Chapter Analysis

 

1. Chapter 1 ~ Managerial Accounting & The Business Organization

 

In this chapter, the main focus is on how management accounting is used in companies as well as new roles accountants play, which are different from what they used to be in the past. First of all, management accounting is developed and used for managers within a company. On the other hand, financial accounting is used for external parties such as shareholders, banks and government agencies. Therefore, these two accountings are conceptually different in terms of their purposes respectively. When companies make decisions, they certainly need information on cost structure of department or each product. Combined with the fact that today’s business is getting more complicated and global, the degree of importance on management accounting has been increasing enormously.

Accordingly, the roles accountants play have been changing. Accountants are more involved in decision making stage, providing cost information to facilitate better and proper decision making. Instead of simply doing clerical works, accountants work closely with operating and sales managers. Since Nike is profoundly involved in international business and has lots of product lines, all processes of decision making get intensely complicated. This is where Nike’s accountants can contribute to lead management to make best decisions, providing crucial cost information. As a market leader in footwear and apparel industry, Nike has been aggressively creating new markets along with redefining old markets. All these actions and strategies need very precise cost and revenue information given by accountants to keep Nike’s competitive advantage.

Here, it is worth mentioning what the Nike’s value chain is, because not only value chain is extremely important to companies, but also value chain and its concept is used throughout all chapters. The following is Nike’s value chain with regard to the decision Nike conducts and the role accountants play.

·         Research and Development ~ R&D is considered one of the key elements for Nike to maintain its competitive advantage in the market. Nike’s decision of R&D is to create high quality products using high technology such as air sole in footwear to differentiate its products from other rival makers. Accountants can give information on trends in sales for various products to seize what consumers' trend and preference are.

·         Design ~ Design is also one of the crucial elements to maintain Nike’s competitive advantage as well as to keep its popularity among different kind of consumers. Nike’s decision on design is to create products that fit and match current consumer taste, sometimes using well-known professional athletes' model, such as Air Jordan. Accountants can give cost information of numerous models, which is critical when Nike decides the price of products to retailer. 

·         Production ~ Since most of the products are manufactured outside the US by manufacturing contractor, Nike’s decision of production is to produce at the best price at the best place. Nike manufactures primarily in Asian countries, due to the relatively cheap labor cost. Accountants can give information cost taking the exchange rate into account. And also, transportation cost from various production places to each destination can contribute to better decision making.

·         Marketing ~ Nike’s decision with regard to marketing is to widely use top professional athletes to endorse its products. Examples of special model are Michael Jordan’s basketball products, Andre Agassi’s tennis products, and Tiger Woods' golf products. It is difficult for accountants to exactly measure the added revenue created by endorsement, however, this is where accountants can give insights to make better decision using their expertise.

·         Distribution ~ Distribution is extremely important for Nike, due to the fact that Nike sells its products to almost 20,000 retailers in the US, and 110 countries in the world. Nike currently has distribution centers in Asia, Australia, Canada, Europe, Latin America, and the US ("NIKE, Inc.") Selecting the best location for distribution is key to deliver products to customers in a timely manner. Accountants can give the shipping and storage cost information to decide where the best location is and how to distribute products throughout the world.

·         Customer Service ~ Nike’s decision with regard to customer service is to define the warranty policies and return policies for each product. Accountants can give the cost information on returned products, which in turn will be an incentive to build better customer relationship.

 

2. Chapter 2 ~ Introduction To Cost Behavior And Cost Volume Relationship

               

This chapter is mainly focused on cost behavior and cost-volume-profit used by mangers to help guide to better decisions. By understanding cost behavior, managers can know which part of the cost and profit structure they can improve. Cost-volume-profit analysis gives mangers an insight of quantitative cost and profit structure to further improve decisions. The following example is a typical Nike’s sneaker, assuming that sneaker is sold for $70 at retail store. This example was taken from Ed Blizt’s article, titled "How can a $9 sneaker cost $70?" (Blits).

 

 

The material cost is for the rubber, the fabric and/or leather in some cases and plastic. Suppliers' profit is the amount the manufacturing company wants, over and above what it costs to make the sneaker after paying rent, equipment and production labor. This is the cost structure of typical $70 sneaker at retail store. To make $6.25 of profit for Nike, the total cost of sneaker itself to retail stores comes to the price of $35.50. Up until now is where Nike’s accountants should consider and analyze the cost-volume-profit analysis to help managers improve their decisions. To get to the price of $70, the following cost structure is presented.

