Cases in Managerial and Cost Accounting

by Allen, Brownlee II, Haskins, Lynch

ISBN: 978-1-934319-40-6 | Copyright 2010

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Analyzing cases is primarily a process of asking and answering questions. In studying cases, the art and skill of asking the right questions is often as important as being able to answer them. For some cases, the questions are obvious, but for most cases, there will be more questions to explore than may be apparent at first.

Some of the cases in this casebook have questions listed at the end of the case; other cases do not contain a list of questions. Moreover, your instructor may or may not provide questions for you. Your assignment may simply be to analyze the case, draw conclusions, and be prepared to present your recommendations. If so, you need to develop your own list of questions. One set of answers may lead to another set of questions, and so on. The process is somewhat like that of peeling an onion to get at the heart of the matter. It sharpens your analytical abilities and sets managerial and cost accounting in the context of real business issues that require thoughtful decisions. We hope you enjoy the learning journey you are about to begin.

About the Book

Managers need accurate, timely, and relevant information in order to understand what is really going on in their businesses. They can use this information as a basis for assessing the extent to which assets are protected, as a means for evaluating performance, and as a basis on which to make numerous business decisions. A great deal of the information managers require is financial in nature, and a significant part of such information is accounting related. We view a well-designed management accounting and cost system as an essential component of a well-managed company. In fact, there are times when we think it can provide a competitive advantage.

Our primary objective in writing this casebook was to create a collection of teaching cases that are interesting, thought-provoking and relevant to contemporary business situations. In designing undergraduate, graduate, and executive education courses pertaining to management accounting and cost systems, we take the perspective that the materials used and the topics covered should allow students to gain an appreciation for the extent to which internal financial information can facilitate both operating and strategic decisions. Our experience has been, however, that the managerial relevance of such information is frequently not at all obvious to students. One reason for this is the tendency for courses to place too much emphasis on the accounting and not enough emphasis on the management.

We advocate broadening and strengthening the management dimensions of managerial and cost accounting courses, and doing so without sacrificing essential accounting content. One very effective way to accomplish this objective is to select topics and materials that demonstrate how costs, cost analysis, planning, and performance measurement can be useful to managers in making operating and strategic decisions. This was our intent in writing Cases in Managerial and Cost Accounting.

Case Organization

As shown below, we have organized this casebook into four parts. They address a variety of topics, beginning with understanding costs and cost behaviors and ending with performance measurement and incentive systems.

Part I
Understanding Costs and Cost Behaviors
Part II
Fundamentals of Product and Service Costing
Part III
Planning, Budgeting, and Variance Analysis
Part IV
Performance Measurement and Incentive Systems

In the remainder of this Preface, we discuss the purpose and content of each of the four parts in detail. At the end, we have included a note to students.

Part I: Understanding Costs and Cost Behaviors

The cases in Part I deal with the nature of costs and cost behaviors, cost-volumeprofit analysis, relevant costs, opportunity costs, sunk costs, and break-even analysis. Relevant costs are expected future costs that change as a result of the decision being considered or that differ among alternative courses of action. Relevant costs must meet two criteria: (1) they must be expected to occur in the future, and (2) they must differ among alternative courses of action. Two important costing concepts that are related to the notion of relevant costs are sunk costs and opportunity costs. Sunk costs are costs that have already been incurred or obligated. They will not change regardless of the course of action selected. Therefore, they are irrelevant in choosing among alternative courses of action. Opportunity costs are the contribution to income that is foregone by not choosing an alternative use for a resource. Because opportunity costs pertain to the future, if they differ among alternative courses of action, they are relevant in choosing among those alternatives.

When making a decision, managers would draw the same conclusion if they use only relevant data as they would draw if they used all of the applicable available data. However, making decisions using only the relevant data streamlines the decision-making process. It allows decisions to be made even when managers don’t have all of the company’s financial information. In addition, it focuses management’s attention on the information that matters rather than on information that is irrelevant to the decision.

Frequently, it is the behavior of various costs that help managers determine whether such costs are relevant to a decision. Why? Because variable costs change in total in proportion to changes in activity level, whereas fixed costs remain unchanged, in the short run, regardless of changes in activity level.

