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Principles of Accounting, Volume 2: Managerial Accounting

13.2 Identify User Needs for Information

Principles of Accounting, Volume 2: Managerial Accounting13.2 Identify User Needs for Information
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  1. Preface
  2. 1 Accounting as a Tool for Managers
    1. Why It Matters
    2. 1.1 Define Managerial Accounting and Identify the Three Primary Responsibilities of Management
    3. 1.2 Distinguish between Financial and Managerial Accounting
    4. 1.3 Explain the Primary Roles and Skills Required of Managerial Accountants
    5. 1.4 Describe the Role of the Institute of Management Accountants and the Use of Ethical Standards
    6. 1.5 Describe Trends in Today’s Business Environment and Analyze Their Impact on Accounting
    7. Key Terms
    8. Summary
    9. Multiple Choice
    10. Questions
    11. Exercise Set A
    12. Exercise Set B
    13. Thought Provokers
  3. 2 Building Blocks of Managerial Accounting
    1. Why It Matters
    2. 2.1 Distinguish between Merchandising, Manufacturing, and Service Organizations
    3. 2.2 Identify and Apply Basic Cost Behavior Patterns
    4. 2.3 Estimate a Variable and Fixed Cost Equation and Predict Future Costs
    5. Key Terms
    6. Summary
    7. Multiple Choice
    8. Questions
    9. Exercise Set A
    10. Exercise Set B
    11. Problem Set A
    12. Problem Set B
    13. Thought Provokers
  4. 3 Cost-Volume-Profit Analysis
    1. Why It Matters
    2. 3.1 Explain Contribution Margin and Calculate Contribution Margin per Unit, Contribution Margin Ratio, and Total Contribution Margin
    3. 3.2 Calculate a Break-Even Point in Units and Dollars
    4. 3.3 Perform Break-Even Sensitivity Analysis for a Single Product Under Changing Business Situations
    5. 3.4 Perform Break-Even Sensitivity Analysis for a Multi-Product Environment Under Changing Business Situations
    6. 3.5 Calculate and Interpret a Company’s Margin of Safety and Operating Leverage
    7. Key Terms
    8. Summary
    9. Multiple Choice
    10. Questions
    11. Exercise Set A
    12. Exercise Set B
    13. Problem Set A
    14. Problem Set B
    15. Thought Provokers
  5. 4 Job Order Costing
    1. Why It Matters
    2. 4.1 Distinguish between Job Order Costing and Process Costing
    3. 4.2 Describe and Identify the Three Major Components of Product Costs under Job Order Costing
    4. 4.3 Use the Job Order Costing Method to Trace the Flow of Product Costs through the Inventory Accounts
    5. 4.4 Compute a Predetermined Overhead Rate and Apply Overhead to Production
    6. 4.5 Compute the Cost of a Job Using Job Order Costing
    7. 4.6 Determine and Dispose of Underapplied or Overapplied Overhead
    8. 4.7 Prepare Journal Entries for a Job Order Cost System
    9. 4.8 Explain How a Job Order Cost System Applies to a Nonmanufacturing Environment
    10. Key Terms
    11. Summary
    12. Multiple Choice
    13. Questions
    14. Exercise Set A
    15. Exercise Set B
    16. Problem Set A
    17. Problem Set B
    18. Thought Provokers
  6. 5 Process Costing
    1. Why It Matters
    2. 5.1 Compare and Contrast Job Order Costing and Process Costing
    3. 5.2 Explain and Identify Conversion Costs
    4. 5.3 Explain and Compute Equivalent Units and Total Cost of Production in an Initial Processing Stage
    5. 5.4 Explain and Compute Equivalent Units and Total Cost of Production in a Subsequent Processing Stage
    6. 5.5 Prepare Journal Entries for a Process Costing System
    7. Key Terms
    8. Summary
    9. Multiple Choice
    10. Questions
    11. Exercise Set A
    12. Exercise Set B
    13. Problem Set A
    14. Problem Set B
    15. Thought Provokers
  7. 6 Activity-Based, Variable, and Absorption Costing
    1. Why It Matters
    2. 6.1 Calculate Predetermined Overhead and Total Cost under the Traditional Allocation Method
    3. 6.2 Describe and Identify Cost Drivers
    4. 6.3 Calculate Activity-Based Product Costs
    5. 6.4 Compare and Contrast Traditional and Activity-Based Costing Systems
    6. 6.5 Compare and Contrast Variable and Absorption Costing
    7. Key Terms
    8. Summary
    9. Multiple Choice
    10. Questions
    11. Exercise Set A
    12. Exercise Set B
    13. Problem Set A
    14. Problem Set B
    15. Thought Provokers
