CHAPTER 1

Accounting: Information for Decision Making

Solutions

REVIEW QUESTIONS

1.1 Step 1: Specify the decision problem, including the decision maker’s goals.
Step 2: Identify options.
Step 3: Measure benefits (advantages) and costs (disadvantages) to determine the value
(benefits reaped less costs incurred) of each option.
Step 4: Make the decision, choosing the option with the highest value.

1.2 Because people place different emphasis on factors such as money, risk, and leisure.

1.3 The benefits of an option less its costs. Because value is the contribution of an option to the
decision maker’s goals, we measure value relative to the status quo, which is not doing
anything at all.

1.4 The value of the next best option.

1.5 An organization is a group of individuals engaged in a collectively beneficial mission. The

key difference between individual and organizational decision making relates to goals –
organizational goals rarely coincide with the goals of all individual participants.

1.6 (1) Policies and procedures; (2) Monitoring; (3) Incentive schemes and performance
evaluation.

1.7 Planning decisions relate to choices about acquiring and using resources to deliver products
and services to customers. Control decisions relate to motivating, monitoring, and
evaluating performance.

1.8 Plan, Implement, Evaluate, Revise (PIER Cycle).

1.9 To help measure the costs and benefits of decision options.

1.10 Persons outside the firm. These individuals make decisions about buying and selling stock,
lending money, dividends, and taxes.

1.11 Persons inside the firm. These individuals make decisions about which products and
services to offer, the prices of products and services, what equipment to purchase, who to
hire and how to pay them.

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1.12 The primary users (external vs. internal), governing principles, the unit of analysis,
emphasis, periodicity, and types of data considered.

1.13 Ethics relate to every step of the decision framework. Ethics can shape our goals, the
options we consider, how we measure costs and benefits, and the ultimate decision we
make.

1.14 The Foreign Corrupt Practices Act of 1977.

1.15 The key financial players include the CEO, CFO, controller, treasurer, and chief internal
auditor. The roles of each player are described in detail in the appendix.

1.16 (1) Competence, (2) Confidentiality, (3) Integrity, and (4) Objectivity.

DISCUSSION QUESTIONS

1.17 Your ultimate goal could be to earn as much as you can before you retire, say, 40 years
after you graduate. With this goal in mind, you have to plan a career path and evaluate the
three job offers to see which of these jobs will take you on that path. Besides pay, factors
such as the reputation of the organization, the quality of on-the-job training you will get,
opportunities to climb the organizational ladder are very important from a career
perspective. If all three job offers are equally attractive in terms of the career you have
chosen for yourself, then short-term goals and desires will dictate which job offer you
should accept. All else equal, you will naturally want to accept the job offer that pays you
the most, or you may be willing to accept slightly lower pay to live in a city that you like,
or work for an organization with better reputation, and so on.

1.18 Yes, this statement is true. Opportunity cost is the value of the next best option. As more
options become available, it is possible that a new option may be more attractive than the
current best option, in which case the new option becomes the best option, and the current
best option becomes the next best option. In this case, the opportunity cost increases but it
can never decrease as long as all the current options are also available to choose from.

1.19 Let us assume that you are not fully prepared for your exam tomorrow (if you are fully
prepared, then you might as well watch TV because you stand to lose nothing i.e., your
opportunity cost is zero). By watching TV, you risk being unable to answer some questions
and making a poorer grade in the exam. Thus, the opportunity cost is the lost benefit from
not receiving a better grade that the preparation would have helped you secure.

1.20 Let us say that the full-time MBA program takes two years to complete. The opportunity
cost of pursuing the program is the income she will be losing over this period by quitting
her existing job, the experience she will lose from not being on the job for two years, and
any promotions she may be foregoing.

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1.21 Differences in individual goals can arise from:

 Differences in preferences: Some individuals place a greater weight on maximizing

wealth, others place a greater weight on being the best in what they do (the two are not
always perfectly correlated)
 Attitudes toward risk: Some have a greater tolerance for risk than others
 Differences in ethical thresholds: What is perfectly acceptable ethical behavior for some
may not be acceptable to others.

A Casino is a good example of a business that exploits variations in individual tastes for risk.
Casinos tailor their offerings to accommodate individuals with different risk tolerance levels
– some involve high stakes where risks and returns are higher, and others involve low stakes.