 

 

Personnel include the salesperson’s payment and rent is for the space in the shopping center. Other cost includes advertising, shopping bag and other costs needed to operate the retail store.

 

3. Chapter 3 ~ Management Of Cost Behavior

 

Since companies usually have more control over their costs than their revenues, controlling and reducing costs are the ultimate goal for accountants. This chapter is focused on cost behavior, using various kind of costs, such as step costs, mixed costs, capacity costs, committed fixed costs, and discretionary fixed costs. Moreover, three methods, high-low method, visual-fit method and least-square regression, are presented to forecast the future cost. The following analysis is based on least-square regression. The reason this method was chosen to forecast the cost-of-goods-sold is that this method uses all data available and the analysis is based on statistical analysis, which is much more reliable and objective than high-low and visual-fit method. Furthermore, by calculating the R-squared, the goodness of fit of the predicted-equation can be found.

 

(Dollars in million)

(All data are taken from Nike Annual Report 1999)                       

 

 

 

Yi = b0 + b1Xi + ei --- Y = 284.8837 + 0.5030X               

 

Interpretation of key numbers for quarterly analysis

·         b0 = 284.8837 ~ No economic interpretation is appropriate, since Xi = 0 is not within the range of observed values.

·         b1 = 0.5030 ~ On the average, within the range of observed values for each 1 million dollars increase in the quarterly revenue, the cost-of-goods-sold per quarter increases 0.5030 million dollars, other things held constant.

·         R-squared = 85.43% ~ Within the range of observed values, variation in quarter revenue explains 85.43% of the variation in cost-of-goods-sold per quarter.

 

(Dollars in million)

(All data are taken from Nike Annual Report 1999)       

 

 

Yi = b0 + b1Xi + ei --- Y = -35.1814 + 0.6212X               

 

Interpretation of key numbers for yearly analysis

·         b0 = -35.1814 ~ No economic interpretation is appropriate, since Xi = 0 is not within the range of observed values.

·         b1 = 0.6212 ~ On the average, within the range of observed values for each 1 million dollars increase in the annual revenue, the cost-of-goods-sold per year increases 0.6212 million dollars, other things held constant.

·         R-squared = 99.76% ~ Within the range of observed values, variation in yearly revenue explains 99.76% of the variation in cost-of-goods-sold per year.

Using a revenue of 1964.00 million dollars in 2^nd quarter of fiscal 2000 and a revenue of 9477.10 million dollars, predicted by Esquivel and Goldman of Morgan Stanley Dean Witter, the following is the forecast of cost-of-goods-sold (Esquivel and Goldman).

 

 

Consequently, gross margin will be 35.19% in 2^nd quarter of fiscal 2000 and 38.25% in fiscal 2000 respectively.

                By scrutinizing the cost behavior, Nike could reduce operating expenses by almost $200 million in fiscal 1999. Two important points deserve mentioning here. First, cutting an additional 9 percent of workforce contributed to $200 million reduction. Other point is that Nike could cut inventories by 14 percent and reduce working capital needs (Nike Annual Report 1999). For Nike’s accountants, providing cost behavior information to managers will further give opportunities to reduce cost.

 

4. Chapter 5 ~ Relevant Information And Decision Making: Marketing Decision

               

When management makes marketing decisions, the key focus should be on relevant information. Sharp distinctions between relevant and irrelevant information are needed to make proper decisions. Accountants must have a sound understanding of this relevant information to be able to provide technical expertise on both financial and managerial aspects. This chapter is focused on how relevant information is important on the decision making phase for organizations under situations such as special sales order, adding or deleting products and resources constrain capacity.

                Other important focus, which is also related to relevant information, is on the concept of pricing. Pricing decision is critical for companies to raise revenues as well as to penetrate the market further. Nike has penetrated the market more profoundly than any other competitors, keeping its market share in terms of sale units approximately 50 percent. Combined with the brand recognition and brand loyalty, Nike can take strong pricing strategy compared to its competitors. Therefore, Nike’s accountants must take into account this market share advantage when they provide information to managers.

                Pricing decisions depend on the characteristics of the market companies are involved. Nike is involved in imperfect competition, which is a market where the price a company charges for a unit will influence the quantity of units it sells. In more detail, Nike is in a tight oligopoly market, due to the extremely high concentration ratio. The four-firm ratio is 85.77%, calculated by adding the percentage of sales accounted for by the top firms in a footwear industry. In such a market condition, demand of footwear is downward slope, while marginal cost slope declines first but gradually goes up as the volume in units increases as usual. Consequently, Nike’s accountants must pay attention to the marginal cost, because it is relevant for pricing decisions.

