MANAGERIAL ACCOUNTING NOTES.docx

**MANAGERIAL ACCOUNTING LESSON 1** Managerial Accounting: An Overview This prologue explains why managerial accounting is important to the future careers of all business students. It begins by answering two questions: (1) What is managerial accounting? and (2) Why does managerial accounting matter...

**MANAGERIAL ACCOUNTING LESSON 1** Managerial Accounting: An Overview This prologue explains why managerial accounting is important to the future careers of all business students. It begins by answering two questions: (1) What is managerial accounting? and (2) Why does managerial accounting matter to your career? It concludes by discussing six topics---ethics, strategic management, enterprise risk management, corporate social responsibility, process management, and leadership that define the business context for applying the quantitative aspects of managerial accounting. **WHAT IS MANAGERIAL ACCOUNTING?** Many students enrolled in this course will have recently completed an introductory financial accounting course. Financial accounting is concerned with reporting financial information to external parties, such as stockholders, creditors, and regulators. Managerial accounting is concerned with providing information to managers for use within the orga-nization. Exhibit P-1 summarizes seven key differences between financial and managerial accounting. It recognizes that the fundamental difference between financial and managerial accounting is that financial accounting serves the needs of those outside the organiza-tion, whereas managerial accounting serves the needs of managers employed inside the EXHIBIT P- 1 Comparison of Financial and Managerial Accounting organization. Because of this fundamental difference in users, financial accounting emphasizes the financial consequences of past activities, objectivity and verifiability, precision, and companywide performance, whereas managerial accounting emphasizes decisions affecting the future, relevance, timeliness, and segment performance. A **segment** is a part or activity of an organization about which managers would like cost, revenue, or profit data. Examples of business segments include product lines, customer groups (segmented by age, ethnicity, gender, volume of purchase, etc.), geographic territories, divisions, plants, and departments. Finally, financial accounting is mandatory for external reports and it needs to comply with rules, such as generally accepted accounting principles (GAAP) and international financial reporting standards (IFRS), whereas managerial accounting is not mandatory and it does not need to comply with externally imposed rules. As mentioned in Exhibit P-1, managerial accounting helps managers perform three vital activities-planning, controlling, and decision making. **Planning** involves establishing goals and specifying how to achieve them. **Controlling** involves gathering feedback to ensure that the plan is being properly executed or modified as circumstances change. **Decision making** involves selecting a course of action from competing alterna-tives. Now let\'s take a closer look at these three pillars of managerial accounting. **PLANNING** Assume that you work for **Procter & Gamble (P&G)** and that you are in charge of the company\'s campus recruiting for all undergraduate business majors. In this example, your planning process would begin by establishing a goal such as: our goal is to recruit the \"best and brightest\" college graduates. The next stage of the planning process would require specifying how to achieve this goal by answering numerous questions such as: - How many students do we need to hire in total and from each major? - What schools do we plan to include in our recruiting efforts? - Which of our employees will be involved in each school\'s recruiting activities? - When will we conduct our interviews? - How will we compare students to one another to decide who will be extended job offers? - What salary will we offer our new hires? Will the salaries differ by major? - How much money can we spend on our recruiting efforts? As you can see, there are many questions that need to be answered as part of the planning process. Plans are often accompanied by a *budget*. A **budget** is a detailed plan for the future that is usually expressed in formal quantitative terms. As the head of recruiting at P&G, your budget would include two key components. First, you would have to work with other senior managers inside the company to establish a budgeted amount of total salaries that can be offered to all new hires. Second, you would have to create a budget that quantifies how much you intend to spend on your campus recruiting activities. **CONTROLLING** Once you established and started implementing P&G\'s recruiting plan, you would transition to the control process. This process would involve gathering, evaluating, and responding to feedback to ensure that this year\'s recruiting process meets expectations. It would also include evaluating the feedback in search of ways to run a more effective recruiting campaign next year. The control process would involve answering questions such as: - Did we succeed in hiring the planned number of students within each major and at each school? - Did we lose too many exceptional candidates to competitors? - Did each of our employees involved in the recruiting process perform satisfactorily? - Prologue - Is our method of comparing students to one another working? - Did the on-campus and office interviews run smoothly? - Did we stay within our budget in terms of total salary commitments to new hires? - Did we stay within our budget regarding spending on recruiting activities? As you can see, there are many questions that need to be answered as part of the control process. When answering these questions your goal would be to go beyond simple yes or no answers in search of the underlying reasons why performance exceeded or failed to meet expectations. Part of the control process includes preparing *performance reports.