“Bridging The GAP in GAAP:
How Management Accountants
Can Add REAL Value”
Wichita State Educational Conference
May 19, 2014
Olen L. Greer, Ph.D., CMA
Professor of Accountancy
Heartland Regional Council
Professional Education Conference
• When:
September 17 and 18, 2014
• Where: University Plaza Hotel & Convention Center,
Springfield, Missouri
• Conference Details:
– 16 hours of CPE.
– Nationally known speakers (e.g. Mr. EXCEL (Bill Jelen),
Former Worldcom Controller David Myers, Collette
Carlson, Dr. Chris Kuehl, Dr. Andrew Urich, and many
others).
– Includes 8 general sessions and 6 sets of 3 concurrent
sessions.
– Registration ($375/$395) includes breakfast, lunch &
breaks for both days.
– Corporate Discounts available.
Heartland Regional Council
Professional Education Conference
• To register, go to:
www.noncredit.missouristate.edu/imaconference.htm
Or call:
(417) 836-6866
BACKGROUND and
PROBLEM
DEVELOPMENT
“Respect” and The Accounting
Profession
“The Way We Were” as of 1986
(per the President of the MSCPA’s)
Clergy
Medical Doctors
Attorneys
Accountants
THE MOST RESPECTED PROFESSIONALS:
__________
“Respect” and The Accounting
Profession
Then came Enron, World Com, Tyco, etc.
“Respect” and The Accounting
Profession, Continued
“Ultimately, the accounting profession sacrificed
the public confidence that underpinned its
reputation. Now, accountants wallow at the
bottom among professions in public-opinion polls
they topped 20 years ago. The business is
drawing fewer top students, more government
scrutiny and bad jokes.”
“No Taste for Accounting,” I. J. Dugan, WSJ
“Respect” and The Accounting
Profession, Continued
“Hard hit by industry scandals, industry
leaders and individual accountants will
need to put their best feet forward to
rebuild a now tarnished image and
restore public faith in what was once a
most trusted profession.”
“If the Shoe Fits,” C. Fitzgerald,
Insight
Central Scandal
Theme:
________________
________________
“And check for this red flag: Are net
earnings (as reported on the income
statement) increasing while cash flow is
declining? That could signal the use of
creative accounting practices designed to
___________________________________
_________________. Exhibit A: Enron.”
“10 Questions Every Investor Should Ask
Before Buying a Stock,” J. Revell, Fortune
“When it comes to reporting earnings, U.S.
companies have about as much credibility
these days as the judges of Olympic figure
skating. So how do you begin to restore
investor confidence post-Enron, post-Tyco,
post-you-name-it? By having companies
state profits in a way that is more
meaningful and ____________________
_________________________________.”
“System Failure,” Joseph Nocera, Fortune
What was the “fix?”
Sarbanes-Oxley
(2002)
SOX legislation impact:
1. The compliance burden on MA’s has
increased, to the point that they have
little-to-no time to focus on
management’s needs.
2. Management must now survive 3 audit
opinions, instead of one.
3. Corporate America has already (as of
2006) spent over $280 billion
complying with SOX (Non-value
adding costs).
Source: “Surviving Three SOX Opinions,”
Crawford, Klamm & Watson, Strategic Finance,
May, 2007.
SOX legislation impact, Continued:
4) The cost per company, per year,
ranges from _______to well over
____________. This is a totally
non-value adding expense.
Source: “2011 Sarbanes-Oxley
Compliance Survey,” conducted
and published by PROVITY Risk
and Business Consulting.
Purposes of Presentation
To examine income measurement problems
CREATED BY GAAP-REQUIRED COSTING
METHODOLOGIES.
To demonstrate how GAAP encourages and
incentivizes managers to manipulate income in
LEGAL ways that can be extremely harmful to
the organization.
To identify ways that the Management
Accountant can add REAL value, using proven
alternatives to GAAP measurement techniques.
The Income Equation
Revenue – EXPENSES = Profit
-COST“A sacrifice made
(economic or otherwise)
to obtain a desired
benefit.”
Cost Accounting 101
GAAP Product Costing-Absorption
Costing
• Product Costs
– _____________________________________
– _____________________________________
– _____________________________________
• Period Costs
– _____________________________________
– _____________________________________
Review Quiz Results
6. ___________________ =
___________________
___________________
Sources of Variation (GAAP)
• Cost flow assumptions (FIFO, LIFO, etc.)
• Cost Allocation Methods
– Actual vs. Normal vs. Standard Cost Systems
– Service Department Cost Allocations: Direct vs.
Step vs. Algebraic Methods
– Joint Cost Allocations: Physical vs. Sales Value
at Splitoff vs. Approximated Net Realizable Value
– Activity-Based Costing vs. Traditional Methods
– ETC. . . . . . . . . . . . . . . . . .
Traditional Income Formula:
Sales – Cost of Goods Sold =
Gross Margin
Gross Margin – S&A Expenses
= Operating Income
Practicum No. 1
The Olga Bonemarrow
Company
• The Olga Bonemarrow Wood
Spirits Company produces two
products, turpentine and
methanol (wood alcohol), by a
joint process.