  8. 7 Budgeting
    1. Why It Matters
    2. 7.1 Describe How and Why Managers Use Budgets
    3. 7.2 Prepare Operating Budgets
    4. 7.3 Prepare Financial Budgets
    5. 7.4 Prepare Flexible Budgets
    6. 7.5 Explain How Budgets Are Used to Evaluate Goals
    7. Key Terms
    8. Summary
    9. Multiple Choice
    10. Questions
    11. Exercise Set A
    12. Exercise Set B
    13. Problem Set A
    14. Problem Set B
    15. Thought Provokers
  9. 8 Standard Costs and Variances
    1. Why It Matters
    2. 8.1 Explain How and Why a Standard Cost Is Developed
    3. 8.2 Compute and Evaluate Materials Variances
    4. 8.3 Compute and Evaluate Labor Variances
    5. 8.4 Compute and Evaluate Overhead Variances
    6. 8.5 Describe How Companies Use Variance Analysis
    7. Key Terms
    8. Summary
    9. Multiple Choice
    10. Questions
    11. Exercise Set A
    12. Exercise Set B
    13. Problem Set A
    14. Problem Set B
    15. Thought Provokers
  10. 9 Responsibility Accounting and Decentralization
    1. Why It Matters
    2. 9.1 Differentiate between Centralized and Decentralized Management
    3. 9.2 Describe How Decision-Making Differs between Centralized and Decentralized Environments
    4. 9.3 Describe the Types of Responsibility Centers
    5. 9.4 Describe the Effects of Various Decisions on Performance Evaluation of Responsibility Centers
    6. Key Terms
    7. Summary
    8. Multiple Choice
    9. Questions
    10. Exercise Set A
    11. Exercise Set B
    12. Problem Set A
    13. Problem Set B
    14. Thought Provokers
  11. 10 Short-Term Decision Making
    1. Why It Matters
    2. 10.1 Identify Relevant Information for Decision-Making
    3. 10.2 Evaluate and Determine Whether to Accept or Reject a Special Order
    4. 10.3 Evaluate and Determine Whether to Make or Buy a Component
    5. 10.4 Evaluate and Determine Whether to Keep or Discontinue a Segment or Product
    6. 10.5 Evaluate and Determine Whether to Sell or Process Further
    7. 10.6 Evaluate and Determine How to Make Decisions When Resources Are Constrained
    8. Key Terms
    9. Summary
    10. Multiple Choice
    11. Questions
    12. Exercise Set A
    13. Exercise Set B
    14. Problem Set A
    15. Problem Set B
    16. Thought Provokers
  12. 11 Capital Budgeting Decisions
    1. Why It Matters
    2. 11.1 Describe Capital Investment Decisions and How They Are Applied
    3. 11.2 Evaluate the Payback and Accounting Rate of Return in Capital Investment Decisions
    4. 11.3 Explain the Time Value of Money and Calculate Present and Future Values of Lump Sums and Annuities
    5. 11.4 Use Discounted Cash Flow Models to Make Capital Investment Decisions
    6. 11.5 Compare and Contrast Non-Time Value-Based Methods and Time Value-Based Methods in Capital Investment Decisions
    7. Key Terms
    8. Summary
    9. Multiple Choice
    10. Questions
    11. Exercise Set A
    12. Exercise Set B
    13. Problem Set A
    14. Problem Set B
    15. Thought Provokers
  13. 12 Balanced Scorecard and Other Performance Measures
    1. Why It Matters
    2. 12.1 Explain the Importance of Performance Measurement
    3. 12.2 Identify the Characteristics of an Effective Performance Measure
    4. 12.3 Evaluate an Operating Segment or a Project Using Return on Investment, Residual Income, and Economic Value Added
    5. 12.4 Describe the Balanced Scorecard and Explain How It Is Used
    6. Key Terms
    7. Summary
    8. Multiple Choice
    9. Questions
    10. Exercise Set A
    11. Exercise Set B
    12. Problem Set A
    13. Problem Set B
    14. Thought Provokers
  14. 13 Sustainability Reporting
    1. Why It Matters
    2. 13.1 Describe Sustainability and the Way It Creates Business Value
    3. 13.2 Identify User Needs for Information
    4. 13.3 Discuss Examples of Major Sustainability Initiatives
    5. 13.4 Future Issues in Sustainability
    6. Key Terms
    7. Summary
    8. Multiple Choice
    9. Questions
    10. Thought Provokers
  15. Financial Statement Analysis
  16. Time Value of Money
  17. Suggested Resources
  18. Answer Key
    1. Chapter 1
    2. Chapter 2
    3. Chapter 3
    4. Chapter 4
    5. Chapter 5
    6. Chapter 6
    7. Chapter 7
    8. Chapter 8
    9. Chapter 9
    10. Chapter 10
    11. Chapter 11
    12. Chapter 12
    13. Chapter 13
  19. Index