* A **performance report** compares budgeted data to actual data in an effort to identify and learn from excellent performance and to identify and eliminate sources of unsatisfactory performance. Performance reports can also be used as one of many inputs to help evaluate and reward employees. Although this example focused on P&G\'s campus recruiting efforts, we could have described how planning enables **FedEx** to deliver packages across the globe overnight, or how it helped **Apple** develop and market the iPad. We could have discussed how the control process helps **Pfizer, Eli Lilly,** and **Abbott Laboratories** ensure that their pharmaceutical drugs are produced in conformance with rigorous quality standards, or how **Kroger** relies on the control process to keep its grocery shelves stocked. We also could have looked at planning and control failures such as **BP\'s** massive oil spill in the Gulf of Mexico. In short, all manage **Decision Making** Perhaps the most basic managerial skill is the ability to make intelligent, data-driven deci-sions. Broadly speaking, many of those decisions revolve around the following three ques-tions. What should we be selling? Who should we be serving? How should we execute? Exhibit P-2 provides examples of decisions pertaining to each of these three categories. The left-hand column of Exhibit P-2 suggests that every company must make decisions related to the products and services that it sells. For example, each year **Procter & Gamble** must decide how to allocate its marketing budget across numerous brands that each generate over \$1 billion in sales as well as other brands that have promising growth potential. **Mattel** must decide what new toys to introduce to the market. **Southwest Airlines** must decide what ticket prices to establish for each of its thousands of flights per day. **General Motors** must decide whether to discontinue certain models of automobiles. The middle column of Exhibit P-2 indicates that all companies must make decisions related to the customers that they serve. For example, Sears must decide how to allocate its marketing budget between products that tend to appeal to male versus female custom-ers. FedEx must decide whether to expand its services into new markets across the globe. Hewlett-Packard must decide what price discounts to offer corporate clients that purchase large volumes of its products. A bank must decide whether to discontinue customers that may be unprofitable. EXHIBIT P-2 Examples of Decision +-----------------------+-----------------------+-----------------------+ | What should we be | Who should we be | How should we | | selling? | serving? | execute? | +-----------------------+-----------------------+-----------------------+ | What products and | Who should be the | How should we supply | | services should be | focus of our | our parts and | | the focus of our | marketing efforts? | services? | | marketing efforts? | | | | | products and | | | | services? | | +-----------------------+-----------------------+-----------------------+ | What new products and | Who should we start | How should we expand | | services should we | serving? | our capacity? | | offer? | | | +-----------------------+-----------------------+-----------------------+ | What prices should we | Who should pay price | How should we reduce | | charge for our | premiums or receive | our capacity? | | products and | price discounts? | | | services? | | | +-----------------------+-----------------------+-----------------------+ | What products and | Who should we stop | How should we improve | | services should we | serving? | our efficiency and | | discontinue? | | effectiveness? | +-----------------------+-----------------------+-----------------------+ **WHY DOES MANAGERIAL ACCOUNTING MATTER TO YOUR CAREER?** Many students feel anxious about choosing a major because they are unsure if it will pro- vide a fulfilling career. To reduce these anxieties, we recommend deemphasizing what you cannot control about the future; instead focusing on what you can control right now. More specifically, concentrate on answering the following question: What can you do now to prepare for success in an unknown future career? The best answer is to learn skills that will make it easier for you to adapt to an uncertain future. You need to become adaptable! Whether you end up working in the United States or abroad, for a large corporation, a small entrepreneurial company, a nonprofit organization, or a governmental entity, you\'ll need to know how to plan for the future, how to make progress toward achieving goals, and how to make intelligent decisions. In other words, managerial accounting skills are useful in just about any career, organization, and industry. If you commit energy to this course, you\'ll be making a smart investment in your future even though you cannot clearly envision it. Next, we will elaborate on this point by explaining how managerial accounting relates to the future careers of business majors and accounting majors **Business Majors** Exhibit P-3 provides examples of how planning, controlling, and decision making affect three majors other than accounting-marketing, supply chain management, and human resource management. The left-hand column of Exhibit P-3 describes some planning, controlling, and decision- making applications in the marketing profession. For example, marketing managers make planning decisions related to allocating advertising dollars across various communication mediums and to staffing new sales territories. From a control standpoint, they may closely track sales data to see if a budgeted price cut is generating an anticipated increase in unit sales, or they may study inventory levels during the holiday shopping season so that they can adjust prices as needed to optimize sales. Marketing managers also make many important decisions such as whether to bundle services together and sell them for one price or to sell each service separately. They may also decide whether to sell products directly to the customer or to sell to a distributor, who then sells to the end consumer. The middle column of Exhibit P-3 states that supply chain managers have to plan how many units to produce to satisfy anticipated customer demand. They also need to budget for operating expenses such as utilities, supplies, and labor