Management Accounting For Managers (A Strategic Perspectives)

Management Accounting For Managers (A Strategic Perspectives) Management Accounting For Managers (A strategic Perspectives) OBARA, LAWYER CHUKWUMA Ph.D, MBA, B.Sc., CPA, MTFA, MNIM. Senior Lecturer, Department of Accountancy Rivers State University of Science and Technology Nkpolu, P.M.B. 5080, Port Harcourt. ,' I ~,j ,:~' ".0, IT] \~, +J; DOKUS PRESS 82 Urualla Street, Mile 1 Diobu, Port Harcourt Tel: 08068558737 Managem~nt Accounting For Managers fA 5tTdtegic PeTspective) Published and Printed in 2003 by The Bluepring Limited 14 Azikiwe Street, G.P.O Box 14368, 08037111132 Port Harcourt, Nigeria. Second Edition Published and Printed in 2011 by ~f" . & .:..<'~;' (C) 82 ~~[~~r~et~M~;1SD~bU, Port Harcourt Tel: 08068558737 OBARA. LAWYER CHUKWUMA 2003 Department of Accountancy Rivers State University of Science and Tech'lc Nkpolu, P. M. B. 5080, Port Harcourt. of:(, All Rights Reserved No part of this publication may be reproduce transmitted. transcribed. stored in a retrieval system of translated into any language or computer language, in an form or by any means. electronic. mechanical, magnetic chemical. thermal. manual or otherwise, without the price consent inwriting of the publishers. ISBN: 978-36473-7-x '--'­ Dedicated: To my wife, Faith Uloma Obara and my son, Samuel Chuks Obara Jr. vii TABLE OF CONTENTS Prefect Foreword Acknowledgments Chapter I Overview of Managerial Accounting 1.1 Historical Perspective 1.2 Differences Between Managerial And Financial Accounting 1.3 The Role of the Management Accountant. 1.4 Scope of Management Accounting 1.5 The Management Accountant and the Managerial Process 1.6. Management Accounting in Service and Non - Profit Organizations. Chapter 2 Cost Accounting A Conceptual Overview 2.1 Conceptual Definition 2.2 Categories of Cost Accou ntancy 2.3 Cost Accounting and Management Accounting 2.4 Desirable Condition for Cost Accounting System 25 viii 2.5 Purpose of Cost Accounting Information 2.6 Analysis of Total Cost 2.7 Cost Accounting Methods 2.8 Costing Classification ,c "'11 Chapter 3 Cost Concepts and classifications It SI 3. lOvervi ew of the Concept of Cost 3.2 Cost Classifications 3.3 Financial statements for Manufacturing Business Chapter 4 Cost Behaviour patterns 4.1 4.2 4.3 4.4 5.1 5.2 5.3 5.4 5.5 e. tl 6 .. 69 Variable Cost Fixed Cost Semi-Verable Cost Analysis of Fixed cost High-Low Method a) b) Visual Fit Method c) Least Squares Method ChapterS Cost-Volume-Profit Relationship and Break Even Analysis Conceptual Overview The Concept of Contribution margin Unit Contribution Margin Break Even Points Sale Mix Consideration I~ '-' I­ C ''I...: 1/1... 'l,~ J'Jl .,.~ J'..rl I . .: 93 Cl C 8 8. :8. I, ,II :1 :1 ix 5.6 5.7 t1argin of Safety Cost Structure and Operating Liverage Chapter 6 Absorption and Managerial Costing Techniques 6. i Conceptual Overview 6.2 Financial ReportingunderYariable And Absorption Costing 6.3 IncomeAnalysis underYariable Costing and Absorption Costing 6.4 Management's use ofYariable Costing And Absorption Costing The Controversy over Fixed Costs 6.5 128 Chapter 7 Business Budget and Budgetary Control 7. I Conceptual Overview 7.2 Objectives of Budgeting 7.3 Advantages of Budgets and Budget Control 7.4 Limitations of Budgets and Budgetary Control 7.5 Essentials for Effective Budgeting 7.6 Human Behaviourand Budgeting 7.7 Budgeting Systems 155 Chapter 8 Capital Budgeting 8.1 Nature and Concept of Capital Budgeting 8.2 Reasons for Capital Budgeting Methods of Investment Appraisal 8.3 8.4 Capital Rationing , 8.5 Limitations of Capital Budgeting Importance of Capital Budgeting 8.6 8. 7 Project Classification 191 ~- x 8.8 Problems and suggested Solutions Chapter 9 Analysis and Interpretation of Financial Statement 9. I 9.2 9.3 9.4 9.5 9.6 Concept of Financial Statement Nature of Financial Statements Limitations of Financial Statements Analysis and Interpretation Types of Financial Analysis Methods of Analyzing Financial Statements 9.7 Concept of Financial Ratio Analysis 9.8 Interpretation of Ratios 9.9 Classification of Ratios 9. I 0 Analysis of Short-Term Financial position Chapter 10 Reporting to Management o. I I 10.2 10.3 10.4 10.5 10.6 Objectives of Reporti ng Types of Report General Principles of Reporting Modes of Reporting Preparation of Reports Uses of Report by Manager 228 xi FORWARD Dr L.e. Obara has taken the pains of simplifying and clarifying the basic concepts and techniques of Management Accounting for the understanding of modern day managers of business organisations. The book aims at both undergraduate and postgraduate students in the management sciences as well as practicing managers. The strategic and practical approaches with examples and illustrations used make for easy comprehension of ManagementAccounting. D.W. MAC LAYTON, ph.D Head, Department of Business and Administration Rivers State University of Science and technology, Port Harcourt. xii PREFACE Managers in all types of organisations managerial accounting information planning and control. for ·-e, -e::'/111 on ce; s : - ~Il;)king, The goal of this text s :: acquaint students of Management with the fundarnenra 5 c ~c.nagerial accounting. The emphasis throughout the ooc -{ accounting information in managing an 5 on using :J'"ga.nisation. Management Accounting for Managers is intendec to be used by students after they have completed a basic course in Financial Accounting. Each chapter is built around one major illustration, in which all aspects of the