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ISBN-10: ISBN-13: 2012 1121539998 9781121539990
x Preface
The basic structure of Part 2 remains intact. A discussion of time-driven activitybased costing was added, along with supporting examples and case materials. Other charges provide updated statistics, improved clarity of discussion, and new problems and cases.
ACKNOWLEDGMENTS
Wearegratefultothemanyinstructorsandstudentswhohavemadesuggestionsforimprovingthisbook.IncludedamongthosepeopleareourcolleaguesattheHarvardBusinessSchoolandtheMarshallSchoolofBusiness,UniversityofSouthernCalifornia,as wellasthefollowing:RussOlive,MassachusettsInstituteofTechnology;Pamela Stuerke,CaseWesternReserveUniversity;MarvinCarlson,SouthernMethodist University;AlanLord,BowlingGreenStateUniversity;andMarcManalastas,Mary VictoriaD.Arce,andJonStuartLim-Vaña,AteneodeManilaUniversity,thePhilippines. Weextendourthankstothereviewerswhocommentedonthetwelfthedition,aswellas previouseditions:TimothyMoffit,KalamazooCollege;MichaelErlerandRichard Rogers,IndianaUniversity;LauriePant,SuffolkUniversity;ClaudeLanfranconi, RichardIveySchoolofBusiness;ThomasKamandWarrenWee,HawaiiPacificUniversity;LenWeld,TroyStateUniversity;MehmetKocaculah,UniversityofSouthern Indiana;ByronK.Henry,HowardUniversity;JefferyKahn,WoodburyUniversity; PamelaRouse,ButlerUniversity;LindaBrown,SaintAmbroseUniversity;AnnL. Watkins,HighPointUniversity;SaadLaraqui,Embry-RiddleAeronauticalUniversity; NoelAddy,MississippiStateUniversity;PhilipDarcy,RegisUniversity;Frances LynnTelavera,NationalUniversity;PatriciaCummins,TroyStateUniversity;Reba Cunningham,UniversityofDallas;KrishagopalMenon,BostonUniversity;Leonardo Rodriguez,FloridaInternationalUniversity;RobertMedden,St.FrancisXavierUniversity;WilliamS.Hopwood,FloridaAtlanticUniversity;AndrewFelo,PennsylvaniaState University;DavidHurtt and Jack Ruhl,WesternMichiganUniversity;StanDavis,Wake ForestUniversity; Tom Hrubec, Franklin University; Warren Wee, Hawaii Pacific University.
We also would like to thank Beth Woods, Lisa Enfinger, Helen Roybark, and Alice Sineath for their help in accuracy checking the text and Thomas Hrubec of Franklin University for creating PowerPoint® presentations to accompany the text.
Robert N. Anthony
David F. Hawkins
Kenneth A. Merchant
Index and Source of Cases
The 109 cases included in this book are listed below in alphabetical order, together with their authors’names and the institution with which each author was affiliated at the time the case was written. Cases with no name shown were written by, or under the supervision of, one of the authors of this book. The copyright on all cases is indicated on the first page of each case. No case may be reproduced in any form or by any means without the permission of its copyright holder. Information on requesting permission to reproduce Harvard Business School cases is included on the copyright page of this book. We regret that we are unable to provide permission information for cases not copyrighted by Harvard.
TitleAuthor
Accounting at MacCloud Winery
Accounting Fraud at WorldCom
Amerbran Company (A)
Amerbran Company (B)
Armco Inc.: Midwestern Steel Division
Axeon N.V.
Baldwin Bicycle Company
Baron Coburg
Behavioral Implications of Airline Depreciation
Accounting Policy Choices
Bennett Body Company
Berkshire Industries PLC
Bill French
Black Meter Company
Body Glove
Borealis
Brisson Company
Browning Manufacturing Company
Butter Lumber Company
California Creamery, Inc.
Campar Industries, Inc.
Carter Corporation
Copies Express
Cotter Company, Inc.
Profs. David F. Hawkins, Robert S. Kaplan, and Gregory S. Miller, Harvard Business School
Profs. Robert S. Kaplan, Harvard Business School and David Kiron, Global Research Group.