costs. In terms of control, they monitor actual spending relative to the budget, and closely watch operational measures such as the number of defects produced relative to the plan. Supply chain managers make EXHIBIT P-3 Relating Managerial Accounting to Three Business Majors ----------------- ----------------------------------------------------------------------------- ------------------------------------------------------------------------------- ------------------------------------------------------------------------- Marketing Supply Chain Management HRM Planning How much should we budget for TV, print, and Internet advertising? How many units should we plan to produce next period? How much should we plan to spend for occupational safety training? How many salespeople should we plan to hire to serve a new territory? How much should we budget for next period\'s utility expense? How much should we plan to spend on employee recruitment advertising? Controlling Is the budgeted price cut increasing unit sales as expected? Did we spend more or less than expected for the units we actually produced? Is our employee retention rate exceeding our goals? Are we accumulating too. much inventory during the holiday shopping season? Are we achieving our goal of reducing the number of defective units produced? Are we meeting our goal of completing timely performance appraisals? Decision Making Should we sell our services as one bundle or sell them separately? Should we transfer production of a component part to an overseas supplier? Should we hire an on-site medical staff to lower our health care costs? Should we sell directly to customers or use a distributor? Should we redesign our manufacturing process to lower inventory levels? Should we hire temporary workers or full-time employees? ----------------- ----------------------------------------------------------------------------- ------------------------------------------------------------------------------- ------------------------------------------------------------------------- numerous decisions, such as deciding whether to transfer production of a component part to an overseas supplier. They also decide whether to invest in redesigning a manufacturing process to reduce inventory levels. The right-hand column of Exhibit P-3 explains how human resource managers make a variety of planning decisions, such as budgeting how much to spend on occupational safety training and employee recruitment advertising. They monitor feedback related to numerous management concerns, such as employee retention rates and the timely completion of employee performance appraisals. They also help make many important decisions such as whether to hire on-site medical staff in an effort to lower health care costs, and whether to hire temporary workers or full-time employees in an uncertain economy. For brevity, Exhibit P-3 does not include all business majors, such as finance, man- agement information systems, and economics. Can you explain how planning, control- ling, and decision-making activities would relate to these majors? **Accounting Majors** Many accounting graduates begin their careers working for public accounting firms that provide a variety of valuable services for their clients. Some of these graduates will build successful and fulfilling careers in the public accounting industry, however, most will leave public accounting at some point to work in other organizations. In fact, the Institute of Management Accountants (IMA) estimates that more than 80% of professional accountants in the United States work in nonpublic accounting environments (www.manet.org/ about\_ima/our\_mission.aspx). The public accounting profession has a strong financial accounting orientation. Its most important function is to protect investors and other external parties by assuring them that companies are reporting historical financial results that comply with applicable accounting rules. Managerial accountants also have strong financial accounting skills. For example, they play an important role in helping their organizations design and **A Networking Opportunity IN BUSINESS** The Institute of Management Accountants (IMA) is a network of more than 70,000 accounting and finance professionals from over 120 countries. Every year the IMA hosts a student leader- ship conference that attracts 300 students from over 50 colleges and universities. Guest speak- ers at past conferences have discussed topics such as leadership, advice for a successful career, how to market yourself in a difficult economy, and excelling in today\'s multigenerational work- force. One student who attended the conference said, \"I liked that I was able to interact with professionals who are in fields that could be potential career paths for me.\" For more informa- tion on this worthwhile networking opportunity, contact the IMA at the phone number and website shown below. Source: Conversation with Jodi Ryan, the Institute of Management Accountants\' Director, Education/ Corporate Partnerships. (201) 474-1556 or visit its website at [[www.imanet.org]](http://www.imanet.org) maintain financial reporting systems that generate reliable financial disclosures. However, the primary role of managerial accountants is to partner with their co-workers within the organization to improve performance. Given the 80% figure mentioned above, if you are an accounting major there is a very high likelihood that your future will involve working for a nonpublic accounting employer. Your employer will expect you to have strong financial accounting skills, but more importantly, it will expect you to help improve organizational performance by applying the planning, con- trolling, and decision-making skills that are the foundation of managerial accounting. **Professional Certification-A Smart Investment** If you plan to become an accounting major, the Certified Management Accountant (CMA) designation is a glob- ally respected credential (sponsored by the IMA) that will increase your credibility, upward mobility, and compensation. Exhibit P-4 summarizes the topics covered in the two-part CMA exam. For brevity, we are not going to define all the terms included in this exhibit. Its