MGAB03H3 Chapter Notes -Sunk Costs

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9 Jan 2011
Chapter 1 The Role of Accounting Information in Ethical Management
Decision-Making Notes
Uncertainties, Biases, and Management Decision Quality
x uncertainties Æ issues and information about which we have doubt; prevent managers from accurately describing a problem,
identifying all possible options, knowing the outcomes of various options, or anticipating all future conditions
x managers often face a great deal of uncertainty when they launch a new product
x managers make poor decisions when they fail to adequately recognize and allow for uncertainties
x this type of failure often occurs because of management bias
x biases Æ preconceived notions that are adopted without careful thought; cause decision makers to ignore weaknesses in their
preferred course of action and prevent them from adequately exploring alternatives
Decision Quality
x decision quality Æ refers to the characteristics of a decision that affect the likelihood of achieving a positive outcome
x uncertainty and bias reduce decision quality
x higher-quality decisions have more positive outcomes because they involve less uncertainty and decision makers are less biased
x with lower-quality decisions, the opposite is true
x managers can actively work to reduce or eliminate their biases—although uncertainties cannot be eliminated, managers can make
higher-quality decisions by acknowledging and more thoroughly addressing uncertainties
Management Decision-Making
x people at different levels in an organization continuously make many different kinds of decisions
x they range from broad decisions to detailed decisions
Organizational Vision
x organizational vision Æ core purpose and ideology of an organization, which guides the organization’s overall direction and
approaches toward various stakeholder groups
x organizational success increases when employees understand the organizational vision and work collectively to achieve it
x to clarify and communicate the vision to employees and other stakeholders, managers sometimes divide the vision into one or
more written statements, which vary from organization to organization
x in general, a vision statement is a theoretical description of what the organization should become
x a mission statement is a summary of the beliefs that define the organization’s culture
x some managers also publish codes of conduct or statements describing the organization’s social or environmental responsibilities
Organizational Core Competencies
x organizational core competencies Æ the organization’s strengths relative to competitors; closely related to organizational vision
x to create value for stakeholders, an organization must have strengths relative to competitors
x the vision should build an existing and achievable strengths
Organizational Strategies
x organizational strategies Æ tactics that managers use to take advantage of core competencies while working toward the
organizational vision; guide long-term decisions such as the proportion of financing through debt and equity, types of goods and
services offered, and investments in property, plant, and equipment
x some of these decisions are made and then rarely need to be reconsidered, while others should be re-evaluated periodically
x to monitor strategic progress, managers establish and monitor long-term goals such as market leadership
Operating Plans
x operating plans Æ specific short-term decisions that shape organization’s day-to-day activities such as drawing cash from LOC,
hiring employee, or ordering materials; often include specific performance objectives, such as budgeted revenues and costs
Actual Operations
x actual operations Æ various actions taken and results achieved over period of time, including customer orders received, revenues
earned, employees hired, costs incurred, units of goods or services produced, cash received and paid, etc.; data about actual
operations are collected and measured by organization’s information system and then used to monitor and motivate performance
Measuring, Monitoring, and Motivating Performance
x managers need information about costs to help decide whether to sell a particular product
x they also need information to measure actual operations so that they can monitor the success of their decisions and motivate
employees to work toward the organizational vision
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x decisions are monitored by comparing actual operating results against plans such as budgets and against long-term goals
x desirable employee behaviour is motivated by tying employee performance evaluation and pay to long-term or short-term results
x organization’s info system can be designed to measure and report info used for decision-making, and monitoring and motivating
x management control systems include planning, monitoring and motivating, and controlling and measuring performance
x managers use management accounting information to facilitate a management control system
x budgets help to quantify planning, and accounting and cost reports help to guide control and performance evaluation
x the learning from the process provides feedback for organizations to improve planning, control, and performance
Cost Accounting and Decision-Making
x cost accounting Æ process of tracing, recording, analyzing, and determining cost of organization’s project, process, or activity
x cost accounting helps managers understand the costs of operating a business so they can use the cost information to make sound
business decisions, particularly to reduce the companys cost and to improve its profitability and productivity
Management Accounting and Financial Accounting
x cost accounting information is used for both management and financial accounting activities
x management accounting Æ process of gathering, summarizing, and reporting information used internally by managers to make
decisions; includes measurement of costs as well as other financial and non-financial information
x because the info gathered is mainly for internal uses, management accounting is not bound by GAAP
x management accounting helps managers plan, control, and measure performance
x management accounting is future oriented and is concerned with reporting on a segment of an organization
x financial accounting Æ process of preparing and reporting financial information that is used most frequently by decision makers
outside the organization, such as shareholders and creditors
