CHAPTER 15

THE NATURE OF MANAGEMENT ACCOUNTING

Changes from Eleventh Edition
All changes to Chapter 15 were minor.
Approach
This chapter is intended as an introduction to the topic of management accounting. The amount of
technical material in the chapter is not great, so probably not much class discussion of the text itself is
required. The classification of management accounting information is intended to lessen the confusion
that arises because different cost constructions are used for different purposes. We suggest that the
threefold distinction be emphasized here, and that it be repeated often in subsequent chapters.

Problems
Problem 15-1
This report includes nonmonetary information (on jobs and number of employees), has future (planned)
information as well as past ("actual"), is optional (not required as a basis for financial statements), focuses
on a segment (service department), has less emphasis on precision (planned numbers are rounded), and is
not an end in itself (useful only as manager uses it).
Note: If the instructor wishes, he or she can ask students to discuss the figures in terms of how well
the Service Department did, as a lead-in to later work in the course. Without technical
background, students can discern such things as the low volume, failure to adjust labor to
volume, and increased labor cost.
Problem 15-2
a.

(1) Differential accounting

(2) Full-cost accounting
(3) Responsibility accounting

(4) Full-cost accounting

(5) Differential accounting
(6) Responsibility accounting

b. Nonquantitative, nonaccounting, operating, and financial accounting. (The instructor may want to
expand on this, with more specifics.)
Problem 15-3
a.

(1) Full-cost accounting

(2) Differential accounting
(3) Full-cost accounting

(4) Responsibility
(5) Differential accounting
(6) Responsibility accounting

b. Nonquantitative, nonaccounting, operating, and financial accounting.

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Problem 15-4
1. Why did the manager fail to make the planned number of prospect calls? Was this the reason for the
failure to obtain the planned number of new accounts and increase in deposit volume?
2. Could the savings in advertising expense have contributed to the failure to achieve the planned
growth in new accounts and deposit volume?
3. Was the $2,200 savings in wages and salaries the result of operating with one employee less than
needed? If so, could this have helped prevent the manager from making the planned number of
prospect calls?
4. Why was revenue lower than planned?
5. Did the manager emphasize loans more than deposits?
The manager of the branch should be concerned about its performance because the major reason for profit
being higher than planned was a $2,200 savings in wages and salaries. Also, he or she should be
concerned over the failure to achieve planned increases in new accounts and deposits.

Cases
Case 15-1: Private Fitness LLC*
Note: This case is new in the Twelfth Edition.
Private Fitness LLC is a springboard case that can be used as the basis of a discussion of management's
need for information. It serves the same purpose for Part 2 of the book that the Kim Fuller case did for
Part 1.
Approach
This case uses a small business as its setting so that students can visualize the business's activities, and so
questions of generally accepted accounting principles will be essentially irrelevant. In fact, a shift the
student needs to make as he/she begins Part 2 of the book is to think of accounting primarily in terms of
its usefulness to a company's management, rather than in terms of reporting to shareholders and other
outside parties. Because of the differing focus of Part 1 of the book, particularly the later chapters, some
students will forget that they are dealing here with information for an apparently unsophisticated manager
to help her run a small business, and not data for a NYSE company.
This case is compelling both because students understand the businessfitness-trainingand because
there is a real problem to discuss. A trusted employee was both stealing cash and, by not recording all
sales, diverting some revenues to herself.
Discussion of this simple case helps students think about both the records needed to run the business and
the challenges managers face in making sure the information put into the records is recorded accurately
(i.e., the challenges faced in maintaining an effective internal control system). The case illustrates a
common problem faced in many small businesseslack of overlapping controls, or in this case, what
auditors call separation of duties.
Discussion
*

This teaching note was prepared by Kenneth A. Merchant. Copyright Kenneth A. Merchant.