The concept of the triple bottom line expanded the role of reporting beyond shareholders and investors to a broader range of stakeholders – that is, anyone directly or indirectly affected by the organization, including employees, customers, government entities, regulators, creditors, and the local community. Naturally, companies may feel their first obligation is to their present and potential investors. But it also makes good business sense to consider other stakeholders who can affect the company’s livelihood. Let’s examine the various users of sustainability reports and their particular information needs. Primary users would be considered shareholders and investors, whereas secondary users would be customers, suppliers, the community and regulators.

Shareholders

Many consider the company’s shareholders to be its primary information user group. These equity investors may be small single investors or they may be part of an institutional investment fund charged with investing on behalf of its members. As shareholders they concern themselves with the future viability of the company and want profits to be sustained or increased over the long term. Shareholders often use financial ratios, such as earnings per share (EPS), return on investment (ROI), and the price/earnings ratio to evaluate the financial health and the sustainability of financial growth of the company. Shareholders not only evaluate whether there is current value in owning stock of the company but also whether there will continue to be value in owning that company’s stock. Otherwise the shareholder is likely to divest of their ownership interest.

One ratio that shareholders often use to measure the value of the company’s stock relative to the company’s earnings is the price-earnings ratio, or P/E ratio. In the P/E ratio, the market price of the stock is divided by the earnings per share of the company’s stock. This ratio indicates the amount an investor is willing to pay for one dollar of the company’s earnings. For example, if a stock is trading at a P/E of 30, then this indicates investors are willing to pay $30 for $1 of current earnings. A high P/E ratio indicates investors expect high future earnings. A low P/E ratio has several interpretations but could indicate a company is undervalued. Many investors use the P/E ratio as a measure of whether or not a stock should be purchased, but no single metric should be used alone. In addition, the P/E ratio is only useful when comparing changes across time for a single company to see trends or lack of trends. The P/E ratio is most useful if compared across companies within a given industry sector. Most often, growth will vary widely between different sectors but will be more similar within a particular sector. Investors buy and sell stock for many reasons, both financial and non-financial. They can sell a stock due to lack of current growth in value or an expected drop in future earnings. They can also buy a stock because the company participates in activities that the shareholder values, such as fair wages and greenhouse emission reductions even if the company has a low P/E ratio. Let’s look at an example of an investment driven by more than just the company’s current financial situation.

In 2008, Warren Buffett’s MidAmerican Energy Company, a subsidiary of Berkshire Hathaway, bought a $230m stake in BYD, a Chinese battery maker about to begin auto production.52 Although the auto industry initially ridiculed Buffet’s investment in such a little- known company, he may well have the last laugh. Since 2008, the company has evolved into the world’s leading producer of electric cars, and its shares now trade at almost 10 times what MidAmerican paid for them. This increase in value reflects the market’s optimism about the future of the company based on the Chinese government’s commitment to speeding up the phasing out of fossil fuels.