• Joint costs amount to $120,000
per batch of output.
• Each batch totals 10,000
gallons, 25% methanol and 75%
turpentine.
• Both products are processed further
without gain or loss in volume.
• Separable processing costs:
Methanol, $3 per gallon;
Turpentine, $2 per gallon.
• Methanol sells for $21 per gallon;
Turpentine sells for $14 per gallon.
• Bonemarrow uses the approximated
net realizable value method for
allocating joint costs to main
products.
QUESTIONS
1) What amounts of Joint Costs would be
allocated to Methanol? Turpentine?
____________________________
____________________________
____________________________
____________________________
____________________________
____________________________
QUESTIONS, Continued
2) What is the total cost of each product
and the per unit cost of each product?
____________________________
____________________________
____________________________
____________________________
____________________________
____________________________
QUESTIONS, Continued
3) What is the Gross Margin on each
product and the Gross Margin
percentage?
____________________________
____________________________
____________________________
____________________________
____________________________
• Suppose that you are the
manager of the Methanol
Division.
• Furthermore, suppose that
you and your staff worked
hard to develop a process by
which the methanol could be
made into a pleasant-tasting
beverage.
• The new selling price would
be $48 per gallon (net of
Excise Tax).
• The additional separable cost
of the new process would be
$9.00, bringing the total
separable cost per gallon to
$12.00 ($9 + $3).
QUESTIONS
1) What amounts of Joint Costs would be
allocated to the new product?
Turpentine?
____________________________
____________________________
____________________________
____________________________
____________________________
____________________________
QUESTIONS, Continued
2) What is the total cost of each product
and the per unit cost of each product?
____________________________
____________________________
____________________________
____________________________
____________________________
____________________________
QUESTIONS, Continued
3) What is the Gross Margin on each
product and the Gross Margin
percentage?
____________________________
____________________________
____________________________
____________________________
____________________________
Olga Bonemarrow Summary
• Use of a GAAP-sanctioned cost
allocation method resulted ______
__________________________.
• Long-term impact: ___________
__________________________.
• REMEMBER: Allocated joint costs
are generally _________ to
product decisions.
ASSERTION:
The GAAP answer to the
“Cost Question” is, in many
if not most cases, the
WRONG answer, when it
comes to decision making.
The Fixed Cost Dilemma
• GAAP requires FFOH to be allocated to
products.
• By allocating FFOH to products, we’re
forcing a fixed cost to behave ____________
____________________________________.
• The amount we allocate to each unit is
dependent on _________________________.
• We don’t know how many units we’re going
to produce until the end of the period!!
Practicum No. 2
The Brassinni Company
The Brassinni Company began
operations in 2011 as a
manufacturer with a capacity of
40 million units of product.
In 2011, 10 million units of
product were manufactured and
sold. Brassinni Company’s
income statement for 2011
follows:
BRASSINNI COMPANY
Income Statement
Year ending December 31, 2011
Sales (10 million units @ $6)
Cost of Goods Sold:
$60,000,000
Variable (10,000,000 @ $2) $20,000,000
Fixed
48,000,000
Total
68,000,000
Gross Margin
($8,000,000)
Less: Marketing & Admin. Costs
10,000,000
Operating Profit (Loss)
($18,000,000)
The board of directors is concerned about the
$18 million loss. A consultant approached the
board with following offer: “I agree to become
president for no fixed salary. But, I insist on a
year-end bonus of 10 percent of operating
profit (before considering the bonus).” The
board of directors agreed to these terms and
hired the consultant.
The new president promptly stepped up
production to an annual rate of 30 million
units. Sales for 2012 remained at 10 million
units. The income statement for Brassinni
Company for 2012 follows:
BRASSINNI COMPANY
Income Statement
Year ending December 31, 2012
Sales (10 million units @ $6)
$60,000,000
Cost of Goods Sold:
Variable (30,000,000 @ $2) $_________
Fixed
48,000,000
Cost of Goods Mf’d
$_________
Less: Ending Inventory:
Variable (20,000,000 x $2) $_________
Fixed (20/30 x 48,000,000)
_________
Total, Ending Inventory _________
Cost of Goods Sold
__________
Gross Margin
$__________
Less: Marketing & Admin. Costs
10,000,000
Operating Profit before Bonus
$__________
Less: Bonus
__________
Operating Profit after Bonus
$__________
The day after the statement was
verified, the president took his check
for $1,400,000 and resigned to take a
job with another corporation. He
remarked, “I enjoy challenges. Now
that Brassinni Company is in the black,
I’d prefer tackling another challenging
situation.” (His contract with his new
employer is similar to the one he had
with Brassinni Company.)
What’s
WRONG with
this picture?
