ANSWERS TO QUESTIONS

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ANSWERS TO QUESTIONS

• The primary difference between financial and managerial accounting is the intended

user of the information. Financial accounting is used by external parties such as investors, creditors, and regulators, while managerial accounting is used by internal business managers.

• Different users will have different information needs, which give rise to many other

differences between financial and managerial accounting. Financial accounting includes standardized financial statements that are objective, reliable, and historic in nature. These reports are prepared on a periodic basis and are reported at a highly aggregate level, for the company as a whole. Managerial accounting information is much broader in nature and can encompass budgets, performance evaluations, and cost accounting reports. The information tends to be more subjective and future-oriented in nature and must be relevant to the particular decision the manager is trying to make. The information in these reports tends to be more detailed and segmented, depending on the manager’s area of responsibility.

• GAAP-based financial statements, which are prepared for external parties, will not

necessarily be useful for internal managerial decision making. Managers often need more detailed information than is included in historically-oriented financial statements. They may need the information broken down by division, business segment, or product line. In addition, managers are typically more interested in what will happen in the future, as opposed to the past. Even if the information is not as objective and verifiable as what would be included in a financial report (for example, it may include more budgeted or forecasted data), managerial accounting information must be relevant to the particular decision the manager is trying to make.

• Service companies sell services (non-tangible items) to consumers or other

businesses. Merchandising companies sell finished goods that they have purchased from someone else. Manufacturing companies make a product using raw materials, then sell it to another manufacturer, merchandising company, service company, or individual consumer.

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• Examples of service firms include hair salons, travel agents, real estate firms, law

firms, dentist’s office, restaurants, etc. Merchandising companies include Wal-Mart, GAP, Safeway, Exxon, etc. Manufacturing firms are those that produce a physical product, whether it is golf balls, furniture, clothing, computers, etc. Manufacturing facilities are often located in “industrial” or “light industrial” areas on the outskirts of metropolitan areas.

• The three functions of management are planning/organizing, directing/leading, and

controlling.

• The three functions of management are interrelated in that one function will affect

what happens in the next function, and the entire process provides feedback for future decision making. For example, managers must first know where they are going and what resources they will need to get there (planning/organizing) before they can begin to direct/lead the organization toward successful achievement of the plan. The controlling function provides feedback to managers about whether the plan is being achieved, so that they can take corrective action by adjusting the plan, the resources, or their implementation of the plan.

• Ethics refers to the standards of conduct for judging right from wrong, honest from

dishonest, and fair from unfair. Although some accounting and business issues have clear answers that are either right or wrong, many situations require accountants and managers to weigh the pros and cons of alternatives before making a final decision.

• Congress enacted SOX in response to a number of high-profile scandals in which

companies failed as a result of erroneous and fraudulent reporting. The act was aimed at renewing investor confidence in the external financial reporting system, but also placed additional responsibilities on company managers.

• The Sarbanes-Oxley Act increased manager’s responsibility for creating and

maintaining an ethical business and reporting environment. For example, managers must perform an annual review of their company’s internal control system and issue a report that indicates whether the controls are effective. This new requirement places more responsibility on all managers (not just accountants) for reporting accuracy. The Act also emphasizes the importance of ethics by requiring public companies to adopt a code of ethics for senior financial officers.

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• The Sarbanes-Oxley Act (see Section 404) attempts to reduce fraudulent reporting

in the following ways:

 Opportunity: SOX attempts to reduce the opportunity for error and fraud

by requiring an internal control report from managers, stronger oversight by the board of directors, and requiring external auditors to attest to the effectiveness of the internal controls.

 Incentives: SOX attempts to counteract the incentive to commit fraud by

providing much stiffer penalties to those who intentionally misrepresent a company’s financial performance.

 Character: SOX emphasizes the importance of character in the

prevention of fraud by requiring companies to create anonymous tip lines for reporting fraud, providing “whistle-blowers” legal protection, and requiring companies to adopt a code of ethics for senior financial officers.

• Companies with strong ethical cultures are rewarded with higher productivity,

improved team dynamics, lower risks of fraud, streamlined process, improved product quality, and higher customer satisfaction.

• Answers will vary. The cash transactions could be anything from purchasing lunch

to paying rent to paying a speeding ticket. The non-monetary exchanges could include volunteer work, helping a friend move, tutoring another student, etc.

• Out-of-pocket costs are those that you pay for “out of your pocket”, whether in cash

or with a credit card. It could be the cost of fuel in your car, or the cost of your lunch. Opportunity costs are the “lost benefits” you incur when you choose to do one thing instead of another. These are typically more difficult to estimate and to quantify. For example, if you rode your bike to school instead of driving, the additional time it took you to ride your bike is an opportunity cost of that decision.But to put a dollar value on it (i.e., quantify it), you would need to know how valuable your time is.

• Cost information is critical to managerial decision making. For example, managers

typically want to know what a product or service costs before they can decide what price they should charge for it. They also need to know how much something costs so they can decide whether to buy it, how much to buy, and what supplier to buy from.

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• A direct cost is one that can be traced to a specific cost object, while an indirect

cost is one that either cannot be traced, or it is not worth the effort to trace the cost.Direct costs include the primary material inputs such as leather, cloth, hardware, etc. Direct costs would also include the wages of workers who were directly involved in making the product (e.g. cutting, sewing, etc). Indirect costs are all other costs incurred to make the product such as including indirect material (e.g.thread), rent on the manufacturing facility, supervision, power to run the machines, etc.

• Variable costs are costs that change, in total, in direct proportion to a change in

activity level. Fixed costs remain the same, in total, regardless of activity level.Fuel and maintenance costs will vary in direct proportion to the number of miles you drive your car. Even though you may not pay for the maintenance costs each and every week, the more miles you drive, the more maintenance your car will need.Costs such as insurance and parking are fixed, regardless of the number of miles driven.

• A relevant cost is one that has the potential to influence a decision; an irrelevant

cost will not influence a decision. For a cost to be relevant, it must 1) differ between the decision alternatives and 2) be incurred in the future rather than in the past.

• Relevant costs are those that will differ between these two alternatives. Examples

include the cost of transportation to and from the different locations, difference in lodging costs, the cost of entertainment at each venue, etc. Irrelevant costs are those that will be incurred regardless of which alternative is chosen, such as the cost of rent and utilities at your apartment back home. If the cost of food and entertainment will be roughly the same in either location, this would be considered an irrelevant cost.

• Direct materials and direct labor are referred to as prime costs. At one point in time

direct materials and direct labor were the primary costs of making a product. As manufacturing processes have become more automated, indirect costs such as machine depreciation and factory supervision have become a larger proportion of the cost.

• Manufacturing overhead includes all manufacturing costs other than direct material

and direct labor, or any cost that is associated with manufacturing that is not directly traceable to the product. Examples include rent, supervision, insurance, utilities, and machinery in the manufacturing facility. It does not include non-manufacturing costs such as general and administrative expenses or selling expenses.

• Prime costs are direct materials + direct labor. Conversion costs are direct labor +

manufacturing overhead. You cannot add them together to arrive at total manufacturing cost because direct labor is included in both and would be “double counted.”