chapters coverage are addressed. Although these major chapter illustrations are based on fictitious organisations, they are generally based on real-world situation. As a result, the illustrations, though not real, are extremely realistic. Again, since managerial accounting lecturers often have differing views on the optimal chapter sequence, flexibility in usage was a paramount objective in writing the text. Each chapter is a module, which can be assigned out of sequence if the lecturer desires. It is my hope that this book which is designed to provide a thorough understanding of Management Accounting and is particularly relevant to­ xiii a) Undergraduates and Post-graduate students reading Accounting, Business Studies and allied subjects, b) ManagE'rs and others in industry, commerce and the Public Sector. With instill into the student a working knowledge of Management Accounting to aid them in their own work and facilitate communication with accountants. L. C. OBARA, Ph.D Department of Accountancy Rivers State University of Science and Technology Port Harcourt. XIV ACKNOWLEDGMENTS The material In this book have been used to teach management Accounting in Nigeria to several sets of Undergraduate Business Education Students at the Rivers State University of Science and Technology. In the process, the materials have benefitted immensely from the comments and quarrels of past students in the department of Business Administration and department of business Education. I acknowledge this contribution. The immeasurable contributions of all my lecturers throughout my university education is also acknowledged. These men and women imparted on me, the knowledge of Accounting in general and management Accounting in particular. They include Chief (Dr.) J. J. M Braide, Chief E. B. Obele, Dr. N. A. Ukpai, Mrs. Grace Umoh, Professor B. A, Fubara, Professor A. I. Ahiazu, Professor P. B. Johnnie, Professor Austin Ezejule, Chief (Dr.) D. W. Maclayton, Dr. L. O. Ottih and Mr. C.C. Ihunda to mention but a few. I will always remain grateful to them and several others who made me what I am today. I want to specifically thank the following friends and colleagues: Messrs B. D. Kabel, L. A Nwanyanwu, Maxwell, T A. Keme, Bassey Eyo, Okon Bassey, Furo Harrison, Bagshaw, Dr. D. I. Hamilton, Dr. Prince Agundu, Ugha Attah Sheilly Mbam Adaugo Shirley, Helen Opigo and several others for their encouragement and advice. My younger one's Engr. Okechukwu, Eze my look alike, Paul, Ijeoma, Charity, Eunice Obuzor, joy, Beauty, Pius, Chiwetara and John Obara. Again I am specially grateful to my daughters and friends- Abigril Ugorji, TonbraAkraka, Tunkumor Beatrice, Nchelem, and my wonderful NkirukaAralu. Finally, I must not lose sight of the immense contribution of my beloved wife, Mrs. F. U. Obara, whose warmth, patience and sacrifice have helped to bring this book project to reality. My wonderful kids Precious-Samuel, Rachel, Daniel Israel and Joel deserved, commendation. They are great joy to my soul. They remain the reason for my inspirations and efforts. In the same vein I want to thank the Director and members of Staff of The Blueprint Ltd for their untiring effort. Above all, I thank God Almighty who alone made this feat possible. L. C. OBARA, Ph.D October, 2003 Chapter I Overview of Managerial Accounting 1.1 1.2 1.3 1.4 I .5 1.6 Historical Perspective Differences Between Managerial and Financial Accounting The Role of the ManagementAccountant Scope of Management Accounting The Management Accountant and the Managerial Process Management Accounting in Service and Non-Profit making Orgaisations. 2 Management Accounting For Managers 1.2 The evolution of Managerial Accoun: 'lg oarallels the development of business organisational fonTs f r- o,..... early 19th Century to the early 20th century. The need (or rna.ntaining the financial chastity of business operations. ensuring the reliability of recorded experience resulting from these operations and conducting a frank appraisal of such experience, has made accounting a prime activity along with such other activities as finance, production and marketing. Accounting concepts, systems and procedures in use today are the outgrowth of a development that began to take formal shape in the accounts of merchants in Italian city states during the Renaissance. The oldest forms of accounting developed as result of the needs of commercial firms to keep track of their relationships with outsiders, to maintain listings of their Assets and to permit an accurate determination of the amounts Accruing to the various parties connected with the conduct of the business. Much of this discussion on the historical perspective of Management Accounting is based on the historical analysis conducted by Kaplan et al (1987). Though this history is brief, it is very useful in understanding the Significant changes that are occurring in managerial accounting. Warren et al (1997) identifies five stages in the growth of Management Accounti ng: a) b) c) d) e) I Historical Perspectives The period of independent contracting The rise of the single activity organisation - internal contracting Multinational firms and product costing The emergence of public corporation and financial reporting and The lean enterprise , >It s c ;a e b a Iii s !IBl[ I lili 'en T il '. l1li ,am '0 !Wmm Ii R P • ;;am: ,;amm Overview of ManagerialAccounting 3 The Period of Independent Contracting The business environment in the early nineth century was dominated by small to medium size business