Understanding the concepts of relevant costs, sunk costs, opportunity costs, and cost behavior is crucial to making good management decisions. The cases in this section of the book illustrate the use of these concepts in a variety of decision contexts, including outsourcing, accepting special orders, determining product mix, setting prices, and optimizing the use of constrained resources. The FinePrint Company case provides a basic introduction to the concepts of cost behavior and relevant costs in the context of a decision regarding whether or not to accept a special order, and in the context of an outsourcing decision. Blackheath Manufacturing Company demonstrates the use of cost behaviors and relevant costs in a pricing decision. Giberson’s Glass Studio considers the impact of constrained resources on costs relevant to a decision about product mix, and it raises the issue of the relevance of cost allocation in a business situation where almost all of the costs are fixed. The Horizon Insurance Agency pertains to an outsourcing decision and highlights the importance of treating a multiyear decision using an investment framework. Breeden Security, Inc. (A) has four budget options to be evaluated using break-even analysis, including a scenario where sales volumes and production volumes differ. BW Manufacturing Company addresses product planning, including decisions about whether to keep or drop a product line and about product pricing, using contribution margin analysis. Finally, Greenlawn Commercial Package Business and The Craddock Cup explore more generally the concepts of relevant costs, sunk costs, and cost-volume-profit analysis in a services environment.

Part II: Fundamentals of Product and Service Costing

The cases in Part II address issues associated with determining the cost of products and services, including overhead allocation, allocation of common costs, and activity-based costing. Some costs (such as certain material and labor costs) can be traced directly to products or services. These costs are called direct costs. Other costs (such as manufacturing supplies, maintenance costs, occupancy costs, and plant administration, among others) often cannot be traced directly to products or services. These costs are called indirect costs, and they often represent service or manufacturing overhead costs. To obtain the full cost of a product or service, companies must include all related direct costs and some amount of indirect costs. The distribution of indirect, or overhead, costs to a product, service, or other unit of output, is called cost allocation. Traditionally, manufacturing overhead costs were accumulated by department and distributed among products in proportion to each product’s use of some easily determined resource, typically direct labor hours or dollars.

In recent years, however, companies have paid considerable attention to the process of cost allocation. First, pooling costs by department may not promote accurate costing because different costs in any given department might be driven by different activities. Instead of departments, companies have tried grouping overhead costs by type of activity (such as setup, purchasing, inspection, etc.) which may have clearer causeand- effect relationships to product costs than do manufacturing departments. Second, direct labor may not be a good indicator of the indirect resources consumed by a product. Therefore, in place of direct labor, companies have begun to use a measure of activity associated with each group of overhead costs to allocate those overhead costs to products or services. For example, the number of production runs might be used to allocate set-up costs, costs of inspection, and other production-run related costs. This focus on activities in allocating overhead costs has become known as activity-based costing. Shun Electronics Company begins the process of exploring this topic by looking at how a company pools its overhead and the danger of cross-product subsidies arising. Breeden Security, Inc. (B) deals with the differences in traditional costing and activity-based costing in distributing overhead costs in a manufacturing environment. Johnson Beverage, Inc. uses activity-based costing to allocate customer service costs and assess customer profitability. Finnegan’s Gardens introduces the use of activity-based costing to determine service-level profitability. Gibson Insurance Company explores the allocation of shared infrastructure costs and its implications for determining business unit costs and product costs. Data Services at Armistead illustrates the use of activity-based thinking in distributing costs among different lines of business in ways that support strategic decisions.

Finally, Wendy’s Chili: A Costing Conundrum addresses the issue of joint costs and the challenge of costing by-products. Wendy’s must determine the cost of a bowl of chili in assessing the profitability of each of its products. This task is particularly difficult because chili is made using a by-product of its hamburgers.

Part III: Planning, Budgeting, and Variance Analysis

The cases in Part III provide the opportunity for in-depth discussion of important issues pertaining to planning and budgeting (including flexible budgeting techniques), basic variance analysis, and strategic profitability analysis.

With Blackheath Manufacturing Company—Revisited, students are asked to prepare a production budget and a budgeted income statement, balance sheet, and statement of cash flows using information regarding the company’s product costs and sales forecasts. This case provides students with an excellent overview of the steps involved in the preparation of a budget.

Toddler Treasures, Inc. illustrates basic variance analysis and its use in measuring and assessing performance. Charley’s Family Steak House (A) and (B) and address flexible budgeting and strategic profitability analysis, and they also require a reconciliation of actual to planned results in a way that highlights the impact of important strategic factors on the difference.

The Oriole Furniture, Inc. (A) case describes a typical annual budgeting process for a division within a company. Students are presented with a situation in which a division is falling well short of its budget during the year, and they are asked to consider actions the company might take midyear to help ensure it reaches its budget by year-end. The case challenges students to consider the purpose of budgets and to discover that ultimately the budget must be linked to realistic plans and strategies or it becomes a meaningless exercise. Finally, the Consumer Service Company (A) case addresses ethical issues associated with negotiating a profit plan via a classroom role play opportunity.

