Part 1 – Introduction to management and Cost Accounting
Chapter 1 – Introduction to Management Accounting
Accounting - “the process of identifying, measuring and communicating economic information to
permit informed judgements and decisions by users of the information”
The users of accounting information
• Managers - require information that will assist them in their decision-making and control
activities. E.g. profitability of various products
• Shareholders - require information on the value of their investment and the income that is
derived from their shareholding
• Employees - require information on the ability of the firm to meet wage demands and avoid
redundancies, their potential for continued employment
• Creditors and the providers of loan capital - firm’s ability to meet its financial obligations
• Government agencies – E.g. Government taxation authorities require information on the
amount of profits that are subject to taxation
• NPO - charitable organizations, clubs and government units such as local authorities
The users of accounting information can be divided into two categories:
1. internal users within the organization, such as managers and other employees who need
this information to operate their part of the business to best effect
2. external users such as shareholders, creditors outside the organization
Differences between management accounting and management accounting
Management accounting is concerned with the provision of information to people within the
organization to help them make better decisions and improve the efficiency and effectiveness of
existing operations.
Financial accounting is concerned with the provision of information to external parties outside the
organization, including the general public.
Management accounting Financial accounting
Legal requirements (for entirely optional, should be statutory requirement for
financial statements) produced only if the benefits it public limited companies to
offers management exceed produce annual financial
the cost of collecting it accounts
Focus on individual parts or focuses on parts of the describe the whole of the
segments of the business organization business
Generally accepted accounting not required to adhere to must be prepared to conform
principles generally accepted accounting with the legal requirements.
principles when providing E.g. Financial Accounting
managerial information for Standards Board (FASB) in the
internal purposes USA, the Financial Reporting
Council (FRC) in the UK
Time dimension concerned with future reports what has happened in
information as well as past the past in an organization
information. E.g. future costs
and revenues
Report frequency and less requires information more published annually and less
emphasis on precision quickly to act on it detailed accounts are
published semi-annually
The Decision - Making, Planning and Control Process
Identifying Objectives
Economic theory traditionally assumes that firms seek to maximize profits for the owners of the firm
or, more precisely, the maximization of shareholders’ wealth, which is equivalent to the
maximization of the present value of future cash flows.
Various arguments have been used
to support the profit maximization
objective:
1. ordinary shareholders are
the owners of the firm,
which therefore should be
run for their benefit by
trustee managers
2. it leads to the maximization
of overall economic welfare
There are 3 reasons for us to concentrate on this objective:
1. It is unlikely that any other objective is as widely applicable in measuring the ability of the
organization to survive in the future
2. It is unlikely that maximizing future profits can be realized in practice, but by establishing the
principles necessary to achieve this objective you will learn how to increase profits
3. It enables shareholders as a group in the ‘bargaining coalition’ to know how much the
pursuit of other goals is costing them by indicating the amount of cash distributed among
the members of the coalition.
The search for alternative course of action
In particular, the company should consider one or more of the following courses of action:
1. developing new products for sale in existing markets (product development)
2. developing new markets for existing products (market development)
3. developing new products for new markets (diversification).
Select appropriate course of action
For managers to make an informed choice of action, data about the different alternatives must be
gathered. E.g.
• the potential growth rates of the alternatives under consideration
• the market share the company is likely to achieve
• projected profits for each alternative
Implementation of the decisions
Once the course of action has been selected, it should be implemented as part of the budgeting and
long-term planning process. The budget is a financial plan for implementing the decisions that
management has made. These budgets are initially prepared at the departmental/responsibility
centre level and merged together into a single unifying statement for the organization as a whole
that specifies the organization’s expectations for future periods known as a master budget and
consists of budgeted profit and cash flow statements.
Comparing actual and planned outcomes and responding to divergencies from plan
The managerial function of control consists of the measurement, reporting and subsequent
correction of performance in an attempt to ensure that the firm’s objectives and plans are achieved.
To monitor performance, the accountant produces performance reports and presents them to the
managers who are responsible for implementing the various decisions compare actual outcomes
(actual costs and revenues) with planned outcomes (budgeted costs and revenues) which should be
issued at regular intervals.
Management by exception, which involves a focus on the ‘vital few’ not the ‘trivial many’ events
that take place in the organization.
The impact of changing business environment on management accounting
Global competition - Throughout the last few decades’ reductions in tariffs and duties on imports
and exports, and dramatic improvements in transportation and communication systems, have
resulted in many firms operating in a global market. This new competitive environment has
increased the demand for information relating to quality and customer satisfaction, and cost
information relating to cost management, ways to add value and profitability analysis by
product/service lines and geographical locations.
Changing product life cycles - A product’s life cycle is the period of time from initial expenditure on
research and development to the time at which support to customers is withdrawn. Intensive global
competition and technological innovation, combined with increasingly discriminating and
sophisticated customer demands, have resulted in a dramatic decline in product life cycles. To be
successful, companies must speed up the rate at which they introduce new products to the market
and constantly develop new products and services as being late can have affect profitability. In many
industries a large fraction of a product’s life cycle costs is determined by decisions made early in its
life cycle which has created a need for management accounting to provide information at the design
stage because many of the costs are committed or locked in at this time.