that performed work for piece rate prices. A piece rate is compensation for services based on account of completed work as opposed to compensation based on work time. Business often operated as a network of independent artisans. Managers would co-ordinate individual artisans in order to build a complete product. For instance, a textile business would co-ordinate separate weaving, spinning, and assembly artisans in order to finish completed garments. The final product price would be determined from the cumulative sum of the individual artisan rates for work completed plus some profit to the manager for co-ordiating the activity. There is little need for managerial accounting information in such an environment. The Rise of The Single Activity Organisation Internal Contracting Shortly after the beginning of the 19th century, a new form of business organisation arose. This organisational form focused a business on a single activity or product. Machinery and labour were placed in a centralized location under the control of a single management structure. As result, the business was often larger than in the past, which enabled it to take advantage of economies of scale. Economies of scale refers to the benefit obtained by spreading the cost of physical Assets over a larger quantity of production. The result was an increased growth in productivity, that only "size" could accomplished. Examples include the early steel, rail roading and Merchandising industries 4 Management Accounting For Managers These new organisational firms, however, introduced a new challenge for managers. No longer were the managers merely co-ordinators of outside independent business. The outside market for services of the earlier era was replaced with employees paid according to daily wage rates. As a result, internal productivity measures were needed to guide management in identifying inefficient operations. These productivity measures would typically compare the total cost to the total volume of outputs. Therefore, ratios such as the cost per ton in steel became the benchmarks for ongoing performance evaluation. Large organisations also give rise to multiple layers of management, where senior managers had responsibility over junior managers. As a result, internal cost information was accumulated within the department and used to evaluate the operating performance of junior managers. The result was crude but effective cost control and performance management system, which worked well for, a single activity organisation. Multi-Divisional Firms and Product Costing Organisation in the late 1800s achieved even greater economies of scale by controlling a span of activities through vertical and horizontal integration. Vertical integration occurs when management wishes to control the various process stages beginning with processing raw materials through final sale of the completed product to the customer. Linking these process stages together forms a value chain. For instance, many wood product companies are vertically integrated. They own and harvest trees and the process trees into wood products, which are finally sold and distributed to lumber yards. These stages are frequently segmented into separates divisions. I•. Overview ofManagerial Accounting 5 A division is a business unit that is co-ordinated by central management. The central management are the senior managers that plan and co-ordinate the roles and responsibilities of the various divisions in achieving the overall organisational objectives. For the wood products company, there would be three division: I number lands, manufacturing and sales. Each division concentrates on its unique contribution to the business. While central management co­ ordinates the divisions into a unified whole. Horizontal integration occurs when an organisation builds an organisational structure around complementary products. Classic examples are Lever Brothers Pic and the PZ group of companies. Central management developed tools to monitor and control the effective coordination and motivation of the division into a well-functioning whole. Three new approaches introduced in response to a need for central co-ordination of separate activities were budgets, Return-On-Investment (ROI) measures, and product cost. Budget is used by central management to plan and control the amount of money used by the divisions on ongoing expenditures. Return On Investment (ROI) was introduced in the early 1900s as a measure of divisional profitability. ROI is calculated as the division's profit divided by the division's assets The division managers would be responsive not only to the sir activity operating ratios used inside th division, btl" meeting divisional profitability targets. These increasingly "modern" organisatio: "11a~ing large quantities of just a very f,.. were instead :na~i-:g 2 va... err of 'J"" . - -~_:"2. varery o:[ a: 'J :::L::.:: . 