 

5. Chapter 7 ~ The Master Budget

 

Budgets are a manager’s key enabler to understand, plan and smoothly control operations. After budget is set up, organizations can have much higher incentives to plan and also control, pursuing the budgeted target. Moreover, budgets help evaluate employee performance by comparing to the previous budget or difference between the budget. Accountants' role is to work extensively with people who work for operations and finance department to get required information to set up organization budgets. This chapter is particularly focused on the master budget along with a different kind of budgets, such as capital budget, continuous budget and cash budget. Since budget information is classified as confidential not only in Nike, but also in every organization, the following part is primarily focused on general characteristics of budget in organization.

In spite of the fact that budgeting is very time-consuming and difficult to set up precisely, advantages of budgets exceed these disadvantages. First of all as stated above, budgeting compels managers to think ahead and plan for the budgeted targets under changing conditions. Even though Nike is the market leader, Nike has to be well prepared due to the aggressive competitors and unstable global economic condition. Judging performance is another advantage that budgeting brings to organizations. Budget brings a wide framework of judging criteria. Finally, budgeting aids managers in coordinating their efforts to let all employees know what managers are expecting for the goal. With managers' deep commitment and wide support from employees in each department, the objective of the organization as whole matches the objective of each employee and department.

Budget can be divided into several categories, depending on the nature of its strategic plan and duration. Capital budget is a detail planned expenditure of facilities, equipment and new products, and therefore, it tends to take a long duration into account. On the other hand, master budget consists of two components: operating budget and financial budget. While operating budget consists of sales budget, purchase budget, cost-of-goods-sold budget, operating expense budget and budgeted income statement, financial budget consists of capital budget, cash budget and budgeted balance sheet. The operating budget focuses on the income statement and its supporting schedules. In contrast, the financial budget focuses on the effects that operating budget and other plans will have on cash. Here, every accountant in organization must work collaboratively with operating and finance department to set up precise and valuable master budget.

When setting up the budget, the sales budget becomes the fundamental part because other budgets are derived from it sequentially. This initial sales budget strongly contributes to time-consuming and a difficulty of building master budget, due to the fact that sales budget contains a certain degree of uncertainty. Forecasting the exact future sales is extremely difficult that organizations allow a certain level of margin error. This in term affects the whole master budget. In order to build a better sales budget, organizations must take into account the historical sales pattern, economics conditions, marketing plan, competitors' actions, buyers' trend and purchasing power, product prices and so forth.

 

6. Chapter 8 ~ Flexible Budgets And Variance Analysis

 

The master budget, mentioned in chapter 7, assumes fixed level of activity. Accordingly, when the actual units sold is different from that of master budget unit, the difference affects the rest of the actual numbers and they will likely to be completely different from master budget, reflecting an inflexible comparison. In order to overcome this inflexible comparison, flexible budget is presented in this chapter along with the variance analysis.

Flexible budget adjusts for changes in sales volume and other cost-driver activities so that it leads managers help focus on a certain area of financial performance that deserves attention. Flexible budget also helps managers explain why the master budget was not achieved. The difference between master budget and actual results, called master budget variances, can be divided into two variances. One is flexible-budget variance, which is the variance between flexible budget and actual result, and another is sales-activity variance, which is the variance between master budget and flexible budget. Flexible-budget variances measure organizations' degree of efficiency in meeting financial plans for which operations managers are primarily responsible. On the other hand, sales-activity variances measure organizations' degree of effectiveness for which marketing managers are primarily responsible. The following hypothetical example is based on the data used in chapter 2.

 

                                 (U = Unfavorable variance, F = Favorable variance)

 

 

 

In this hypothetical example, flexible-budget variance was calculated to be $15,480, implying less efficiency of Nike’s performance. And also, sales-activity variance was calculated to be $31,000, implying a lack of effectiveness of performance. Totally, master budget variance was calculated to be $46,480 as unfavorable variance. When organizations have variances, each significant variance deserves further consideration and analysis. By explaining why a variance occurs, managers are able to recognize changes, focusing on the real problem.

 

7. Chapter 9 ~ Management Control System And Responsibility Accounting

 

So far, many important tools that managers in organizations can utilize have presented such as relevant costing, budgeting and variance analysis. Although, each tool is very useful by itself, it becomes much more useful when each tool is integrated in part of management control system. Management control system is a logical integration of techniques to gather and use information to plan organization-wide goal, to make better decisions, to motivate and evaluate employee, and to monitor performance as well as the achievement of the organizational goal. The first step is to identify the organizational goal or mission.