1.22 This problem is an exercise in conditional probability. You have no choice but to pick a
door at random in the first stage. Once the door has been opened you have only two
options: Stay with your initial pick or switch. Let us evaluate the chance of winning with
both options.
(1) Suppose you stay with your initial pick. Then, the following outcomes are possible
a. You initially picked the door that had the prize. Since you are staying with your
choice, you win for sure.
b. You initially picked a door that did not have the prize. Then, because you are
staying with your choice, you lose for sure.
Because the initial choice is random, the probability that you are in situation (a) is 1/3
and the probability that you are in situation (b) is 2/3. In situation (a) staying with your
choice leads to 100% chance of winning and in situation (b) staying leads to 0% chance
of winning. Thus, the probability of winning by following this strategy is 1/3*1 + 2/3*0 =
1/3.

(2) The key to computing the probability of winning in this case is to realize that the host
will only open the door that does NOT have the prize. Then the following outcomes are
possible:
a. You initially picked the door that had the prize. Then, if you switch, you lose for
sure.
b. You initially picked a door that did not have the prize. Then, one of the two
remaining doors has the prize. But, the host will not pick this door. He will only
open the door without the prize, meaning that the closed door (which you did not
pick) has the prize for sure.
The probability that you are in situation (a) is 1/3 and the probability that you are in
situation (b) is 2/3. In situation (a) switching leads to 0% chance of winning and in
situation (b) switching leads to 100% chance of winning. Thus, the probability of
winning by following this strategy is 1/3*0 + 2/3*1 = 2/3! A random pick followed by
switching doors is the smart choice.

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This problem has vexed many people (do a Google search on “Monty Hall Problem”)
because the solution is counter intuitive.

1.23 The goal of a nonprofit hospital is to provide adequate healthcare to the community it
serves at low cost, without a profit motive. The goal of a university is to meet the
educational needs of the community/country and to promote knowledge and discovery.
Many universities also attract students from other states/countries as part of an outreach
effort to promote diversity and learning. State universities are mostly government funded
and do not have an explicit profit motive, but most private universities do. The goal of an
honor society in a university is to promote academic excellence, cultural diversity, and
leadership.

1.24 The goal of a class is typically articulated in the syllabus – to effectively communicate the
subject matter and its importance to the students, and to ensure that students leave the class
with a good understanding of the concepts, principles and methods relating to the subject
matter. Your individual goals might include learning the subject thoroughly and/or earning
an “A” in the class. Goals can diverge. You may not be as interested in the subject matter
as you are in getting an “A.” You would prefer easier exams, and less homework. But your
instructor may be more interested in your learning the subject matter and may assign you a
lot of homework, and may administer tough exams. The instructor can motivate you by
making you work hard, giving challenging tests, presenting the subject matter in a way that
gets you interested, and offering a lot of help and guidance outside the classroom.

1.25 Sales commissions are a way to motivate sales personnel to strive hard to sell more. The
more they are able to sell, the more money they get. The advantage of course is that
revenues and profits increase for the organization. The disadvantage is that commissions
often make the sales people follow aggressive tactics with potential buyers (you may have
experienced this behavior in auto dealerships, department stores, furniture stores, and
consumer electronics stores). Such behavior may turn away customers in the long run.
Commissions also promote cut-throat competition among sales personnel in vying for
customers, which can prove counter-productive.

1.26 In wars and in combat situations, individuals have to depend on each other for survival.
Working well in groups becomes a matter of life and death. So there is a natural alignment
between team and individual goals. In a typical profit-making organization, the “free-rider”
problem is more difficult to eliminate, because there is a natural incentive for each
individual to contribute minimally to team goals and yet try to reap the full benefit. You
may see this behavior when you work on group assignments for your class. Some
individuals take responsibility and put in the effort needed, while others – realizing that the
work is going to get done – do not contribute as much, and devote their time to other
“productive” activities. The incentives are similar in profit-making organizations as well.

1.27 When we say “that wasn’t too bad,” we are essentially comparing what happened with
what we expected would happen. That is, our expectations were not met. Most of us plan
ahead, and sometimes things don’t quite go the way we plan, for reasons beyond our

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control. In such instances, we adjust our expectations and then evaluate what actually
happened. For example, let us say you set out on a drive to Chicago from Bloomington,
Indiana and you plan to cover the distance in 4 hours. But along the way, you run into
unexpected rough weather, and it takes you 6 hours to reach Chicago. Given the driving
conditions that you had to endure, you say to yourself “that wasn’t too bad.”