6 Management Accounting For Managers Up to this time managers knew how efficiently the department was running, through operating ratios, but not how department resources contributed to the cost of a particular product. New accounting issues emerged with respect to attaching and allocating manufacturing cost to products. Emergence Of The Public Corporation And Financial Reporting Beginning in the early 1900s, most businesses relied on external financing from common stock ownership. The public owners were not as active in the business as were the early owner-managers, but were, instead, distant investors. As a result, these external owners required information on the economic performance of the firm in order to guide their investment decisions. External financial reporting emerged in response to this need during the first three decades of the 1900s. The new financial reporting requirements caused the managerial accounting system to be combined with the financial reporting system, the connection between managerial and financial accounting is more evident in the case of valuing inventories. Financial reporting required that the inventory be valued at the cost of manufacturing the products. These manufacturing costs were, in turn, determined from the internal cost records. Some argue that financial accounting reporting needs became dominant to managerial accounting reporting needs when the two systems were linked through inventory valuation. Those who argue for the "fall" of managerial accounting refer to the apparent halt in managerial accounting ". Overview ofManagerial Accounting 7 practice innovation during the 1920s. Indeed, many of the managerial accounting ideas put into practice in the 1920s are dominant today, whereas financial accounting has undergone radical innovation since then. The reason for this lapse in managerial accounting practice innovation is not entirely clear. Undoubtedly, the lack of powerful decentralized information - processing technology was a major factor. Regardless of the reason for few innovations from 1920 to 1980, the recent history has been anything but stagnant. Managerial accounting is re-emerging in organisations as an important function for guiding mangers through complex times. The Lean Enterprise In today's dynamic world, companies must provide high quality products at a competitive cost. Such companies are termed lean enterprises. Most Japanese Companies such as Toyota Motor Company fall under this catergorization of a lean enterprise. Lean enterprises have embraced two important business approaches to support their ambitions of high quality at competitive cost: I) Total quality management and Continuous process improvement 2) Total quality management states that the organisation's primary objective is to earn the allegiance of customers by delighting them with superior products and services. This requires that the company know what customers value in products and services and then deliver this value through superior product design and operational system. Continuous .process improvement extends the concept of quality beyond the products and services that customers buy to everything that is done by the employees of a company. Under this 8 Management Accounting For Managers philosophy, employees are expected to continually improve and "re-engineer" the business system of which they are a part. continuous improvement can lead to efficient and effective process that will be even more efficient and effective in the. future. Lean enterprise advocates believe that employees' continual improvements to their company's processes and products will lead to more satisfying jobs, better ways to work, better products for the customers, and higher profits for the company. Organisations that are embracing a lean enterprise philosophy are re-inventing their methods of works and the managerial accounting system that is measuring the work. Such new approaches includes just-in-time processing, activity-based costing, cost of quality and other non-financial performance parameters. tta.m 0rJi ~ I~ tIIl~il Historical Summary Exhibit 1.1 Below summarizes the discussion on this PdualiI!mllliiu historical perspectives of managerial accounting. The time line shows the approximate history of organisational and management philosophies are closely related to major innovations in managerial accounting. The table below the time line list some of the major managerial accounting innovations that have occured in response to the major organisational and management philosophies. TIe 'III Exhibit 1.1: The evolution of Managerial Accounting G 1800 1850 Independent Contracting Internal Contracting t 1900 1950 2000 -------------------------------------t t t t Multi divisional Firms Public The lean Corporations enterprise !; II~I~ ..,IIII.wm, "';j IliIilmillillilhilliiHl! 1~1mr-,,{ Overview ofManagerial Accounting 9 s Management of Organizational Philosophy Managerial Accounting Innovations Independent Contracting Very little managerial accounting; Mostly transactions processing Internal Contracting Single activity cost and operating Performance measures Multidivision Firms Divisional performance evaluation through budgets and ROI, and basic product costing Public Corporations Shift in Orientation from managerial accounting toward inventory valuation and financial accounting The lean enterprise Reemergence and continuing development of managerial accounting to support products and service at competitive cost. ­... II'" Concept of Management Accounting • In ordinary, language, management accounting is used describe the modern concept of accounts as a tool management in contrast to the conventional annual ~alf-yearly accountant prepared mainly for information to of or of I 0 Management Accounting For Managers proprietors, the object being to so expand the financial and statistical information as to shed light on all phases of the activities of organization. Lucey (1998) argued that, since management will be interested in any information produced by an accounting system, all accounting could be said to be management accounting whether it was for example published accounts