The new ethical investing movement focuses on eliminating investments that conflict with shareholders’ values, such as dependence on environmentally damaging fossil fuels. The movement is growing each year. In 2016, ethical investments topped $8.7 trillion, up 33% from 2014, and they now account for 20% of all investment under professional management.53 Ethical investors are increasingly avoiding polluters, weapon manufacturers, and tobacco companies as well as companies with a poor track record on human rights or philosophies that do not align with a fund’s religious tenets. Pension funds, such as the New York City Pension Fund54 have announced a move away from investing in companies in the fossil fuel industry, a move that will put substantial pressure on these companies to seek out alternatives to the non-renewables business model. On the opposite side of the country, the California Public Employees’ Retirement System announced that it had divested from most of its holdings in thermal coal stock.55

Investors are also increasingly looking to the future to evaluate whether a firm’s stock price is sustainable. Consider that, as the cost of renewable energy alternatives become cheaper, non-renewable resources become less able to compete. That is, the price of the non-renewable commodity falls to a point where the costs of extraction become greater than the price that can be obtained for the asset, and so the non-renewable resource remains in the ground.56 At this point, the value of the asset, the mine, is impaired, which leads to a reduced share price.

For example, in mid-2017, Coal India, the largest coal-mining company in the world, announced that it would close 9657 of its 394 mines58 by March 2018 because they would be no longer economically viable after the Indian Government announced it would cut its commitments to purchase coal after 2022.59

Investors, including ethical investors, must look to the future of their investments, buying shares that are sustainable for the long term to provide better returns. A recent Harvard Business Review study showed that socially responsible companies post higher profits and stock performance than those that were not focused on social responsibility.60 This result is supported by a Deutsche Bank analysis of more than 2,000 studies dating back to the 1970’s, 90% of which suggested that socially responsible investing gives better returns than passive investing.61

Ethical Considerations

Millennials Are Demanding Sustainable Investments

According to the Forum for Sustainable and Responsible Investment, a U.S.-based membership organization, “sustainable, responsible and impact investing is an investment discipline that considers environmental, social and corporate governance criteria to generate long-term competitive financial returns and positive societal impact.”62 Demand for this type of sustainable investments is being driven in a large part by millennials who prefer that their investments align with their personal beliefs and values. Ethical companies are seeing value in the millennial investors because “millennials are poised to receive more than $30 trillion of inheritable wealth.”63 Forward-looking companies need to develop an awareness of millennial values.

Forward-looking companies and investment advisor companies also need to adapt to a sustainable investment environment. This changes the perspective of accounting because managers will need to look to other factors besides profits to guide management’s business decisions. Management and accountants will need to look beyond just numbers, and this will require a change in culture, technology, and operational and financial reporting to investors, potential investors and stakeholders.

Lenders

Sustainability reports provide useful information for lenders. Lenders want to know that the company borrowing from them does not have any going-concern risks that could affect its ability to repay the loan (Figure 13.8). They want to know the company will not be sued for human rights violations at home or abroad, be unable to repay its loans because consumer boycotts have hurt its cash flow, or that they maintain valuable property assets in high-risk areas. For example, after the 2017 Houston floods, a number of Houston-based banks were examined to find that they had a high level of exposure in commercial real estate in Houston.64 This type of investment concentration in a single geographic area can be risky for lenders as a single disaster can have a more damaging effect than on a portfolio spread over a broader geographical area.

A image shows plants growing from stacks of money of different sizes.
Figure 13.8 Sustainable Investment. Lenders appreciate sustainable investment because it gives them assurance that their loans will be repaid. (credit: modification of “Money Coin Investment” by “nattanan23”/Pixabay, CC0)

Employees

Employees and potential employees want to know that the company they work for is concerned about their safety and is an ethical organization. They want assurance that they will be fairly compensated and that all employees have equal rights and opportunities, regardless of gender, race, religion, or sexual orientation.

