Principles of Accounting, Volume 2: Managerial Accounting

Citation

Franklin, M., Graybeal, P., & Cooper, D. (2019). Principles of Accounting, Volume 2: Managerial Accounting. OpenStax, Rice University. Free official edition: https://openstax.org/details/books/principles-managerial-accounting

Chapter Summary

This is the second half of OpenStax's two-volume Principles of Accounting, written for the managerial half of a two-semester course that, according to the preface, serves both accounting and non-accounting majors. Its 13 chapters move from what managers need from accounting (Chapters 1–2), through cost-volume-profit analysis and product costing systems (Chapters 3–6), to planning and control (Chapters 7–9), decisions (Chapters 10–11), and performance and sustainability reporting (Chapters 12–13). Each chapter opens with a "Why It Matters" scenario, usually about a student or a small business, and sections end with summaries keyed to the learning objectives. The same appendices as Volume 1 follow: financial statement analysis, the time value of money and suggested resources, plus an answer key for odd-numbered Multiple Choice and Questions items.

Chapter 1: Accounting as a Tool for Managers

The chapter defines managerial accounting as the supply of financial and nonfinancial information to internal decision makers, and groups a manager's work into planning, controlling and evaluating. It sets out seven differences from financial accounting, from users and report types to verification, and notes that managerial accounting does not have to follow GAAP. It describes the skills and career paths of management accountants, the Institute of Management Accountants and its ethics statement, the Sarbanes-Oxley Act and the Foreign Corrupt Practices Act, and trends such as ERP systems, lean manufacturing, total quality management, just-in-time production, Lean Six Sigma, the balanced scorecard, globalisation and corporate social responsibility.

Chapter 2: Building Blocks of Managerial Accounting

Starting from the fixed and variable costs of owning a car, the chapter compares merchandising, manufacturing and service firms and how their income statements differ. It classifies costs as fixed, variable, mixed and step, and as direct materials, direct labour and manufacturing overhead, prime and conversion costs, stressing the relevant range. It then shows how to split mixed costs into fixed and variable parts with a scatter graph and the high-low method; least-squares regression is named but left to more advanced courses.

Chapter 3: Cost-Volume-Profit Analysis

Built around a student club selling T-shirts, the chapter introduces contribution margin per unit, as a ratio and in total, and the contribution margin income statement. It calculates break-even points in units and in dollars, runs sensitivity analyses for changes in price, volume, variable cost and fixed cost, extends break-even analysis to several products using a composite unit based on the sales mix, and ends with margin of safety and operating leverage.

Chapter 4: Job Order Costing

The chapter contrasts job order and process costing and follows the three product costs through a job order system: materials requisitions, time tickets and overhead applied with a predetermined overhead rate, all recorded on job cost sheets. It traces costs from raw materials through work in process and finished goods to cost of goods sold, explains how to dispose of underapplied or overapplied overhead, gives the journal entries, and shows that service businesses can use the same approach.

Chapter 5: Process Costing

Using a family cookie business, the chapter explains process costing for mass-produced units: a work in process account for each department, conversion costs, equivalent units for materials and conversion, and the cost of units transferred to the next department or to finished goods. It works through an initial and a subsequent processing stage and the related journal entries. The chapter uses the weighted-average method and states that the FIFO method is usually left to more advanced courses.

Chapter 6: Activity-Based, Variable, and Absorption Costing

The chapter begins with traditional overhead allocation using a single rate based on labour hours, labour cost or machine hours, then introduces cost drivers and the five steps of activity-based costing (ABC), comparing when each approach suits a business. It closes by contrasting absorption costing, which assigns all manufacturing costs to products, with variable costing, which assigns only variable costs; it shows how to reconcile the two incomes and notes that variable costing is not accepted under GAAP but fits cost-volume-profit analysis.

Chapter 7: Budgeting

After contrasting two students who do and do not plan for a semester abroad, the chapter explains why and how managers budget, including bottom-up, top-down and zero-based approaches. It builds a master budget: sales, production, direct materials, direct labour, overhead and selling and administrative budgets leading to a budgeted income statement, then the capital and cash budgets and a budgeted balance sheet. It contrasts static with flexible budgets and shows how variances against the budget are used to evaluate results.