purpose is simply to emphasize that the CMA exam focuses on the planning, controlling, and decision-making skills that are critically important to nonpublic account- ing employers. The CMA\'s internal management orientation is a complement to the highly respected Certified Public Accountant (CPA) exam that focuses on rule-based compliance-assurance standards, financial accounting standards, business law, and the tax code. Information about becoming a CMA is available on the IMA\'s website (www. imanet.org) or by calling 1-800-638-4427. EXHIBIT P-4 CMA EXAM CONTENT SPECIFICATIONS +-----------------------------------+-----------------------------------+ | **Part 1** | **Part 2** | | | | | Financial Reporting, Planning, | Financial Decision Making | | Performance, and Control | | | | Financial statement analysis | | External financial reporting | | | decisions | Corporate finance | | | | | Planning, budgeting, and | Decision analysis. | | forecasting | | | | Risk management | | Performance management | | | | Investment decisions | | Cost management | | | | Professional ethics | | Internal controls | | +-----------------------------------+-----------------------------------+  question-how well am I performing relative to my plan? Chapter 3 teaches you mea- surement skills related to product, service, and customer profitability. However, it is vitally important that you also understand managerial accounting involves more than just \"crunching numbers.\" To be successful, managers must complement their measurement skills with six business management perspectives that \"go beyond the numbers\" to enable intelligent planning, control, and decision making. **An Ethics Perspective** Ethical behavior is the lubricant that keeps the economy running. Without that lubricant, the economy would operate much less efficiently-less would be available to consumers, quality would be lower, and prices would be higher. In other words, without fundamental trust in the integrity of business, the economy would operate much less efficiently. Thus, for the good of everyone-including profit-making companies-it is vitally important that business be conducted within an ethical framework that builds and sustains trust. **Code of Conduct for Management Accountants** The Institute of Management Accountants (IMA) of the United States has adopted an ethical code called the Statement of Ethical Professional Practice that describes in some detail the ethical responsibilities of management accountants. Even though the standards were developed specifically for man- agement accountants, they have much broader application. The standards consist of two parts that are presented in full in Exhibit P-6 (page 10). The first part provides general guidelines for ethical behavior. In a nutshell, a management accountant has ethical responsibilities in four broad areas: first, to maintain a high level of professional competence; second, to treat sensitive matters with confidentiality; third, to maintain personal integrity: and fourth, to disclose information in a credible fashion. The second part of the standards specifies what should be done if an individual finds evidence of ethical misconduct. The ethical standards provide sound, practical advice for management accountants and managers. Most of the rules in the ethical standards are motivated by a very practi- cal consideration-if these rules were not generally followed in business, then the economy and all of us would suffer. Consider the following specific examples of the consequences of not abiding by the standards: - Suppose employees could not be trusted with confidential information. Then top managers would be reluctant to distribute such information within the company and, as a result, decisions would be based on incomplete information and operations would deteriorate. - Suppose employees accepted bribes from suppliers. Then contracts would tend to go to the suppliers who pay the highest bribes rather than to the most competent suppli- ers. Would you like to fly in aircraft whose wings were made by the subcontractor who paid the highest bribe? Would you fly as often? What would happen to the air- line industry if its safety record deteriorated due to shoddy workmanship on con- tracted parts and subassemblies? - Suppose the presidents of companies routinely lied in their annual reports and financial statements. If investors could not rely on the basic integrity of a company\'s financial statements, they would have little basis for making informed decisions. Suspecting the worst, rational investors would pay less for securities issued by companies and may not be willing to invest at all. As a consequence, companies would have less money for productive investments-leading to slower economic growth, fewer goods and services, and higher prices. Not only is ethical behavior the lubricant for our economy, it is the foundation of managerial accounting. The numbers that managers rely on for planning, control, and decision making are meaningless unless they have been competently, objectively, and honestly gathered, analyzed, and reported. As your career unfolds, you will inevitably face decisions with ethical implications. Before making such decisions, consider performing the following steps. First, define your alternative courses of action. Second, identify all of the parties that will be affected by your decision. Third, define how each course of action will favorably or unfavorably impact each affected party. Once you have a complete understanding of the decision context, seek guidance from external sources such as the IMA Statement of Ethical Members of IMA shall behave ethically. A commitment to ethical professional practice includes: overarching principles that engess our vallies, and standards that guide our conduct. PRINCIPLES IMAs overarching ethical principles include: Honesty, Fairness, Objectivity, and Responsibility. Members shall act in accordance with these principles and shall encourage others within their organizations to adhere to them. STANDARDS A member\'s failure to comply with the following standards may result in disciplinary action. I. COMPETENCE Each member has a responsibility to: Maintain an appropriate level of professional expertise by continually developing knowledge and skills. 