PART II: SOLUTIONS TO PROBLEMS AND CASES
CHAPTER 1
INTRODUCTION
P 1–1: Solution to MBA Students (10 minutes)
[Using accounting information for decision making and control]
Together the two observations highlight the extremes in the trade-offs of using
accounting information for decision and control. In the first case, there is more analysis of
opportunity costs that are hard to capture with typical accounting information. In the
second case, there is less intended interest in opportunity cost and greater emphasis on
control.
P 1–2: Solution to One Cost System Isn't Enough (15 minutes)
[Economic Darwinism]
The first part of the quote describes the tension (and conflict) that arises when a
single accounting system is used for multiple purposes. This part of the statement is an
accurate description of practice. However, the quote has a couple of problems, including:
•While the quote describes the costs of using a single system ("a single system ...
can't perform important managerial functions adequately"), the quote does not describe the
benefits derived from using a single system (lower bookkeeping costs, a single audit, less
confusion).
•Because the quote ignores the benefits of a single system, it ignores the concept of
economic Darwinism. It does not address the question of how surviving (successful)
,companies can compete if a single system "can't perform important managerial functions
adequately."
•Also, the quote assumes that managers are bound to their internal accounting
systems, that no other alternative information sources are available. Often managers
develop their own ad hoc, "off-line" information systems for decision making. These
systems include spreadsheets, informal observation, and "walking around."
P 1–3: Solution to U.S. and Japanese Tax Laws (15 minutes)
[Influence of conflicting demands on cost systems]
The internal accounting system supports multiple uses, including financial
reporting, taxes, contracting (debt and management compensation), internal decision
making, and internal control. Because multiple purposes are served, trade-offs must be
made among the competing demands. When more emphasis is placed on one purpose
(taxes), less consideration can be given to other uses (internal decision making and
control). By linking taxes to external reporting, Japanese firms’ financial reports will be
based on accounting procedures that give more weight to tax considerations. In the U.S.,
companies can keep two sets of books, one for taxes and the other for financial reporting.
Thus, in the U.S., there is more of a decoupling of taxes and everything else. Except for the
additional bookkeeping costs of producing the two separate sets of reports, tax
considerations are predicted to have less influence on the choice of internal (and thus
external) accounting procedures in the U.S. than in Japan.
The question is raised as to why firms use the same accounting procedures for
internal reports as they do for external reports. Or for that matter, why do tax laws and
external financial reporting considerations have any effect on internal accounting
procedures? Why don’t firms maintain multiple sets of accounts, one for each purpose (e.g.,
financial reporting, internal decision making, and internal control)? Clearly there are
additional bookkeeping costs for maintaining multiple sets of accounts. But also, there are
confusion costs and, in many instances, firms explicitly link senior executive compensation
to externally reported financial statements. Such explicit linkage of executive pay to
externally reported net income presumably exists to control agency costs between
management and shareholders. Once senior management performance and rewards are
linked to external reports, the internal reporting system will become linked to the external
reports and basically less consideration will be given to choosing accounting procedures
that aid in internal decision making and internal control.
, In Japan, the firm’s accounting systems are less likely to be used for internal uses
(decision making and control) than in the U.S. Because they cannot rely as much on their
accounting systems for internal uses (because more weight is placed on using accounting
procedures to reduce taxes), Japanese managers are more likely to use non-accounting-
based systems for internal decision making and control.
P 1-4: Solution to Using Accounting for Planning (15 minutes)
[Usefulness of historical costs]
a. Historical costs are of limited use in making planning decisions in a rapidly changing
environment. With changing products, processes and prices, the historical costs are
inadequate approximations of the opportunity costs of using resources.
Historical costs may, however, be useful for control purposes, as they
provide information about the activities of managers and can be used as
performance measures to evaluate managers.
b. The purpose of accounting systems is to provide information for planning purposes
and control. Although historical costs are not generally appropriate for planning
purposes, additional measures are costly to make. An accounting system should
include additional measures if the benefits of improved decision making are greater
than the costs of the additional information.
P 1–5: Solution to Budgeting (15 minutes)
[Trade-off between decision making and control]
In this firm, the bonus is based on meeting the budget. Two incentives exist: sales
people will under-forecast future sales and they have little incentive to sell more than the
budget.
, This firm tries to use the budget for two functions: decision making and control. In
deciding on next year’s production plans, sales peoples’ forecasts of future sales are
important. However, these same forecasts (after revision by supervisors) are used as part
of the compensation scheme to motivate the sales people to achieve their goals. By using
the budget (forecasts) as part of the control system, the firm gives up some of the budget’s
usefulness as a decision making tool to set production plans. While senior managers might
recognize that the sales people’s forecasts are low, they don’t know exactly how low. This
introduces more uncertainty into planning for next year’s production.
P 1-6: Solution to Golf Specialties (20 minutes)
[Average versus variable cost of an incremental order]
a. Given that the variable cost per head cover is 1.10 euros, the fixed cost per week is:
AC = FC / Q + VC
3.10 = FC/600 + 1.10 3.50 = FC/500 + 1.10
FC = 1,200 euros FC = 1,200 euros
b. The change in total cost if the 100 unit Kojo offer is accepted is:
600 × 3.10 euros – 500 × 3.50 euros = 110 euros
Or, each head cover has variable cost of 1.10 euro. Since Kojo is willing to pay 2
euros per head cover or 200 euros for 100 covers, by accepting this order GS makes
90 euros a week. Therefore, GS should accept Kojo’s offer if these are all the
relevant facts.