Recent studies show that employees increasingly want to work for companies that align with their own values and will be more loyal to those organizations. In 2016, 76% of millennials said that a company’s social and environmental commitments were considerations in employment, with 64% of millennials indicating that they would not work for a company that did not have strong corporate social responsibility practices.65

Employees also report higher levels of satisfaction when their employers engage in corporate giving programs that are aligned with employee values or are chosen by employees.66 For example, Intel will donate $10 to an educational institution, environmental program, or other community organization for every hour an employee volunteers there. More than 40% of Intel’s U.S. employees have donated time that totals hundreds of thousands of volunteer hours.67 Other firms have corporate giving programs that match employee’s charitable donations dollar for dollar.

Customers

Customers often have many choices about where to spend their hard-earned dollars. They want to know the companies to which they give that money reflect their own values and beliefs. If a company is seen to be uncaring about an issue, then customers may arrange campaigns to boycott the company (see the Nestlé story for an example of such consumer activism).

A 2016 study by Unilever showed that 33% of consumers buy from brands they believe are doing social or environmental good and that this presents a €966 billion (over 1.1 trillion $USD) opportunity for brands. As such, it is important for a company to demonstrate their commitment to CSR, and sustainability reporting offers a medium to do this.68

Governments and Regulators

Governments and regulators want to be able to see that a company is behaving responsibly. If they are confident that it is, there is less need to design laws and regulations that might restrict the company even more than if it undertook best-practice measures on its own. Many companies form industry alliance groups that aim to implement best practices in trade, social responsibility, or environmental initiatives.

Community

The community at large also wants to know that the organization is behaving at the level of society’s expectations. This reflects the existence of a social contract, the expectation that companies will hold to an unwritten contract with society as a whole. If a firm is undertaking actions that might harm society or that reject its general values, community backlash may cost the firm dearly.

In summary, a company’s accountability to a wider group of users is an element of stakeholder theory. This theory presents a view that asserts a corporation has an obligation to groups beyond just its shareholders.

Your Turn

Identifying Stakeholders

Locate the sustainability report of a Fortune 500 company and read the management discussion in it. Explain who you think the company considers its primary and secondary users. What information about itself and its operations does the company attempt to convey to each audience? Do you think its choices meet the information needs of these two groups of stakeholders? Why or why not?

Solution

Invariably, the primary users will be shareholders and creditors. Secondary users would be customers, employees, environmental groups, the community and regulators. The strength or relevance of each user will be dependent on the type of business discussed in the response.

Ethical Considerations

Public Benefit Corporations

Traditionally, standard American corporations consider their ultimate purpose as maximizing the profits of the shareholders. In the United States, directors of for-profit corporations recognize that one of their major goals is to maximize shareholder value. While corporations generally have the ability to engage in any legal activities, including those that are socially responsible, corporate decision-making must be justified in terms of creating shareholder value. Mission driven and other socially conscious businesses, impact investors, and social entrepreneurs are constrained by this inflexible legal framework that does not accommodate for-profit entities whose mission and impact is central to their business model.

In response, the benefit corporation model has emerged, which “broadens the perspective of traditional corporate law by incorporating concepts of purpose, accountability and transparency with respect to all corporate stakeholders, not just stockholders.”69 Public benefit corporations expand the obligations of boards, requiring them to consider environmental and social factors, as well as the financial interests of shareholders. This gives directors and managers the legal protection to pursue a mission other than maximizing profit and consider the impact their business has on society and the environment.