1. Perform professional duties in accordance with relevant laws, regulations, and technical standards. 2. Provide decision support information and recommendations that are accurate, clear, concise, and timely. 3. Recognize and communicate professional limitations or other constraints that would preclude responsible judgment or successful performance of an activity. II\. CONFIDENTIALITY Each member has a responsibility to: 1. Keep information confidential except when disclosure is authorized or legally required 2. Inform all relevant parties regarding appropriate use of confidential information. Monitor subordinates activities to ensure compliance. 3. Refrain from using confidential information for unethical or illegal advantage. III\. INTEGRITY Each member has a responsibility to: 1. Mitigate actual conflicts of interest. Regularly communicate with business associates to avoid apparent conflicts of interest.\ Advise all parties of any potential conflicts. 2. Refrain from engaging in any conduct that would prejudice carrying out duties ethically. 3. Abstain from engaging in or supporting any activity that might discredit the profession. IV\. CREDIBILITY Each member has a responsibility to 1. Communicate information fairly and objectively. 2. Disclose all relevant information that could reasonably be expected to influence an intended user\'s understanding of the reports, analyses, or recommendations. 3. Disclose delays or deficiencies in information, timeliness, processing, or internal controls in conformance with organization policy and/or applicable law. RESOLUTION OF ETHICAL CONFLICT In applying the Standards of Ethical Professional Practice, you may encounter problems identifying unethical behavior or resolving an ethical conflict. When faced with ethical issues, you should follow your organization\'s established policies on the resolution of such conflict. If these policies do not resolve the ethical conflict, you should consider the following courses of action: 1. Discuss the issue with your immediate supervisor except when it appears that the supervisor is involved. In that case, present the issue to the next level, If you cannot achieve a satisfactory resolution, submit the issue to the next management level. If your immediate superior is the chief executive officer or equivalent, the acceptable reviewing authority may be a group such as the audit committee, executive committee, board of directors, board of trustees, or owners. Contact with levels above the immediate superior should be initiated only with your superior\'s knowledge, assuming he or she is not involved Communication of such problems to authorities or individuals not employed or engaged by the organization is not considered appropriate, unless you believe there is a clear violation of the law. 2. Clarify relevant ethical issues by initiating a confidential discussion with an IMA Ethics Counselor or other impartial advisor to obtain a better understanding of possible courses of action. 3. Consult your own attorney as to legal obligations and rights concerning the ethical conflict. Professional Practice, the IMA Ethics Helpline at (800) 245-1383, or a trusted confidant. Before executing your decision ask yourself one final question-would I be comfortable disclosing my chosen course of action on the front page of The Wall Street Journal? Toyota Encounters Major Problems When Toyota Motor Corporation failed to meet its profit targets, the company set an aggressive goal of reducing the cost of its auto parts by 30%. The quality and safety of the company\'s automobiles eventually suffered mightily resulting in recalls, litigation, incentive campaigns, and marketing efforts that analysts estimate will cost the company more than \$5 billion. The car maker\'s president, Akio Toyoda, blamed his company\'s massive quality lapses on an excessive focus on profits and market share. Similarly, Jim Press, Toyota\'s former top U.S. executive, said the problems were caused by \"financially-oriented pirates who didn\'t have the character to maintain a customer-first focus.\" Sources: Yoshio Takahashi, \"Toyota Accelerates Its Cost-Cutting Efforts,\" The Wall Street Journal, December 23, 2009, P. B4; Mariko Sanchanta and Yoshio Takahashi, \"Toyota\'s Recall May Top \$5 Billion,\" The Wall Street sournal, March 10, 2010, p. B2; and Norihiko Shirouzu, \"Toyoda Rues Excessive Profit Focus,\" The Wall Street Journal, March 2, 2010, p. B3. A Strategic Management Perspective Companies do not succeed by sheer luck; instead, they need to develop a strategy that defines how they intend to succeed in the marketplace. A strategy is a \"game plan\" that enables a company to attract customers by distinguishing itself from competitors. The focal point of a company\'s strategy should be its target customers. A company can only succeed if it creates a reason for its target customers to choose it over a competitor. These reasons, or what are more formally called customer value propositions, are the essence of strategy. Customer value propositions tend to fall into three broad categories-customer inti-macy, operational excellence, and product leadership. Companies that adopt a customer intimacy strategy are in essence saying to their customers, \"You should choose us because we can customize our products and services to meet your individual needs better than our competitors.\" Ritz-Carlton, Nordstrom, and Virtuoso (a premium service travel agency) rely primarily on a customer intimacy value proposition for their success. Companies that pursue the second customer value proposition, called operational excellence, are saying to their target customers, \"You should choose us because we deliver products and services faster, more conveniently, and at a lower price than our competitors.\" Southwest Airlines, Walmart, and Google are examples of companies that succeed first and foremost because of their operational excellence. Companies pursuing the third customer value proposition, called product leadership, are saying to their target customers, \"You should choose us because we offer higher quality products than our competitors.