Chapter 8: Standard Costs and Variances

Following a student planning a campus coffee shop, the chapter explains how standards for price and quantity are set and computes materials price and quantity variances, labour rate and time variances, variable overhead rate and efficiency variances, and two fixed overhead variances (spending and volume). It stresses that the purpose of variance analysis is to find out why a variance happened, and that manufacturers, retailers and service firms all use standards.

Chapter 9: Responsibility Accounting and Decentralization

The chapter compares centralised and decentralised organisations and how decisions are made in each, then sets out five types of responsibility centre (cost, discretionary cost, revenue, profit and investment centres), introduces return on investment and residual income, and argues that managers should be judged on controllable costs. It ends with transfer pricing (general, market price, cost-based and negotiated models) and the extra difficulty of taxes, duties and currencies in international transfers.

Chapter 10: Short-Term Decision Making

Beginning with a coffee shop's used grounds, the chapter defines relevant information, including avoidable and unavoidable costs and qualitative factors. It applies this to five decisions: accepting or rejecting a special order (depending on spare capacity), making or buying a component, keeping or dropping a segment or product (where allocated costs matter), selling at the split-off point or processing further, and using a constrained resource by ranking products on contribution margin per unit of that resource.

Chapter 11: Capital Budgeting Decisions

The chapter describes the capital budgeting process, with screening and preference decisions, and evaluates projects using payback and the accounting rate of return. It then teaches the time value of money (present and future values of lump sums and ordinary annuities, using tables) and applies it in net present value and internal rate of return. A final section compares the strengths and weaknesses of the four methods.

Chapter 12: Balanced Scorecard and Other Performance Measures

Using a student cleaning business, the chapter explains why performance measurement matters for goal congruence and lists features of an effective measure, such as controllability, timely feedback and a mix of short- and long-term measures. It calculates return on investment (split into sales margin and asset turnover), residual income and economic value added, and presents Kaplan and Norton's balanced scorecard with its financial, internal business, customer, and learning and growth perspectives.

Chapter 13: Sustainability Reporting

The final chapter defines business sustainability and how it can create value, recounts cases such as the Union Carbide disaster in Bhopal that pushed companies toward accountability, and identifies the information needs of shareholders, lenders, employees, customers, governments and communities, including the idea of a social contract. It introduces materiality and three reporting initiatives (the Global Reporting Initiative, the Sustainability Accounting Standards Board and the International Integrated Reporting Council's six capitals) and closes with future issues such as artificial intelligence and the skills workers will need.

Key Concepts

• Planning, controlling and evaluating: the three main responsibilities of management that managerial accounting supports.
• Cost behaviour: fixed, variable, mixed and step costs, valid within a relevant range.
• High-low method: estimating the fixed and variable parts of a mixed cost from the highest and lowest activity levels.
• Contribution margin and break-even point: sales minus variable costs, and the volume at which it covers fixed costs.
• Margin of safety and operating leverage: how far sales exceed break-even, and how sensitive operating income is to sales changes.
• Job order and process costing: costing custom jobs individually versus averaging costs over identical units by department.
• Predetermined overhead rate: estimated overhead divided by an estimated activity base, used to apply overhead during the year.
• Equivalent units: partly completed units expressed as a number of whole units for costing.
• Activity-based costing: assigning overhead through several cost pools and cost drivers.
• Absorption and variable costing: including or excluding fixed manufacturing overhead in product cost.
• Master, static and flexible budgets: the full set of operating and financial budgets, and budgets set at one activity level versus adjusted to actual activity.
• Standard costs and variances: price, quantity, rate, efficiency, spending and volume variances.
• Responsibility centres: cost, discretionary cost, revenue, profit and investment centres.
• Transfer pricing: setting prices for goods passed between segments of the same company.
• Relevant costs: costs and revenues that differ between alternatives; sunk and unavoidable costs are ignored.
• Net present value and internal rate of return: discounted cash flow methods for capital investment decisions.
• ROI, residual income and EVA: financial measures of segment performance.
• Balanced scorecard: financial, internal business, customer, and learning and growth measures used together.
• Materiality and sustainability reporting frameworks: GRI, SASB and integrated reporting.