Prof. James S. Reese, University of Michigan
Prof. James S. Reese, University of Michigan
Profs. Kenneth A. Merchant, London School of Economics and Wim A. Van der Stede, University of Southern California
Prof. W. T. Andrews, Guilford College
Profs. C. A. Bliss and R. N. Anthony, Harvard Business School
Profs. Kenneth A. Merchant, London School of Economics and Wim A. Van der Stede, University of Southern California
R. C. Hill and Prof. N. E. Harlan, Harvard Business School
Profs. Bjorn Jorgensen and Robert S. Kaplan, Harvard Business School
Profs. Kenneth A. Merchant, London School of Economics and Wim A. Van der Stede, University of Southern California
Prof. R. F. Vancil, Harvard Business School
xxiv Index and Source of Cases
Darius Company
Delaney Motors
Dispensers of California, Inc.
Enager Industries, Inc.
Formosa Plastics Group
Forner Carpet Company
Freedom Technology Company
Genmo Corporation
Grennell Farm
Hardin Tool Company
Harwood Medical Instruments PLC
Hospital Supply, Inc.
Huron Automotive Company
Identify the Industries
Import Distributors, Inc.
Industrial Electronics, Inc.
Innovative Engineering Company
Joan Holtz (A)
Joan Holtz (B)
Joan Holtz (C)
Joan Holtz (D)
Kim Fuller
Kim Park
Landau Company
Las Ferreterías de México, S.A. de C.V.
Leasing Computers at Persistent Learning
Lewis Corporation
Lipman Bottle Company
Lone Pine Cafe (A)
Lone Pine Cafe (B)
Lupton Company
Lynch’s Chicken Ranch, Inc.
Profs. A. Reinstein, University of Detroit and R. N. Anthony, Harvard Business School
Prof. James S. Reece, University of Michigan
Prof. James S. Reece, University of Michigan
J. Brown and Prof. John K. Shank, Harvard Business School
Prof. Michael W. Maher, University of California, Davis
Prof. James S. Reece, University of Michigan
Jeremy Cott and Profs. Sharon M. McKinnon, Northeastern University, and William J. Bruns Jr., Harvard Business School
Prof. James S. Reece, University of Michigan
Prof. James S. Reece, University of Michigan
Profs. C. B. Nickerson and R. N. Anthony, Harvard Business School
Profs. David Hawkins, Gregory S. Miller, and V. G. Narayaman, Harvard Business School
Prof. James S. Reece, University of Michigan
Profs. Kenneth A. Merchant, London School of Economics and Wim A. Van der Stede, University of Southern California
Prof. Devin Shanthikumar, Harvard Business School
Prof. M. J. Sandretto, Harvard Business School
Prof. James S. Reece, University of Michigan
Profs. Kenneth A. Merchant and Lesley Porter, University of Southern California
Maynard Company (A)
Maynard Company (B)
Maxim Integrated Products
Medieval Adventures Company
Medi-Exam Health Services, Inc.
Midwest Office Products
Morgan Manufacturing
Music Mart, Inc.
National Association of Accountants
Norman Corporation (A)
Norman Corporation (B)
Olympic Car Wash
Patagonia, Inc.
Paul Murray
PC Depot
Phuket Beach Hotel: Valuing Mutually
Prof. James S. Reece, University of Michigan
Prof. Robert S. Kaplan, Harvard Business School
Prof. Julie H. Hertenstein, Northeastern University
Profs. Kenneth A. Merchant, University of Southern California and Wim A. Van der Stede, London School of Economics
Profs. Su Han Chan and Ko Wang and Mary Wong, Exclusive Capital ProjectsUniversity of Hong Kong
Piedmont University
Pinetree Motel
The Politics and Economics of Accounting
Profs. James S. Reece, University of Michigan
Karthik Ramanna, Harvard Business School for Goodwill at Cisco Systems
Polymedica Corporation (A)
Precision Worldwide, Inc.
Prestige Telephone Company
Private Fitness LLC
Productos Finas
Proxim, Inc.
Puente Hills Toyota
Quick Lunch
Ribbons an’Bows, Inc.
Rock Creek Golf Club
SafetyMonitoringDevices,Inc.
Save-Mart
Shelter Partnership, Inc.
Shuman Automobiles, Inc.