Part IV: Performance Measurement and Incentive Systems

The cases in Part IV address issues associated with performance measurement and incentive systems. Several of these cases focus on the choice of performance measures. First, Performance Measurement at Thomas J. Lipton provides the opportunity to address the challenges surrounding the choice of performance measures in general, and the surrounding use of ROI as a performance measure in particular. This case requires students to compare and contrast the benefits related to the use of ROI and Residual Income as performance measures. It also requires students to develop an understanding of alternative measures of income and investment used in the calculation of each of these metrics. Second, Maverick Lodging provides students the opportunity to examine the design and implementation of a balanced scorecard, and The Gail Palmer Ashton Graduate School of Business offers the opportunity to explore the challenge of designing some performance metrics in a university setting.

Two cases focus on some interesting issues surrounding transfer pricing decisions. Specifically, Lynchburg Foundry: The Ductile Dilemma deals with transfer pricing in a manufacturing environment within the context of the castings industry; Xyberspace Consulting, Inc. deals with pricing shared services within the context of a consulting firm.

The Mountain Lumber Company case addresses issues associated with performance measures and incentive compensation. It asks students to evaluate a performance measurement and incentive plan for a lumber company. This case can be used to introduce issues related to performance measurement and compensation, and it can also serve to address a comprehensive set of issues at the end of a module pertaining to performance measurement and incentive systems.

Expand/Collapse All
Blackheath Manufacturing Company: Cost behaviors and relevant costs in a pricing decision (pg. 5)
Giberson’s Glass Studio: Cost behaviors and relevant costs in a product mix decision with constrained resources (pg. 9)
The Horizon Insurance Agency: Relevant costs and cash flows in an outsourcing decision (pg. 16)
FinePrint Company: Cost behaviors and relevant costs in a special order decision and an outsourcing decision (pg. 2)
Breeden Security, Inc. (A): Budgeting scenarios and break-even analysis (pg. 20)
BW Manufacturing Company: Product planning using contribution margin analysis (pg. 23)
Greenlawn Commercial Package Business: Relevant costs and sunk costs in decision making in a services environment (pg. 28)
The Craddock Cup: Cost behaviors; sunk costs; break-even analysis; overhead allocation (pg. 31)
Shun Electronics Company: Overhead allocation in product costing and uncovering cross-product subsidies (pg. 38)
Breeden Security, Inc. (B): Evolution of costing systems from traditional cost systems to activity-based cost systems; customer profitability analysis (pg. 45)
Johnson Beverage, Inc.: Using activity-based costing to assess customer profitability (pg. 57)
Finnegan’s Gardens: Costing services: allocation of common costs and line of business profitability (pg. 64)
Gibson Insurance Company: Allocating shared infrastructure costs for determining business unit costs and product costs (pg. 70)
Data Services at Armistead: Costing services using activity thinking and strategic choices; customer profitability analysis (pg. 80)
Wendy’s Chili: A Costing Conundrum: Joint costs and costing by-products: costing the chili (pg. 91)
Blackheath Manufacturing Company —Revisited: Budgeting and profit variance analysis (pg. 102)
Toddler Treasures, Inc.: Basic variance analysis of direct materials, direct labor, and overhead (pg. 109)
Charley’s Family Steak House (A): Developing a profit plan (pg. 112)
Charley’s Family Steak House (B): Flexible budgeting and strategic profitability analysis (pg. 119) Flexible budgeting and strategic profitability analysis (pg. 126)
Oriole Furniture, Inc. (A): Profit planning and control (pg. 130)
Consumer Service Company (A): Negotiating a profit plan and ethics of budgeting (pg. 135)
Performance Measurement at Thomas J. Lipton: Measuring product-line performance: ROI vs. Residual Income (Economic Profit) (pg. 140)
Maverick Lodging: The Balanced Scorecard system in a hotel management company (pg. 152)
The Gail Palmer Ashton Graduate School of Business: The Balanced Scorecard Initiative Developing performance metrics in a university setting (pg. 170)
Lynchburg Foundry: The Ductile Dilemma: Transfer pricing and costing a by-product (pg. 175)
Xyberspace Consulting, Inc.: Transfer pricing: allocation of shared services costs (pg. 186)
Mountain Lumber Company: Linking performance measures to strategy: evaluating a performance measurement and incentive plan (pg. 194)
Brandt R. Allen

Brandt R. Allen

James C. Wheat, Jr. Professor of Business Administration Brandt R. Allen teaches courses in accounting, information systems and general management. He was Associate Dean, Executive Education, for 14 years at Darden.

