people are nervous driving, and others hate being in a crowded bus) • The risk of damage to cars in the school parking lot versus the parking lot at an apartment (students have insurance, but there is a deductible) • Reliability of bus service, that is, on-time service history, labour relations, financial solvency D. Students who have never ridden a bus may be biased against the bus option because their information about this option is limited. In addition, limited information combined with the non-rational escalation of commitment bias could encourage students to believe that using their cars justifies their investment in a car and they may prefer that option to the bus option. © 2012 John Wiley and Sons Canada, Ltd. Chapter 1: The Role Of Accounting Information In Ethical Management Decision Making 13 PROBLEMS 1.33 Risks - College Course Sequence A. Many potential uncertainties may be identified, including the following: • Which courses teach skills that will be needed in other courses? • Will enough class sections be offered at appropriate times? • Will enough space be available in a particular course? • Who will teach a particular course? B. Many answers are possible for this question. Following are some explanations for the uncertainties listed in Part A: • Which courses teach skills that will be needed in other courses? Some courses are specifically identified as prerequisites for other courses. However, considerable flexibility may exist in the sequence of courses taken. When there is flexibility, students are often uncertain about the types of skills taught in particular courses and the extent to which skills in one courses are required for another. For example, a cost accounting course may teach spreadsheet and communication skills that will be useful in other accounting courses. • Will enough class sections be offered at appropriate times? Sometimes course offerings change from year to year or even at the last minute based on a variety of factors, including course demand, instructor availability, departmental personnel changes, university budgets, and so on. • Will enough space be available in a particular course? It is not possible to know for sure how many other students will attempt to register for a particular course. In addition, it may be uncertain whether a particular professor will be permitted or will allow students to enroll on an overload basis. • Who will teach a particular course? Even when instructors are scheduled for a course, sometimes there are last minute changes. Students are uncertain whether the teacher will be someone from whom they can learn. Even if other students have recommended an instructor, students are uncertain about whether they will enjoy the course and learn from the instructor. 1.34 Relevant Information, Bias - Office Photocopy Machine A. The annual lease payment is relevant since it will not be incurred if the photocopy machine is purchased. Similarly, the purchase price is relevant because it will not be incurred if the machine is leased. There are many other possible answers to this question. © 2012 John Wiley and Sons Canada, Ltd. 14 Cost Management B. Any cost that would be incurred under both options would be irrelevant. Examples include the cost of supplies such as copier paper and toner. There are many other possible answers to this question. C. To choose between options, it is necessary to investigate how the two options would differ. By definition, relevant costs differ across options and help the decision maker choose between options. If irrelevant information is included, costs would be over- estimated for one or both options which could lead to a poor quality decision. D. When service people are paid based on commission for parts sold, they may tend to recommend use of more parts than necessary, which in turn increases their compensation. A service repair person under this compensation scheme might recommend replacing parts earlier than necessary or recommend using lower quality parts that must be replaced more frequently. 1.35 Business Risk, Degree of Risk, Risk Appetite - Community Children’s Hospital A. There are more possibilities than are listed, but here are some of the uncertainties the CEO faces in the “buy hotel” alternative: • Vacancy rates (i.e. demand for rooms) • Optimal pricing structure for the rooms • Hotel operating costs • Tax consequences of running a for-profit business as a sideline to a not-for-profit business (uncertainty alleviated if she purchases tax advice) • Ways that hotel maintenance may differ from hospital maintenance • Security in this neighborhood in the future • Long-term future of a hotel in a declining neighborhood B. There are more possibilities than are listed, but here are some of the uncertainties for the “heart monitor” decision: • Future demand for neo-natal equipment at the hospital • Expected wages for the special technician (although she can easily find this out) • Maintenance or operating costs for the monitors that are not disclosed by the medical supply vendor • Expected useful life of the monitors • Hospital’s ability to charge patients for the new equipment • Effect of the new equipment on how nurses spend their time C. The “buy hotel” alternative probably has a greater degree of uncertainty because it is outside the core competencies of the hospital and CEO. D. The hospital’s risk appetite affects whether managers are willing to take on more risk for potentially higher returns. If the hospital has little appetite for risk (i.e., is risk averse), the managers are likely to choose the less risky alternative. If the hospital is risk neutral, the © 2012 John Wiley and Sons Canada, Ltd. Chapter 1: The Role Of Accounting Information In Ethical Management Decision Making 15 managers are likely to choose the alternative that provides the best return for the level of risk incurred. If the hospital is risk seeking, the managers are likely to choose a risky alternative with a higher rate of return. However, the managers might or might not make decisions that are consistent with the hospital’s appetite for risk. Sometimes managers fail to consider the organization’s risk appetite when making decisions. 