Nike’s goal or mission is to become a truly global sports and fitness company ("NikeBiz| Inside Nike| Bio Knight.") As the biggest footwear and apparel company in the world, Nike has been seeking a new market aggressively. In fact, fiscal 1999 results showed that 43 percent of total Nike’s annual sales came from outside the US. Since the US’s market is relatively matured and saturated, Nike believes its further growth in the international market, especially in Europe and Asia. In terms of manufacturing aspect, Nike virtually manufactures all of its footwear products outside the US (98 percent in Asian countries), while it manufactures some of the apparel products in the US (Nike Form 10-K 1999). Combined with the extremely harsh competition and the rapid changes in technology along with the consumer trend, Nike has to particularly focus on R&D, design and distribution among its value-chain, mentioned in chapter 1. Those three value-chain elements are Nike’s key success factors to achieve or drive towards its goal.

For Nike to achieve its goal, responsibility accounting can be applied in management control system. Responsibility accounting is to identify what parts of the organization have primary responsibility for each objective based on value-chain activity to develop performance measures and targets and to design reports of these measures by subunit or responsibility center. Another substantial factor that plays an important role to achieve organizational goal is associated with employee. Organizational goal cannot be achieved with only a strong management leadership or a management commitment. A certain level of high employees' commitment and involvement is necessary, especially when organizations' priority is on quality. Total quality management (TQM) has been one of the efficient management philosophies to improve quality as well as the customer satisfaction since 1980s' however, there are lots of cases that organizations have abandoned or reduced their efforts of TQM program. One of the main reasons has been less employees' commitment and involvement. Here, not only Nike’s management but also any other management in organizations should create a system that motivates employees with a transparent and fair reward system. Once individuals' self-interest by highly motivated employees aligns with organizational goal, organizations can seize a higher prosperous stage. 

 

8. Chapter 10 ~ Management Control In Decentralized Organization

 

Nike has showed a tremendous growth rate in terms of its annual sales revenue in the past decade. Although, Nike experienced decline in sales revenue for the first time in five years, Nike achieved progress in terms of its financial analysis. The following table shows some of Nike’s progresses.

 

(Numbers are calculated by using data taken from Nike Annual Report 1999)

               

This strong revenue growth was derived from the international marketing strategy. In fact, Nike considers international market as a critical strategy to gain further sales revenue since the US’s market is relatively matured as mentioned in chapter 9.

                Some macroeconomic factors give incentives and opportunities for Nike to penetrate international market more profoundly. Among one of them is China’s status of Normal Trade Nation ~NTR (previously "Most Favored Nation ~ MFN"), which was extended to June 2000 by the Clinton administration in June 1999 (Nike Form 10-K 1999). China is not only a material source of footwear production for Nike, bit also a great potential of future market, taking into account its population and its economic growth. The financial crisis, occurred in Asian countries in 1997, undermined the Asian economy as whole, however, it seems the worst situation has passed and Asian countries are coming back as the recent stock markets show. Asian market will be one of the most important markets for Nike to sustain its growth.

                Another macroeconomic factor is international pact such as WTO signed among GATT nations and NAFTA singed among the US, Canada and Mexico. Due to these agreements, Nike can appreciate considerably cuts on global tariffs on many products. Finally, with respect to Europe market, GDP will grow in all European countries from 2.1 in 1999 to 2.8 in 2000, indicating Europe will continue to be a strong revenue-driven market ("Economic Indicators").

                 Even though Nike has high degree of international operations, Nike has decentralized organizational structure. Critical decisions are made at the local level where each country has its own culture or market nature. Example can be found in German, where Nike signed an endorsement contract with Formula-1 champion driver Michael Schumacher. He does not have much impact on the US’s market, however, he has a big influence on Germany as well as on Europe market. Another example can be found in Japan, where Nike has endorsement contract with Japanese professional soccer player and uses him in TV commercial as one of the marketing strategies. If Nike were not decentralized, these contracts could not have made or could have taken longer time. The more organizations become diversified, the more they should be decentralized to make critical decisions at the place where they occurred. Nike has integrated its nature of decentralized structure into the management control systems very well, which allows Nike to respond to each market more quickly at the best time.