His current research interests include accounting fraud, vendor incentives, how companies formulate and implement information systems strategy and the impact of emerging technology on corporate transformation.

Before joining the Darden faculty in 1970, Allen was a professor at the Harvard Business School and before that a research engineer with the Boeing Company. He has been a guest lecturer at IMD in Lusanne, Switzerland; the London Business School, the Melbourne Business School, the University of Capetown Business School and INALDE in Bogotá, Colombia, among others.

He has served as director or trustee for several organizations including the Data Switch Corporation, St. Anne’s-Belfield School and the Edwin Gould Foundation for Children. He has also served as a consultant to AOL, British Petroleum, Cargill, Citibank, GlaxoSmithKline, IBM, Lloyds of London, MCI, PWC, State Farm Insurance, Unilever and UTC. From 2002–08, he chaired the CIO Council of the Conference Board.

E. Richard Brownlee II

E. Richard Brownlee II

Dale S. Coenen Professor of Business Administration Richard Brownlee is the area coordinator for Accounting and teaches "Financial and Managerial Accounting" at the University of Virginia Darden School of Business.

He is also the faculty leader of Darden's sustainability concentration, and he teaches the course "Business and Sustainability." Brownlee has served on the University of Virginia faculty senate, and he currently serves as the co-chair of the University of Virginia's Sustainability Policies and Procedures Committee, a subcommittee of the University's Presidential Committee on Sustainability.

Brownlee also teaches extensively in Darden's Executive Education programs in the areas of financial and managerial accounting, financial management and sustainable business practices. Brownlee was formerly associated with Peat, Marwick, Mitchell & Co. and has served as a consultant to the Institute of Chartered Financial Analysts and various businesses.

Prior to joining the Darden faculty in 1975, he taught at Ohio University, the University of Northern Iowa and Georgia State University. Brownlee has coauthored textbooks on accounting and financial reporting as well as casebooks on financial and managerial accounting. He has written numerous cases and teaching notes and has received awards for both his teaching and scholarship.

Mark E. Haskins

Mark E. Haskins

Professor of Business Administration Mark Haskins teaches in the University of Virginia Darden School's MBA program.

In addition, he has designed and delivered executive education programs for such clients as IBM, INTELSAT, MCI, Coopers & Lybrand, Aetna Insurance, Norfolk Southern Railroad, AES Corporation, Rolls Royce NA, Harris Corporation, the U.S. Navy and the U.S. Air Force. Professor Haskins has taught executives in the United Kingdom, Belgium, Thailand, Australia, Hong Kong and the United States.

He has published articles in numerous practitioner and academic business journals. His current writing interests focus on a variety of issues pertaining to talent development, financial reporting and crafting effective learning experiences. Haskins has served on the University of Virginia faculty senate and has also led the Darden School's First Year MBA program group.

Luann J. Lynch

Luann J. Lynch

Professor Luann J. Lynch teaches Accounting in the First Year core MBA program and a Second Year elective in management accounting.

She is frequently recognized for her outstanding teaching; she was the recipient of the University of Virginia Alumni Board of Trustees Teaching Award and elected Faculty Marshall in 2000, was nominated for the Outstanding Faculty Award from the State Council of Higher Education for Virginia (SCHEV) in 2001, has been recognized as an Outstanding Professor in BusinessWeek’s Guide to the best Business Schools, and is frequently nominated for the Outstanding Faculty Award at Darden.

Her research interests are primarily in the design and impact of incentive and compensation systems. The focus of her work can be broadly characterized as an exploration of how incentives and compensation systems are structured to encourage the desired behavior by the individuals or organizations. In particular, her work has examined incentive issues associated with stock options; compensation in post-merger integration efforts; and the effect of financial reporting, accounting and regulation on incentive compensation. She has published her work in leading accounting and finance journals, including The Accounting Review, Journal of Accounting and Economics, Journal of Financial Economics and Review of Accounting Studies. From 2006 to 2009, she held the Robert F. Vandell research chair at Darden in recognition of her research contributions. In 2006, she received the Glen McLaughlin Prize for Research in Accounting Ethics for work related to compensation around the implementation of the Sarbanes-Oxley Act. From 2005 to 2008, she served as Darden’s Associate Dean for Intellectual Capital.

Prior to joining the faculty at the Darden School, she taught in the Master of Accounting program at the Kenan-Flagler Business School at the University of North Carolina. She was assistant vice president at Roche Biomedical Laboratories, Inc., and held positions in finance and accounting at Roche, Northern Telecom (NorTel) and Procter & Gamble. She holds an MBA from Duke University’s Fuqua School of Business and a doctorate in accounting from the University of North Carolina.

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