CHAPTER 1
INTRODUCTION
P 1–1: Solution to MBA Students (10 minutes)
[Using accounting information for decision making and control]
Together the two observations highlight the extremes in the trade-offs of using
accounting information for decision and control. In the first case, there is more analysis of
opportunity costs that are hard to capture with typical accounting information. In the
second case, there is less intended interest in opportunity cost and greater emphasis on
control.
P 1–2: Solution to One Cost System Isn't Enough (15 minutes)
[Economic Darwinism]
The first part of the quote describes the tension (and conflict) that arises when a
single accounting system is used for multiple purposes. This part of the statement is an
accurate description of practice. However, the quote has a couple of problems, including:
•While the quote describes the costs of using a single system ("a single system ...
can't perform important managerial functions adequately"), the quote does not describe the
benefits derived from using a single system (lower bookkeeping costs, a single audit, less
confusion).
•Because the quote ignores the benefits of a single system, it ignores the concept of
economic Darwinism. It does not address the question of how surviving (successful)
,companies can compete if a single system "can't perform important managerial functions
adequately."
•Also, the quote assumes that managers are bound to their internal accounting
systems, that no other alternative information sources are available. Often managers
develop their own ad hoc, "off-line" information systems for decision making. These
systems include spreadsheets, informal observation, and "walking around."
P 1–3: Solution to U.S. and Japanese Tax Laws (15 minutes)
[Influence of conflicting demands on cost systems]
The internal accounting system supports multiple uses, including financial
reporting, taxes, contracting (debt and management compensation), internal decision
making, and internal control. Because multiple purposes are served, trade-offs must be
made among the competing demands. When more emphasis is placed on one purpose
(taxes), less consideration can be given to other uses (internal decision making and
control). By linking taxes to external reporting, Japanese firms’ financial reports will be
based on accounting procedures that give more weight to tax considerations. In the U.S.,
companies can keep two sets of books, one for taxes and the other for financial reporting.
Thus, in the U.S., there is more of a decoupling of taxes and everything else. Except for the
additional bookkeeping costs of producing the two separate sets of reports, tax
considerations are predicted to have less influence on the choice of internal (and thus
external) accounting procedures in the U.S. than in Japan.
The question is raised as to why firms use the same accounting procedures for
internal reports as they do for external reports. Or for that matter, why do tax laws and
external financial reporting considerations have any effect on internal accounting
procedures? Why don’t firms maintain multiple sets of accounts, one for each purpose (e.g.,
financial reporting, internal decision making, and internal control)? Clearly there are
additional bookkeeping costs for maintaining multiple sets of accounts. But also, there are
confusion costs and, in many instances, firms explicitly link senior executive compensation
to externally reported financial statements. Such explicit linkage of executive pay to
externally reported net income presumably exists to control agency costs between
management and shareholders. Once senior management performance and rewards are
linked to external reports, the internal reporting system will become linked to the external
reports and basically less consideration will be given to choosing accounting procedures
that aid in internal decision making and internal control.
, In Japan, the firm’s accounting systems are less likely to be used for internal uses
(decision making and control) than in the U.S. Because they cannot rely as much on their
accounting systems for internal uses (because more weight is placed on using accounting
procedures to reduce taxes), Japanese managers are more likely to use non-accounting-
based systems for internal decision making and control.
P 1-4: Solution to Using Accounting for Planning (15 minutes)
[Usefulness of historical costs]
a. Historical costs are of limited use in making planning decisions in a rapidly changing
environment. With changing products, processes and prices, the historical costs are
inadequate approximations of the opportunity costs of using resources.
Historical costs may, however, be useful for control purposes, as they
provide information about the activities of managers and can be used as
performance measures to evaluate managers.
b. The purpose of accounting systems is to provide information for planning purposes
and control. Although historical costs are not generally appropriate for planning
purposes, additional measures are costly to make. An accounting system should
include additional measures if the benefits of improved decision making are greater
than the costs of the additional information.
P 1–5: Solution to Budgeting (15 minutes)
[Trade-off between decision making and control]
In this firm, the bonus is based on meeting the budget. Two incentives exist: sales
people will under-forecast future sales and they have little incentive to sell more than the
budget.
, This firm tries to use the budget for two functions: decision making and control. In
deciding on next year’s production plans, sales peoples’ forecasts of future sales are
important. However, these same forecasts (after revision by supervisors) are used as part
of the compensation scheme to motivate the sales people to achieve their goals. By using
the budget (forecasts) as part of the control system, the firm gives up some of the budget’s
usefulness as a decision making tool to set production plans. While senior managers might
recognize that the sales people’s forecasts are low, they don’t know exactly how low. This
introduces more uncertainty into planning for next year’s production.
P 1-6: Solution to Golf Specialties (20 minutes)
[Average versus variable cost of an incremental order]
a. Given that the variable cost per head cover is 1.10 euros, the fixed cost per week is:
AC = FC / Q + VC
3.10 = FC/600 + 1.10 3.50 = FC/500 + 1.10
FC = 1,200 euros FC = 1,200 euros
b. The change in total cost if the 100 unit Kojo offer is accepted is:
600 × 3.10 euros – 500 × 3.50 euros = 110 euros
Or, each head cover has variable cost of 1.10 euro. Since Kojo is willing to pay 2
euros per head cover or 200 euros for 100 covers, by accepting this order GS makes
90 euros a week. Therefore, GS should accept Kojo’s offer if these are all the
relevant facts.