mainly for external consumption or routine product costs for internal use. However, for practical purposes, such a description is too broad and imprecise. The certified institute of management accounting sees management accounting as an integral part of management concerned with identifying, presenting and interpreting information use for: a) formulating strategy b) planning and controlling activities c) decision taking optimizing the use of resources; b) e) disclosure to shareholder and others external to the entity; f) disclosure to employees, g) safeguarding assets. The above according to Lucy (1998) involves participation in management to ensure that there is effective: I) formulation of plans to meet objectives (strategic planning); formulation of short term operation plans (budgeting 2) /profit planning); 3) acquisition and use of finance (financial management) and recording of transition (financial accounting and cost accounting); 4l :5 , 1 :1 ~ la ! Overview ofManagerial Accounting 4) 5) 6) II communication offinancial and operating information; corrective action to bring plans and results into line (financial control): reviewing and reporting on system and operations (internal audit, management audit). These details are illustrated in exhibit 1.2 below Exhibit 1.2 Element of Management Accounting Financial Management Information for Operation Control (Cost Accounting/Budgeting) Stewardship Reporting (Financial Accounting) Management accounting could also be seen as being primarily concerned with data gathering (from internal and external sources) analysi ng, process; ng" i nte rpreting and communicating the resulting information for use within the organization so that management can plan more effectively, 12 Management Accounting For Managers make decisions and control operations. the institute of Chartered Accountants of England and Wales has stated that 'any form of accounting which enables business to be conducted more efficiently can be regarded as Management Accounti ng". However, by far the most authoritative description of management accounting has been furnished by the management accounting team of anglo-american council on productivity in its report reading thus; "Management accounting is the presentation of accounting in such a way as to assist management in the creation of policy and the day-to-day operation of an undertaking. It can, therefore, be said that management accounting with all its paraphernalia does not supplant financial Accounting as is commonly under stood but supplements the basic structure of traditional accounting to serve the diverse requirements of modern management. As a matter of fact, a single structure underlies both financial accounting and management accounting. This structure consists of a few basic principles and concepts, a set of relationship among elements comprising the accounting system. Difference Between Managerial And Financial Accounting Although economic information can be ciassified in many ways, accountants often divide accounting information into two types: financial and managerial. The diagram in exhibit 1.3 illustrates the relationship between managerial accounting and financial accounting and understanding this relationship is understanding the information needs of useful in management. Ii II ~ I! I. Overview of Managerial Accounting I 3 Financial accounting evolved from the stewardship function and is concerned majorly with such matters as: financial record keeping, the preparation of Final Accounts, dealing with debtors and creditors, the raising of finance, and dealing with all aspects of taxation. To the extent that management uses the financial statements in directing current operations and planning future operations, the two areas of accounting overlap. For instance, in planning future operations, management often begins by evaluating the results of past activities as reported in the financial statement. It is very important to note in this regard, that the financial statements objectively and periodically report the results of past operations and the financial condition of the business according to generally accepted accounting principles (GAAP). Management information includes both historical and estimated data used by management in conducting daily operations, planning future operations and developing overall business strategies. Managerial accounting reports may stress different features of the business, from high level strategy to detailed operations. Similarly, the cost information used by management may vary, depending on the nature of the decision. We sometimes refer to this as different costs for different purposes". Thus usefulness guides the accountant in preparing accounting reports for management. The characteristics of managerial accounting are influenced by the varyi ng needs of management. First, useful managerial accounting reports provide both objective measures of past operations and subjective estimates about future decisions. Using subjective estimates in managerial accounting reports assists management in responding to business opportunities. Second, managerial reports need not be prepared according to generally accepted accounting principles since managerial accounting 14 Management Accounting For Managers information is only used by management, the accountant can provide the information in any useful format. Third, managerial accounting reports may be provided periodically, as with financial accounting, or at any time management needs information. EXhibit 