Advances in manufacturing technologies - To compete effectively, companies must be able to
provide high quality innovative products or services at a low cost, while providing first-class
customer service and being flexible to cope with short product life cycles, demands for greater
product variety from more discriminating customers and increasing international competition.
World-class manufacturing companies have responded by replacing traditional production systems
with lean manufacturing systems that seek to reduce waste by implementing just-in-time (JIT)
production systems, focusing on quality, simplifying processes and investing in advanced
manufacturing technologies (AMTs).
The impact of information technology and digitalization - the use of IT to support business activities
has increased dramatically and the development of electronic business communication technologies
known as e-business, e-commerce or internet commerce have had a major impact.
It has significantly impacted the work of management accountants: it has substantially reduced
information gathering and the processing of information, especially for recording and reporting cost
and revenue transactions and instead they can access this directly on their personal computers.
Digitalization and the generation of big data are a trend with enormous potential. Big data is a term
that describes the large volume of raw data that previously was not available to companies but is
made possible by artificial intelligence and the Internet of Things. Artificial intelligence (AI) such as
machine-based learning is a simulation of human intelligence. The Internet of Things (IoT) involves
the interconnection via the internet of computing devices embedded in everyday objects, like
smartphones, enabling them to send and receive data.
Environmental and sustainability issues - There is now a general recognition that environmental
resources are limited and should be preserved for future generations. Customers are no longer
satisfied with companies simply complying to legal requirements.
Reasons why environmental management accounting is becoming increasingly important in many
organizations:
1. environmental costs can be large for some industrial sectors
2. regulatory requirements involving huge fines for non-compliance have increased
significantly over the past decade
3. society is demanding that companies focus on being more environmentally friendly
Pressure to adopt higher standards of ethical behaviour - A code of ethics has now become an
essential part of corporate culture. Identification of what is acceptable ethical behaviour has
attracted much attention in recent years. Management accountants have a critical part to play in the
management of ethical performance and an obligation to uphold ethical standards. Professional
accounting organizations (e.g. CIMA & AICPA) play an important role in promoting a high standard of
ethical behaviour by their members.
Deregulation and privatisation - Privatization of government-controlled companies and
deregulation has resulted in the elimination of pricing and competitive restrictions. Deregulation,
intensive competition and an expanding product range create the need for these organizations to
focus on cost management and develop management accounting information systems that enable
them to understand their cost base and determine the sources of profitability for their products,
customers and markets.
Focus on value creation - recent developments have resulted in management accounting
distinguishing between value-added and non-value-added activities. Recently, increasing attention
has been given to the importance of intellectual capital (also known as intangible assets) arising from
the observed dramatic differences between the book and market values of many companies,
particularly technology companies and some service businesses.
Customer orientation - They are being encouraged to look outward at customer requirements and
reflect that internally, rather than only inward at their own operations.
Focus on customer satisfaction and new management approaches
Cost efficiency - Keeping costs low and being cost efficient provides an organization with a strong
competitive advantage.
Quality - In addition to demanding low costs, customers are demanding high-quality products and
services for which companies are responding by focusing on total quality management (TQM).
Time as a competitive weapon - management accounting systems now place more emphasis on
time-based measures, such as cycle time which is the length of time from start to completion of a
product or service consisting of the sum of processing time, move time, wait time and inspection
time. Only processing time adds value to the product, and the remaining activities are non-value-
added activities in the sense that they can be reduced or eliminated without altering the product’s
service potential to the customer.
Innovation and continuous improvement - Management accounting supports continuous
improvement by identifying opportunities for change and then reporting on the progress of the
methods and projects, involving both financial and non-financial aspects, that have been
implemented. Benchmarking is a continuous process of measuring a firm’s products, services or
activities against the other best performing organizations, either internal or external to the firm that
is increasingly being adopted for achieving continuous improvement. Allowing employees to take
actions without the authorization by superiors has come to be known as employee empowerment.
It is argued that by empowering employees and giving them relevant information they will be able to
come forward with improvement suggestions, respond faster to customers, increase process
flexibility, reduce cycle time and improve morale.
Functions of management accounting
A cost and management accounting system should generate information to meet the following
requirements:
1. allocate costs between cost of goods sold and inventories for internal and external profit
reporting
2. provide relevant information to help managers make better decisions
3. provide information for planning, control, performance measurement and continuous
improvement
Financial accounting rules require that we match costs with revenues to calculate profit.
Consequently, any unsold finished goods inventories (or partly completed work in progress) will not
be included in the cost of goods sold, which is matched against sales revenue during a given period.
Cost accounting is concerned with cost accumulation for inventory valuation to meet the
requirements of external reporting and internal profit measurement, whereas management
accounting relates to the provision of appropriate information for decision-making, planning, control
and performance evaluation.