1.36 Decision-Maker Bias - Gene Horita A. Gene is basing his understanding of accounting careers on his father’s experience. There are many different types of accounting careers, and not all of them involve long hours during tax season or at any other time. In addition, it is possible that Gene’s father would have spent most of his time at work regardless of his career. Gene may not know much about careers in information systems, but he is idealizing careers in this field. Sometimes when employees are working against a deadline in preparing a new software product, a lot of overtime is incurred. B. Gene could analyze his perspective and control for his biases by doing some informational interviewing with people in both accounting and information systems careers. He could check with both the accounting and information systems departments at his college and ask for phone numbers of alumni who have been successful in their careers. Through conversations with these people he will get a better understanding of the different options available for each career path. He could also secure internships in both areas to have an inside view of these career paths, although it may be difficult to get an internship without declaring a major. 1.37 Identifying Risk A. The managers cannot be certain how much the company will save in labour and insurance costs if it decides to purchase the new equipment. There also may be unforeseen costs in modifying the company’s production processes, such as employee training, system testing, and production down time. In addition, a reduction in labour cost probably means that the company will reduce its labour force, and the new equipment might require employees having different skills than in the past. The managers cannot be certain how a reduction will affect the morale and work quality of workers who remain, and the new workforce might cost more per employee than the old one. B. Either internship would provide work experience for Amira, but she cannot be certain how much or completely anticipate the types of learning would occur with each option. Also, she might have preferences for living in one location versus the other, but she cannot perfectly foresee the living and social arrangements in each setting. © 2012 John Wiley and Sons Canada, Ltd. 16 Cost Management 1.38 Relevant Information, Bias, Recommendations - Francisco A. Relevant costs for deciding whether to go camping or stay home this year: • $1,000: this is not relevant because it represents the past cost of the camper • $150 (1,000 kilometres x $0.15): the gas & oil portion of this is relevant because it is incremental • $220 (1,000 kilometres x $0.22): depreciation is not relevant because it is related to the past cost of the camper and insurance is not relevant because Francisco will insure the camper whether they take the trip or not. • $250: the cost of groceries is relevant only to the extent that it exceeds the cost of groceries while at home. • $100: the cost of beverages is relevant only if it exceeds the cost of beverages while at home. • Entertainment costs (movies, etc.) that the family might incur if they stay at home during their vacation time that they would not incur if they go camping instead B. The relevant costs for deciding whether to continue to use the camper or to sell it and stay in motels in the future: • $1,000: this is not relevant (but the estimated cash inflow from selling the camper will be relevant) • $150: this is now relevant because it is an estimate for the future costs of using the camper. The family will probably drive their car if they sell the camper, so that option will incur some level of gasoline, oil, tires, and maintenance cost. • $220: depreciation is not relevant, but insurance is now relevant because it differs across the alternatives • $250: the cost of groceries is relevant only to the extent that it exceeds the cost of groceries while at home,also may need to consider differences in patterns of eating in restaurants. • $100: the cost of beverages is relevant only if it exceeds the cost of beverages while at home. • Motel costs: If they sell the camper, the family will incur costs to stay in motels. • Storage costs of the camper (if any) would no longer be required if the camper is sold. C. Other factors that Francisco might consider include: • The enjoyment that his children receive from camping (if they do in fact enjoy it) and whether their preferences will change as they grow older • The enjoyment that Francisco receives from camping • Francisco’s wife’s displeasure with camping and enjoyment of the alternatives • Expected selling price of the camper © 2012 John Wiley and Sons Canada, Ltd. Chapter 1: The Role Of Accounting Information In Ethical Management Decision Making 17 D. Some students might recommend that Francisco keep the camper because they view it as better than staying in motels. Others might suggest that Francisco should experience more things than just state and national parks. Still others might think that a camper must be too small for a 5-person family, so Francisco should sell it. Personal biases often sway the way that people look at information for a problem. They often ignore information that contradicts their preferences. Francisco and his family do not necessarily have the same experiences and preferences as students when responding to this question. One way for students to control biases is to first recognize their own preferences. Then they can look for ways in which their preferences affect what they consider to be relevant or important. Another way is to talk about this problem with other people who are likely to have preferences different from theirs. E. As outsiders, it is difficult for students to give advice because they cannot know which priorities should be used to solve this problem. Accordingly, the best advice students could give Francisco might be to discuss it with the family and come up with the best solution/compromise for the family. They could also recommend that Francisco remain open to his own biases. 