BRASSINNI COMPANY
Variable Costing Income Statement
Year ending December 31, 2011
Sales (10 million units @ $6)
____________________:
_________________________________________
_______________________________________
Less: Ending Inventory:
_________________________________________
Variable Cost of Goods Sold
Contribution Margin
Less: Fixed Costs:
________________________________________
Marketing & Admin. Costs
10,000,000
Total Fixed Costs:
Operating Profit (Loss) before Bonus
Less: Bonus
Operating Profit (Loss) after Bonus
$60,000,000
20,000,000
$_________
_________
__________
__________
___________
Cost Accounting 201
Variable Costing
• Basic Premise of Variable Costing:
FFOH (Capacity Costs) are costs of
“being in business.”
• Therefore, FFOH should be treated as a
Period Cost, rather than a Product Cost
(as required by GAAP and Absorption
Costing).
Cost Accounting 201
Variable Costing, Continued
• Products inventoried using variable
production costs only (direct
material, direct labor, and variable
factory overhead).
• Income Statement Format:
Contribution Margin Format.
Cost Accounting 201
Variable Costing, Continued
Income Formula:
Sales – Variable Expenses =
Contribution Margin
Contribution Margin – Fixed
Expenses = Operating Income
The Brassinni Company
Variable Costing Income Statement
Year ending December 31, 2011
Sales (10 million units @ 6$)
$60,000,000
Variable Cost of Goods Sold:
Variable (30 mil @ 2$)
$60,000,000
Variable Cost of Goods Mf’d $60,000,000
Less: Ending Inventory:
Variable Costs (20 mil x $2)
$40,000,000
Variable Cost of Goods Sold
20,000,000
Contribution Margin
$40,000,000
The Brassinni Company
Variable Costing Income Statement, Continued
Year ending December 31, 2011
Contribution Margin
$40,000,000
Less: Fixed Costs:
Fixed Factory Overhead
$48,000,000
Marketing & Admin. Costs
10,000,000
Total Fixed Costs:
58,000,000
Operating Profit (Loss) before Bonus
($18,000,000)
Less: Bonus
1,400,000
Operating Profit (Loss) after Bonus
($19,400,000)
The Brassinni Company, Summary
Total impact of actions by President of Brassinni Company on:
Reported Net Income:
_____________________________________________
_____________________________________________
Cash Flow:
_____________________________________________
_____________________________________________
_____________________________________________
_____________________________________________
Absorption Costing
• Income is a function of
– ______________________________
– ______________________________
• Income can be manipulated by ___________
____________________________________.
• Phantom Profits are created.
• Cash Flow is destroyed!
Variable Costing
• Income is a function of ______________ only.
• Managers cannot ____________ with
production.
• Is consistent with Cost-Volume-Profit Analysis.
• Contribution Margin Format for Income
Statement.
• CM is a concrete measure, whereas Gross
Margin is a “moving target.”
• Simplicity.
Income measurement differences:
1. If P > S, NIABS ____ NIVAR
2. If P < S, NIABS ____ NIVAR
3. If P = S, NIABS ____ NIVAR
4. In the long run, NIABS ______ NIVAR
I REPEAT:
The GAAP answer to the
“Cost Question” is, in many
if not most cases, the
WRONG answer, when it
comes to decision making.
Review Quiz Results
7. ___________________
___________________=
____________________
“Respect” and The
Accounting Profession
Today
Respondents to the 2011 Fifth Annual
Global Leadership Survey conducted by
the International Federation of
Accountants (IFAC) rated the
Accountancy Profession “7” on a 1-10
scale.
“Respect” and The
Accounting Profession
Today, Continued
Accountants in North America received the
highest rating (8.7 on a 1-10 scale).
Accountants in Europe received the lowest
rating (6.7).
“Respect” and The
Accounting Profession
Today, Continued
The top concern for the second consecutive
year was:
_______________________
______________________
“Respect” and The Accounting
Profession Today, Continued
 Providing management with accurate,
relevant information for decision-making is
the ethical obligation of the management
accountant.
 Recognizing when and when not to use
GAAP methodologies will reestablish the
relevance and the reputation of the
management accountant.
Conclusions/Recommendations
To management accountants: Your time has
come!! SOX has increased the responsibility
of management (and thus, management
accountants) for the numbers on financial
statements. We need to assert ourselves and
our methodologies in instances where those
methodologies are clearly superior to those
currently required by the financial
accounting governing bodies.
Conclusions/Recommendations,
Continued
To managers: Use Variable Costing for a
“True” measure of income.
To the Rule Makers (FASB, SEC): ADOPT
VARIABLE COSTING FOR EXTERNAL
REPORTING PURPOSES!!
On Enron’s Financial Tactics:
“What we’re looking at here is an
example of superbly complex financial
reports. They didn’t have to lie. All they
had to do was to obfuscate it with sheer
complexity—although they probably lied
too.”
Congressman John Dingell, MI in FORTUNE, 12/24/01
1st World Congress of Accountants,
1904, St. Louis, Missouri.
“The . . . . accountant touches business life on
every side . . . . The crowning glory of our
profession is that it must ever stand for the
highest ideals in the life of the individual and for
the slow but sure evolution of society into a state
where honor and honesty shall not be mere
abstractions.”
Joseph Sterrett, Chairman of the Congress