\" Apple, Cisco Systems, and W.L, Gore (the creator of GORE-TEX® fabrics) are examples of companies that succeed because of their product leadership.\' The plans managers set forth, the variables they seek to control, and the decisions they make are all influenced by their company\'s strategy. For example, Walmart would not make plans to build ultra-expensive clothing boutiques because these plans would conflict with the company\'s strategy of operational excellence and \"everyday low prices.\" Apple would not seek to control its operations by selecting performance measures that focus solely on cost-cutting because those measures would conflict with its product leadership customer value proposition. Finally, it is unlikely that Rolex would decide to maplement drastic price reductions for its watches even if a financial analysis indicated that establishing a lower price might boost short-run profits. Rolex would oppose this course of action because it would diminish the luxury brand that forms the foundation of the company\'s product leadership customer value proposition. A Four-Year Waiting List at Vanilla Bicycles Sacha White started Vanilla Bicycles in Portland, Oregon, in 2001. After eight years in business, he had a four-year backlog of customer orders. He limits his annual production to 40-50 bikes per year that sell for an average of \$7,000 each. He uses a silver alloy that costs 20 times as much as brass (which is the industry standard) to join titanium tubes together to form a bike frame. White spends three hours taking a buyer\'s measurements to determine the exact dimensions of the bike frame. He has resisted expanding production because it would undermine his strategy based on product leadership and customer intimacy. As White said, \"If I ended up sacrificing what made Vanilla special just to make more bikes, that wouldn\'t be worth it to me.\" An Enterprise Risk Management Perspective Every strategy, plan, and decision involves risks. Enterprise risk management is a process used by a company to identify those risks and develop responses to them that enable it to be reasonably assured of meeting its goals. The left-hand column of Exhibit P-7 provides 12 examples of the types of business risks that companies face. They range from risks that relate to the weather to risks associated with computer hackers, complying with the law, employee theft, and products harming customers. The right-hand column of Exhibit P-7 provides an example of a control that could be implemented to help reduce each of the risks mentioned in the left-hand column of the exhibit. Although these types of controls cannot completely eliminate risks, they enable companies to proactively manage their risks rather than passively reacting to unfortunate events that have already occurred. In managerial accounting, companies use controls to reduce the risk that their plans will not be achieved. For example, if a company plans to build a new manufacturing facility within a predefined budget and time frame, it will establish and monitor control measures to ensure that the project is concluded on time and within the budget. Risk management is also a critically important aspect of decision making. For example, when a company quantifies the labor cost savings that it can realize by sending jobs overseas, it should complement its Managing the Risk of a Power Outage Between January and April of 2010, the United States had 35 major power outages. For business owners, these power outages can be costly. For example, a New York night club called the Smoke Jazz and Supper Club lost an estimated \$1,500 in revenue when a power outage shut down its on-line reservation system for one night. George Pauli, the owner of Great Embroidery LLC in Mesa, Arizona, estimates that his company has an average of six power outages every year. Since Pauli\'s sewing machines cannot resume exactly where they leave off when abruptly shut down, each power outage costs him \$120 in lost inventory. Pauli decided to buy \$700 worth of batteries to keep his sewing machines running during power outages. The batteries paid for themselves in less than one year. EXHIBIT P-7 Identifying and Controlling Business Risks  financial analysis with a prudent assessment of the accompanying risks. Will the overseas manufacturer use child labor? Will the product\'s quality decline, thereby leading to more warranty repairs, customer complaints, and lawsuits? Will the elapsed time from customer order to delivery dramatically increase? Will terminating domestic employees diminish orale within the company and harm perceptions within the community? These are the types of risks that managers should incorporate into their decision-making processes. A Corporate Social Responsibility Perspective Companies are responsible for creating strategies that produce financial results that satisfy stockholders. However, they also have a corporate social responsibility to serve other stakeholders-such as customers, employees, suppliers, communities, and environmental and human rights advocates-whose interests are tied to the company\'s performance. Corporate social responsibility (CR) is a concept whereby organizations consider the meeds of all stakeholders when making decisions. CSR extends beyond legal compliance to include voluntary actions that satisfy stakeholder expectations. Numerous companies, such as Procter & Gamble, 3M, Eli Lilly, and Company, Starbucks, Microsoft, Genentech, Johnson & Johnson, Baxter International, Abbott Laboratories, KPMG, PNC Bank, Deloitte, Southwest Airlines, and Caterpillar, prominently describe their corporate social performance on their websites. Exhibit P-8 presents examples of corporate social responsibilities that are of interest to six stakeholder groups? If a company fails to meet the needs of these six stakeholder groups it can adversely affect its financial performance. For example, if a company pollutes the environment or fails to provide safe and humane working conditions for its employees, the negative publicity from environmental and human rights activists could cause the company\'s customers to defect and its \"best and brightest\" job