1.39 Income Statement Information, Solve for Unknowns – Mouse Max A. The first step is to classify all costs as fixed and variable. Cost of goods sold includes direct materials, direct labour, and manufacturing overhead. Direct materials are variable because the total amount increases with the volume produced and sold. Direct labour costs may be fixed or variable; it is variable if workers are paid based on time worked and their work hours depend on production needs. Direct labour is fixed if workers are paid a flat amount regardless of production schedules. A solution is provided below for each assumption. The problem states that all manufacturing overhead is fixed. The sales commission cost is variable because the total amount depends on the number of units sold. No information is provided about the nature of other selling costs or administration costs. Most of these costs are likely to be fixed. The next step is to calculate the amount of manufacturing overhead that is included in cost of goods sold (COGS) on the income statement. Total COGS of $1,220,000 divided by 100,000 units sold equals $12.20 per unit. Subtracting the per-unit cost of direct material and direct labour, manufacturing overhead cost per unit is $6.20 ($12.20 - $5.00 - $1.00). © 2012 John Wiley and Sons Canada, Ltd. 18 Cost Management Variable cost income statement assuming direct labour costs are variable: Revenue $2,500,000 Variable costs: Direct materials (100,000 × $5.00) $ 500,000 Direct labour (100,000 × $1.00) 100,000 Variable selling (100,000 × $1.50) 150,000 Total variable costs 750,000 Contribution margin 1,750,000 Fixed costs: Manufacturing overhead (100,000 × $6.20) 620,000 Selling and admin ($1,150,000 - $150,000) 1,000,000 Total fixed costs 1,620,000 Operating income $ 130,000 Variable cost income statement assuming direct labour costs are fixed: Revenue $2,500,000 Variable costs: Direct materials (100,000 × $5.00) $ 500,000 Variable selling (100,000 × $1.50) 150,000 Total variable costs 650,000 Contribution margin 1,850,000 Fixed costs: Direct labour (100,000 × $1.00) 100,000 Manufacturing overhead (100,000 × $6.20) 620,000 Selling and admin ($1,150,000 - $150,000) 1,000,000 Total fixed costs 1,720,000 Operating income $ 130,000 B. Traditional income statements conform to a set of rules (such as IFRS or Canadian ASPE) so that information is comparable across organizations. These reports are developed for external parties who want to compare operations in one firm with those in another and be assured that the way the information is reportedis similar across firms. C. When managers use an average cost based on cost of goods sold information, they include an estimate of fixed cost. If the volume of units actually produced is not identical to the predicted number, total fixed costs will either be overestimated or underestimated. 1.40 Strategic Management Process The purpose of this problem is for students to demonstrate an understanding of concepts introduced in the chapter. Below are possible answers. Actual student answers will vary. © 2012 John Wiley and Sons Canada, Ltd. Chapter 1: The Role Of Accounting Information In Ethical Management Decision Making 19 A. Our organization mission is to provide customers with convenience, an enjoyable experience, and high quality, good tasting food. Two core competencies would be the ability to produce foods that customers consider a good value and to deliver the food very quickly so that the customer wait time is not long. B. Our organization’s general strategy is to compete on low prices, food that tastes good and is a good value and is served relatively quickly. This general strategy maps to the core competencies identified in Part A. C. Managers will need to work closely with suppliers to ensure high quality, low cost ingredients. In addition, employee training will need to emphasize quick service. D. Accounting information is valuable in monitoring operations to ensure that operations follow plans. Costs or timeliness of service may fail to meet expectations, requiring some type of intervention. For example, diagnostic control systems are likely to include budgets for costs and customer wait time. Financial statements would also be valuable for comparing this period’s overall results with last period’s results or with budgets. 