1.28 Yes, it does. There is a control problem in both scenarios. But in the first scenario the
control problem is not related to divergence in goals, which is the case when you have to
evaluate another individual’s performance. A process can go out of control for reasons
beyond your control, and all you can do is to fine tune the process. Feedback on how the
process is going helps in this respect. In the second case, you have to control another
individual’s actions through monitoring or by providing appropriate incentives.

1.29 Financial statements of companies are in general very aggregate. They provide an
assessment of performance over a period, say, a quarter or a year. They reflect the
combined outcome of scores of actions taken by thousands of individuals within the
organization over that period. They also report past performance and are not forward
looking, which is what we need for decision making. Therefore, financial statements are
not particularly useful for day-to-day decision making.

1.30 Yes, in general, this is true. Most accounting systems are designed to measure historical
performance. However, the purpose of a management accounting system is to help decision
making by providing reasonable estimates of opportunity costs. To the extent that trends in
historical cost patterns can help in estimating future costs (or opportunity costs), even
traditional financial accounting systems do help.

1.31 One could argue effectively that firms, interested in surviving in a competitive
marketplace, would want to do so. By engaging auditors even if not required to do so, firms
are signaling to investors that they have nothing to hide and that they are good firms to
invest in. As another example, in this increasing global product markets, many companies
seek third-party quality assurance (such as ISO 9000) to convey to all the markets around
the world that their products are of high quality. Note that such third-party certifications are
not required by governments.

1.32 This is a tough question. You face a difficult trade-off involving a troubling ethical
dilemma. Many TV channels, especially family-oriented channels, would opt to not show
the tape because it might hurt their viewership in the long-run, let alone cause emotional
harm in the short run. Such channels do not face much of a trade-off. On the other hand,
other TV stations, in particular cable channels, might well allow their profit motive to
dictate their decision.

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EXERCISES

1.33.
a. Microsoft corporation lists “[T]o enable people and businesses throughout the world to
realize their full potential” as its overarching mission. The firm also lists a variety of related
goals and strategies, such as trustworthy computing and broad customer connection, designed
to accomplish this mission.

Microsoft’s goals and objectives are particularly noteworthy because they do not make
explicit reference to the shareholders’ ultimate goal of maximizing the return on their
investment. There are at least two ways to view this.

Some argue that, as a modern organization, Microsoft recognizes the claims of multiple
stakeholders in the corporation arising because of the firm’s size and impact on the economy.
That is, the organization recognizes its obligations to parties such as its customers,
employees, and society. A modern firm’s mission statement reflects this broader view of the
organization in which profit maximization is not the firm’s only goal.

Others argue that even the broader statements are a means to an end. For example, the goal of
“trustworthy computing” or “excellence in everything we do” surely increases the market for
Microsoft’s products. Similarly, a firm may stress environment-friendly operations because
doing so is good business. The focus helps the firm reduce costs (by reducing the risk of
future litigation and payouts), increase revenues (by potentially enlarging the customer base),
and comply with governmental regulations (thereby avoiding fines). Similar arguments apply
for firms’ attention to worker health and safety. Thus, one might view all of Microsoft’s
goals and strategies as being consistent with profit maximization.

Both views are reasonable. The strength of your belief in the for-profit orientation of
corporations determines your choice between the two extremes listed above.

b. The mission statement for the Metropolitan Museum of Art (popularly known as the Met)
states:

The mission of The Metropolitan Museum of Art is to collect, preserve, study, exhibit,
and stimulate appreciation for and advance knowledge of works of art that
collectively represent the broadest spectrum of human achievement at the highest
level of quality, all in the service of the public and in accordance with the highest
professional standards.

This statement underscores the museum’s not-for-profit motive and emphasizes the
museum’s mission on all aspects of the study of art. Notice that, similar to the mission
statement of the Corporation for Public Broadcasting, the Met’s mission statement is very
inclusive regarding the definition of art and the museum’s beneficiaries.

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Both Microsoft’s and the Metropolitan Museum of Art’s mission statements take a broad
view of the organization’s mission. Microsoft’s mission statement is very customer focused,
whereas the Met’s mission statement focuses on the art itself. The differing foci are
indicative of Microsoft’s for-profit orientation (quality, innovative products, and customer
satisfaction are all stepping-stones to profit) and the Met’s orientation of increasing the
appreciation for art (regardless of profit).

1.34. The credo for Johnson and Johnson states:

We believe our first responsibility is to the doctors, nurses and patients,

to mothers and fathers and all others who use our products and services.
In meeting their needs everything we do must be of high quality We must constantly
strive to reduce our costs in order to maintain reasonable prices. Customers' orders
must be serviced promptly and accurately. Our suppliers and distributors must have
an opportunity to make a fair profit.