1.3 Financial and Managerial accounting Reports based Primarily on Users Usefulness to external Users Usefulness to Management Shareholders, Creditor; Management, Government Agencies. General PUblic Management Objective Objective and Subjective Standard Reporting format according to generally accepted accounting principles Flexible reporting formats according to management needs I I Characteristic Reports Prepared periodically Reports Prepared to provide information about the business as awhole Reports Prepared periodically or as needed Reports Prepared to provide information about the business and its divisions disportrnents. projects products territories or any other unit of the business needed for decision making Overview ofManagerial Accounting I5 The Role Of The Management Accountant The management accountant is an important member of the management team. Here we will examine his roles from two perspectives, organisational and ethical. Organizational Roles To clearly appreciate the organizational roles of the management accountant, exhibit 1.4 below will be very useful Exhibit 1.4 Organization Chart for Faloa Nigeria Ltd Board of Directors Chief Executive Officer Vice President Financial (Chief Financial Officer) Vice President Sales Vice President Personnel Vice President Production The individual reporting units in an organization can be viewed as having either (I) line responsibilities or (2) staff responsibilities. A line department or unit is one directly involved in the bank objectives of the organisation. For Faloa Nigeria Limited the Vice President, production and the I 6 Management Accounting For Managers departmental managers occupy line positions because they are directly involved. In a hospital, the doctors and nurses occupy the line position, while in a University, the faculty occupy the line position. A staff department or unit is one that provides service, assistance, and advice to the department with line or other staff responsibilities. A staff department has no direct authority over a line department. In most business organizations, the chief management accountant is called the Controller. The Controller has a staff relationship with others in the organizations. The management accountant provides financial and accounting advice and assistance to managements but assumes no direct operational responsibility. However, in providing information and analysis for management, the Management Accountant must be thoroughly familiar with the operations of the business. The position of the management accountant provides an excellent perspective on many aspects of the business, and because of this critical role, he is considered a valued member of the senior management. lcaNl'"" 6EIII!" iiitdlllUu iiinmflIclIl" pmrallll( ~ btm iiiilldli~ :B1IIIII111I!I lill~. ~ 1., Ethical Role of Management Accountants Ethics are moral principles that guide the conduct of individuals when they are acting alone as members of a profession or as employees of an organisation. The institute of management accountants has developed guides to professional conduct, called Standards of Ethical Conduct for Management Accountants. These standards comprise four major categories of ethical professional conduct: I) competence 2) confidentially 3) integrity and ~" Overview 4) E: e ofManagerial Accounting 17 objectivity In addition, many organizations have developed their own codes of conduct to guide their employees in performing their daily responsibilities. Management Accountants are in a unique position to influence management decision making by providing relevant information concerning alternative courses of action. In providing this information, Management Accountants should adhere to proper ethical conduct. Business men and women should work within an ethical framework. Although an ethical framework is formed through individual experiences and training, there are a number of sound principles that form the foundation for ethical behaviour. I. "1€ Avoid small ethical lapse . Small ethical lapse may appear harmless in and of themselves. Unfortunately. such lapes can compromise the management accountant position. small ethical lapse can build up and lead to larger consequences at a later point in time. :a 2. Focus on long-term reputation. One characteristic of an ethical dilemma is that it places an individual under severe short-term pressure. The ethical dilemma is created by the stated or unstated threat that failure to 'go along may result in undesirable consequences. A management accountant should respond to ethical dilemmas by resisting short-term pressures and instead focusing on long-term reputation. A management accountant loses effectiveness jf that reputation becomes tarnished. 3. Be prepared to suffer adverse personal consequences for holding to an ethical position. In some unethical organizations, management accountants have suffered personal consequences for holding to their ethical 1e nt 3!ls as :nt :::'1'( ,es I 8 Management Accounting For Managers Positions. Instances abound where management accountants resign their positions because they were unable to support management in what was perceived as unethical behaviour. 'W"II 0011 :10' I~ The Management Accountant And The Managerial Process !