Profs. David F. Hawkins, Harvard Business School, and Jacob Cohen, INSEAD
Prof. William J. Bruns Jr., Harvard Business School
Prof. William J. Bruns Jr., Harvard Business School
Prof. Mark Bradshaw, Harvard Business School
Profs. Kenneth A. Merchant, University of Southern California, Wim A. Van der Stede, London School of Economics, and Prof. Pieter Jansen, University of Groningen
Profs. Robert O. Schlaifer and Robert N. Anthony, Harvard Business School
Prof. James S. Reece, University of Michigan
Prof.WimA.VanderStede, LondonSchoolofEconomics
A. M. McCosh and Profs. David Hawkins, J. R. Yeager, and James S. Reece, Harvard Business School
xxvi Index and Source of Cases
Silic: Choosing Cost or Fair Value
Prof. David Hawkins, Harvard Business School, on Adoption of IFRS Vincent Dessain, and Anthony Barron, Harvard Business School Europe Research Center
Silver Appliance Company
Sinclair Company
Sippican Corporation (A)
Sippican Corporation (B)
Springfield National Bank
Stafford Press
Stern Corporation (A)
Stern Corporation (B)
SunAir Boat Builders, Inc.
Supplement to Identify the Industries
Tru-Fit Parts, Inc.
Tokyo AFM
UPC, Inc.
Waikerie Co-operative Producers, Ltd.
Waltham Oil and Lube Center, Inc.
Wareham SC Systems, Inc.
Woodside Products
Xytech, Inc.
Zumwald AG
Prof. James S. Reece, University of Michigan
Prof. Robert S. Kaplan, Harvard Business School
Prof. Robert S. Kaplan, Harvard Business School
Prof. Ray G. Stephens, The Ohio State University
Prof. James S. Reece, University of Michigan
Prof. James S. Reece, University of Michigan
Profs. M. E. Bennett and James S. Reece, Harvard Business School
Prof. Charles M. Williams, Harvard Business School
Prof. James S. Reece, University of Michigan
Prof. Francois Brochet, Harvard Business School
Prof. James S. Reece, University of Michigan
Profs. Kenneth A. Merchant, London School of Economics and Wim A. Van der Stede, University of Southern California
Organizations can be classified broadly as either for-profit or nonprofit. As these names suggest, a dominant purpose of organizations in the former category is to earn a profit, whereas organizations in the latter category have other objectives, such as governing, providing social services, and providing education. Accounting is basically similar in both types of organizations.
The Need for Information
In its details, information differs greatly among organizations of various types. But viewed broadly, the information needs of most organizations are similar. We shall outline and illustrate these general information needs by referring to Varsity Motors, Inc., an automobile dealership.
Varsity Motors seeks to earn a profit by selling new and used automobiles and parts and accessories, and by providing repair service. It is an organization of 52 people headed by Pat Voss, its president. It owns a building that contains the showroom, service shop, a storeroom for parts and accessories, and office space. It also owns a number of new and used automobiles, which it offers for sale; an inventory of spare parts, accessories, and supplies; and cash in the bank. These are examples of the resources the company needs to conduct its business.
Illustration1–1 depicts the different types of information that might be useful to people interested in Varsity Motors. As shown in the illustration, information can be either quantitative or nonquantitative. Quantitative information is information that is expressed in numbers. Examples of nonquantitative information are visual impressions,
ILLUSTRATION
1–1
Types of Information
conversations, television programs, and newspaper stories. Accounting is primarily concerned with quantitative information.
Accounting is one of several types of quantitative information. Accounting information is distinguished from the other types in that it usually is expressed in monetary terms. Data on employees’ages and years of experience are quantitative, but they are not usually considered to be accounting information. The line here is not sharply drawn, however; nonmonetary information is often included in the notes to accounting reports when it will help the reader understand the report. For example, an accounting sales report for Varsity Motors would show not only the monetary amount of sales revenue, but also the number of automobiles sold, which is nonmonetary information. What information is needed about the amounts and financing of the resources used in Varsity Motors and the results achieved by the use of these resources? This information can be classified into four categories: (1)operating information, (2)financial accounting information, (3)management accounting information, and (4)tax accounting information. Each is shown in the bottom section of Illustration 1–1.