We are responsible to our employees, the men and women who work with us
throughout the world. Everyone must be considered as an individual.
We must respect their dignity and recognize their merit. They must have a sense of
security in their jobs. Compensation must be fair and adequate,
and working conditions clean, orderly and safe. We must be mindful of ways to help
our employees fulfill their family responsibilities. Employees must feel free to make
suggestions and complaints. There must be equal opportunity for employment,
development and advancement for those qualified. We must provide competent
management, and their actions must be just and ethical.

We are responsible to the communities in which we live and work and to the world
community as well. We must be good citizens – support good works and charities and
bear our fair share of taxes. We must encourage civic improvements and better
health and education. We must maintain in good order the property we are privileged
to use, protecting the environment and natural resources.

Our final responsibility is to our stockholders. Business must make a sound profit.
We must experiment with new ideas. Research must be carried on, innovative
programs developed and mistakes paid for. New equipment must be purchased, new
facilities provided and new products launched. Reserves must be created to provide
for adverse times. When we operate according to these principles, the stockholders
should realize a fair return.

The above statement underscores J&J’s multi-faceted objectives. It recognizes obligations to

customers, suppliers, employees, the community and shareholders. Interestingly, the
statement places shareholders last, implicitly asserting that if we take care of the others,
shareholders will automatically earn a fair return. The importance of the credo to the firm
also is evident by its placement on the firm’s home page.

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1.35.
a. For this decision, your goal is to minimize the amount that you pay over the semester for
fitness – cost is your primary consideration.

b. Based on the information provided, you have two options:

1. Join the fitness center for the semester at a cost of $80.

2. Pay for the fitness center on a per use basis at a cost of $4 per visit.

We also could include a third option – not using the fitness center at all (the status quo).
However, it appears that you have rejected this option and are committed to using the fitness
center in some fashion.

c. The cash outflow associated with option is:

1. $80, or the amount it costs to join the fitness center.

2. 16 × $4 = $64. (Since you plan on using the fitness center 16 times and each visit costs
$4).

d. Given the available options, you are better off (to the tune of $16, or $80-$64) by paying for
the fitness center on a per-use basis rather than joining the fitness center.

Notice how the four step framework is applicable to “everyday” decisions, in addition to
business decisions. Indeed, we could use the four-steps to frame every decision we make.

Additionally, the timing of cash flow may be important – if a student has to pay the $80 all at
once, then this reduces the attractiveness of joining as some students may not have the $80 to
spare, especially at the beginning of the semester.

Note: Uncertainty and beliefs might affect students’ choices – for example, if students
believe that there is a significant chance they will really get into an exercise routine and use
the fitness center more often than once a week, then joining may be the best way to go. If
students believe that they will use the center more than 20 times, then joining is the low-cost
alternative (since 20 × $4 = $80). Further, some may pay the fee to motivate themselves...“I
paid $80 and I need to get some return for it.” However, as we will learn later, such thinking
is a classic “sunk cost fallacy.”

1.36.
a. Angela’s goal in this decision problem is to make the most money or maximize profit.
b. Angela has three options:
(i) Raise the price of the Jelly donuts from $1.20 to $1.50 each.
(ii) Keep the price at $1.20 per jelly donut but make 100 more jelly donuts and 100 less
chocolate donuts.
(iii) Not do anything.

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c. Cash flow associated with option (i): Net cash inflow per glazed donut: $0.40 (= price of
$0.80 – cost of $0.40). Net cash inflow per jelly donut: $0.90 (= 1.50 – 0.60). Net cash
inflow per chocolate donut: $0.50 (= 1.00 – 0.50). Total expected cash flows to Angela from
this option: 300 * $0.40 + 250 * $0.90 + 200 * $0.50 = $445.
Cash flow associated with option (ii): Net cash inflow per glazed donut: $0.40 (= price of
$0.80 – cost of $0.40). Net cash inflow per jelly donut: $0.60 (= 1.20 – 0.60). Net cash
inflow per chocolate donut: $0.90 (= 1.00 – 0.50). Total expected cash flows to Angela from
this option: 300 * $0.40 + 350 * $0.60 + 100 * $0.50 = $380.
Cash flow associated with option (iii) = 300 * $0.40 + 250 * $0.60 + 200 * $0.50 = $370.
d. Based on the calculations in part c. above, Angela should raise the price of her Jelly donuts to
$1.50.