Footnotes

  • 52 Keith Bradsher. “Buffet Buys Stake in Chinese Battery Manufacturer.” New York Times. September 29, 2008. https://www.nytimes.com/2008/09/30/business/worldbusiness/30battery.html
  • 53 Matt Whittaker. “Ethical Investing Continues to Grow.” U.S. News and World Report. January 27, 2017. https://money.usnews.com/investing/articles/2017-01-27/ethical-investing-continues-to-grow
  • 54 William Neuman. “To Fight Climate Change, New York City Takes on Oil Companies.” New York Times. January 10, 2018. https://www.nytimes.com/2018/01/10/nyregion/new-york-city-fossil-fuel-divestment.html?
  • 55 Randy Diamond. “CalPERS Reveals It Divested from Most Thermal Coal Companies.” Pensions & Investments. August 7, 2017. http://www.pionline.com/article/20170807/ONLINE/170809876/calpers-reveals-it-divested-from-most-thermal-coal-companies
  • 56 M.K. Linnenluecke, J. Birt, J. Lyon, and B.K. Sidhu. “Planetary Boundaries: Implications for Asset Impairment.” Accounting & Finance 55, no. 4 (2015).
  • 57 IANS. “Coal India Could Close 53 Underground Mines This Fiscal.” The Economic Times. September 12, 2018. https://economictimes.indiatimes.com/industry/indl-goods/svs/metals-mining/coal-india-could-close-53-underground-mines-this-fiscal/articleshow/65783526.cms
  • 58 Coal India. Annual Report and Accounts 2016–2017. n.d. https://www.coalindia.in/DesktopModules/DocumentList/documents/Annual_Report_&_Accounts_2016_17_Deluxe_English_07112017.pdf
  • 59 Harriet Agerholm. “World’s Biggest Coal Company Closes 37 Mines as Solar Power’s Influence Grows.” Independent. June 21, 2017. http://www.independent.co.uk/news/world/asia/coal-india-closes-37-mines-solar-power-sustainable-energy-market-influence-pollution-a7800631.html
  • 60 MoneyShow. “Socially-Responsible Investing: Earn Better Returns from Good Companies.” Forbes. August 16, 2017. https://www.forbes.com/sites/moneyshow/2017/08/16/socially-responsible-investing-earn-better-returns-from-good-companies/#7f73a8a1623d
  • 61 MoneyShow. “Socially-Responsible Investing: Earn Better Returns from Good Companies.” Forbes. August 16, 2017. https://www.forbes.com/sites/moneyshow/2017/08/16/socially-responsible-investing-earn-better-returns-from-good-companies/#7f73a8a1623d
  • 62 US SIF. “SRI Basics.” n.d. https://www.ussif.org/sribasics
  • 63 Ernst & Young. Sustainable Investing: The Millennial Investor. 2017. https://www.ey.com/Publication/vwLUAssets/ey-sustainable-investing-the-millennial-investor-gl/$FILE/ey-sustainable-investing-the-millennial-investor.pdf
  • 64 Ely Razin. “As Harvey Leaves Houston Reeling, These Banks Are More Exposed Than Others.” Forbes. August 31, 2017. https://www.forbes.com/sites/elyrazin/2017/08/31/as-harvey-leaves-houston-reeling-these-banks-are-more-exposed-than-others/#423dcb5e6355
  • 65 Cone Communications (Whitney Dailey). “Three-Quarters of Millennials Would Take a Pay Cut to Work for a Socially Responsible Company, According to the Research from Cone Communications.” November 2, 2016. http://www.conecomm.com/news-blog/2016-cone-communications-millennial-employee-engagement-study-press-release
  • 66 America’s Charities. “Facts and Statistics on Workplace Giving, Matching Gifts, and Volunteer Programs.” n.d. https://www.charities.org/facts-statistics-workplace-giving-matching-gifts-and-volunteer-programs
  • 67 Intel. “Giving Back: How Our Employees Make a Difference.” n.d. https://www.intel.com/content/www/us/en/jobs/life-at-intel/usa/giving-back.html
  • 68 Unilever. “Report Shows a Third of Consumers Prefer Sustainable Brands.” May 5, 2017. https://www.unilever.com/news/Press-releases/2017/report-shows-a-third-of-consumers-prefer-sustainable-brands.html
  • 69 Morris, Nicols, Arsht & Tunnel. “Understanding Delaware’s Benefit Corporation Governance Mode.” The Public Benefit Corporation Guidebook. May 2016. http://news.mnat.com/rv/ff00272e4c8b3699806e25d24c48a286df5bf926
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