A considerable amount of operating information is required to conduct an organization’s day-to-day activities. For example, Varsity Motors’employees must be paid exactly the amounts owed them, and the government requires that records be maintained for each employee showing amounts earned and paid, as well as various deductions. The sales force needs to know what automobiles are available for sale and each one’s cost and selling price. When an automobile is sold, a record must be made of that fact. The person in the stockroom needs to know what parts and accessories are on hand; and if the inventory of a certain part becomes depleted, this fact needs to be known so that an additional quantity can be ordered. Amounts owed by the company’s customers need to be known; and if a customer does not pay a bill on time, this fact needs to be known so that appropriate action can be taken. The company needs to know the amounts it owes to others, when these amounts should be paid, and how much money it has in the bank.
Operating information constitutes by far the largest quantity of accounting information. As suggested by the arrows at the bottom of Illustration 1–1, operating information provides much of the basic data for management accounting, financial accounting, and tax accounting.
Only in rare instances can outside parties insist that an organization furnish information tailor-made to their specifications. In most cases, they must accept the information that the organization chooses to supply. They could not conceivably understand this information without knowing the ground rules that governed its preparation. Moreover, they cannot be expected to learn a new set of ground rules for each organization of interest to them, nor can they compare information about two organizations unless both sets of information are prepared according to common ground rules. These ground rules are the subject matter of financial accounting (also called financial reporting).
Varsity Motors’president, vice president of sales, service manager, and other managersdo not have the time to examine the details of the operating information. Instead, they rely on summaries of this information. They use these summaries, together with other information, to carry out their management responsibilities. The accounting information specifically prepared to aid managers is called management accounting information. This information is used in three management functions: (1)planning, (2)implementation, and (3)control.
Planning
Performed by managers at all levels, in all organizations, planning is the process of deciding what actions should be taken in the future. A plan may be made for any segment of the organization or for the entire organization. When Varsity Motors’service manager decides the order in which automobiles will be repaired and which mechanic will work on each of them, the service manager is engaged in planning in the same sense as, but on a smaller scale than, the president when the latter decides to build a new showroom and service facility.
An important form of planning is budgeting. Budgeting is the process of planning the overall activities of the organization for a specified period of time, usually a year. A primary objective of budgeting is to coordinate the separate plans made for various segments of the organization to ensure that these plans harmonize with one another. For example, Varsity’s sales plans and service department capacity plans must be consistent. Also, budgeting helps managers determine whether the coming year’s activities are likely to produce satisfactory results and, if not, what should be done. Even tiny organizations find budgeting useful; many persons prepare a budget for their household.
Accounting is related to all of the activities described above, and in all of them the emphasis is on using accounting information in the process of making decisions. Both managers within an organization and interested outside parties use accounting information in making decisions that affect the organization. Thus, of the several available definitions of accounting, the one developed by an American Accounting Association committee is perhaps the best because of its focus on accounting as an aid to decision making. This committee defined accounting as the process of identifying, measuring, and communicating economic information to permit informed judgments and decisions by users of the information.
The Profession of Accounting
In most organizations the accounting group is the largest staff unit, that is, the largest group other than the “line” activities of production and marketing. The accounting group consists essentially of two types of people: (1)bookkeepers and other data-entry employees who maintain the detailed operating records and (2)staff accountants whodecide how items should be reported, prepare the reports, interpret these reports, prepare special analyses, design and operate the systems through which information flows, and ensure that the information is accurate.
All publicly owned companies and many other organizations have their accounting reports audited by an independent public accounting firm. These firms also perform other services for clients. Some of these firms are very large with tens of thousands of employees and hundreds of offices around the world, with annual revenues totaling billions of dollars. They are far larger than any law firm, medical group practice, orother professional firm. At the other extreme, thousands of independent public accountants practice as individuals.
We described above four types of accounting information: operating information, financial accounting information, management accounting information, and tax accounting information. Since our viewpoint is that of the current and potential users (as opposed to preparers) of accounting information, we shall not describe operating and tax accounting information in any great detail. The book is therefore divided into two approximately equal parts, the first on financial accounting and the second on management accounting.
The discussion of financial accounting comes first because the structure of financial accounting underlies all accounting. This structure consists of a few basic principles and concepts, a set of relationships among the elements comprising the accounting system, a terminology, and a number of rules and guidelines for the application of the principles and concepts to specific situations. We shall describe the financial accounting structure in a general way in Chapters 2, 3, and 4; and we shall then go over the same ground again in more detail in Chapters 5 through 14.