1.37.
a. The cash outflow associated with scrapping the action figures is $1,000; as such, the value of
this option is ($1,000).

b. Reworking the action figures will cost Toys Ahoy! $1,200, but selling them to the toy store
will bring in $750 in revenues. Thus, the cash flow associated reworking the action figures
and selling them to the toy store is $750 – $1,200 = ($450).

Unfortunately, the value of both options is negative. However, relative to scrapping the toys,
reworking them increase’s Toys Ahoy!’s profit by ($450) – ($1,000) = $550. Thus,
reworking the action figures is the preferred option.

c. Intuitively, the fact that Toys Ahoy! spent $6.25 to produce each action figure is not
relevant to the decision at hand because Toys Ahoy! has already incurred the expenditure –
it is a sunk cost.

1.38.
a. Rachel’s cash outflow associated with Option 1 is $1,050 (airfare of $750 + one night hotel
stay for $175 + other expenses of $125). With Option 2, Rachel’s cash outflow would be
$725 (car rental of $150 + two nights’ hotel stay for $350 + other expenses of $225).
b. The opportunity cost of Option 1 is the value of Option 2, which is ($725). The opportunity
cost of Option 2 is the value of Option 1, which is ($1,050).
c. The value of Option 2 is greater than its opportunity cost (i.e., $725 is lower in cost than
$1,050). Yes, Option 2 is better for her based on the expenses given.
d. Well, drives can be long and exhausting, and Rachel may not feel alert at the conference.
This is a “cost” that Rachel has to bear with the second option. She might well feel that the
extra $325 she has to spend is well worth avoiding strenuous driving. On the other hand,
often fights get canceled due to factors beyond one’s control. With driving, there is a little
more control. This is an intangible benefit associated with Option 2.

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1.39.
a. The following table provides the value of each of the four options that Usman faces:

Option 1 Option 2 Option 3 Option 4

Revenue $2,500 $5,000 $1,700 $0
Cost 700 3,800 250 400
Value (net cash flow) $1,800 $1,200 $1,450 ($400)

b. The opportunity cost of Option 1 is $1,450. The opportunity cost of each of options 2, 3 and
4 is $1,800.
c. Based on the data given, value exceeds opportunity cost only for Option 1 (the value of
Option 1 is $1,800, its opportunity cost is $1,450).
d. Doing charity work may give Usman a tremendous amount of satisfaction that is
immeasurable. The question is whether this satisfaction is worth more than $1,800 he stands
to make by choosing Option 1.

1.40.
a. The three options available to Nick are: (i) Status quo: Continue doing what he does and
reject the job offer; (ii) accept the job offer, but don’t work on computer repairs in the
evening; (ii) accept the job offer, and continue repairing computers for his clients for two
hours in the evening.
b. (i) Status quo option: Nick’s monthly income under this option will be $11,250 (=$75 per
hour * 6 hours a day * 25 days a week).
(ii) Accept the job, and not work in the evenings: Nick’s monthly income will be $7,500.
(iii) Accept the job, and work in the evenings: Nick’s monthly income will be $10,000
($7,500 + ($50 per hour * 2 hours a day * 25 days)).
c. The opportunity cost of the status quo option is $10,000. The opportunity cost of each of the
other two options is $11,250.
d. Nick should choose the status quo. The opportunity cost of this option is $10,000 (accepting
the job, and continuing to work in the evenings.) which is less than its value of $11,250.

1.41.
a. The opportunity cost of any option is the value of the next-best option. Assume Jon could use
the same color paint for another job. What’s Jon’s next-best option? The problem makes it
clear that the paint is “unique” and has few, if any, alternative uses. Given this, Jon’s
opportunity cost of using the paint for another job is $0. This estimate assumes that there is
no cost to storing the paint.

b. Jon’s next-best option is to dispose of the paint at a cost of $40. Jon can avoid this cost by
using the paint for another job. Thus, the opportunity cost of using the paint for another job is
($40). Jon should therefore be willing to pay someone up to $40 to let him use the paint in
their job.

c. The fact that Jon received a non-refundable advance of $350 does not change the opportunity
cost in any way. The revenue and the cash costs are past events and are sunk. Both value and

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opportunity cost are forward looking – because this amount does not change relative to
the status quo, the $350 is not relevant to the decision at hand.