~ LillI' Drucker (1974) argued that management consists of the following functions - planning, controlling, organizing communicating and motivating. Planning is used by management to develop the organization's objectives (goals) and to translate these objectives into courses of action. Planning can be categorized as either strategic planning for operational planning. Strategic planning is developing long-range courses of action to achieve goals. Long-range courses of action, called strategies, can often involve periods ranging from five to ten years. Strategic plan establish business policy and priorities for such activities as research and development, marking, financing, and plant expansion. A strategic plan, which must be approved by the senior management, should integrate all aspects of the business operations necessary for achieving long - rang goals. Again, because the strategic plan is influenced by the changing environment within which the business operates, the strategic plan should be periodically reviewed and revised. Operational Planning sometimes called tactical planning, is the short-term planning used for achieving operational goals. The goals of the operational plan should directly support the overall strategic objectives of the organisation". Thus, operational plans complement the strategic plan and are typically established for short term periods ranging from days to several years. m. li&,11111 _iill Ide ,~ u I~ .. iDIIll iis III'II11ilBll TIm! ~b! pma 3ItibE de ~, , i_ l-.m IIIII1B Overview ofManagerial Accounting 19 Control involves a comparism of actual performance with plans, so that deviations from plan can be identified and corrective action taken. Once managers have planned the goals and directed the action, there comes the need to assess how well the plan is working. This feedback allows management to isolate significant departures from plans for further investigation and possible remedial action. It may also lead to a revision of future plans. this philosophy of controlling is referred to as management by exception. Organising is the establishment of the framework within which required activities are to be performed and the designation of who should perform these activities. Organising requires a clear definition of a manager's responsibility and lines of authority. Effective Communication between all levels of management within an organisation is essential to co-ordinate day -to-day operations. An important part of communication is the various accounting and performance reports rr.anagerr-ent uses in both operational and strategic planning. T:,ese reports usually include estimates showing the effects of allter'latives plans. The financial estimates for these plans can Jllr'ov de persuasive evidence for one or more of the dill!;:er 1 at ives. Motivation means influencing human behaviour so that the ::?'1:cipants identify with the objectives of the organisation <i!l!rll: - a'ce decisions that harmonizes with these objectives. T~e role of the management accountant in the imi;2.,:-,,:.~e""'1ent process is to supply the managers quantitative nt':"--2.:on required for the effective discharge of these '-,""':~'~,==~ a: functions • If_.· ,,,_.-_.' 20 Management Accounting For Managers Scope Of Management Account The scope of management accounting is so wide and broad-based that it encompasses, within its fold, a searching analysis of allthe aspects and branches of business operations. However, the areas included within the ambit of this subject may be concretized as: General Accounting:- This includes recording of a) external transactions covering cash receipts and payments, recognition of liabilities and setting up of sales and receivables. It also covers preparation of regular financial statements which are made up from account balances. b) Cost Accounting:- It consists of the application of double entry technique to internal transactions which means the application of costs to jobs, operations, processes and products. It helps in sharpening the internal aspects of general accounting. Budgeting And Forecasting:- This envisages the c) framing of budgets in cooperation with operating and other departments preferably using standard measures for amounts included in the budgets. Cost Control Procedures: These provide for internal d) reports which will compare actual and desired performance. they also help in converting a budget into an operating plan. Cost and Statistics:- It is concerned with the provision e) of statistical and analytical services to the various departments of the business. f) Taxation: this requires the computation of income in accordance with the income tax laws and regulations, filling of returns and making tax payments. Methods and Procedures:- They deal with g) organisation, reducing the cost and improving efficiency i~))), i~@1 I. .­I­ AIm: -mI I .., I ill III 111 liil I~ lij .~ 2,1 I" Overview ofManagerial Accounting 2 I h) f j f f E: -- i. c :1 .S i) of accounting as also of office operations, including the preparation and issuance of accounting and other manuals, where these will prove useful. Audit:-it need devising a system of internal control by establishing internal audit coverage for all operating units Office services:- the main burden of this activity is the maintenance of data processing and other office management services, life communication, duplication, printing and mails etc. Limitations of Management Accounting Despite the fact that the development of an effective discipline in managerial accounting is one of the most significant steps to improve managerial performance, the new discipline has to face conditions which limit the effectiveness of management through accounting. such conditions are: I. Lack of Knowledge and Understanding:- As the emergence of management accounting has been the result of fusion of a number of subjects like statistics, accounting management theory, economics, engineering, etc, an inadequate grounding on the part of management in any one or more of these subjects is bound to have an unfavourable effect on the consideration and solution of problems relating to management performance. 