The second half of the book discusses the nature and use of management accounting information. The management of an organization can establish whatever ground rules it wishes for the accounting information collected for its own use. Thus, although the principles of financial accounting are applicable to all organizations, the rules of management accounting are tailor-made to meet the needs of the management of a specific organization.
Nevertheless, a similarity exists in both financial accounting practices and management accounting practices in most organizations. There are obvious economies in using financial accounting information wherever possible for management accounting purposes rather than devising two completely different systems for the two purposes.
The Financial Accounting Framework
Suppose you were asked to keep track of what was going on in an organization in order to provide useful information for management. One way of carrying out this assignment would be to write down a narrative of important events in a log similar to that kept by the captain of a ship.
After some experience with your log, you would gradually develop a set of rules to guide your efforts. For example, since it would be impossible to write down every action of every person in the organization, you would develop rules to guide you in choosing between those events that were important enough to record and those that should be omitted. You also would find that your log would be more valuable if you standardized certain terms. People who studied it would then have a clearer understanding of what you meant. Furthermore, if you standardized terms and their definitions, you could turn the job of keeping the log over to someone else and have some assurance that this person’s report of events would convey the same information that you would have conveyed had you been keeping the log yourself.
In devising these rules of keeping a log, you would necessarily be somewhat arbitrary. There might be several ways of describing a certain event, all equally good. But in order to have a common basis of understanding, you would select just one of these for use in your recordkeeping system. 8 Part 1
Part 1
Criteria
Example
guide to action. This means that accounting principles do not prescribe exactly how each event occurring in an organization should be recorded. Consequently, there are many matters in accounting practice that differ from one organization to another. Most of these differences are inevitable because a single detailed set of rules could not conceivably apply to every organization. In part, the differences reflect that, within “generally accepted accounting principles,” management has some latitude in which to express its own ideas about the best way of recording and reporting a specific event.
Readers should realize, therefore, that they cannot know the precise meaning of a number of the items in an accounting report unless they know which of several equally acceptable possibilities has been selected by the person who prepared the report. The meaning intended in a specific situation requires knowledge of the context.
Accounting principles are established by humans. Unlike the principles of physics, chemistry, and the other natural sciences, accounting principles were not deduced from basic axioms, nor can they be verified by observation and experiment. Instead, they have evolved. This evolutionary process is going on constantly; accounting principles are not eternal truths.
The general acceptance of an accounting principle usually depends on how well it meets three criteria: relevance, objectivity, and feasibility. A principle has relevance to the extent that it results in information that is meaningful and useful to those who need to know something about a certain organization. A principle has objectivity to the extent that the resulting information is not influenced by the personal bias or judgment of those who furnish it. Objectivity connotes reliability, trustworthiness. It also connotes verifiability, which means that there is some way of finding out whether the information is correct. A principle has feasibility to the extent that it can be implemented without undue complexity or cost.
These criteria often conflict with one another. In some cases the most relevant solution may be the least objective and the least feasible. Often, in this situation a less relevant but more objective and more feasible solution may be selected.
The development of a new product may have a significant effect on a company’s real value— “miracle” drugs and personal computer chips being spectacular examples. Information about the value of new products is most useful to the investor; it is indeed relevant. But the best estimate of the value of a new product is likely to be that made by management, and this is ahighly subjective estimate. Accounting therefore does not attempt to record such values. Accounting sacrifices relevance in the interests of objectivity.
The measure of the value of the owners’ interest or equity in a biotechnology firm such as Genentech, Inc., obtained from the stock market quotations (i.e., multiplying the price per share of stock times the number of shares outstanding) is a much more accurate reflection of the true value than the amount listed as owners’ equity that appears in the corporation’s financial statements. The marketplace gave this value as $26.4 billion; the accounting records gave it as $6.8 billion. The difference does not indicate an error in the accounting records. It merely illustrates the fact that accounting does not attempt to report firm market values.
In developing new principles, the essential problem is to strike the right balance between relevance on the one hand and objectivity and feasibility on the other. Failure to appreciate this problem often leads to unwarranted criticism of accounting principles. It is easy to criticize accounting on the grounds that accounting information is not as relevant as it might be; but the critic often overlooks the fact that proposals to increase
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