1.42.
a. The incremental cost of carrying one additional passenger for Greyhound is very minimal. So
the cash flow to Greyhound from issuing the ticket is close to $40.
b. The opportunity cost allowing the individual to travel is to leave with another empty seat.
Therefore, the opportunity cost is zero as they are many available seats in the bus. The cash
flow associated with denying the individual’s request to travel is the opportunity cost of $40.
c. Yes. If Greyhound allows people to get on for a fraction of the ticket price just because there
are still some empty seats, human tendency would be to wait till the last minute to get a
cheap ticket. If everybody engages in this behavior, think of what would happen ahead of a
bus leaving. Therefore, setting a firm ticketing policy and sticking to the policy pays off in
the long run. In the short run, it may well be the case some seats will be unfilled, but the
ticket price would be set appropriately in anticipation of such eventualities.

1.43.
a. Zap’s decision problem centers on what to do with the 25,000 unsold “ZAP” kits. Zap’s goal
is to maximize profits. For the unsold 25,000 units, this means maximizing the revenue, or
net cash inflow, received (number of units sold multiplied by the selling price per unit) from
the sales of this product.

It is important to note that the amount Zap paid to produce the 25,000 units, or 25,000 ×
$7.50 = $187,500 is sunk and is not at all relevant to their decision. From a financial
accounting standpoint, this amount will be expensed on the income statement regardless of
the option chosen.

b. Based on the information provided, Zap has two options:

1. Sell the 25,000 units to the national home-improvement store for $7 per unit.
2. Sell the product via the company’s website. Under this option, the company expects to
sell 60% of the remaining 25,000 units at a selling price of $9.95 per unit.

We could, of course, conceive of other options, such as discarding all of the “ZAP” kits or
donating them to a municipality (for parks, etc.). However, it appears that Zap does not wish
to explore these options.

c. The increase in Zap’s cash flow under each option is:

Option
1. Sell to store 2. Sell via website
Expected sales in units 25,000 15,000
(= 25,000 × .60)
Selling price per unit $7.00 $9.95
Net increase in cash flow $175,000 $149,250

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Again, we note that the cost of producing the 25,000 units, or 25,000 × $7.50 = $187,500 is a
sunk cost and is not relevant to measuring the net cash flow associated with each option.
Moreover, we are interested in measuring the future sacrifices and future benefits associated
with each option. The fact that Zap spent $187,500 to produce the 25,000 units is not relevant
because the expenditure (and associated cash outflow) occurred in the past – it is a sunk cost.

d. Given the available options, Zap’s preferred option is to sell the remaining 25,000 units to
the home-improvement store for $7 a unit. Even though it appears that Zap will lose $7.00 –
$7.50 = ($0.50) per unit, the company maximizes its cash flow and profit by selling the
unsold units “at a loss.”

Note: This exercise illustrates the classic price-quantity tradeoff – in this instance, the
company is better off selling more units at a lower price than selling fewer units at a higher
price. In other instances, the relation flips.

1.44.
a. The owners likely have multiple goals. Making a profit is important, as is winning games and
championships. Some owners also probably enjoy the prestige and glamour associated with
owning a professional sports team. Yet other owners wish to give back to the city and
community by funding appropriate recreational outlets.

Each person in the coaching staff ultimately worries about his or her own career. Surely, the
coaching staff enjoys what they do and being associating with “winners.” However, some
part of their concern about the team’s success stems from its effect on their personal career
prospects. Coaches are not as worried as owners about the team’s overall profitability or
other monetary issues.

Players have potentially conflicting goals. On the one hand, they wish to do what is best for
the team. However, they also recognize that they have only a few years in their careers and
that their earnings during this period must sustain them through their lives. Thus, players
bargain aggressively with owners, sometimes putting team profitability in jeopardy. Such
actions may also create animosity among players and affect the team’s effectiveness. For
instance, a player may “hold out” (i.e., not report to training camps) for more compensation.

b. Teams can and do use a number of systems to align players’ incentives with team incentives.
Clauses giving incentive pay for reaching different levels of the playoffs and reaching
milestones in performance (e.g., batting averages, rushing yards) are common. Contracts also
usually specify parameters for physical fitness, as well as norms for expected behavior.
Contracts often allow teams to ‘fire’ players if they engage in behavior that damages a team’s
reputation.

Designing and implementing contract-based and formal control measures is difficult in this
setting as team performance depends on many factors. It is often difficult to specify what
players should do or to measure their contribution to the team’s success. Teams therefore rely

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a great deal on intangibles such as “leadership” and “culture” when motivating players to do
the right thing. Coaches sometimes discipline players by benching them for games or
denying players time on the field/court. They also rely on the players’ ego and the value
players attach to their reputation to keep players in check.