2007 McGraw-Hill/Irwin

Chapter 15

To run this simple privately-held business, Rosemary does not have to be concerned with generally
accepted accounting principles. She does need to keep records that will allow the easy preparation of a tax
return. But her primary concern should be in maintaining systems records that allow her to manage the
business effectively. These include the following:
1. Scheduling system. What instructors, and other employees, should be on duty at what hours?
When should classes of particular types be scheduled? What rooms should be used for what
purposes at what hours? When should facility cleaning and maintenance be scheduled? What is
the capacity utilization? Are more space, equipment, or instructors needed?
2. Revenue system. Revenue is dependent on the number of clients attending classes and private
workouts.
3. Payroll system. What pay is due the employees? Most of the compensation is commission-based,
paid as a percentage of revenue associated with the instructors activities. But the manager, Kate
Hoffman, is also paid a salary.
4. Operating cost system. Bills for on-going items, like rent, heat, and light, need to be paid on
time. The expenses need to be recorded accurately and tracked over time so that trends can be
monitored.
5. Fixed asset system. The costs of the facility and equipment need to be assigned to time periods.
Issues that might be raised:
1. How often should Rosemary prepare summary financial statements (e.g., monthly, quarterly,
annually)? Does she need an income statement, or is a cash flow statement sufficient for her
management purposes? Does she need to prepare a balance sheet at all?
2. How should prices be set? Should they be set only by looking at competitors prices, or should
they depend on costs (e.g., cost of the space and equipment used and required instructor
expertise)? If the latter, does Rosemary need a job costing system, or would a periodic back of
the envelope calculation be sufficient?
3. Should Rosemary pay herself a salary and commission for the classes she ran, or should she take
merely the residual profits (or cash flow) from the business?
4. Should the equipment (e.g., exercise bicycles) be expensed when acquired, or should the
equipment costs be spread over some period of time to provide a more meaningful time-series
picture of costs? If the latter, what equipment life should be used, and should the cost of
equipment be spread equally to time periods over that useful life?
Addressing the Specific Problems
Students must first recognize that there are two problems to be solvedthe theft of cash and the
unrecorded revenue. There are a lot of internal control options, most of which involve options that go far
beyond the accounting. I like to divide the options into three categories, (1) action controlsthose that
limit the managers ability to perform the specific bad actions, (2) results controlsthose that improve
the pay-for-performance system, and (3) personnel/cultural controlsthose that encourage either more

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employee honesty (self-control) or encourage employees to monitor each others behaviors (social
control).
1. Action controlse.g., hire a supervisor (accomplish separation of duties), camera with videotaping
capability, locked cash box, use of receipts and reconciliations with cash in the drawer/cash register.
2. Results controlsStudents must recognize that providing Kate a bonus of, say, 10% of revenues or
profits does little to reduce her motivation to pocket 100% of the revenue through theft of cash or direct
pocketing of revenues. Revenue-based bonus systems could be effective motivators if Rosemary is sure
that every client is recognized on the system, but by themselves they wont ensure that every client is
recognized.
There are some more creative and better possibilities. For example, should instructors be set up as little
entrepreneurs? Let them keep all the revenue, but charge them a fixed fee for access to the facility. If this
alternative is chosen, then Rosemary would have to develop a fee schedule that could be based on a cost
accounting.
3. Personnel/cultural controlsstricter hiring criteria (e.g., background checks), building a strong
family culture, group rewards (which encourage mutual monitoring).
What should Rosemary do?
To answer this question, students will have to consider the benefits (control effectiveness) and costs in
this specific setting. Some alternatives, such as a camera, might be effective in tracking usage of the
facility, but it is an expensive solution. A wide range of answers are possible here. Students should see
that there is not just one solution to this problem.
The case also raises the question as to what Rosemary should do with Kate. Some students get
emotionally involved in considering this issue, but these discussions are probably not worth much class
time.
Pedagogy
This is a short case. It can be used in class even if students have not prepared the case in advance.
Most students can probably read the case in 10 minutes, and the answers to the questions can developed
in the ensuing class discussion. With or without advanced preparation, the discussion can easily consume
even up to 75 minutes of class time.