Accounting Book Questions Chapter one

What is the primary difference between financial accounting and managerial accounting?

1. 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

How did the Sarbanes-Oxley Act affect managers' responsibility for creating and maintaining an ethical business and reporting environment?

10. 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.

How did the Sarbanes-Oxley Act attempt to reduce fraudulent reporting by addressing opportunity, incentives, and character?

11. 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.

According to a recent Statement on Management Accounting (SMA), what are some of the potential benefits of a strong ethical business climate?

12. 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.

Why are businesses starting to incorporate sustainability into their business model?

13. 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.

What factors does sustainability accounting include that traditional accounting systems do not?

14. 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.

Think about your activities over the last week. Identify two exchanges or transactions for which the cost incurred would be measured in dollars and two that were nonmonetary.

15. 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.

Think about all of the choices you make on a day-to-day basis: everything from driving versus riding a bike to school or deciding where to have lunch. Pick three decisions you have made today. Identify an out-of-pocket and opportunity cost for each decision.

16. 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.

Explain the difference between a direct cost and an indirect cost. Take a look at your purse or wallet. Name two direct costs of making your purse or wallet. Name two indirect costs of making it.

18. 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.

Explain the difference between fixed and variable costs. Give an example of a cost that varies with the number of miles you drive your car each week and an example of a cost that is fixed regardless of how many miles you drive your car each week

19. 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.

Explain how the primary difference between financial and managerial accounting results in other differences between the two.

2. 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.

Explain the difference between relevant and irrelevant costs. What are the two criteria used to determine whether a cost is relevant?

20. 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.

Suppose you and your friends are planning a trip for spring break. You have narrowed the destination choices to Panama City, Florida, and Galveston Bay, Texas. List two costs that are relevant to this decision and two costs that are irrelevant to this decision

21. 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.

What are prime costs? Why have they decreased in importance over time?

22. 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."

What types of costs are included in manufacturing overhead? Other than direct materials and direct labor, what costs would not be included in manufacturing overhead?

23. Product costs are initially recorded as inventory on the balance sheet. They are transferred to Cost of Goods Sold on the income statement when the product is sold. Period costs are expensed on the income statement as soon as they are incurred.

Why can't prime cost and conversion cost be added together to arrive at total manufacturing cost?

24. Product costs are called inventoriable costs because they are initially recorded as inventory and are not expensed until the inventory is sold. These costs are initially recorded in inventory accounts (on the balance sheet) and follow the flow of the product as it makes its way through the production process. Once the product is finally sold, the product costs are transferred to Cost of Goods Sold, where they will be matched against sales revenue on the income statement.

What is the difference between product and period costs in terms of how and when they are treated in the financial statements (balance sheet and income statement)?

25. According to GAAP, all manufacturing costs must be treated as a product cost, which means the costs will be included in inventory (on the balance sheet) until the product is sold. Once the product is sold, the product costs are transferred to Cost of Goods Sold, where they will be matched against sales revenue on the income statement

Explain why product costs are also called inventoriable costs and how those costs move through a company's financial statements.

26. Since period costs are expensed in the period they are incurred, they would only appear on a company's income statement and not its balance sheet.

What triggers the movement of product costs from an asset on the balance sheet to an expense on the income statement?

27. Incorrectly classifying advertising as a product cost would overstate product cost which could impact the balance sheet inventory accounts as well as cost of goods sold on the income statement. Since this advertising cost wasn't expensed immediately as it should have been, total expenses on the income statement might also be understated if some of the goods haven't been sold (i.e., some of the cost is still held on the balance sheet as inventory).

Why are traditional, GAAP-based financial statements not necessarily useful to managers and other internal parties?

3. 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.

Explain the difference between service companies, merchandising companies, and manufacturing companies.

4. 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.

Consider the area within a 3-mile radius of your campus. What service companies, merchandising companies, and manufacturing firms are located within that area?

5. 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.

What are the three basic functions of management?

6. The three functions of management are planning/organizing, directing/leading, and controlling.

How are the three basic management functions interrelated?

7. 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.

What are ethics and why is ethical behavior important to managers?

8. 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.

What events or factors led to the creation and enactment of the Sarbanes-Oxley Act of 2002?

9. 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.

Why is it important for managers to be able to determine the cost of a particular item? Name one decision that a company might make using cost information.

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.