1.45. Yes. This is a classic example of how a conflict of interests can come about. With respect
his own evening work, Nick is solely responsible for the quality of what he does. However, when
part of a larger organization, there is some room for sharing and shirking one’s responsibility.
Naturally, we would expect Nick to think about his own evening even as he is going through the
motions of the day. So, the employer should be concerned. This is why employments contracts
typically have clauses that prevent full time employees from taking on other jobs that would
interfere with their work.

1.46.
Organizations invest in monitoring programs because the organization’s goals may not
always coincide with the goals of individual employees. When owners and other stakeholders
delegate decision making, they run the risk that employees will make decisions that may not
be in the organization’s best interests. For example, employees may pad expense accounts,
take excessive breaks or time off, or even steal from the company.

Monitoring can help by either penalizing undesired behavior or rewarding desired behavior.
For example, mystery shopper programs help assess the quality of store operations and make
sure that employees are following company policies. For example, a fast food franchisee may
not keep the facilities up to the standards consistent with the franchisor’s corporate image.
Audit visits and other mechanisms serve to deter such behavior – in extreme instances, the
franchisee could lose its license.

Just telling someone to follow the rules often is not enough. Enforcement or follow-up is
necessary. Without enforcement, employees might simply agree to the rules but then ignore
them and do whatever they want. Incentive schemes such as bonus pay and stock options also
help align individual goals with organizational goals.

1.47.
The following table provides the required classifications, including comments pertaining to
the rationale underlying each classification.

Action/Decision Stage Rationale

Whether to hire two or three dental Plan This decision relates to the
hygienists? Dr. Shapiro has narrowed his choice of a resource level.
choices to two or thee hygienists based on Hiring more staff provides
expected patient volume. greater capacity, allowing Dr.
Shapiro to serve more patients,
but also commits Dr. Shapiro
to greater costs.

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Prepare a staffing schedule so that at least Implement This action relates to

one hygienist is available during all times implementing the choice. The
the office is open. associated decision (we could
view each possible schedule as
a decision option) relates to
how resources, in this case
hygienists, will be used to
deliver services.

Track the number of patients seen by Evaluate This on-going control process
each hygienist per week. helps Dr. Shapiro figure out
the efficiency and
effectiveness with which he is
using costly resources.
Moreover, because Dr.
Shapiro sees each patient
during each visit, he also can
personally track the quality of
work done by each of his
hygienists.

Re-evaluate the adequacy of current Revise Over several weeks or months,

staffing levels. Dr. Shapiro will get a sense of
whether his hygienists are
fully utilized. He will also
determine whether additional
hygienists need to be hired or
which, if any, of his hygienists
need to be let go.

This problem illustrates the classical loop between planning and control. We typically begin
with a plan that is based on a set of assumptions (in this case, expected patient volume).
These assumptions are our beliefs about the unknown future. We then implement our
choices. As time passes, we obtain new information about the actual outcomes (in this case,
actual patient volume and the quality of work done by each hygienist). On an on-going basis,
this new information will cause us to adjust how we implement our plans (e.g., change the
schedule for the next week). Over a period, we will accumulate enough information to revise
our original set of assumptions, which might cause us to revisit the decision.

The overall point is that there is a natural cycle of doing something based on a set of
assumptions, comparing actual outcomes with expectations, and then revising our
assumptions. In many instances, the broad loop relating to a decision contains smaller loops
within it. For instance, we can think of creating each week’s schedule as forming a separate
planning and control cycle.

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1.48.
The following table lists the four stages of the planning and control cycle and the associated
decisions/actions. There are many possible decisions for each category.

Stage Action/Decision
Plan One possible decision is whether to price at the same levels as last
year or to raise prices by, for example, 10% to account for the higher
cost of flowers this year. Other decisions include whether to hire
additional help or how much money to spend on advertising.
Implement Based on the chosen price level, order and stock enough bouquets to
meet the expected demand. (Notice that we could view this as a
decision in itself, viewing each volume of order as an option.)
Evaluate Compare actual sales to budgeted sales. Identify reasons for any
deviations. (Again, we could view this as a decision by framing each
possible reason for a deviation as a possible option. We then choose
among possible explanations.)
Revise Shari would use data on actual sales, her prices versus the prices of
other florists, and national trends to revise her expectations about
future sales. This revised belief will be a key input into her pricing
decision for next Mother’s day.
As we see, Shari begins with a plan that is based on a set of assumptions (in this case, how
much demand she might expect for any given price). These assumptions are her beliefs about
the unknown future. She then implements her choices (e.g., post prices, order flowers). As
Mother’s day nears, pre-orders and information about other florists’ prices might give Shari
an impetus to revise her prices. That is, she obtains new information on an ongoing basis,
which in turn causes her to adjust her implementation (e.g., revise prices, run more ads).
Over a period, she will accumulate enough information to revise her original set of
assumptions, which might cause her to improve the next pricing decision.