 

9. Chapter 11 ~ Capital Budgeting

 

This chapter is focused on one of the essential business activities, capital budgeting. Capital budgeting is the long-term planning for making and financing investments that affect financial result over more than a year. A several capital budgeting models can be used, such as net-present-value (NPV) method, payback period and accounting rate-of-return (ARR) method. NPV method, the most popular version of discount-cash-flow model, computes the present value of all expected future cash flows using a minimum desired rate of return. If the NPV becomes positive value after the calculation, it is basically the sign to carry out the new project. Payback period measure the time the project takes to recoup the initial dollars investment, and ARR method expresses a project’s return as the increase in expected average annual operating income divided by the initial required investment. Even though ARR has profitability as an objective, both payback period and ARR method ignore the time value of money. Consequently, most of organizations use NPV method as capital budgeting model.

The most recent project launched by Nike was "World Shoe" project, which is aimed at markets in Asia, Africa and Latin America. Priced at $15 a pair, the World Shoe is a canvas shoe, made with technology Nike pioneered in the 1970s', and it is specifically designed for developing countries where Nike has manufacturing plants but does little business (Dworkin). The World Show will not be sold in the US or other developed countries not to cannibalize Nike’s own advanced and expensive shoes. This World Shoe strategy coincides with Nike’s corporate strategy that is to expand its international market. Since the target markets are developing countries, one thing deserves to note here. Developing countries have relatively high or sometimes extremely high inflation rates. Countries in South America, such as Brazil and Argentina have triple-digit annual inflation rates that have considerable effects on cash flow predictions. Nike should consider the inflation thoroughly on capital-budgeting decision stage.

 

(Source: http://www.glbalfindata.com/tbcpi.htm)

 

10. Chapter 15 ~ Overhead Application: Variable And Absorption Costing

 

In this chapter, two major methods of product costing are compared. One is variable costing and another is absorption costing. The only and decisive difference between both methods is that fixed manufacturing overhead is excluded from the cost of products under variable costing but is included in the cost of products under absorption costing. Absorption costing is more widely used because variable costing is not allowed for external-reporting or tax purposes. However, a number of organizations uses variable costing due to its usefulness on performance measurement by removing the impact of changing inventory levels from financial results. The following example is Nike’s standard costs for production of sneakers used in chapter 2.

 

 

Fixed manufacturing overhead is budgeted at $42,500. Expected production in each month is 10,000 sneakers, and the sales price is $35 per sneaker. And also, both budgeted and actual selling and administrative expenses are $50,000 monthly. Actual product quantities are:

 

 

There are no variances from the standard variable manufacturing costs, and the actual fixed manufacturing overhead incurred is exactly $42,500. Based on the above information, the following is Nike’s income statement using variable costing and absorption costing.

 

 

 

Standard absorption cost = 42,500/10,000 + 20 = $24.50

Computation of production-variance based on expected volume of production of 10,000 sneakers:

 

U = Unfavorable, F = Favorable

 

 

As the results show, whenever sales exceed production, that is, when inventory decreases, variable-costing income is greater than absorption-costing income. And also, production does not affect operating income under variable costing, which can prevent managers from producing unneeded units just to increase operating income under absorption costing. One thing is worth to note here that if organizations implement just-in-time production system, there is no difference between variable costing and absorption costing due to the sharply reduced inventory levels.

 

 

 

 

 

 

List of References

 

 

 

 

Textbook:

Horngren, Charles T, Gary L. Sundem, and William O. Strattoon. Introduction to management accounting. New Jersey: Prentice Hall, 1999

 

 

 

Blitz, Ed. "How can a $9 sneaker cost $70?" 1998. Union Tribune. Online. Available: http://nikebiz.com/media/n_shoecst.shtml. November 20 1999.

 

Dworkin, Andy. "Nike aims low-cost canvas footwear at developing markets." The Oregonian, Portland, Ore. (1999) Online. EBSCO / Newspaper Source. November 21 1999.

 

"Economic Indicators." Economist. 18 September 1999: 114.

 

Esquivel, Josephine R, and Lora Goldman. "NIKE (NKE): Analyst Meeting in London Upbeat; Reiterate Strong Buy." Morgan Stanley Dean Witter U.S. Investment Research. (1999): 11pp. Online. Research Bank Web. November 25 1999.

 

"Global Financial Data CPI Data." Global Financial Data. Online Available: http://www.glbalfindata.com/tbcpi.htm. November 28 1999

 

"NIKE Inc." Hoover’s Company Profiles. 1999. Online. NC LIVE / EBSCO. November 21 1999.

 

"NikeBiz| Inside Nike| Bio Knight." nikebiz.com. Online Available: http://www.nikebiz.com/story/b_knight.shtml. November 29 1999.

 

 

 

Nike Annual Report 1999

 

Nike Form 10-K 1999