2. Persistence of Intuitive Decision- Making:- Though the main contribution of management accounting has been the elimination of intuitive management, there is always a temptation to take an easy course of arriving at decisions by intuition rather than taking the tortuous path of scientific decision - making. 3. Wide Scope:- The ambitious nature of the objective, which management accounting seeks to serve, and the 22 Management Accounting For Managers extremely wide scope of the subject matter dealt with by. It create many difficulties. Thus, it is one thing to record, interpret and evaluate an objective historical event converted into money figures while it is something quite different to perform the same function in respect of past possibilities, future opportunities and unquantifiable situations. 4. Top-Heavy Structure:- The installation of a system of management accounting requires a very elaborate organisation and a very large number of rules and regulations with the consequence that the entire proposition becomes quite costly and can, therefore, be adopted only byvery big concerns. 5. Evolutionary Strange:- Comparatively management accounting is a new discipline and is still very much in the state of evolution. Therefore, it comes across the same impediments a relatively new discipline has to face­ sharpening of analytical tools, improvement of techniques and fluidity of concepts creating uncertainly about their applications. 6. Psychological Resistance:- Adoption of a system of management accounting brings about a radical change in the established pattern of t he activity of management personnel. It calls for re-arrangement of personnel as well as their activities. This is normally characterized with oppositions from several quarters. Management Accounting in Service And Non-Profit Organizations Generally, it is believed that, the basic ideas of management accounting was exclusively developed for manufacturing organisation. Events today have proved that, management accounting concepts apply to all types of organizations IIlf if fIlE IC .1 1t lQIII 11m ill!! IIl1n '111* IlllII 1 I J .• Overview ofManagerial Accounting e lie e ,. I '. 23 including service organizations such as Public Accounting Firms. Law Firms. Management Consultancy Firms, Real Estates firms, Transportation companies, Insurance companies, Hospitals, Schools, Libraries, Government Agencies and Hotels. These organizations do not make or sell tangible goods. Managers and accountants in these service and non-profit organizations have much in common with their counterparts in manufacturing organizations. Funds has to be raised and spent. Budget has to be prepared and control system put in place and implemented. Resources must be used prudently and in-line with the objective of the firm. Horngren et al (1999) identify the common characteristics of both profit-seeking and non-porfit service organizations. They include the following: I. Labour is Intensive: The highest proportions of expenses in school and law firms are wages, salaries, and payroll­ related costs, not the costs relating to the use of machinery, equipment, and physical facilities. 2. Output is usually difficult to define: The output of a university might be defined as the number of degrees granted but many critics would maintain that the real output is "what is contained in the students' brains". Therefore measuring output is often considered impossible. 3. Major inputs and outputs cannot be stored: An empty airline seat cannot be saved for a later fight, and a hotel's available labour force and rooms are either used or unused as each day occurs. Employees' feelings and behaviour is affected directly by management accounting reports. A performance report that is used to evaluate the operations under the responsibility of a particular manager may be perceive as 24 Management Accounting For Managers unfair if it attributes excessive costs to the operation. Such manager may lose confidence In the system. On the contrary, a system that managers believe in and trust can be a major influence on their decisions and actions In summary, management accounting can best be seen as a balance between costs and benefits of accounting information plus an awareness of the importance of behavioural effects. End of Chapter Review Questions CI:I I. 2. 3. 4. 5. 6. 7. View publication stats Explain the term "Management Accounting" and state what you understand to be its main objectives. Trace the origin, history and the evolution of Management Accounting. What are the major differences between managerial accounting and fanatical Accounting. Evaluate the organizational and ethical roles of Management Accountants. Describe how Managerial Accounting supports management's planning, directing, controlling, communication, motivating and decision making. Discuss exhaustively the basic limitation of Management Accounting. It is believed that the basic ideas of Management Accounting was exclusively developed for manufacturing firms, and not service/non-profit organizations. Critized this assumption in the light of the present-dayempherical experience. 11 :1,2 1) 2.4 2.5 2-'1, 1,Jl Hi