x due to the fact that the information is for external users, financial accounting must be prepared in accordance with GAAP
x the information gathered from financial accounting is historical fact and is primarily concerned with the organization as a whole
Strategic Cost Management
x cost accounting is often defined narrowly as relating to the measurement of costs within an organization
x however, cost accounting information is increasingly being defined more broadly to include both financial and nonfinancial
information and to include items that do not relate strictly to the measurement of costs
x strategic cost management Æ expansion of management accounting to simultaneous focus on reducing costs and strengthening
an organization’s strategic position; which is what has emerged from the new trend
x as strategic cost management gains in popularity, organizations are also adopting balanced scorecards
x balanced scorecard Æ a formal approach used to help organizations translate their vision into objectives that can be measured
and monitored using both financial and nonfinancial performance measures
Information Systems and Management Decision-Making
x managers use many types of information to help make decisions, which can be gathered formally or informally
x formal methods include point-of-service optical character readers, such as those used when people purchase merchandise at retail
stores—track inventory levels, geographic distribution of sales, trends, relationships between prices and sales, and so on
x informal methods of collecting information—from both inside and outside an organization—are also important
x most organizations have many databases that contain info collected formally or informally from internal or external sources
x access to database information is often restricted to specific individuals
x in addition, much valuable information is not readily accessible because it is held in the minds of employees, which is called
intellectual capital and is not formally captured by an information system
x thus, it is difficult for decision makers, even within a firm, to gain access to all the information they might wish to use
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Internal and External Reports
x to facilitate decision-making and meet external reporting requirements, accounting departments use software to generate a
variety of internal and external reports that summarize or highlight information
x internal report Æ document that presents information for use only inside an organization, such as a capital budget, analysis of a
potential acquisition, operating and other budgets, bonus computations, and analysis of supplier quality
x external report Æ document that presents information for use outside an organization such as financial statements, news releases,
inventory reports for suppliers, tax return, and regulatory reports
x although reports are developed for a specific audience, they may be used for other purposes
x internal reports such as quarterly sales data can be shared with people outside the organization
x similarly, external reports such as financial statements are sometimes used within the organization
x in addition, organizations use reports prepared outside the organization for internal decision-making
Business Intelligence Systems
x recent information system developments have focused on BI
x the Internet and BI software provide opportunities for managers to save costs and improve profitability in the following ways:
o integrating systems: throughout an organization; between an organization and its customers and suppliers
o improving management of: customer relationships; supply chains; work teams within an organization
Improving Information and its Use in Decision-Making
Types of Uncertainties
x because decision makers cannot see the future (and even historical info is imperfect), they cannot perfectly predict future results
x many types of uncertainties cloud management decisions
x managers may be unable to—(1) accurately describe a problem; (2) identify all possible options; (3) know the outcomes of
various options; and (4) anticipate all future conditions
x higher-quality decisions result from better information as well as better decision processes
x organizations often use complex and sophisticated information systems to gather and organize information for decision-making
x because of this sophistication, some decision makers are mistakenly confident that info they use is correct, and ignore uncertainty
x other decision makers, recognizing that uncertainties always cloud decisions, go to the other extreme: instead of relying on
imperfect information, they believe it is sufficient to use only their intuition to make important business decisions
Relevant Information for Decision-Making
x relevant information Æ knowledge, facts, data, or factors that help the decision maker evaluate and choose among alternative
courses of action; concerns the future and varies with the action taken
x irrelevant information Æ knowledge, facts, data, factors, or issues that do not help the decision maker evaluate and choose
among alternative courses of action; does not vary with the action taken
x managers are less efficient and make lower-quality decisions when they allow irrelevant info to inappropriately influence choices
x whether a given type of information is relevant or irrelevant depends on the decision and other factors
Relevant and Irrelevant Cash Flows
x cash flows are commonly used as information in management decisions
x thus, managers often need to distinguish between relevant and irrelevant cash flows
x relevant cash flows Æ cash flows that occur under one course of action or decision alternative, but not under another; also called
incremental or avoidable cash flows because they are avoided if the course of action or decision alternative is not taken
x irrelevant (unavoidable) cash flow Æ cash flows that occur regardless of which course of action or decision alternative is chosen
x they are irrelevant for a specific decision because they do not help managers choose among alternatives
Identifying Relevant Cash Flows
x to identify relevant cash inflows and outflows, use an incremental cash flow approach
x in the lease-or-build decision, managers would identify any additional cash inflows and outflows that would occur if the new
facilities were built and compare them to the inflows and outflows for the lease option
The Impact of Biases
x biases cause decision makers to ignore information that is contrary to their preconceived notions
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