Critical Analysis

Strengths

• Standard coverage in a sensible order. The book covers what an introductory managerial accounting course usually includes, from cost behaviour and CVP through job order, process and activity-based costing to budgeting, variances, relevant costing and capital budgeting.
• Clear step-by-step methods. Procedures are given as explicit steps, such as the five steps of ABC, the equivalent-unit calculation and the journal entries for job order and process systems, which helps students follow the calculations.
• Decision focus. Chapters 10 and 11 frame each technique as a choice between alternatives and list qualitative factors and the strengths and weaknesses of each capital budgeting method, rather than presenting formulas alone.
• Beyond costing. Chapters on responsibility accounting, performance measurement and sustainability reporting connect accounting numbers to organisational design and to wider stakeholder concerns, and Chapter 1 gives attention to ethics through the IMA statement and US law.
• Practice and features. Each chapter has Multiple Choice, Questions, two exercise sets, two problem sets and Thought Provokers, plus Your Turn, Think It Through, Concepts in Practice and Ethical Considerations boxes; several chapters revisit the retailer Gearhead Outfitters in Continuing Application boxes.

Limitations

• Simplified treatment of harder methods. Least-squares regression for cost estimation and the FIFO method of process costing are named but left to more advanced courses, and the variance chapter covers a basic set of variances.
• Mostly a manufacturing and US perspective. Many examples assume a manufacturer, and the regulatory context (SOX, FCPA, GAAP) is American, even though the book notes that service firms also use these tools.
• Control systems at an introductory level. Budgetary slack, goal congruence and employee motivation are raised in the budgeting and performance chapters, but the design of control and incentive systems as a whole is left to more specialised texts.
• Time-bound content. The sustainability chapter describes reporting bodies, standards and events, including the US position on the Paris Agreement, as they stood around 2019, and these have since changed, so this chapter in particular needs updating from current sources.
• Limited student answers. As in Volume 1, students get answers only to odd-numbered Multiple Choice and Questions; exercise and problem answers are for instructors.

Where It Fits in the Course

For a Management Accounting course, this book matches the introductory Management Accounting by Rohde, Seal, Mustard, Garrison and Noreen in scope, and can serve as a free first text or a companion for its core chapters on cost behaviour, CVP, product costing, budgeting and variances. It also prepares students for the fuller texts on the list, Drury and Tayles's Management and Cost Accounting and Datar and Rajan's Horngren's Cost Accounting, which take product costing, cost allocation and variance analysis further, including methods this book leaves aside.

The more specialised titles have a different emphasis. Merchant and Van der Stede's Management Control Systems deals in depth with control, performance evaluation and incentives, which this book only introduces in Chapters 9 and 12, and Atrill and colleagues' Management Accounting for Decision Makers places the techniques in a decision-making context at a higher level. Students moving to those books can use Chapters 3 and 7–12 here as a refresher on the basic calculations.

How to Use This Book

Some familiarity with basic financial accounting, such as Volume 1, helps, especially for the journal entries in Chapters 4 and 5, but the decision-making chapters need only arithmetic. Chapters 1 and 2 should come first, since cost classifications are used throughout. Chapter 3 (CVP) underpins Chapter 6's variable costing and Chapter 10's decisions, and Chapters 4–6 should be read in sequence as one block on product costing. Chapters 7 and 8 belong together, since standards and variances build on budgets, and Chapters 9 and 12 can be read as a pair on performance evaluation.

When studying, set out each calculation in a table as the book does (contribution margin statements, equivalent-unit schedules, budgets), redo the worked examples before looking at the solutions, and use the Think It Through boxes to practise explaining a decision in words. Chapter 11's time value of money section, together with Appendix B, is also useful preparation for finance courses.

Edition and Sources

This guide is based on Principles of Accounting, Volume 2: Managerial Accounting by senior contributing authors Mitchell Franklin, Patty Graybeal and Dixon Cooper (OpenStax, 2019; hardcover ISBN 978-1-947172-60-9), read in the official PDF from https://openstax.org/details/books/principles-managerial-accounting. It draws on the preface, the full table of contents, every chapter's "Why It Matters" opening and full section-by-section end-of-chapter summary, and selected passages, including the discussion of cost estimation methods in Chapter 2, the process costing methods in Chapter 5, the balanced scorecard in Chapter 12, the sustainability cases in Chapter 13 and the Continuing Application boxes.