candidates to apply elsewhere-both of which are likely to eventually harm financial performance. This explains why in managerial accounting a manager must establish plans, implement controls, and make decisions that consider impacts on all stakeholders. A Process Management Perspective Most companies organize themselves by functional departments, such as the Marketing Department, the Research and Development Department, and the Accounting Department. These departments tend to have a clearly defined \"chain of command\" that specifies superior and subordinate relationships. However, effective managers understand that business processes, more so than functional departments, serve the needs of a company\'s most important stakeholders-its customers. A business process is a series of steps that are followed in order to carry out some task in a business. These steps often span departmental boundaries, thereby requiring managers to cooperate across functional depart-ments. The term value chain is often used to describe how an organization\'s functional  departments interact with one another to form business processes. A value chain, as pany\'s products and services. shown in Exhibit P-9, consists of the major business functions that add value to a com- Managers need to understand the value chain to be effective in terms of planning, con-rol, and decision making. For example, if\'a company\'s engineers plan to design a new product, they must communicate with the Manufacturing Department to ensure that the product can actually be produced, the Marketing Department to ensure that customers il buy the product, the Distribution Department to ensure that large volumes of the product can be cost-effectively transported to customers, and the Accounting Department as ensure that the product will increase profits. From a control and decision-making standpoint, managers also need to focus on process excellence instead of functional per-Somance. For example, if the Purchasing Department focuses solely on minimizing the post of purchased materials, this narrowly focused attempt at cost reduction may lead to meater scrap and rework in the Manufacturing Department, more complaints in the Customer Service Department, and greater challenges in the Marketing Department because dissatisfied customers are turning their attention to competitors. Managers frequently use a process management method known as lean thinking, or shat is called Lean Production in the manufacturing sector. Lean Production is a man-gement approach that organizes resources such as people and machines around the flow sE business processes and that only produces units in response to customer orders. It is sten called just-in-time production (or JIT) because products are only manufactured in sponse to customer orders and they are completed just-in-time to be shipped to custom-ers. Lean thinking differs from traditional manufacturing methods, which organize work departmentally and encourage departments to maximize their output even if it exceeds castomer demand and bloats inventories. Because lean thinking only allows production is response to customer orders, the number of units produced tends to equal the number sE units sold, thereby resulting in minimal inventory. The lean approach also results in fewer defects, less wasted effort, and quicker customer response times than traditional production methods. Greenpeace Leverages the Power of Social Media anen Nestlé purchased palm oil from an Indonesian supplier to manufacture Kit-Kat candy bars Sreenpeace International used social media to express its disapproval. Greenpeace claimed that the Indonesian company destroyed rainforest to create its palm oil plantation; therefore, Nestlé\'s actions were contributing to global warming and endangering orangutans. Greenpeace posted YouTube videos, added comments to Nestlé\'s Facebook page, and sent Twitter Tweets to communicate its message to supporters. At one point, the number of fans on Nestlé\'s Facebook page grew to 95,000, most of them being protesters. Nestlé terminated its relationship with the supplier, which provided 1.25% of Nestlé\'s palm oil needs. A Nestlé spokesperson says the dif-iculty in responding to social media is to \"show that we are listening, which we obviously are, while not getting involved in a shouting match.\" Louis Vuitton Implements Lean Production Louis Vuitton, headquartered in Paris, France, used lean production to increase its manufacturing capacity without having to build a new factory. It created U-shaped work arrangements for teams of 10 workers, thereby freeing up 10% more floor space in its factories. The company was able to hire 300 more workers without adding any square footage. Louis Vuitton also uses robots and computer programs to reduce wasted leather and the time needed to perform certain tasks. A Leadership Perspective An organization\'s employees bring diverse needs, beliefs, and goals to the workplace. Therefore, an important role for organizational leaders is to unite the behaviors of their fellow employees around two common themes-pursuing strategic goals and making optimal decisions. To fulfill this responsibility, leaders need to understand how intrinsic motivation, extrinsic incentives, and cognitive bias influence human behavior. Intrinsic Motivation Intrinsic motivation refers to motivation that comes from within us. Stop for a moment and identify the greatest accomplishment of your life. Then ask yourself what motivated you to achieve this goal? In all likelihood, you achieved it because you wanted to, not because someone forced you to do it. In other words, you were intrinsically motivated. Similarly, an organization is more likely to prosper when its employees are intrinsically motivated to pursue its interests. A leader, who employees perceive as credible and respectful of their value to the organization, can increase the extent to which those employees are intrinsically motivated to pursue strategic goals. As your career evolves, to be perceived as a credible leader you\'ll need to possess three attributes--- technical competence (that spans the value chain), personal integrity (in terms of work ethic and honesty), and