The overall point is that there is a natural cycle of doing something based on a set of
assumptions, comparing actual outcomes with expectations, and then revising our
assumptions. In many instances, the broad loop relating to a decision contains smaller loops
within it. For instance, we can think of offering a discount at day’s end as forming a separate
planning and control cycle within the overall cycle that we discussed above.

1.49.
a. We classify the data from the financial statements into three broad groups. We interpret
financial statements broadly to mean any documentation filed with the Securities and
Exchange Commission (SEC) or other regulatory bodies.

Financial data such as the firm’s income and cash flow from operations are invaluable in
assessing future prospects. The investor might also perform ratio analysis, such as computing
the debt-to-equity and current ratio, to understand and explore a company’s risk factors.

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Governance data such as the composition of the board of directors and compensation
arrangements help the investor assess the effectiveness of the company’s management and
control systems.

Finally, operating data such as the capacity of the plant, and the number of plants and
employees help investors understand the business. Investors may also examine the firm’s
client base (e.g., does one client account for 10% or more of sales?). In addition, the
management discussion of results section probably will discuss the company’s pipeline of
drugs and their potential.

b. Investors would consider the costs and benefits of other investment options. A firm’s
financial statements provide information only about its own affairs. Thus, the investor has to
look elsewhere to assess the firm’s relative standing (i.e., to assess the opportunity cost of
investing in the firm). For instance, some competitor analysis is necessary to judge whether
the firm is earning similar or higher rates of return than its competitors.

Investors also would likely collect data from pharmaceutical publications about the market
potential for the firm’s current and proposed drugs. For instance, financial statements might
not reveal a lot about obtaining FDA approval for the drugs in-process. Medical publications
and conference presentations might help refine these beliefs. Other data pertinent to market
share and growth (from trade associations) also seem important.

Finally, considerations such as the extent of diversification provided and fit with the
investor’s risk-profile also play an important part in the investment decision.

1.50.
As shown in the table below, Linda may be surprised to find managerial accounting
information invaluable in her new position. As a manager, Linda decides how best to use the
organizational resources entrusted to her, and she will find both financial and non-financial
information from her company’s managerial accounting system to be helpful for making
these decisions.

Information Are the information items financial/non-financial in

Decision Items nature?
Whether actual Budgeted costs Budgeted and actual cost data are financial in nature.
costs are in
line with Actual costs Linda may use non-financial data such as the volume of
expectations? production to adjust her estimates of expected costs. After
Actual volume of all, the more units produced, the greater the expected cost
production as the company will be using more materials and labor.
Linda also may rely on non-financial data such as
absenteeism rates and whether her company was starting a
new product to figure out the source of the cost differences.

Whether to Price charged by The supplier’s price and internal cost data are financial.
make a tool in- the supplier
house or buy it Non-financial data include supplier quality and reliability,

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from a Cost to make the as well as the reliability and quality of the tools if they
supplier? tool internally were manufactured by Linda’s firm.

Supplier quality
and reliability

How many Rate of wear Use data, such as rate of wear, are non-financial. Cost data,
tools to which would be used to determine the amount of safety
purchase for Expected cost of stock, are in financial terms.
making tool
100,000 units
of a product? Expected loss if
tool not available

What is the Expected rate of Data concerning use patterns, including rate of wear and
right inventory use, variance in variance in use rates, are non-financial. Data about cost
level for a use rates across estimates, including storage costs and capital costs, are
given tool? time periods (e.g., expressed in financial terms.
Linda’s firm may
have seasonal
production
cycles)

Cost of tool, cost

of capital, other
storage costs

Whether to Cost to make the Again, the cost data are in financial terms whereas data
make a new new tool pertaining to quality and expected lives are non-financial in
tool or to nature.
refurbish an Cost to refurbish
existing tool? existing tool

Expected lives of
the two tools

Quality of the
tools

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1.51.
Let us