1.41 Strategic Decision Quality, Business Risk - Starbucks A. Students may answer this question based on what they already know about Starbucks. Alternatively, they could search on the Internet to identify statements that describe the company’s vision and/or core competencies. Following is the company’s mission statement and principles (Source: www.starbucks.com/about-us/company- information/mission-statement, accessed July 20, 2010): Our Starbucks Mission Statement Our mission: to inspire and nurture the human spirit – one person, one cup and one neighborhood at a time. Here are the principles of how we live that every day: Our Coffee It has always been, and will always be, about quality. We’re passionate about ethically sourcing the finest coffee beans, roasting them with great care, and improving the lives of people who grow them. We care deeply about all of this; our work is never done. Our Partners We’re called partners, because it’s not just a job, it’s our passion. Together, we embrace diversity to create a place where each of us can be ourselves. We always treat each other with respect and dignity. And we hold each other to that standard. Our Customers © 2012 John Wiley and Sons Canada, Ltd. 20 Cost Management When we are fully engaged, we connect with, laugh with, and uplift the lives of our customers – even if just for a few moments. Sure, it starts with the promise of a perfectly made beverage, but our work goes far beyond that. It’s really about human connection. Our Stores When our customers feel this sense of belonging, our stores become a haven, a break from the worries outside, a place where you can meet with friends. It’s about enjoyment at the speed of life – sometimes slow and savored, sometimes faster. Always full of humanity. Our Neighborhood Every store is part of a community, and we take our responsibility to be good neighbors seriously. We want to be invited in wherever we do business. We can be a force for positive action – bringing together our partners, customers, and the community to contribute every day. Now we see that our responsibility – and our potential for good – is even larger. The world is looking to Starbucks to set the new standard, yet again. We will lead. Our Shareholders We know that as we deliver in each of these areas, we enjoy the kind of success that rewards our shareholders. We are fully accountable to get each of these elements right so that Starbucks – and everyone it touches – can endure and thrive. Environmental Mission Statement Starbucks is committed to a role of environmental leadership in all facets of our business. We fulfill this mission by a commitment to: • Understanding of environmental issues and sharing information with our partners. • Developing innovative and flexible solutions to bring about change. • Striving to buy, sell and use environmentally friendly products. • Recognizing that fiscal responsibility is essential to our environmental future. • Instilling environmental responsibility as a corporate value. • Measuring and monitoring our progress for each project. • Encouraging all partners to share in our mission. Starbucks mission statement includes comments about high quality coffee and an experience where employees are engaged with customers—i.e., the “human connection” discussed in the company’s principles. Romance and theatre are the way that baristas engage with customers as they prepare the drinks. B. Some of Starbucks business risks include entry into the market of fast-food stores which also sell coffee. Coffee prices and availability are also potential business risks. Economic © 2012 John Wiley and Sons Canada, Ltd. Chapter 1: The Role Of Accounting Information In Ethical Management Decision Making 21 downturns may affect customers’ abilities to purchase expensive coffee drinks or alternatively may represent an affordable “luxury” in poor economic times and cause an increase in coffee purchases. See Exhibit 1.11 for examples of many types of business risks. C. At the time the decision was made, customers must have been concerned about long wait lines, and the decision reduced those. Because waiting time affects the customer experience, it reflects part of Starbucks’ mission and values. However, the decision caused customers to be separated from the experience of easily watching their coffee drinks being prepared, and thus conflicted with a strategy of fully engaging the customers. 1.42 Steps in Decision-Making Process (Appendix 1B) Starbucks’s decision to install automatic espresso machines can be described using Steps 1, 2, and 3 of Steps for Better Thinking model as follows (see details of the model in Appendix 1B). Step 1: Starbucks’ managers identify any problems in their operations as a regular, ongoing effort to improve customer experience (part of the company’s mission; see the solution to Problem 1.41 above). Specifically, the managers were probably concerned about efficiency and wait time as stores became busier, and they had identified the use of automatic espresso machines as potential solution. Step 2: Starbucks managers most likely explored alternative solutions to customer wait times, and they also would have considered the costs and benefits of installing automatic espresso machines. The costs and benefits would have included the expected effects on cash flows, such as the cost of the equipment and the expected increase in revenue from faster service. They also would have considered qualitative factors such as the effect on customers of shorter wait times and the company’s ability to rapidly open new stores using automatic machines that required less employee training. Step 3: The managers would have weighed the pros and cons of the automatic espresso machines before deciding to use them. At the time, they must have concluded that the advantages outweighed the disadvantages. Their decision might have been heavily influenced by the company’s rapid growth and a desire to increase per-store revenues. 1.43 Ethical Decision-Making, Relevant Information, Risks, Biases - Larry A. The ethical issue is whether it is proper for Larry to help Annie with her homework. Larry’s interests potentially conflict with those of Annie, his professor, and other students in the course. B. When identifying alternatives, there is a tendency to automatically filter out some of the options. When answering a question like this one, student
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