strong communication skills (including oral presentation skills and writing skills). To be perceived as a leader who is respectful of your co-workers\' value to the organization, you\'ll need to possess three more attributes-strong mentoring skills (to help others realize their potential), strong listening skills (to learn from your co-workers and be responsive to their needs), and personal humility (in terms of deferring recognition to all employees who contribute to the organization\'s success). If you possess these six traits, then you\'ll have the potential to become a leader who inspires others to readily and energetically channel their efforts toward achieving organizational goals. Extrinsic Incentives Many organizations use extrinsic incentives to highlight important goals and to motivate employees to achieve them. For example, assume a company establishes the goal of reducing the time needed to perform a task by 20%. In addi-tion, assume the company agrees to pay bonus compensation to its employees if they achieve the goal within three months. In this example, the company is using a type of extrinsic incentive known as a bonus to highlight a particular goal and to presumably motivate employees to achieve it. While proponents of extrinsic incentives rightly assert that these types of rewards can have a powerful influence on employee behavior, many critics warn that they can also produce dysfunctional consequences. For example, suppose the employees mentioned above earned their bonuses by achieving the 20% time reduction goal within three months. However, let\'s also assume that during those three months the quality of the employees\' output plummeted, thereby causing a spike in the company\'s repair costs, product returns, and customer defections. In this instance, did the extrinsic incentive work properly? The answer is yes and no. The bonus system did motivate employees to attain the time reduction goal; however, it also had the unintended consequences of causing employees to neglect product quality, thereby increasing repair costs, product returns, and customer defections. In other words, what may have seemed like a well-intended extrinsic incentive actually produced dysfunctional results for the company. This example highlights an important leadership challenge that you are likely to face someday-designing financial compensation systems that fairly reward employees for their efforts without inadvertently creating extrinsic incentives that motivate them to take actions that harm the company. Cognitive Bias Leaders need to be aware that all people (including themselves) possess cognitive biases, or distorted thought processes, that can adversely affect planning, controlling, and decision making. To illustrate how cognitive bias works, let\'s consider the scenario of a television \"infomercial\" where someone is selling a product with a proclaimed value of \$200 for \$19.99 if viewers. call within the next 30 minutes. Why do you think the seller claims that the product has a \$200 value? The seller is relying on a cognitive bias called anchoring bias in an effort to convince viewers that a \$180 discount is simply too good to pass up. The \"anchor\" is the false assertion that the product is actually worth \$200. If viewers erroneously attach credibility so this contrived piece of information, their distorted analysis of the situation may cause them to spend \$19.99 on an item whose true economic value is much less than that amount. While cognitive biases cannot be eliminated, effective leaders should take two steps to reduce deir negative impacts. First, they should acknowledge their own susceptibility to cognitive bias. For example, a leader\'s judgment might be clouded by optimism bias (being overly optimistic in assessing the likelihood of future outcomes) or self-enhancement bias (overestimating ones strengths and underestimating ones weaknesses relative to others). Second, they should acknowledge the presence of cognitive bias in others and introduce techniques to minimize their adverse consequences. For example, to reduce the risks of confirmation bias (a bias where people pay greater attention to information that confirms their preconceived notions, while devaluing information that contradicts them) or groupthink bias (a bias where some group members support a course of action solely because other group members do), a leader may routinely appoint independent teams of employees to assess the credibility of recommendations set forth by other andividuals and groups. SUMMARY This prologue defined managerial accounting and explained why it is relevant to business and counting majors. It also discussed six topics- ethics, strategic management, enterprise risk anagement, corporate social responsibility, process management, and leadership-that define ame context for applying the quantitative aspects of managerial accounting. The most important acel of the prologue was to help you understand that managerial accounting matters to your faere career regardless of your major. Accounting is the language of business and you\'ll need to speak it to communicate effectively with and influence fellow managers. GLOSSARY an the end of each chapter, a list of key terms for review is given, along with the definition of each term. These terms are printed in boldface where they are defined in the chapter.) Carefully study each term to be are you understand its meaning. The list for the Prologue follows. dget A detailed plan for the future that is usually expressed in formal quantitative terms. (p. 3) asiness process A series of steps that are followed in order to carry out some task in a business. (p. 14) Castrolling The process of gathering feedback to ensure that a plan is being properly executed or modified as circumstances change. (p. 3) Corporate social responsibility A concept whereby organizations consider the needs of all stakeholders when making decisions. (p. 13) ecision making Selecting a course of action from competing alternatives. (p. 3) aterprise risk management A process used by a company to identify its risks and develop responses to them that enable it to be reasonably assured of meeting its goals. (p. 12)